Earnings Call Transcript - LEA Q1 2023

Operator, Operator

Good morning, everyone, and welcome to the Lear Corporation First Quarter 2023 Earnings Conference Call. Please note that today's event is being recorded. I would now like to turn it over to Ed Lowenfeld, Vice President of Investor Relations. Please proceed.

Ed Lowenfeld, Vice President, Investor Relations

Thanks, Jamie. Good morning, everyone, and thank you for joining us for Lear's first quarter 2023 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 up 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 first 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.

Raymond Scott, President and CEO

Thanks, Ed. Please look at Slide 5, which shows key financial metrics for the first quarter. Lear had a strong start to the year, achieving notable increases in both revenue and earnings compared to last year. Sales rose by 12% to $5.8 billion, while core operating earnings surged by 43% to $263 million. Adjusted earnings per share climbed 54% to $2.78. Slide 6 outlines the key highlights from the quarter. Both our Seating and E-Systems segments experienced significant growth in the market and improved margins compared to last year. In Seating, we are pleased to announce that the Conquest award mentioned in our previous earnings call pertains to the Wagoneer and Grand Wagoneer. We will be producing complete seats and key thermal components for these vehicles, with production set to start later this year. This Conquest award exemplifies Lear's excellent reputation for quality, operational excellence, and product execution, as we strengthen our partnership with Stellantis. In E-Systems, we are gaining traction in electrification with additional awards for two of our innovative products. Stellantis acknowledged our advanced technical capabilities as the leading supplier of high-performance battery disconnect units, choosing Lear to provide the BDU for a new electric vehicle. We are also growing our Intercell connect board backlog thanks to additional volumes awarded by General Motors for their Ultium Battery platform. Our customers continue to recognize Lear for its innovative technology and quality. For the sixth consecutive year, we have been named a supplier of the year by General Motors. I am thrilled that we have completed the acquisition of IGB, which will significantly contribute to the expansion of our Thermal Comfort Systems business, enhancing our market share and margins in Seating. I appreciate everyone who helped make this transaction possible. It took a lot of hard work and time to finalize this deal, and I am proud to welcome the IGB team to the Lear family. Slide 7 provides a business profile of IGB and highlights the advantages of the acquisition. IGB introduces new technologies to Lear, including active cooling, steering wheel heating, and occupant detection sensors. This acquisition also complements the capabilities we gained from Kongsberg and adds scale to our growing Thermal Comfort Systems business. IGB has a well-diversified customer base, which includes many of the world’s largest global OEMs. This acquisition is a crucial part of our comprehensive thermal comfort strategy to reinforce Lear's leadership as the most vertically integrated automotive seat supplier, boost our market share, and further enhance our industry-leading margin and return profiles. Lear is uniquely positioned to complete incomplete seats and offer complete thermal comfort systems capabilities. These distinctive capabilities will transform the thermal comfort systems market by creating innovative designs that enhance performance, efficiency, and comfort while lowering weight and costs. On Slide 8, I will explain the evolution of our thermal comfort systems product strategy. Currently, many OEMs design and source each thermal component separately and then combine them by layering them. Many of these features depend on redundant subcomponents, leading to an increased number of parts and requiring more space for packaging. The Kongsberg and IGB acquisitions, along with our internal advancements over the past decade in seating, provide us with a broad capability to improve this model. Our teams are focusing on best practices from the combined organization to boost efficiency and flexibility in our manufacturing operations. Following the Kongsberg acquisition, our team has been diligently working to create more efficient thermal comfort modules by merging common functions across various components. For example, we are developing a system that combines ventilation with lumbar and massage modules. We are also innovating solutions that position thermal comfort components closer to the occupant by integrating them directly into the trim covers. This integration will enhance the performance of thermal comfort systems, speeding up the sensation for the occupant, and reducing packaging size within the seat, allowing better integration of these elements into the rear seats. Another product in development is FlexAir, a foam alternative that is 100% recyclable and reduces CO2 emissions by up to 50% and mass by up to 20% compared to conventional foam. Our customers are increasingly recognizing these innovations. Currently, we are working on 15 development projects across 41 different car lines with seven OEMs for various thermal comfort systems. Recognizing the benefits of more efficient thermal comfort systems, our customers are granting sourcing control of these products to Lear. As the unique JIT supplier with these capabilities, this control is exclusive to us, giving us a competitive edge in the market and enabling us to deliver higher-performing and more efficient solutions. The final phase of our strategy is to merge our modular component solutions with our FlexAir foam alternative and trim cover capabilities to create a fully integrated seat module by incorporating all thermal comfort elements into an efficient modular design. This will lead to significant part reduction and weight savings, while improving the comfort for the occupant. These advancements will also reduce costs for our customers in thermal comfort systems and enhance the overall value for Lear Corporation. Slide 9 presents a pro forma outlook for our combined thermal comfort portfolio. The addition of the IGB product line strengthens our market position in key thermal comfort categories, and we project a top three market position for each major product. Pro forma revenue for the combined Thermal Comfort Systems business in 2022 is estimated at $550 million, expected to grow to around $800 million by 2027. This growth will stem from a combination of industry trends and innovation. The overall thermal comfort market is predicted to expand over two percentage points faster than vehicle production. With enhanced packaging, improved performance, and lower costs, we are confident that the market will grow more rapidly as take rates increase and these products spread beyond luxury segments into rear seat applications. Traditionally, sourcing control for thermal comfort components was about 30% of JIT programs. Given our enhanced capabilities, our opportunity for directing this sourcing is increasing, as seven major customers have granted us 100% sourcing control for future thermal comfort systems. This unique competitive leverage allows us to offer a superior value proposition to our customers, unmatched by competitors. Looking ahead, we believe that our thermal comfort system strategy not only positions us for higher market share but also has the potential to increase our overall seating profitability beyond our current margin target of 7.5% to 8.5%. On Slide 10, I will showcase some notable business awards from the first quarter. The Conquest win for the Wagoneer and Grand Wagoneer represents a significant program included in our three-year backlog disclosed in February. We also secured an award for seats on a second program set to launch in late 2024, with combined revenue estimates for both programs reaching about $600 million by 2027. Since 2019, we have won $2 billion in Conquest awards. It's substantial, and with our robust pipeline of Conquest opportunities, we expect this momentum to persist, leading to further market share gains. In E-Systems, we are continually winning awards in electrification, high-voltage and low-voltage wiring, as well as various EV platforms. The pace of new business wins in E-Systems this year significantly surpasses where we were last year at this time. Just last week, we were awarded the BDU for the new Stellantis electric vehicle, reinforcing our position as a leader in high-performance BDUs. Additionally, the volume increase awarded by General Motors for the ICB further demonstrates their confidence in our technical expertise and escalates the value of our program. Our expected revenue for 2025 on this platform has risen to a range of $50 million to over $100 million, up from the initially anticipated $150 million; we now project peak revenue to reach $250 million. Now I would like to hand the call over to Jason for a financial review.

Jason Cardew, Senior Vice President and CFO

Thank you, Ray. Slide 12 shows vehicle production and key exchange rates for the first quarter. Global production increased 6% compared to the same period last year and was up 8% on a Lear sales weighted basis. Production volumes increased by 10% in North America and by 17% in Europe, while volumes in China were down 8%. The dollar strengthened against both the euro and RMB. Slide 13 highlights Lear's growth over market. For the first quarter, total company growth over market was 6 percentage points, driven by favorable platform mix and the impact of new business in both segments, with Seating growing 6 points above market and E-Systems growing 4 points above market. Growth over market was particularly strong in Europe and in China. In Europe, sales outperformed industry production by 12 points, with both business segments benefiting from higher volumes on the Land Rover, Range Rover and Defender. New programs such as the BMW 7 Series in Seating and new wiring and electronics content on the Volvo XC40 and XC40 Recharge in E-Systems contributed to the strong growth in the region as well. In China, growth over market of 8 points resulted from strong production on the Mercedes C-Class and E-Class in Seating and the Volvo XC40 and XC40 Recharge in E-Systems. Our North America business lagged industry growth estimates by 1 percentage point. This was driven by unfavorable platform changes primarily related to the changeover of the Ford Escape in E-Systems, which was partially offset by the benefit of new business. Turning to Slide 14. I will highlight our financial results for the first quarter of 2023. Sales increased 12% year-over-year to $5.8 billion. Excluding the impact of foreign exchange, commodities and acquisitions, sales were up by 14%, reflecting increased production on key Lear platforms and the addition of new business. Core operating earnings were $263 million compared to $184 million last year. The increase in earnings resulted from the impact of higher production on their platforms and the addition of new business, partially offset by the impact from foreign exchange. Adjusted earnings per share improved significantly to $2.78 as compared to $1.80 a year ago. First quarter operating cash flow was a use of $36 million. Operating cash flow was negatively impacted in the quarter by the timing the customers received as compared to last year and a significant increase in sales late in the quarter. Our outlook for full year operating and free cash flow is unchanged. Slide 15 explains the variance in sales and adjusted operating margins in the Seating segment. Sales for the first quarter were $4.5 billion, an increase of $540 million or 14% from 2022, driven primarily by an increase in volumes on Lear platforms and our strong backlog. Excluding the impact of commodities, foreign exchange and acquisitions, sales were up 15%. Core operating earnings improved to $300 million, up $83 million or 38% from 2022, with adjusted operating margins of 6.7%. The improvement in margins reflected higher volumes on their platforms and an improvement in commodity costs, partially offset by higher engineering spending and launch costs to support our strong new business backlog and recent Conquest awards as well as the impact of foreign exchange and acquisitions. Slide 16 explains the variance in sales and adjusted operating margins in the E-Systems segment. Sales for the first quarter were $1.4 billion, an increase of $97 million or 8% from 2022. Excluding the impact of foreign exchange and commodities, sales were up 12%, driven primarily by higher volumes on key platforms and our new business backlog. Core operating earnings improved to $49 million or 3.5% of sales compared to $42 million and 3.2% of sales in 2022. The improvement in margins reflected higher volumes on Lear platforms and our margin-accretive backlog, partially offset by higher commodity costs, net of customer recovery, the impact of foreign exchange and elevated launch costs. Moving to Slide 17. We highlight our strong balance sheet and liquidity profile, a major competitive advantage for Lear in a rising interest rate environment. The acquisition of IGB will be financed with the 3-year fully prepayable term loan. We do not have any near-term outstanding debt maturities. Our earliest bond maturity is in 2027, and our debt structure has a weighted average life of approximately 14 years. Our cost of debt is low, averaging approximately 4%. In addition, we had $2.9 billion of available liquidity. We remain committed to returning excess cash to our shareholders, having repurchased $25 million worth of stock in the first quarter, along with our quarterly dividend. Our current share repurchase authorization has approximately $1.2 billion remaining, which allows us to repurchase shares through the end of 2024. Now turning to Slide 18. This slide highlights the key factors that will impact our financial outlook. While our first quarter results were strong, and industry production volumes are continuing to recover, there is still uncertainty around the pace of the recovery and overall global macro environment. As a result, we are not changing our full year outlook at this time. We expect a modest improvement in industry production levels this year, while remaining well below prior peak levels. We expect a gradual but sustained recovery stretching into 2024 and beyond. The outlook for commodity cost is somewhat mixed. While we did see a significant reduction in steel prices late last year, prices in North America have since rebounded. We are seeing some moderation in select chemical commodity prices as well as freight and logistics costs, but are also experiencing higher component costs as our supply base contends with higher labor costs. On the positive side, we expect to largely offset the headwinds we're facing through improved operating performance and negotiated sharing agreements with our customers. In addition, we're benefiting from resilient demand on luxury vehicles and other key platforms as well as our margin-accretive backlog. As we weigh these risks and opportunities, we continue to take aggressive steps to improve our competitive position and financial performance. We also continue to make significant progress through our Lear Forward initiatives, including aggressive steps to improve capacity utilization and working capital management and remain on track to meet or exceed our $50 million savings target for the year. These performance improvement actions, coupled with strategic investments in key products such as thermal comfort systems and high-voltage connection systems, have positioned both businesses for sustained revenue growth and margin expansion. Now I'll turn it back to Ray for some closing thoughts.

Raymond Scott, President and CEO

Thanks, Jason. Please turn to Slide 20. The first quarter was a great start to the year. Both business segments saw year-over-year margin growth, with strong growth over market. Our Lear Forward plan continues to yield results. The team has identified and implemented actions that will reduce costs and improve operating cash flow. We continue to win business in both Seating and E-Systems, and our pipeline of new opportunities is very strong. Closing the IGB transaction was the final piece required to solidify our thermal comfort systems strategy. With this completed, we are looking forward to giving you a comprehensive update of our Seating business, with a particular focus on thermal comfort on June 27. We'll be hosting a Seating Product Day on Lear Campus in Southfield, Michigan. We look forward to seeing many of you in person. In closing, I want to thank the Lear team for their tireless efforts that resulted in another strong quarter. I firmly believe we have the best team in the industry, and I am proud to work with you each and every day. Now we'd be happy to take your questions.

Operator, Operator

Our first question comes from John Murphy from Bank of America.

John Murphy, Analyst

Maybe just to ask one simple one first, just on scheduled stabilization. I'm just wondering if you could kind of highlight how much they've stabilized in the first quarter, how much sort of the disruption caused to you last year and what do you expect to not reoccur this year?

Raymond Scott, President and CEO

This year is significantly better than last year. We've gained more stability in production from our customers, allowing us to plan more effectively for any potential downtime. This increased clarity improves our internal efficiency as we navigate the production environment. Although there have still been some short-notice issues, the overall situation is much improved compared to last year, particularly in terms of financial strength. Jason, do you have anything to add?

Jason Cardew, Senior Vice President and CFO

Yes, we did not observe a significant premium cost for the quarter, and it has improved compared to the previous year. We have experienced a steady enhancement, especially when comparing the first half of last year to the second half and again in the first quarter. As Ray pointed out, we are still facing some premium costs and encountering intermittent production from our customers. Additionally, there are challenges with new programs our customers are implementing and issues within our supply chain, which slightly impacts the conversion rates reflected in our backlog volume. However, these challenges are considerably less significant compared to what we dealt with over the past two years.

John Murphy, Analyst

I have a second question regarding the IGB acquisition. Is there a greater opportunity for content with electric vehicles compared to what you currently offer with internal combustion engines, particularly concerning the in-seat HVAC systems? Additionally, I would like to clarify a point you made about CD margins. You mentioned a target range of 7.5% to 8.5%, and I understand there might be potential for that to exceed 7.5% to 8.5% due to IGB. Could you confirm that?

Raymond Scott, President and CEO

I'm really excited to discuss this, John. Today is a significant moment for Lear Corporation, as we've been working towards this for a decade. Recently, our team reviewed the inefficiencies found in seat design over these ten years. We are focusing on how we can redesign and package priceable features within seats for improved efficiency, cost, mass, and weight. These aspects are especially important to our customers in the electric vehicle sector due to the impact on battery consumption and the synergy with HVAC systems in the seats. We're confident we can incorporate this improved packaging across a variety of seat types, not just in luxury vehicles but also in more mid-range offerings, supporting a more efficient system overall. In the short term, we are progressing through three phases, starting with leveraging our purchasing power and optimizing how we scale with our manufacturing capabilities concerning traditional parts. We have a strong partnership with our suppliers, and both companies bring valuable strengths to our operations. Additionally, we are well-protected with nearly 400 patents related to our new modular component designs, which we believe will foster growth. These components are also beneficial to our margins. Our primary goal is to provide our customers with a compelling value proposition while simultaneously enhancing our margins, which is the cornerstone of our strategy. The progression of these goals is highlighted by our acquisition of IGB, along with the successful acquisition of Kongsberg, putting us in a strong position to enhance our offerings in the seat system.

Jason Cardew, Senior Vice President and CFO

Yes. The only thing I would add, Ray, to what was important about IGB, it brought steering wheel heat and panel heating, which I think also plays an important role as you think about reducing the use of the HVAC and the impact on the battery and shifting that to other parts of the interior that are more efficient for heating and cooling the occupant. So that's important additional product capabilities that we were after with IGB.

Raymond Scott, President and CEO

John, we discussed the upcoming Investor Day. While we can't share too much publicly for competitive reasons, we're excited about the transformational changes we've made to our components. Once we present these changes to customers, it's clear they will be well received. It's unusual for us to have complete control over sourcing for these programs, but we're achieving that due to our recent acquisitions, our capabilities, and our vision for creating value. At Investor Day, we look forward to sharing more about our decade-long efforts to enhance the seat system and our belief that the market, valued between $2.5 billion and $3 billion, can expand rapidly when we offer a system that delivers significant value to our customers.

John Murphy, Analyst

And if I could just sneak one more in on the IGB Intercell connect boards. You seem like you're winning more and more on the Ultium platform. I mean that is a platform. So I'm just curious, when you think about that, how much share do you have on that Ultium platform as far as you can tell on what you've won so far? I mean, is that being dual-sourced? Or are you sole-sourced on that? What's the story there?

Raymond Scott, President and CEO

It's still sourced today, and we have a strong position with General Motors on that particular component, yes, 50%.

Operator, Operator

And our next question comes from Rod Lache from Wolfe Research.

Rod Lache, Analyst

I had a couple of questions. Currently, the E-Systems margins are at 3.5%, but you had projected 4.5% for the year. Could you provide some insights on what changes we might expect moving forward and your thoughts on incremental margins? Does your guidance still stand? The exit rate would obviously need to be significantly higher to achieve that average. Additionally, regarding Seating, is it typical for incremental margins on new business to be around the mid-6s, or should we draw different conclusions from that?

Jason Cardew, Senior Vice President and CFO

I'll start with the second part of the question first, Rod. So Seating backlog has been rolling out in the 8% to 10% range. And I think if you look out over the next couple of years, we would anticipate that, that's about the rate it would roll on. Sometimes, you have a blip in a quarter where you have a mix of what has rolled off versus what's rolled on. But it's generally in that 8% to 10% range is what we're seeing. In terms of E-Systems margins, you're right. We do expect to see higher margins in the second half of the year than the first half of the year, so at 3.5% here in the first quarter. If we look out in the second quarter, the midpoint of our guidance, we would expect similar margins, maybe slightly higher in E-Systems in the second quarter, which means the second half needs to be roughly 5.5%. There's a number of catalysts to that. One, our launch costs in the first half of the year are much higher than they will be in the second half of the year. We're going through not just launching the backlog, but we had significant new program changeovers. So the Ford Escape, which we had referenced in the prepared remarks, but also the Colorado Canyon with GM is a big program for E-Systems. So those 2 programs, we had a significant investment in launch costs in the beginning part of the year, and that will be less in the second half of the year. In addition to that, we're in deep discussions, negotiations with our customers on commodity and inflation recovery. We did a nice job in the quarter, but we have a lot of work to do there. And we're confident that we'll achieve the assumptions that we've outlined for commodities in E-Systems for the full year. In addition to that, you have your normal seasonality. And so you had the LTA agreements that are contractual that we approved in the first part of the year, first quarter, second quarter that get negotiated throughout the year and then offset through our own cost reduction actions, restructuring actions, normal plant efficiencies, purchase savings with our supply base. And as is typically the case, particularly in E-Systems, you see that stuff sort of layered on throughout the year. And those things taken together, we believe, get us to about 5.5% for the second half of the year. And I would say the range is 5.5% to 6% in the fourth quarter, maybe even a little bit beyond that as we exit the year in E-Systems.

Rod Lache, Analyst

I didn't fully grasp the balance of the positive and negative factors you're discussing regarding commodities. Could you clarify that? It seems there's some caution in your tone, which isn't unexpected given the macro environment. Earlier in the year, you suggested the possibility of reaching the higher end of your guidance range. Are you noticing any changes in customer schedules or product mix that could be influencing that, or is it simply a matter of being cautious?

Jason Cardew, Senior Vice President and CFO

I would describe the current situation as one of caution and conservatism. There have been no changes since I addressed an investor conference earlier this quarter. If the conditions from the first quarter persist for the rest of the year, and we experience no significant decline in demand that affects production, nor disruptions arising from labor negotiations in the U.S. and Canada, then we anticipate revenue reaching the upper end of our guidance range, or possibly slightly exceeding it. Specifically, we are maintaining a conservative assumption for foreign exchange rates, projecting an average of around $1.05 for the full year, lower than the $1.07 we used in the first quarter. Currently, the average exchange rates from the last five days suggest revenue could be about $300 million higher than what we've factored into our guidance, which would reflect positively on our overall company margins. Regarding commodities, we experienced increased revenue in the first quarter, a trend we expect to continue, as our directed suppliers are raising their prices, with us acting merely as intermediaries. This has generated nearly $200 million in additional revenue without impacting earnings, as our suppliers negotiate directly with our customers. Additionally, we anticipate around $100 million in revenue from pass-through agreements in light of rising component costs, particularly in E-Systems. When considering the impact of commodities and foreign exchange along with the earlier closure of IGB, we project roughly $500 million to $600 million in revenue tailwinds, albeit with limited earnings associated with this. Turning to commodities specifically and how our guidance has adjusted, we lock in steel prices in North America one quarter at a time. Thus, the pricing benefit we experienced in the first quarter was based on fourth-quarter pricing. Now, the second quarter reflects the average prices from the first quarter, which means those costs are rising. We expect this trend to continue into the second half, before dipping again by the fourth quarter. Consequently, the expected benefit from steel has decreased from $30 million to around $20 million, factoring in the unrecovered portion of steel costs. We have seen some favorable trends in chemical costs along with freight and logistics, helping to offset the rising steel prices. However, we are facing pressures on component costs, especially in E-Systems, with insulated wire being particularly challenging. There are notable challenges with suppliers like Leoni, and while we are negotiating cost-sharing pass-through agreements, there is still pressure on pricing.

Rod Lache, Analyst

To clarify, you didn't mention any transactional impact from the foreign exchange considering your peso exposure. Is that fully hedged?

Jason Cardew, Senior Vice President and CFO

For the full year, we're approximately 85% hedged on the peso, and most of our currency pairs are between 60% to 85%. We were slightly less hedged in the first quarter, which had a minor impact. However, we do not foresee a significant issue for the full year at this time. We have a rolling 24-month hedge program and have covered about 40% of that exposure for next year as well, which should provide assistance. Currently, it is not a substantial concern, with an estimated impact of around $10 million for the full year compared to our initial expectations.

Operator, Operator

And our next question comes from Dan Levy from Barclays.

Dan Levy, Analyst

Sorry, I jumped on late, and I know you talked a bit about E-Systems, but maybe you could just address in the quarter the conversion was on volume mix and on backlog, which is meaningfully lower than what you had seen in prior quarters. So maybe you could just get a bit into the conversion on E-Systems within the quarter?

Jason Cardew, Senior Vice President and CFO

Yes. Part of that is the mix of revenue by region. And so in North America, where we tend to have a little higher variable margin profile than in Europe and in Asia. And so given the changeover activity on these key platforms like the Ford Escape and the GM Colorado Canyon, it's a pickup program. So revenue was down on those and up on our European programs and a little bit in Asia. And so that's really the driver, the sort of mix of program by region. Backlog, as we look out for the balance of the year, we expect that to continue to roll on sort of in the 10% range in E-Systems. So we feel pretty good about how the backlog is rolling on. And you can see that as continuing to be accretive to margins in E-Systems.

Dan Levy, Analyst

Understood. And then just as a follow-up, I know you said that for commodities, you're now assuming $20 million for the year versus the prior outlook $30 million tailwind. Maybe you could just remind us, within that number, what you're assuming on recoveries for non-raw material items, be it maybe some of the pass-through components, which you said you're seeing some recoveries there or freight or most notably labor on Europe. Are you assuming within that recoveries for labor where I know you had assumed that there was going to be some wage inflation on your side?

Jason Cardew, Senior Vice President and CFO

Yes. At this point, we want to be cautious about that for competitive reasons, but we are in discussions with our customer regarding labor. In both of our business segments, we often work with models used by our customers, which include labor rate inputs. This has opened the door for us to communicate with our customers. There is a certain level of wage inflation that we must manage each year, and we typically offset it through productivity. However, we are particularly concerned about the extraordinary wage inflation in places like Mexico, where wage costs have significantly increased. Regarding component cost increases and recovery, we expect to recover between 90% and 95% of those costs within the year, which we don't foresee becoming a major challenge. On the seating side, we anticipate nearly 100% recovery since most of those costs involve direct components, with our customer negotiating directly with suppliers. For E-Systems, where there is less direction and more negotiations are required, we still expect to see a high level of recovery this year.

Dan Levy, Analyst

And can you just clarify within the $20 million if there's a gross number on that or that's the net there a gross number?

Jason Cardew, Senior Vice President and CFO

Our gross impact for this year that we're estimating at this point is about $200 million.

Operator, Operator

And our next question comes from James Picariello from BNP Paribas.

James Picariello, Analyst

So on the E-Systems' commodities and component sourcing headwind, the $5 million or $6 million headwind for the quarter, can you just confirm what does that impact look like through the rest of the year for E-Systems?

Jason Cardew, Senior Vice President and CFO

Yes. We anticipate a slightly lower impact for the remainder of the year compared to the first quarter. The first and second quarters should be fairly similar, with more recovery expected in the latter half of the year. Overall, we do not foresee it reaching $25 million for the full year. If we project based on the $6 million, we expect it to be lower, benefiting from recovery in the second half.

James Picariello, Analyst

Right. And there's some associated recovery tied to the lessening effect in the second half. Or is this just expectation on pricing?

Jason Cardew, Senior Vice President and CFO

It's the recovery that drives the difference between the first half and the second half. Yes, I believe we still have some adjustments to make regarding the purchase accounting, which might result in a minor change. However, we anticipate that the margins in thermal comfort will roughly break even this year. We are currently undergoing some restructuring. Ray mentioned the purchasing synergies, and we are identifying opportunities in that area. We expect the combined business to be profitable next year. Initially, we had planned for it to positively impact seat margins in 2024, and we still expect that to occur likely in the latter half or towards the end of 2024 due to delays in securing the IGB regulatory approval and completing the closing process. When we refer to 2024 as being beneficial, we initially assumed it would be a full year under our management, but it is now four months later than that. We continue to believe this business will enhance seat margins, and we expect contribution margins to be comparable to seating or slightly higher, around the 20% to 25% range on certain programs. Over time, as we focus on this business, the effect on seat margins will grow, potentially raising them to the 7.5% to 8.5% range or beyond. We will share more specific details during the Investor Day in June, and we look forward to discussing it further at that time.

Operator, Operator

And our final question today comes from Emmanuel Rosner from Deutsche Bank.

Emmanuel Rosner, Analyst

I was hoping to put maybe a final point on your outlook and, I guess, what's assumed in there. Q1 played out, I guess, a bit better than expected, and then you were even improving back in March. But now based on the unchanged outlook, you'd be basically assuming some sequential deterioration in profit at midpoint or maybe sort of like stable versus the first quarter at the high end, and that's despite obviously improving margins in E-Systems, for example. So can you maybe just holistically talk about how you see sort of the rest of the year play out? Where are the areas of caution that would essentially keep you, I guess, a bit more cautious now?

Jason Cardew, Senior Vice President and CFO

Yes. The caution revolves around our assumptions regarding production volume, which we are reasonably confident about, as well as other influencing factors. By maintaining our full-year outlook after a strong first quarter, it implies that the second quarter may see a decline of about 2.5%. Industry volumes are down approximately 2.5% in the second quarter compared to the first quarter, and there are fewer working days in Europe and North America, which aligns with our expectations. This suggests a revenue decrease of $125 million to $200 million compared to the first quarter. If this trend continues, it indicates a significant contingency regarding production volumes for the latter half of the year, suggesting lower revenues then. It is still early, and many geopolitical and macroeconomic variables are at play. We felt it was wise to maintain our stance for now. However, if conditions mirror those of the first quarter, we would certainly consider adjusting our outlook in the second quarter earnings call.

Emmanuel Rosner, Analyst

Understood. I have a follow-up regarding E-Systems. Based on your outlook, it seems that achieving around 5.5% margins in the second half requires significant upside to meet your midterm targets. As we consider the period beyond the second half or the exit rates for the fourth quarter, is the primary factor for improvement simply increasing revenues and operating leverage? Or are there other significant elements that will contribute to your midterm expectations?

Jason Cardew, Senior Vice President and CFO

Yes. We talked about this, I think, on the fourth quarter earnings call. And certainly in other settings, we've described sort of that bridge from 4.5% this year to 8% in 2025. So you can look at it two different ways. One way is just looking at sort of volume and backlog. We see that as 250 basis points of the improvement from '23 to '25, and then 100 basis points of net performance. So this year, net performance is sort of negligible in both segments. We see it as 50 basis points positive in '24 and '25 through a combination of lower inflation, some continued success in passing through higher commodity costs and just fully realizing the benefits of our restructuring program and other cost reduction initiatives without that added weight of extraordinarily high wage inflation that we saw this year. Another way to look and to think about the E-Systems progression from '23 to '25, if you look at it by business segment, we talked about 100 basis points of the improvement being driven by the growth in connection systems. And certainly, this additional volume with GM on the Intercell connect board helps there. So we had previously expected $285 million of additional revenue there. It's going to be a little bit more than that now with the additional volume awarded on that platform. That's 100 basis points. If you look at our core electronics and what we're doing with that business, we see 125 basis points of margin growth over that 2-year time period in electronics, and then that sort of leaves 125 basis points for the wire business, which is a combination of net performance and stronger volumes.

Operator, Operator

And our next question comes from Colin Langan from Wells Fargo.

Colin Langan, Analyst

I just wanted to clarify something. Did you say there's a $200 million gross commodity headwind, but you still expect a net positive of $20 million? I'm a bit confused because I thought in 2021, there was around $450 million and you netted $185 million. Did I misunderstand? Also, what makes you confident that you can achieve that level of recovery compared to the past? Are the contracts different now due to the changes over the last couple of years?

Jason Cardew, Senior Vice President and CFO

Well, part of it is the lag effect. So you're seeing some recovery in the first part of this year, for example, that relates to higher steel costs that existed last year. And so there's a bit of a lag benefit that we're seeing. And the balance of it really is we've worked hard to get as many of our components on an indexed agreement as we can to try and kind of insulate us from that risk. And so as there are changes that take place, that makes a little bit more straightforward to pass it through. It doesn't make it easy looking at kind of Frank has certainly a ton of work by the team in both business segments. The other big factor, though, and probably the more important factor is that we see about $180 million of directed supplier increases where it's just a one-for-one pass-through. So that's really what's driving the increase, and so there's no impact on OI. So it's 100% pass-through. So it's a little bit misleading from that standpoint. If you go back to what we anticipated at the beginning of the year, we expected the gross impact to be favorable, so $105 million because of what was happening with steel. And so now that has swung all the way in the other direction where we're seeing a gross impact that's unfavorable by $200 million. That's a $300 million change again and with $180 million of that in seating on directed suppliers has just passed through.

Colin Langan, Analyst

Got it. Okay. In the last quarter, you mentioned $85 million in gross labor cost challenges, which is in addition to the $200 million related to the clients not overlapping. Can you provide an update on that? Has most of that already affected you, and are you aiming for recoveries throughout the rest of the year, or is there more expected later this year?

Jason Cardew, Senior Vice President and CFO

The labor inflation on the hourly side mostly began at the start of the year. Some salary programs have different effective dates globally, with some starting in January and others later on. The discussions that began with customers in the first quarter will continue throughout the year. We won't complete everything in the second quarter; it will take time, and some discussions may even extend into next year. This makes for a challenging dialogue with customers. Ultimately, we need to be the most competitive option for them, and we believe we are. Our strong presence in both segments supports our negotiations to gradually pass these additional costs along.

Colin Langan, Analyst

And just one quick follow-up. Where does that fall in the walk? Is that under net performance, if I look at Slide 15 and 16? Because I don't even think there's net performance on 15. So which bucket does that added cost follow?

Jason Cardew, Senior Vice President and CFO

That is in the net performance. You're correct, Colin.

Operator, Operator

And our final question today comes from Adam Jonas from Morgan Stanley.

Unidentified Analyst, Analyst

We're curious if you have noticed any significant change or slowdown in the production or orders for electric vehicles by OEMs this year.

Raymond Scott, President and CEO

We're not seeing that. I mean, across the board. It's still a heavy push from all of our customers on EV, and with some customers even additional capacity and quotes are out for additional volume. So we haven't seen the demand side change at all from our perspective, particularly with the top of the OEMs. So no changes.

Unidentified Analyst, Analyst

Okay. And then a quick follow-up. Can you say that the chip shortage is over now? Or is there still incremental production?

Raymond Scott, President and CEO

A little hesitant to say that. Yes. I'm hesitant. I was engraved in me for a long time. I see that we're in a much better position. What I will tell you is that what we're experienced is they're still at the brokers, there's premium costs that we're trying to negotiate. There might be chips that are available through other outlets that we can get our hands on, but there's still premiums associated with those chips. So that hasn't necessarily dissipated. But I'd say generally, and I think it's all relative to where we were a year ago, we're in a much better position. There's still certain chips that are tougher to get, but I think, holistically, across all chips, we're in a much better position.

Unidentified Analyst, Analyst

Great. Thank you, so much.

Raymond Scott, President and CEO

Yes, thank you. Is that the last one? Okay. I thank Jason, nice job today. Really a nice job and there is a lot of heavy lifting for you. That's a nice job, nice job the team here and I appreciate all the hard work for everyone that's on the phone, the Lear team, incredible quarter. I appreciate all the hard work that you're doing every single day. Really good work. And again, just so I want to welcome the IGB family into the Lear family. We're really excited. I mean, this could be a transformational change for us. We've been working on this for over 10 years. And I think that the 2 very strategic acquisitions of IGB and Kongsberg were complete. We can now move on this thing and Frank can get those margins up. And so let's get to work you guys. I appreciate everything. Thank you.

Operator, Operator

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