Lear Corporation — Form 10-Q Summary
Reporting period: Thirteen weeks ended March 28, 2015, compared with March 29, 2014. Lear designs and manufactures automotive seating, leather and related components, and electrical distribution systems for global automotive original equipment manufacturers. The interim financial statements are unaudited.
Key Financial Metrics
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Net sales | $4,521.4 million | $4,359.8 million | Up 4% |
| Gross profit | $425.7 million | $360.5 million | Up 18% |
| Gross margin | 9.4% | 8.3% | Up 110 basis points |
| Income before taxes and equity income | $206.3 million | $169.3 million | Up 22% |
| Net income attributable to Lear | $147.3 million | $122.0 million | Up 21% |
| Diluted earnings per share | $1.86 | $1.47 | Up 27% |
| Net cash used in operating activities | $66.6 million | $54.2 million | Higher use of cash |
| Capital expenditures | $98.8 million | $96.4 million | Up modestly |
| Cash and cash equivalents at period end | $748.2 million | $919.4 million | Down from prior-year quarter end |
Business and Segment Performance
- Seating: Sales increased 8% to $3.485 billion; segment earnings increased to $196.1 million from $152.2 million, and margin improved to 5.6% from 4.7%. Results benefited from Eagle Ottawa, new business and higher production volumes, partly offset by foreign exchange and customer price reductions.
- Electrical: Sales declined 9% to $1.036 billion, primarily because of foreign exchange. Segment earnings were $137.0 million versus $138.3 million, while margin improved to 13.2% from 12.2%.
- Global automotive production increased approximately 2% year over year to 22.1 million units. North American production rose 2%, European and African production rose 3%, Asian production rose 2%, and South American production declined 15%.
Liquidity, Debt and Capital Allocation
- Current assets were $5.642 billion and current liabilities were $4.060 billion at March 28, 2015. Accounts receivable increased to $3.171 billion and inventories increased to $986 million, contributing to negative operating cash flow.
- Total debt was approximately $1.983 billion, including the $500 million Term Loan Facility, $500 million of 2023 Notes, $325 million of 2024 Notes, $650 million of 2025 Notes and other debt. The revolving credit facility had no borrowings and provided $1.25 billion of available capacity.
- Lear borrowed $500 million under the Term Loan Facility to help fund the Eagle Ottawa acquisition and redeemed its remaining 2020 Notes for approximately $255 million, recognizing a $14.3 million debt extinguishment loss.
- Financing activities provided $314.5 million, including the term loan, while investing activities used $564.2 million, including $473.3 million for Eagle Ottawa and $98.8 million of capital expenditures.
- Management estimated 2015 capital expenditures at approximately $500 million. Scheduled cash interest payments on the Notes and Term Loan Facility were estimated at $49 million for the remaining nine months of 2015.
- Lear repurchased 1.03 million shares for $112.4 million at an average price of $109.09 per share. Remaining authorization was $887.6 million through December 31, 2017.
- The quarterly dividend increased 25% to $0.25 per share.
Material Changes Versus the Prior Comparable Period
- Net sales increased $161.6 million, despite a $369 million negative impact from foreign exchange. Eagle Ottawa contributed approximately $193 million of sales, while improved production and new business also supported growth.
- Gross margin expanded to 9.4% from 8.3%, reflecting favorable operating performance, restructuring benefits, Eagle Ottawa and new business, partly offset by price reductions and foreign exchange.
- SG&A increased to $151.7 million from $136.7 million, including approximately $8.4 million of Eagle Ottawa transaction costs. Amortization increased to $13.3 million from $8.5 million due to acquired intangible assets.
- Interest expense increased to $24.4 million from $16.8 million because of acquisition-related debt.
- Operating cash flow deteriorated to a $66.6 million use from a $54.2 million use, primarily because working capital consumed $344.2 million versus $286.8 million in the prior-year quarter.
- Comprehensive income declined sharply to $28.8 million from $117.8 million, primarily due to a $141.3 million foreign currency translation loss.
Acquisition, Unusual Items and Outlook
- On January 5, 2015, Lear acquired Eagle Ottawa for a preliminary net purchase price of $843.4 million, including $823.3 million of cash paid and $20.1 million of contingent consideration. The allocation included $354.5 million of goodwill and $211.3 million of customer-related intangible assets. Integration was reported as proceeding as planned.
- Acquisition-related items included $8.4 million of advisory costs and a $16 million acquisition-related inventory fair-value adjustment.
- Restructuring charges were $7.3 million, plus approximately $1 million of manufacturing inefficiency charges. Lear expected approximately $30.3 million of additional restructuring costs related to actions initiated as of March 28, 2015.
- Lear recognized $14.3 million of debt extinguishment losses and $14.0 million of net tax benefits in the quarter. The effective tax rate was 30.5%, compared with 31.1% in the prior-year quarter.
- Management expects global automotive production growth and identified opportunities in seating, emerging markets, connectivity, safety and higher-content vehicles. No formal earnings or revenue guidance was provided in the filing.
Risks, Contingencies and Other Matters
- Key risks include automotive production volumes, customer model changes or losses, customer-imposed price reductions, supplier and labor disruptions, raw material and commodity costs, foreign exchange, interest rates, restructuring execution, acquisition integration, cybersecurity, environmental matters, product liability, warranty and recall claims, and access to capital.
- Foreign currency transaction exposure remained significant. A hypothetical 10% strengthening of the U.S. dollar against exposed currencies was estimated to have an approximately $23 million adverse annual earnings impact.
- Foreign exchange derivatives had approximately $1.7 billion of notional amount and a net fair value liability of approximately $31.9 million at March 28, 2015.
- Recorded reserves included $11.8 million for pending legal disputes, $27.6 million for product liability and warranty claims, and $8.5 million for environmental matters. Outcomes remain uncertain.
- Lear stated that it was in compliance with the covenants under its debt agreements. Eagle Ottawa was excluded from management’s internal-control evaluation as permitted by SEC rules while integration continued.
Important Facts for Investors to Verify
- Whether Eagle Ottawa delivers expected synergies and earnings contribution after integration, including the effects of acquired intangible amortization and inventory fair-value adjustments.
- Whether working-capital investment normalizes and operating cash flow improves following the substantial first-quarter cash use.
- The effect of the additional $500 million term loan on leverage, interest expense and covenant headroom.
- The pace and cost of remaining restructuring actions, including the estimated $30.3 million of additional costs.
- Exposure to foreign exchange, particularly the euro and Brazilian real, and the adequacy of hedging programs.
- Future vehicle production, customer pricing, model launches, raw-material costs and potential warranty, recall, legal and environmental liabilities.
- The timing and scale of additional share repurchases and dividends relative to acquisition funding, capital expenditures and debt reduction.