Lear Corporation — 2017 Q3 Form 10-Q Summary
Business context and reporting period
Lear designs and manufactures automotive seating, electrical distribution systems, electronic modules and related software for global automotive original equipment manufacturers. The filing covers the unaudited three and nine months ended September 30, 2017, compared with October 1, 2016.
Reportable segments are Seating and E-Systems. Global light-vehicle production increased 3% year over year in the first nine months, with growth in Europe and Africa, Asia and South America partly offset by a 4% decline in North America.
Financial performance and key metrics
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Net sales | $4,981.5 million | $4,526.4 million | $15,103.2 million | $13,914.1 million |
| Gross profit | $555.9 million | $513.9 million | $1,716.2 million | $1,590.0 million |
| Gross margin | 11.2% | 11.4% | 11.4% | 11.4% |
| Net income attributable to Lear | $295.2 million | $214.4 million | $912.9 million | $745.2 million |
| Diluted EPS | $3.96 | $2.98 | $12.80 | $10.10 |
| Operating cash flow | Not separately provided | Not separately provided | $1,184.3 million | $1,093.9 million |
- Q3 sales increased 10%; nine-month sales increased 9%.
- Q3 net income attributable to Lear increased 38%, while diluted EPS increased 33%, aided by lower average shares outstanding.
- Q3 SG&A was $158.2 million, or 3.2% of sales, versus 3.4% in the prior-year quarter. Nine-month SG&A was $471.1 million, or 3.1% of sales, versus 3.3%.
- The reported Q3 effective tax rate was 20.2%, versus 28.4%; the nine-month rate was 20.7%, versus 27.9%. Reported rates benefited from tax items described below.
- Q3 segment earnings were $385.2 million, including Seating earnings of $298.8 million at a 7.7% margin and E-Systems earnings of $155.5 million at a 14.0% margin.
- Nine-month segment earnings were $1,211.0 million, including Seating earnings of $941.8 million at an 8.0% margin and E-Systems earnings of $476.7 million at a 14.3% margin.
Cash flow, balance sheet, debt and liquidity
- Operating cash flow was $1,184.3 million for the first nine months, up from $1,093.9 million. Accounts receivable, inventory and accounts payable increased primarily to support higher sales.
- Investing cash flow used $700.1 million, including $430.2 million of capital expenditures and $286.8 million paid for the Antolin Seating acquisition. Management estimated 2017 capital spending at approximately $585 million.
- Financing cash flow used $545.8 million, including $332.2 million of share repurchases, $104.4 million of dividends to Lear stockholders and $42.7 million of dividends to noncontrolling interests.
- Cash and cash equivalents were $1,253.7 million at September 30, 2017, compared with $1,271.6 million at December 31, 2016. Approximately $917 million was held by foreign subsidiaries and could generally be repatriated without additional income tax expense.
- Debt consisted principally of $1,725 million of senior notes and a $250 million term loan. The company also had a $1.75 billion revolving credit facility with no borrowings outstanding. Reported long-term debt was $1,953.0 million, excluding the current portion.
- In August 2017, Lear issued $750 million of 3.8% senior notes due 2027, redeemed its $500 million 2023 notes and entered into a new $1.75 billion revolving facility plus a $250 million term loan, both maturing in 2022.
- Management stated that cash, operating cash flow and available revolver capacity were sufficient to meet ordinary-course obligations, dividends and authorized share repurchases. Lear was in compliance with debt covenants at September 30, 2017.
Material changes versus the prior comparable period
- Revenue growth was driven by new business, the Antolin Seating acquisition and favorable foreign exchange, partly offset by lower production volumes on key North American platforms.
- Antolin Seating was acquired on April 28, 2017 for $291.5 million, including contingent consideration. The business had approximately $370 million of annual sales and was included in the Seating segment from the acquisition date.
- Lear gained control of Shanghai Lear STEC in September 2017, consolidated the affiliate and recorded a $54.2 million gain from remeasuring its prior equity interest. A 45% redeemable noncontrolling interest of $147.7 million was recorded.
- Gross margin remained 11.4% for the nine-month period but declined to 11.2% in Q3. Favorable operating performance and restructuring benefits were offset by customer price reductions, foreign exchange and lower production volumes.
- Restructuring charges were $48.6 million in the first nine months, and approximately $36 million of additional costs were expected for activities initiated through September 30, 2017.
- Shares repurchased during the first nine months totaled $332.2 million; remaining authorization was $667.8 million. Quarterly dividends increased to $0.50 per share from $0.30 in the comparable 2016 periods.
Guidance, outlook, commentary and risks
- The filing does not provide a clear full-year revenue or earnings guidance figure. Management estimated 2017 capital expenditures at approximately $585 million and expected pension contributions of approximately $10 million to $15 million.
- Management highlighted long-term opportunities from increased vehicle content, connectivity, safety, efficiency, electrification, autonomous driving and growth in Asia.
- Approximately $300 million of excess foreign tax credits at certain foreign subsidiaries could be recognized in the fourth quarter of 2017 if foreign earnings are repatriated; the filing states that recognizing all or a substantial portion was likely.
- Reported earnings included a $54.2 million affiliate-consolidation gain, a $21.2 million debt-extinguishment loss, restructuring and acquisition-related costs, and substantial tax benefits. These items reduce comparability with the prior period.
- Key risks include global vehicle production levels, platform and customer concentration, customer-imposed price reductions, raw-material and commodity costs, supplier disruptions, labor issues, foreign exchange, customer and supplier financial condition, product liability and recalls, restructuring execution, cybersecurity, legal and environmental matters, tax valuation allowances and access to capital.
- Recorded reserves at September 30, 2017 included $8.7 million for legal disputes, $49.1 million for product liability and warranty claims and $9.0 million for environmental matters. The company stated that ultimate outcomes remain uncertain.
- Antolin Seating was excluded from management’s internal-control evaluation as permitted by SEC rules while integration continued; it represented approximately 4% of total assets and 2% of Q3 net sales.
Important facts for investors to verify
- Whether the $54 million affiliate gain, tax benefits and debt-refinancing effects are excluded when assessing underlying earnings quality.
- Progress, cash cost and expected benefits from restructuring, including the approximately $36 million of remaining expected costs.
- Integration and performance of Antolin Seating and Shanghai Lear STEC, including the valuation and redemption terms of the redeemable noncontrolling interest.
- Actual vehicle production volumes, customer pricing, launch execution and performance of key North American platforms.
- Capital allocation decisions regarding the remaining $667.8 million repurchase authorization, $0.50 quarterly dividend and approximately $585 million capital-spending estimate.
- Liquidity, leverage and covenant headroom after the 2027 notes issuance and new credit agreement.
- Fourth-quarter tax outcomes, including potential recognition of approximately $300 million of foreign tax credits.