Lear - Earnings Call - Q3 2019
October 25, 2019
Transcript
Speaker 0
Hello. Thank you for joining Lear's Third Quarter Earnings Conference Call. I will now turn the call over to Alicia Davis, Senior Vice President of Corporate Development and Investor Relations. Please go ahead. Thanks, Carmen.
Good morning, everyone, and thanks for joining us for Leer's third quarter twenty nineteen earnings call. Presenting today are Ray Scott, Lear's President and CEO Jeff Vanest, Senior Vice President and CFO and Jason Cardew, Vice President of Other members of Lear's senior management team, including Frank Orsini, President of our Seating division Carl Esposito, President of E Systems and John Asmeyer, our Chief Technology Officer, also have joined us on the call. Following prepared remarks, we will open the call for Q and A. You can find the presentation that accompanies these remarks at ir.weir.com. Before we begin, I'd like to take this opportunity to remind you that as we conduct this call, we will be making forward looking statements to assist you in understanding Lear's expectations for the future.
As detailed in our safe harbor statement on slide two, our actual results could differ materially from these forward looking statements due to many factors discussed in our latest 10 ks and other periodic reports. I also want to remind you that during today's presentation, we will refer to non GAAP financial metrics. You are directed to the slides in the appendix of our presentation for the reconciliation of non GAAP items to the most directly comparable GAAP measures. The agenda for today's call is on Slide three. First, Ray will review highlights from the quarter and provide a business update.
Then Jason will review our third quarter financial results. Finally, Ray will offer some concluding remarks. Following the formal presentation, we would be happy to take your questions. Now I'd like to invite Ray to begin.
Speaker 1
Thanks, Lisa, and thanks, everyone, for joining us today. Earlier this morning, we released our third quarter financial results, a summary of which appears on slide five. Sales in the quarter were $4,800,000,000 adjusted operating margin was 7%, and EPS was $3.54 Adjusted operating margins in Seating and E Systems were 8.27.6%, respectively. For the last six weeks, our largest customer has been experiencing a labor strike. The strike has had a significant effect on North American auto supply chain, including Lear.
Despite the impact of the strike and other industry headwinds, we delivered solid financial results in the quarter. While global production was down 3% in the third quarter, sales in our seating business business, excluding the impact of foreign exchange, increased 3% or six points above market. In E Systems, third quarter margins, although lower on a year over year basis, came in a bit better than what we were forecasting back in July. Slide six provides some recent business highlights. Last month, Carlos Buzzito, a seasoned executive with expertise in electronics, software development, and connectivity, joined Lear as the president of E Systems.
Kakarl is a proven leader with the right skills to further enhance E Systems' products and performance. On our second quarter earnings call, we told you we were accelerating our restructuring efforts to respond to the challenging production environment. Driving efficiencies in all areas of our business is not new to us. It's in our DNA, And we are executing our plan for further improvement. We will provide a detailed update of our progress early next year.
On our second quarter call, we also laid out the framework for a comprehensive plan to improve our performance in these systems and position it for continued profitable growth. We have now the most experienced e systems leadership team in our history. In addition to Carl, Mike Balsey, an automotive industry veteran, recently joined the E Systems team. Mike leads our electrical distribution business, an area in which he has deep expertise and play a pivotal role in driving improvements and profitable growth in the division. Last month, we welcomed Xin Yi as our new head of e systems in Asia.
Xin is an accomplished executive with extensive knowledge of the Asian automotive market. He is based in Shanghai and will play a key role in our efforts to enhance growth and profitability in China. Carl, Mike, and Sim, as well as other recent addition additions deepen the already strong management team we have in place in these systems and position us well for the future. In addition to having the right people, we also have the right organizational structure. We have reorganized these systems to ensure greater visibility into profitability and financial returns by product segment, region, customer and program.
As I said in our last earnings call, we are committed to expanding in areas with high growth and profit potential and exit low return and noncore product lines. We continue to pursue opportunities in electronics, software services, and data that offer incremental sales and margin expansion potential. I'm also very excited about the potential for increased vertical integration of our wire harness business. The future of our business in terminal terminals and connectors and other engineered components is very promising as we increase our efforts to partner with our OEM customers to meet their sourcing needs and leverage our own manufacturing capabilities. On the technology front, I'm happy to report that Xevo has been named a finalist in 2020 PACE Award, a prestigious award that is recognized around the world as the industry benchmark for innovation.
Also, Hyundai recently agreed to launch Zivo's markets in vehicle commerce platform for Hyundai's Kia, vehicles in The United States and in Europe. And with new partnerships such as the one with Hyundai, that number will only continue to grow. Finally, MiR was awarded the J. D. Power seat equality award, sweeping the luxury vehicle category for the second consecutive year and placing first in two mass market vehicle segments.
I'm extremely proud of these awards, and they are a testament to our continued focus on operational excellence and quality. But, before I hand it over to Jeff, I do wanna express my sincere gratitude to him for his twenty years of Lear's, Lear Corporation, his outstanding leadership, his wise counsel, and most importantly, his friendship. I will miss you, Jeff. We all miss you. We wish you the best in retirement.
You absolutely deserve it. Thanks, Jeff. Thanks, Ray. And thanks to the entire Lear team. It's been an honor and a privilege to serve as Lear's CFO and to have worked with such a great company for most of my professional life.
I'm proud and happy to transition the CFO role to Jason, a person I have known and respected to his whole professional life. I know that as I enter retirement, I leave the job in very capable hands. Now Jason, our next CFO, will provide a review of our third quarter financial results. Thanks, Jeff. Slide eight shows vehicle production for the third quarter.
In the quarter, global vehicle production was down approximately 700,000 units or 3% from 2018. Lear's top programs were down greater than the market in each of our major regions, with Europe down 7%, North America down 6% and China down 14%. From a currency standpoint, all major currencies continued to weaken against the U. S. Dollars in the quarter.
Turning now to Slide nine. For the quarter, sales were $4,800,000,000 down $67,000,000 or 1% from last year, driven by production declines in all our major markets and the negative impact of foreign exchange, partially offset by new business. Excluding the impact of foreign exchange and the acquisition of Xevo, sales were flat, reflecting three points of growth above market. Core operating earnings were $338,000,000 down $61,000,000 primarily due to lower production volumes on Lear platforms. Core operating margins were 7% in the quarter.
Third quarter free cash flow was $193,000,000 compared to $107,000,000 in 2018. Slide 10 explains the third quarter year over year variance in sales and adjusted operating margins in the Seating segment. Despite the impact of the strike at our largest customer, sales in the quarter were $3,700,000,000 up 1% from the 2018. Excluding the impact of foreign exchange, sales increased 3%, representing six points of growth above market. The increase in sales was driven by growth from the backlog, partially offset by lower production on their platforms, including the strike related impact on North American sales.
Seating margins were 8.2%, down 40 basis points from last year due to the impact of lower volumes, partially offset by strong operational performance. Slide 11 provides the first quarter year over year sales and adjusted operating margin walk for our E Systems segment. Sales in the third quarter were $1,100,000,000 down 8% from the 2018. The decrease in sales was driven by volume declines on Lear platforms as well as currency headwinds. These were partially offset by growth from the backlog as well as the Xevo acquisition.
EP Systems margins were 7.6% in the quarter. Consistent with the first half of the year, margins were impacted by lower volumes and unfavorable platform mix on key Lear programs. Net performance in the quarter was negatively impacted primarily by continuing effects from commercial agreements we reached in the second quarter as well as investments to support our backlog, elevated labor costs and other economics. Slide 12 shows our return of capital to shareholders as a percentage of free cash flow since 2015. Over the last five years, we have returned, on average, almost 70% of free cash flow in the form of dividends and share buybacks to our investors.
Our capital allocation philosophy has not changed. After, first, investing in the business to support our customers, expand our product and process capabilities and improve our cost competitiveness second, making focused, strategic acquisitions that add to our product capabilities and offer sales diversification and third, maintaining investment grade credit metrics, we are committed to returning excess cash to shareholders. Slide 13 shows full year IHS global vehicle production volumes, our production assumptions for our platforms and our currency assumptions. IHS is forecasting 2019 global industry production to be down 6% year over year. This represents a reduction of approximately 1,900,000 units or 2% as compared to its July forecast.
We based our production outlook on several sources, including internal estimates, customer production schedules and IHS forecasts. At the midpoint of our updated guidance, our volume assumption for our top platforms in North America is down 12% in Europe down 9%, and in China down more than 20%. Slide 14 provides our updated financial outlook for 2019. Primarily as a result of the strike at our largest customer, we are lowering our full year 2019 financial outlook. At the midpoint of our outlook, sales are estimated to be $19,250,000,000 down 9% from 2018, reflecting lower production on their platforms, including from the impact of the strike, partially offset by the addition of new business.
Excluding the impact of foreign exchange and the acquisition of Xevo, sales are expected to be down 6% year over year. Core operating earnings at the midpoint of our 2019 outlook are expected to be $1,250,000,000 Our updated free cash flow guidance primarily reflects our outlook for lower earnings, partially offset by lower capital expenditures. Slide 15 summarizes the changes in sales and earnings from the full year outlook we provided in July. Since our July outlook, we have experienced significant lost volume from the strike and other further declines in global vehicle production. These factors, combined with the impact of weakening global currencies against the U.
S. Dollar, result in a sales decline versus our prior outlook of approximately 4%. Our operating earnings and margins have been impacted primarily by lower production volumes, partially offset by favorable net performance, which includes lower incentive compensation expense. On a segment basis, we now forecast full year Seating margins in the mid-seven percent range, down from approximately 8% in the prior outlook, primarily reflecting the impact of the strike. In E Systems, our clear margin outlook is unchanged at the mid-eight percent range.
So the strike will materially affect our 2019 financial results. We are taking aggressive steps to mitigate the impact, including instituting further reductions in discretionary spending. Our updated outlook reflects the results of these efforts. I will now turn it back over to Ray for some concluding remarks. Thanks, Jason.
Now turning to Slide 17. In summary, we delivered solid financial results in the third quarter despite the challenging macro environment. I'm proud of what we have accomplished. Without question, challenges remain, but we have an experienced management team that can successfully navigate the current environment. And I would be happy to take your questions.
Speaker 0
Thank you. And your first question comes from the line of Rod Lache with Wolfe Research. Rod, please go ahead.
Speaker 2
Good morning, everybody. Thanks for taking my I was hoping, first of all, you could just clarify the change to your revenue guidance. Prior guidance for revenue was 19,800,000,000.0 to $20,300,000,000 and you're now 19,000,000 to 19,500,000,000.0 So I could see the $800,000,000 taken off. And it looks like FX was probably a $75,000,000 impact, and it looks like you've adjusted some European platforms down about 1% or $90,000,000 So it's a little over $600,000,000 left. Could you just give us a little bit more insight into how much of that is the GM strike or the Hyundai strike?
And how is that kind of spread between Q3 and Q4?
Speaker 1
Sure. Let me first start by just sort of describing the thought process we went through on on providing our updated outlook. Obviously, if the vote had been completed on the GM strike prior to, issuing our guidance, this would have been a little bit different conversation. And so, given that GM's our largest customer, particularly in North America, we have kind of a wider range than we ordinarily would at this time of the year. And so what we've assumed, at the top end of the range is that we would lose seven weeks of production to the GM strike.
And so that's two weeks in the third quarter and five weeks in the fourth quarter. And so we're now completing the sixth week of the as we sit here today. We expect to hear the results of the vote later today. And what we've what we've assumed at the high end of the range is that there's one additional week of lost production, as a result of the time it takes to get ramped up. That's not what GM has told us.
That's that's simply our assumption that we use, to set the the top end of the range. The bottom end of the range, we've assumed three additional weeks, of lost production due to the GM strike. So if those were to not pass today, and the negotiations were to continue, we'd protect it for three additional down weeks. So at the middle of the range, we've assumed effectively eight point five weeks of lost production. And, Ron, that's about $525,000,000 of lost revenue.
The weekly impact of the strike has kind of grown as the strike has continued on, as more facilities are impacted, as Mexico eventually became impacted. And each week of the strike now is 70,000,000 to $75,000,000 of lost revenue. So that's the missing piece to your walk on the revenue guidance.
Speaker 2
Okay. So just just to clarify, if if the strike is over tonight, you you basically lose a month in the quarter. So maybe $280,000,000 of impact in the quarter. It looks like you're assuming quite a bit more than that, even aside from the currency and the adjustments. Am I missing something there?
Speaker 1
Yes. So if the vote is passed today and GM is able to resume production next week, that would represent an opportunity even to the high end of our range. We've assumed one additional week of lost production as they ramp production back up at the high end of our guidance range.
Speaker 2
Okay. Thanks for clarifying that. And then, could you just spend a little bit of time talking about the prospects for recovery in that productivity line item in your bridge in E Systems. How are you expecting that to look here over the next couple of quarters? When would you start to expect that to turn?
And presumably, there's going to be some benefit over the next year from the $75,000,000 of restructuring savings and Xevo becoming neutral to earnings. So could you give us a little bit of color on the prospects there?
Speaker 1
Yeah. I think, Rob, why don't you kinda take a step back here and and, you know, think it through these systems. I mean, I break this down into near term, medium term, longer term, and and there's a lot going on. I mean, one, you know, in the near term, obviously, it was establishing a strong management team. And I'll tell you that the team we put into place is, without question, the best team we've ever had in these systems from an experience standpoint and, the things that they're focused on.
The second part of the near the the more near term was putting in place the disciplines which we're focusing on return on invested capital. And a lot of the things that we're doing are very similar to what if you remember back in 02/1967, I was asked to go in each systems and turn that business around. It was about $1,800,000,000 and and lost money. And then back in 1314, asked to go turn seating or improve seating, and that was down about 200 basis points. We had very similar actions.
And so in the near term, we're we're definitely on track as far as putting a strong management team, driving disciplined return on invested investment capital invested capital. Looking at improving our China operations, we talked about that as being an issue for us, and we've hired, an expert at, looking at that business and staying focused. Our plants are running extremely well. I mean, you know, one thing to take note that the plants are running, extremely well, and we're doing a real nice job of launches. On medium term term, it's, what we've talked about, the the the transition to more, you know, higher margin products such as power electronics and connectivity.
And there's a really good opportunity. And we're getting a lot of good traction right now with our customers on this, engineered products into EDCs within the wire harness business. And, you know, I'd say one major change there, and we talked about the lack of really being able to, get our our engineered components on on harnesses in the past because of catalogs and and other restrictions, our customers have a completely different mindset now. The doors are open. We're making very good progress.
Now, that will take some time, because there's there's design validation requirements that we have to go through, testing, resourcing, that type of stuff. But nonetheless, we're getting and making some very good progress there. And the restructuring actions that, you alluded to are, on track, and and we're making some very good progress there. Long term in the business, we've done a nice job of looking at the overall product portfolio we talked about. We're gonna stay focused on where we can generate really good returns, and then obviously exit business that, we'll consider to be, you know, making the type of returns that we would target.
And then the continuation of vertical integration. I think the last one is the the software and data platforms. I mean, we're really doing a nice job. And one thing I I wanna mention is on the Xevo platform hunt, 33,000,000 vehicles. And we're it's up from what was just a short period of time of of April, 25,000,000.
And so those things are gonna start paying dividends longer term. But, you know, when I look at where we're at in E Systems and thinking about the experiences I've had in in the two different segments, We'll walk ahead of where we were in the lease system prior, back in 02/2007, and then, seating in, thirteen, fourteen with a strong management team in place. And I I think these these these issues that we're looking at as far as improving, the overall margin take some time, and they they're gonna the traction will take you know, will hit at different times too. And I know, Kyle, you're in the room. Can you kinda go through some of the the way you're getting at some of the, differentiation of our product?
Yeah. So in in that medium term, a lot of new product launches and particularly around the electrification side, really strong portfolio of products. And I think something that differentiates Lear is that that those broad product offerings will make everything from the outlet to the output of the electronics and the power management become broader systems. And as we see further integration of those electronic components and power electronics, then greater power density, greater, opportunity for the customers to have improved vehicles in terms of charging performance, We integrate those things. And so on the longer term, you'll see a deeper integration of power electronics and subsystems that we make today.
In terms of new business, 40% of the wins this year have been around electrification and connectivity. So playing in the right place is clearly where the the market's going. As I think longer term around the software and data services, as as Ray mentioned, connectivity is gonna really transform automotive like like as in so many other industries. And we're there. We're first with the first 4.5 g embedded connection.
We'll be there with the first five g embedded connection. And we'll use that connectivity position to help deliver services and software, help enable things like the the Zepo services. That growth in software, stand alone services applications, in fact, we've received one the first RFPs for stand alone software from our customers. So we're seeing the interest there from a software perspective. And as we we work on the product roadmaps, the portfolio, we're developing that not only for for hardware, but software and the services aspect.
So really excited about both the the midterm and the longer term, future for eSystems. Kinda pretty good on the team. Yeah. That's great, Carl. I mean, Rod, I wanna go through all this because it's important.
There's a lot of different aspects that we're going after here. From my experience and before Jason I turn it over to Jason to kinda answer your question in the financials. You know, I don't think we've ever been in a better position. This this business I'm very confident in this business. It's amazing talking to customers, and we've won significant awards recently, on some of the things I'm talking about with power electronics and connectivity.
And there's an absolute right for us to play in this vertical integration, and the doors are open. It's an opportunity we haven't had, I think, in the past, but now is a real opportunity for us to continue to drive profitable business in E Systems. And with the software that we're developing, it it really is impressive. And every customer I go and talk to about Xevo, what we're doing with XO or Rod and all in that with our our capabilities is is really positive, and we picked up some really nice contracts. And so there's a lot of things we're doing, Rod, and why I wanna go through all this as an explanation.
I've done this twice before. We've never been in this type of position and looking at the product lineup, the team that we have in place, the discipline that we're focused on. So I feel really good about the business, and and I want Jason to kinda give you an overview of how we see that business playing out over the next several years. And, Rod, maybe starting with I think part of your question was the net performance of any systems in the third quarter. And similar to what we saw in the second quarter, there was a margin compression, two eighty five basis points in third quarter year over year that we attributed to net performance.
And about 125 basis points of that is related to the pricing agreements that we reached in the second quarter that have a full year effect. Two things have changed in the third quarter that were a little bit different than second quarter. First, our launch costs and engineering costs were higher in the quarter, and so that was about a 90 basis point headwind year over year. Commodity costs were a little bit higher, similar to second quarter. That was about 50 basis points.
And so the remaining piece of the explanation, is what I saw an improvement on in the quarter. So our ability to offset the contractual price reductions that had been previously agreed to improved. So our performance on cost reduction programs, commercial negotiations, plant cost savings all improved in the quarter. And so that was less of a headwind year over year. Looking out and putting some numbers around Ray and Carl Swift's comments, and we've said this publicly already, we sort of see the near to medium term operating margin in these systems sort of in that 7.5% to 10% range.
And so looking out over the next eighteen months or so, it's likely more in the lower end of that range and gradually increasing as we see the benefit of several things: one, the benefit of the vertical integration that Ray referred to and two, as we mature businesses with some of these new customers, we see opportunities to improve margins there. And we also see opportunities on our some of our more mature programs that have finally finished the changeover cycle. Once you get through the launch cycle and you're able to deploy your cost reduction programs, we see some margin benefit from that. You can't decide the fact that we've digested a massive reduction in production volumes on our core programs in that segment. And so our restructuring program is partially designed to take some excess capacity out and improve the margin profile of that business over time.
And you highlighted the restructuring program. That certainly will help us in the near term, improve margins there. And looking out longer term, we see this mix of business allowing us to get back to that 10% -plus operating margin, level, and that's just a bit further up.
Speaker 2
Okay. Great. That's very helpful. I appreciate the detail. Just to clarify, in the next couple of quarters, though, a lot of these things are kind of longer term and midterm opportunities that look pretty attractive.
But in the next couple of quarters, in terms of execution, should we be focusing on that 300 basis points or so year over year bridge starting to compress as you start to get more, internal efficiency, productivity and restructuring, kind of mitigating some of the headwinds you mentioned?
Speaker 1
Yeah. It's a bit early to provide 2020 guidance at this stage, and there's lots of moving parts. And so we'll get into that in more detail, in January, on our fourth quarter earnings call when we provide our formal guidance.
Speaker 2
Your
Speaker 0
next question comes from the line of Brian Johnson with Barclays.
Speaker 2
Morning. I have two sets of questions. One, a little bit of housekeeping follow-up on your production guidance, also recognizing you're not quite ready for 2020. Do you just have a broad sense of how your major customer could ramp up and the potential to catch up on production this quarter versus first half? And if so, in first half, is it going to be first quarter inventory rebuilds or spread through the year?
Speaker 1
Yeah. As far as the the strike and and, how how they're gonna ramp back up, obviously, we've been in limited conversations with General Motors, and I'd I'd prefer to wait till they announce, you know, what they're gonna do in in respect to callback and and accelerating their launch. I mean, Jason mentioned how we've kind of looked at it in our guidance, and it, would be a slower ramp up. It's obviously they come back quicker. That that's good news for us.
And we haven't really gotten into all the details of how they clock back and and how they might get that volume back at this stage.
Speaker 2
Okay. And just a related follow-up on that, and then I'll ask a seating question. The SUVs were slated to change over next year. You know, any sense of how the strike's gonna affect the timing of that changeover?
Speaker 1
Yes. We're not expecting a meaningful change in that. We've heard nothing about a change in the launch plan for the SGD. We were expecting that to happen in the second quarter of next year.
Speaker 2
Okay. Second set of questions, just really around the Seating business. And some investors have been asking, given the price negotiations that happened mid summer with a major customer in electronics. Our customers approaching Lear and, frankly, your competitors pushing for price downs in the seating segment, either in just in time assembly, which enjoys higher ROIC or in some of the components. Or, you know, alternatively, is a major competitor still having to walk price up and that's benefiting the industry?
Speaker 1
Well, let me let me start with the productivity and the the request from our customers for price downs. I haven't seen any changes, both both in e systems and seating. I know we made some decisions, last quarter in e systems, which have already benefited us in in our relationships with our customers and longer term growth. So that was a a good decision to make to, you know, grow our business longer term and create value for our shareholders. In respect to, how our customers are are behaving with price downs with some of the pressures they have, Now, I will say that that I've seen more of a willingness to look at things differently in respect to DAV and cost downs with design.
You know, I have had some really good conversations with our customers and how we can look at the whole value chain and reduce cost. But nothing on the the final price downs. It's been more of a collaborative, you know, where can we help them? Are there alternatives? Are there things that we can do to really be more efficient as a system supplier?
And we pride ourselves on that. Something that we're very good at, and we we have something we'd work on internally, which is cost technology optimization, which I believe we are the benchmark. And we've been recognized by our customers for that. And so I've seen that pick up, and which I think is good for us because there's share programs and things that we can work with our customers that help offset volume reductions, those type of things that we're good at negotiating. So, I think that's a positive sign for us.
And I do think that, you know, referring to your your other point, we have picked up some nice conquest business. You know, even this week, we, just were awarded some conquest business that, you know, I talked about in in the seating area that that takes some time. You know, customers do not like resourcing during a product cycle or product life, or during a time. And so we're starting to see the next generation of awards coming, and and that's been very positive for us. And so I I hope to continue to see this happening.
Speaker 3
Okay. Thank you.
Speaker 0
Thanks, Brian. Your next question is from the line of Emmanuel Rosner with Deutsche Bank. One moment. Emmanuel, your line is open.
Speaker 4
Hi. Good morning.
Speaker 1
Good morning.
Speaker 4
Good morning. Good morning. So question a couple of questions on E Systems. The the the backlog in the revenue walk was a little bit on the the contribution was a little bit on the low low side at $21,000,000. And even sort of on a year to date basis, I think we're probably only around, like, 150 or 160,000,000.
Can you maybe talk about what's sort of going on there? Is it sort of like the impact from the lower global production volume? Or is some business being pushed out or delayed into future quarters?
Speaker 1
Yeah. So our backlog for 2019 has come down. We talked about $1,000,000,000 backlog in total for the company back in January, and we've seen that come down by about $350,000,000 for this year. And E Systems is for the brunt of those reductions. If you look at the composition of their backlog, about 60% of this year's backlog in E Systems was slated for Asia, which is primarily in China.
And China has been hit harder than any other market in terms of lower production volumes. And so what we've seen this year is really a combination of lower production volumes, some programs that have ramped up slower, and that's impacted both segments and some programs that have been delayed and pushed out to next year. And as we look at 2020 and our backlog, we do see that trend sort of continuing. And we do expect the backlog for next year to be a bit lower than this year as a result of some of the same issues that we experienced this year. Lower volumes is the main contributor to that.
And if you kind of step back and look at what IHS was calling for twenty nineteen, twenty twenty production volumes globally back in December when we established our backlog, they've cut their global outlook by 8% this year and 8% next year. They've cut China by 12% this year and 15% next year. And that has had a meaningful impact on the backlog for both years. And in addition to that, we've had some programs that were delayed this year, pushed into next year that will help next year. Unfortunately, we had further program delays out of 2020 and into 2021.
Now, that will help us as we look out into that third year of the backlog when we do formally update that in January. Then on the positive side, as Ray mentioned, we've seen two positive developments in the third quarter. We've seen the initial benefit of the commercial agreements that we negotiated in the second quarter starting to result in new business wins on the E Systems side, albeit much of that is outside of our three year backlog window, but it's positive development nonetheless. We've seen a really strong build on the quote pipeline on electrification and connectivity and the amount of business supported there. We have talked about $1,000,000,000 of quote pipeline and electrification and connectivity for this year.
That's actually grown to $1,300,000,000 of which 1 point dollars has been sourced. And we continue to win consistent with our targeted share of sort of 25 to 35%. So that's extremely positive. And as Ray mentioned as well, we're starting to see an uptick in our conquest awards. And we've had over $300,000,000 of conquest awards, in Seating this year that will benefit the longer term growth of that segment.
I think as you look at longer term and some of the data services and software aspects, that will also decouple from the OEM production rates as we look to the services that are offered broadly to already fielded vehicles. And so that's, again, another exciting aspect as we look to to new areas of growth in eSystems.
Speaker 5
I appreciate all the details.
Speaker 4
And then secondly, on the E Systems margin. So you gave a lot of helpful color before. I think 125 basis points was the impact from the commercial agreements in the quarter. Can you just, for that specific piece, talk to us about how to think about it on a go forward basis? I understand that it probably goes through at least the end of the year in terms of year over year walk, so in the fourth quarter as well.
Does that carry through 2020, or would that be part of different discussion?
Speaker 1
Yeah. So the agreements that we reached earlier in the year, those are lifetime agreements. So they've they've been implemented in the purchase orders this year, and so they will carry on to next year. We've talked about this before. Sort of 2% to 3% has been the annual price down range in the E Systems business historically, and we're at the higher end of the range this year.
Too early to tell what next year looks like. But yes, there is a carryover effect of that. But I also highlighted that in the third quarter, we made some progress towards offsetting that with our cost reduction programs, and we expect that to continue in the fourth quarter and into next year.
Speaker 0
Your next question will come from the line of Dan Levy with Credit Suisse.
Speaker 6
I wanted to ask a couple of questions just on decremental or just on margins in general. First, just wanted to start on the GM strike. I noticed in your Slide 15, highlighting the volume the margin impact from volume FX, that's a 22 conversion. I believe that that's probably something that's pretty typical. You know, I would have expected maybe larger decrementals given, in this case, the GM strike, the production presumably on your end literally ground to a halt.
That's going to be much worse than something where production is going from flat to down to. So if you could just give some color on what the decremental margins have looked like on the GM piece of business. And subsequently, as we potentially are looking at higher production in 2020, would you get typical incremental margins on that business? Or are there going to be any ramp inefficiencies? Do you have the capacity to handle that properly?
Speaker 1
Yes. First, in terms of this year, and similar to what we've described previously, our variable margins in Seating are 15% to percent 25 to 3% in E Systems. And the GM North America business is some of our most vertically integrated business, so it's gonna skew sort of to the higher end of that range as a result of that. And in in addition, as you pointed out, given the sudden nature of the losses in volume, that pushes the cost the, our ability to take variable costs out, is a little bit more difficult and pushes the number up a bit there. Also, in that in that bar on the chart, we we do have FX, and that's sort of alluded to the conversion and and as well as volume reductions on other platforms with varying margins.
So, the way to think about the GM margin is, as I mentioned, sort of in our normal range, and maybe a little higher on the Seating side just because of the level of of vertical integration. And in terms of how we may benefit next year from that, to the extent that volume comes back on overtime, on Saturday or Sunday production, certainly, the incremental margin would be slightly less. As a result of that, would have some shrink even costs. But I'd say generally, it should be in line with the variable margin profile of both business segments.
Speaker 6
Great. Okay. And then just a second follow-up on margins or, I guess, trying to gauge downside risk. As we're looking into 2020, I know you're not providing 2020 guidance. To the extent that we have maybe continued volatility in China or Europe, obviously, the question is what may arise related to the CO2 emission regs and how that could flow through to the industry?
Just give us a sense of sort of your typical decremental margins by whether it's in Europe or China. And what options do you have to mitigate any downside pressure in either of those regions?
Speaker 1
Yeah. I think we've talked about it in the past that, in general, our European margins are in line with our segment averages. Maybe I'm seeing a little bit lower, little bit less vertical integration in in Europe than we have globally. And then E Systems may be a little bit higher because we are a little more vertically integrated. We have a strong, terminal and connectors business, in in Europe.
China, you talked about the effect of lower volumes on some of our mature programs kind of skewed to the higher end of the range on E Systems with the loss of floor business and other mature business there. And what we're doing in response to that is restructuring our footprint, taking capacity out, moving to lower cost facilities to try and sort of repair the or offset the effects of that lost volume. And we'll continue to do that as we look into 2020. And we took our restructuring program for this year up to $200,000,000 increased our savings outlook to about $75,000,000 annually. We talked about that in the second quarter call, and 80% of that is expected to benefit us next year, roughly 60,000,000.
And so we continue to expect, that to be the case next year at
Speaker 2
this stage.
Speaker 1
And just to add a little bit, more to what we can do, and we've we're taking a very, proactive approach to this. And and you did, mention a few different issues that could happen next year. In some respects, we're assuming they can happen, and we're taking those steps to make sure we're countering, and driving efficiency. What's great about having, the two divisions, both between Seating and E Systems, for example, we're we're looking at in our consolidating, in our manufacturing plants, where we can drive efficiencies between the two divisions. We're looking at all of our logistics lanes and where we can continue to consolidate in the event that volume gets reduced.
We're in negotiations right now with our customers. There's a lever that we have, obviously, called productivity that we start negotiating in the event that the customers aren't hitting their contractual volumes, and then we negotiate through our productivity. The synergies that we have between the two divisions can't be overlooked either. We're looking at how we can share resources globally within a region, and then down to a platform. And so if it's program management, sales, engineering, we have a great opportunity for us to continue to drive, down our cost.
And so, you know, in in some respects, having the uniqueness of the two divisions help us in in in light of any type of reductions. And so we're preparing for that right now. We have continuous meetings. We've put together a team that's dedicated to this. We're looking at every line item within our cost.
Jason talked about discretional spending. We're obviously getting at that aggressively, but more mid to longer term, we have some really unique opportunities to drive between the two business divisions, and we're taking advantage of that. So there's a lot of different levers we're pulling. Obviously, we're very sensitive to any changes within volume, and we're reacting quickly.
Speaker 6
Great. Thank you. That's very helpful. Appreciate it.
Speaker 0
Your next question comes from the line of Amitav Sankivyanshi with Morgan Stanley.
Speaker 1
Great. Thank you
Speaker 5
for taking the question. Just thinking a bit ahead here, you know, it seems like the the conversation around electrification is picking up, and and I'm just wondering if that creates an opportunity for you to, you know, accelerate the the, you know, the the product portfolio transition, you know, away from from wire harnesses, maybe more towards terminals and connectors as you talked about, that that would be helpful.
Speaker 1
Right. I think the the electrification, portion is very complementary actually between the wiring terminal connectors, the high voltage wiring, that that connect into our onboard chargers and our charging systems is very complementary. So when we look at those business opportunities going forward, we look at that very holistically at what what content per vehicle can we really capture across the broader portfolio. So I think it's very complementary. And in terms of the time frame, too, Arvind, this is more in the medium to long term.
These programs are typically awarded between two point five and three point five years in advance of production. And so we've had a lot of success this year in winning business in that side, and we would expect the margin profile of these systems overall to improve as that ramps up. But it's out there a little bit. It's not we're not gonna see a meaningful impact, but certainly next year, maybe a little less so or or a little more so in, in 2021 when we begin to watch some of that. But Carl just walked in this morning and just gave us a bit of good news, and we just won a nice bit of business on the the electronic side, power electronic side, that had some very nice returns.
And so but to Jason's point, it's a little bit outside the window, but nonetheless, you know, actually, Kyle and I have been out meeting with all the customers, and we've had some really good conversations. And that's why when I say I'm confident, you know, there's there's a nice fit for Lear. And we have been we are a niche, in some respects, supplier that we're not the mega tier with the black box design. And they love our ability to be very flexible and agile when we come in with our design capabilities. And so that's paying off really well.
And and like I said, we've met with the customer. It's been really positive feedback. I'm very confident that we're at a nice position within power electronics and connectivity. But to Jason's point, it does take a little bit more time, and we're very selective. You know, one thing to point out that, you know, we don't quote all business around the world.
We're very selective with the customers we wanna position ourselves with, the vehicles we wanna be on, because there's a lot of different quotes out there right now in power electronics. And, you know, we're we're we're, like I said, looking at what what, best position for us to be with the best customers, with the best product. And so but it has been, you know, overwhelmingly positive from our customers' perspective. I've had the opportunity to to visit a number of customers with Ray and really impressed with the deep customer relationships that that Lear has and I think the trust in the company. And customers clearly want Lear in their future vehicles and want us to understand our product portfolio and road map and how we align with where they're going.
And on the software side, our connectivity and deeper levels of integration into the vehicle. So it's really exciting.
Speaker 5
Okay. And maybe near term, had the commercial agreement there in last quarter weighed on E Systems margins. You mentioned that perhaps that would help the backlog in 2020. You provided some nice color there on the backlog. With regard to 2020, but it sounds like it will be lower than 'nineteen.
So how do we get comfort that the commercial agreement, did in fact drive further business?
Speaker 1
Yeah. First of all, let me clarify that the the agreements that we put in place this year with our customers were for potential business that are outside of our backlog window. And so it's not a 2020 effect. It was more of a relationship, if you wanna think about it
Speaker 4
in this term near term. It was
Speaker 1
about continuing that relationship in a positive way to grow the business long term, and that's already paid dividends for us. We've already established contracts. Unfortunately, like I said, they're outside the the three year window. But there's an element here, though, too. Like Jason mentioned, we were very good at offsetting our productivity.
We do that through a lot of different levers we pull internally. There was a time element of how, we were getting at some of our efficiencies. And so it also opened the door on VAV sharing programs, other things that will impact us more near term and help us improve our margin profile. And those actions are still in place, and we'll bring those out with our customer today. But that has changed from how we work with our customers, which will impact our margin more short term.
Longer term, we're already seeing the benefits of of cutting those deals. They absolutely were the right thing to do, and and those are paying the dividends already.
Speaker 2
Great. Appreciate it.
Speaker 0
Your next question is from the line of Ittai Migali with Citi.
Speaker 1
Great. Just
Speaker 2
had one revenue and one margin question. First, going back to the second half revenue, hoping you can quantify the GM strike effect in the third quarter. And then also what your revenue in the third quarter ex GM strike looked like relative to your internal expectations? Also, whether it be some of the pressure you're seeing in your guidance ex GM strike, is that some of it in the third quarter? Or is that entirely happening in the fourth quarter?
Speaker 1
Yes. So the GM strike impact both the third and the fourth quarter, less so in the third quarter. It's about $95,000,000 of revenue in the third quarter. And the margin impact isn't as significant in the third quarter because, in the case of some of the component plants on the E Systems side, for example, we we continue to build some inventory. And and so that offsets the impact a little bit.
Looking out to the fourth quarter, the impact is much more significant. If you look at sort of the second half, impact on margins, it's about 100 basis points impact on the Seating margins, a little bit more than that, and about 50% on E Systems. So absent the GM strike, we would have been at 8%, in the second half of the year in Seating and in the high 7s mid- high 7s in E Systems.
Speaker 2
Got it. I guess asked a little bit differently. Out the $725,000,000 I think you mentioned earlier about 500,000,000 and change is GM. So the other kind of 200,000,000 is that entirely in the fourth quarter? Or was some of that pressure also impacting you in the third quarter relative to your initial internal expectation?
Speaker 1
Yes, that's largely in the fourth quarter. The third quarter actually came in a little bit stronger than we had anticipated. So both the foreign exchange impact and the volume impact during in the fourth quarter. And and we were a bit conservative in our range just given all the uncertainty around the strike and how meaningful that impact is per week. And so we do have built in some additional reductions in volume that have yet to be announced, and those customers have factored into that low end of the range.
Speaker 2
That's helpful. And then just my last question, going back to incremental margins. If I look at the kind of the backlog incremental contribution margin, it has been declining, I think, in both segments over the last few quarters. Is that just a function of the backlog itself being somewhat smaller? And then how should we think about that backlog incremental margin perhaps into 2020 and beyond?
Speaker 1
Yes. In general, we've been rolling out new business in line with our segment overall margins. Sometimes in a quarter, it can be skewed a bit just because of you have the impact of business rolling off, you know, that we've lost in business that's rolling on. And if the net number in revenue, for example, in the system is $20,000,000 in the quarter, it's it's not a real meaningful margin look. But in general, the business that's rolling on is in line with the segment margins that we have in both business segments today.
Your
Speaker 0
next question is from the line of Chris McNally with Evercore.
Speaker 3
Hi, guys. Thanks so much for the question. One real quick one. It's been asked a couple of times. I just wanted to verify.
So the backlog comments that you're roughly making for 2020, that's roughly lower than the $1,000,000,000 adjusted number for this year, more or less. I know you're not going give official guidance, but just I wanted to make sure it's lower than the adjusted number. That's correct. Okay. Great.
And then, you know, on on E Systems and,
Speaker 1
you know, that's been some of the
Speaker 3
way that the backlog adjustments have been made. Can you talk about, when we think about the push, I mean, we always have a question of are the volumes sort of lost versus moved? In Asia, is it really that basically it's disappointing performance of these platforms? So it's not it's quasi lost, meaning they haven't been pushed to the right, and so lost backlog this year doesn't go into 2020 or 2021. It's really more around the volume of those launches are lower.
Speaker 1
I'd say, generally speaking, it's more of that than than delays in the case of of Asia. But there there's been other factors in Asia. You know, there's a a program, many systems in in China that was loss making, and we've decided to exit that that program. And that's part of what's impacting the backlog, so that's a negative to the 2020 backlog that will be helpful, for the margin profile of the business going forward. There have been, a couple of modest programs that have been canceled, as well, where it'd be zero volume, and that's that's impacted the the number.
But, you know, in general, I'd, you know, roughly, call it, a third of that is probably just lower volume on a continuing basis on the, business that that is launching or have launched.
Speaker 3
Okay. Great. And and and then just on the margin profile and and eSystems, if we take the sort of this base levels and the the the mid sevens and and it sounds like things are gonna be slow going. You talked about 10%, know, further out. That's that's multiyear.
But you you do mention, you know, some of the things that you're doing, potentially about a cost savings program. You're gonna give us more detail on, some of the discretionary items. Could we expect in the sort of in 2020 that we get a movement back to even if it's just below 8% range? Or is that sort of still on the list, like, and we should kind of think about the restructuring is is a year or two out until we get volume, and we're gonna stay in this sort of mid 7% range?
Speaker 1
Yeah. For a lot of reasons, I think it's still it's too early to try and guide to an operating margin, for E Systems for for next year. I mean, what we can point to is that we are I think we've stabilized in the second half of this year. We were encouraged by what we saw in the third quarter and what we see in our fourth quarter absent the GM strike, sort of in the mid to high sevens. But, you know, you look out to next year, there's a lot of uncertainty on the production environment.
And I think we would be, you know, foolish to try and call the number right now, given all that uncertainty. And I think we'll have a lot more clarity in January, in terms of what our customers' plans are and and maybe even some favorable developments on the macroeconomic side that give us more confidence in what the production environment looks like next year. Also, as I mentioned, we do have some elevated engineering spending in that segment because of our success in growing electrification connectivity. And I think we won more business this year than we had initially anticipated. And so there's a little bit of a headwind, as a result of that to think about for next year.
And then just in terms of overall company margins, you know, thinking about next year, you know, one factor that, they haven't come up so far in the dialogue, but I'll just point you to that guidance to guidance walk that we provided in in the formal presentation. You'll see that we had a pretty significant reduction in discretionary spending and incentive compensation expense. It was about $30,000,000 and and half of that in each of those two buckets. Both of those are headwinds as we, think about, the 2020 margin profile, of the company next year as well.
Speaker 3
And then just the last technical. The Xevo drain, on margins in E Systems in the second half, I think it was something 50 basis points or more, but I'm because, obviously, you get some of that will annualize. But just how much was Xevo a drag on E Systems margins in the second half?
Speaker 1
So for the full year, it's about 40 basis points. So it's a little bit better than what we had originally anticipated. In the third quarter, we came in, you know, a little bit better than anticipated. And and that's really just the timing of ramping up our hiring on the SG and A side. And, you know, and so we did we did see that that, you know, the outlook for is able to improve slightly, for this year from what we had initially anticipated.
Speaker 3
Okay. Great. Thank you so much.
Speaker 0
Your next question will come from the line of Joseph Spak with RBC Capital Markets.
Speaker 7
You may have sort of just touched on part of my question. But you mentioned on that Slide 15, the 15 basis points of improvement within the margin guidance revision from that performance. And I think that's that's that incentive comp pullback in discretionary spending. But is that all of it? Or because you also talked about some underlying performance improvement, I think, in these systems that sort of being masked.
So is that also part of the 15? I just wondering if you could break that down a little bit further.
Speaker 1
Yeah. I would say, half of that is incentive compensation, and the other half you could split into two categories. One is performance improvements in the underlying businesses, and the other half is sort of temporary measures that we've taken given the extraordinary impact of the of the strike with GM and other volume reductions. And that that portion sort of comes back, I think, next year, more so than the other the other portion of it.
Speaker 3
Okay.
Speaker 7
The, another quick one. I mean, Mercedes has had a pretty, I think, visible launch issue with one of their key programs. I mean, how has has that impacted your profit performance, at all on on the SUV?
Speaker 1
Yeah. The Mercedes launch is, yeah, it's been a it's a very complex it's a great launch for us. But, yeah, it's it's it's definitely hit us on the the cost side.
Speaker 7
And is that
Speaker 0
done? Or It's
Speaker 1
it's ramped up a little bit slower than what we had originally anticipated. Longer term, that's a fantastic, platform for us. Very much very complicated, and we have seen a slight elevation of launch costs as a result of the slower ramp up. But we're excited about the prospects for that program, next year once it gets up to full volume.
Speaker 7
Okay. And then just last one, bigger bigger picture, on Xevo. And I know you have, like, one of the customers in the GM marketplace, and we saw this quarter, they talked about putting in Android Automotive into into info payment to struck a deal there. What are the implications for for Xevo there?
Speaker 1
Yeah. John, do you wanna give a look?
Speaker 4
Yeah. Yeah. Sure. So so there there aren't actually any implications. If you if you look in the press release from GM, actually said they're going to keep their unique services and applications in the platform, one of those being in vehicle commerce.
So the underlying platform of
Speaker 1
that is the Xevo market. So we
Speaker 4
see it more as complementary services, making the ecosystem richer.
Speaker 1
Okay.
Speaker 3
Thank you very much.
Speaker 0
Your next question is from the line of David Kelley with Jefferies.
Speaker 1
Just a quick question on the Seating backlog, which stepped up in the quarter. It's accelerated throughout the year. Was there anything customer specific or unique that's driving the ramp up this year? Just trying to square that off with your comments related to the step down in industry volumes and impact on backlog. Are you referring, David, to the impact on this year's backlog?
Yes. Yeah. Yeah. And so in Seating, the impact has been a reduction of about 130, 140,000,000 from what we initially expected at the beginning of the year. So more of the reduction in 2019 is really with new systems.
But it's, the biggest driver of that, the biggest single driver relates to the ramp up in volume on some of these new programs in North America that we've talked about historically, where the ramp up's gone a bit slower than anticipated. And so some of that comes back next year. But also keep in mind that we've sort of taken a step back and looked at industry volumes overall, and we're a bit more cautious, on on volumes globally and, in in each region specifically and on the programs in the backlog. And so that will kind of offset the sort of carryover benefit of some of those programs that have had a slower ramp up this year. Okay.
Great. I appreciate it. And last one and a quick one. Anything to call out from the E Systems portfolio review? Or is that still ongoing?
Well, yeah, that's still ongoing right now. I will we'll come, we'll come back with a more detailed plan and
Speaker 5
and the overall product portfolio.
Speaker 1
But I'll tell that we have discussed, like I said, some great areas that we have right to play in, and one of those features is engineered components in the Ts and Cs. And so, the work's ongoing, and obviously, we'll have more at a later date. Okay. Perfect. Thank you.
Thank you.
Speaker 0
And our final question will come from the line of John Murphy with Bank of America Merrill Lynch.
Speaker 4
I just want to give a quick congrats to Jeff. It might not seem like it, but we'll definitely miss you.
Speaker 1
Just a first question, you guys talked about some stress in sort
Speaker 4
of your tier supply base and what sort of the disruption in the GM schedules and the pressure in global volumes. We've been hearing more and more about that in North America and Europe as well. Just curious what you're seeing there, what you're doing to mitigate risk and how we should think about that going forward.
Speaker 1
Yes. It certainly wouldn't be a surprise to see some distress given how much, insert volumes have come down. But we have seen very little impact on our supply base. It's held up very well. Even with the massive impact of GM strike, we've seen very, you know, resilient suppliers in our portfolio.
So we've been, pleasantly surprised, I think, by that. We were preparing, for for distress in the supply base, but it really hasn't, it hasn't been an issue for us. I think, in general, the comment, too, we've made on these systems, and we've we've seen some issues relative to the chip manufacturers. And we looked, obviously, very closely with our customers in getting alternative designs approved, validated, and give us the ability to have, alternative sourcing. And so we we do keep a very close eye on any type of distressed supplier or other related items within the supply base.
And in in in particular cases, we'll obviously take those forward to our customers and find some optional construction or, engineered components that we can, move quickly to. So, let's get our eye on it. Like Jason said, that that that significant issue is due to the strike, but probably more just general issues relative and probably more, significant within E and the chip manufacturers.
Speaker 4
Okay. That's very helpful. And then just a second question. When you're looking at the 7.5% to 10% range, you're kind of talking on E Systems margins for the next eighteen months. I know you're not giving the exact guidance,
Speaker 1
but if we were to think about sort of
Speaker 4
the major swing factors, if we're looking twelve to eighteen months out, why you would have hit seven point five percent or why you would have hit 10%. I mean, is it mostly macro or are there some other key factors we can focus on to stay stay on top of that we should think about?
Speaker 1
I think there's three or four factors that are gonna determine the the you know, where we find ourselves on that range over the the coming couple of years. And one is the success rate on, as Ray mentioned, the vertical integration side. We're already seeing some opportunities there. It does take twelve to eighteen months to ramp that up, and so it'll take a little bit of time. That's going to be a driver.
We are seeing an opportunity to improve margins with some of our new customers in the portfolio. That takes time. But the level of success we have with that is going to be a key factor. Our restructuring program is going to be a key factor, combining capacity across CD and E Systems, as Ray mentioned earlier, taking the capacity out, in other cases, specifically E Systems to adjust to the lower production volumes, will also be a factor. And then longer term, you know, the penetration in in software, penetration in in electrification, connectivity or power electronics and connectivity will be a significant factor.
Those are the key areas that that we're focused on. And then maybe a little further out, the effects on on the management of the portfolio overall. I mentioned one example where, you know, we're we're exiting a program that's loss making today. That's gonna have a near term, benefit, say, you know, twelve months out, and that fills out. So things like that, will lead to improvement, but it's it's gonna take a little bit of time.
You know, once again, we had a lot of volume reductions to to digest. The first step in the process is really stabilizing the business. And and I think we've we've done that, here in the third quarter and and feel really good about what's happened so far in the third and and early into the fourth quarter with with that business.
Speaker 4
Great. Thank you very much.
Speaker 1
Okay. Is that it? Is it
Speaker 0
Thank you, presenters. Do you have any closing remarks?
Speaker 1
Yeah. Just just real quick. It's probably just to their team on the on the phone now. But, hey, Jeff, thank you for your years of, commitment, your dedication. I mean, you're a special person.
Wish you all the best in retirement. I know you'll enjoy it. I'm sure Donna will send you back to work soon, but, Steve's the best. And to the Lear team, great job on the quarter. Really outstanding job.
And we got challenges ahead of us, but one thing I love about this company is we step up and we keep driving. And I love what we're doing. I think we have absolutely the right plan in place to continue to drive this business forward. And I thank you for all your efforts, and and great job to the team around the table. Thank you for everything.
Thanks.
Speaker 0
Thank you for joining today's web today's conference. You may now disconnect.