Lear Corporation (LEA) Q4 2017 Earnings Report, Transcript and Summary

Good morning. My name is Dan and I'll be your conference operator today. At this time, I would like to welcome everyone to the Fourth Quarter and Full Year 2017 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]. Thank you. I would now like to turn the call over to Joel Elsesser, Vice President, Investor Relations. Please go ahead.

Thanks Dan. Good morning and thank you for joining us for our fourth quarter and full year 2017 earnings call. Our press release was filed this morning with the Securities and Exchange Commission, and the presentation for our call is posted on our web site, lear.com, through the Investor Relations link. Today's presenters are Matt Simoncini, President and CEO; Jeff Vanneste, Chief Financial Officer; and Ray Scott, President of our Seating Division. Also participating on the call are several other members of Lear's leadership team. Before we begin, I'd like to remind you that during the call, we will be making forward-looking statements that are subject to risks and uncertainties. Some of the factors that could impact our results are described in the slide titled, Investor Information, at the beginning of the presentation and also in our SEC filings. We will also be referring to certain non-GAAP financial measures. Additional information regarding these measures can be found in the slides labeled Non-GAAP Financial Information at the end of the presentation. Slide 3 shows the agenda for today's review. Following the formal presentation, we will be pleased to take your questions. Now please turn to slide 4 and I'll turn it over to Matt.

Thanks Joel and good morning. 2017 marked our eighth consecutive year of improving financial performance. We achieved record fourth quarter and full year results in all key financial metrics. Results like this just don't happen. They are the results of strong execution and the significant investments we have made in our business over the last decade. These investments have expanded our global product capabilities, provided an industry leading cost structure and driven superior shareholder returns. At 2017, we delivered a total return to shareholders at 35%. Over the last five years, our total return was approximately 300%, and that's nearly three times that of the S&P 500. Despite a record performance, our shares remain at a discount to the peer group. Now I'd like to turn it over to Jeff to discuss the 2017 results, as well as review our 2018 guidance.

Thanks Matt. Slide 6 shows the financial highlights for the fourth quarter. Our positive momentum continues, with record sales, record core operating earnings and record adjusted earnings per share. Sales grew 16% in the quarter, despite flat global industry production, driven by our record sales backlog, the acquisition of Grupo Antolin's seating business and favorable foreign exchange. Core operating earnings increased 14% to a record $441 million, primarily driven by the addition of new business and operating efficiencies. Slide 7 shows the quarterly results for our two product segments; both segments had double digit sales growth, as we continue to gain market share with 20% growth in our E-Systems segment. Both segments also had strong earnings growth in the quarter. In Seating, adjusted earnings grew by 13%. In E-Systems, adjusted earnings grew by 16%. Margins were down slightly from a year ago, reflecting higher development costs associated with the backlog, our growing business in China, and investments in R&D to support our alternative energy vehicle and connectivity initiatives. Slide 8 highlights our financial results for the full year, where we again achieved records in all key financial metrics. Full year sales, core operating earnings and adjusted earnings per share, all experienced double digit growth compared with 2016. Sales grew by nearly $2 billion or 10% to a record $20.5 billion, driven by our sales backlog and the acquisition of Grupo Antolin's seating business. We generated record free cash flow of $1.2 billion, as we continue to convert a high percentage of our earnings to cash. Slide 9 shows our segment results for the full year. Sales in both segments grew by approximately 10% year-over-year compared to 2% industry production growth, reflecting market share gains and continued content growth. Both segments delivered record earnings and generated returns well in excess of our cost to capital. Slide 10 provides an update on our share repurchase and dividend programs. During the fourth quarter of 2017, we bought approximately 700,000 shares for $122 million, bringing our full year share repurchases to $454 million. As of the end of 2017, we have a remaining share repurchase authorization of $546 million, which expires in December of 2019, and a diluted outstanding share count of 68.1 million shares. Since initiating the share repurchase program in early 2011, we have repurchased 44 million shares of our common stock for a total of $3.5 billion, at an average price of $79 per share. This represents a reduction of 42% of our outstanding shares at the time the program was initiated. We have also increased our dividends each year since 2011. In total, we have returned over $4 billion to shareholders through share repurchases and dividends. Slide 12 shows the key assumptions behind our 2018 guidance. Our vehicle production outlook is based on the January 2018 IHS forecast. Slide 13 provides a summary of the financial outlook, which is unchanged from the guidance we provided at the Deutsche Bank Conference last week. Our 2018 outlook represents another year of record sales, earnings and cash generation. Slide 14 shows our 2018 to 2020 backlog. Our consolidated sales backlog of $3.2 billion is the largest in our history. I would like to take a moment to remind you, how we define backlog, because it is different from all of our competitors. Our backlog reflects only awarded new business, net of any loss business. It does not include any pursuit business, replacement business, or content growth. It's not a wish list, and it's not based on estimated lifetime revenues or bookings. Because our backlog includes only awarded programs, we believe that is a true proxy for future sales growth. For 2019 and 2020, there are still programs that are up for bid, so we fully expect the backlog in those years to grow, as those new programs are awarded. E-Systems accounts for 40% of the backlog, as we continue to increase market share and win new business, aligned with emerging industry trends, especially vehicle electrification and connectivity. Currently, new awards relating to these emerging trends represent approximately $400 million or 30% of our E-Systems backlog, with quoting for new programs increasing rapidly. In addition to our consolidated backlog, we have $700 million in backlog at our non-consolidated joint ventures. Including these new business awards, our total backlog is approximately $4 billion. Now I will turn it back to Matt, who will review our performance over the last several years.

Great. Thanks Jeff. Nice job. As I mentioned in my opening slide, we have been investing in our business for a long time now, and slide 16 highlights the significant investments we have made. Since 2011, we have invested $5.5 billion in our business through capital expenditures, acquisitions and footprint actions. With these improvements, we have established an industry leading product portfolio and low cost footprint, with complete design, engineering and manufacturing capabilities in every automotive producing region in the world. We believe our product capabilities and cost structure, provides Lear with a significant and sustainable competitive advantage. This is how we have been able to increase our operating margins by more than 300 basis points since 2012. Slide 17 summarizes the key acquisitions that we have made over the last six years, to bolster our product capabilities, strengthen our competitiveness, drive sales growth and improve diversification. In Seating, the acquisitions at Guilford Mills and Eagle Ottawa combined with our existing capabilities in cut and sew, foam and structures, enable us to offer unique seat designs to our customers with the highest level of craftsmanship. Grupo Antolin's seating business also strengthened our market share with key customers in Europe and helped bring additional technologies to Lear. Our acquisitions in E-Systems, that position Lear to capitalize on the significant growth opportunities in that segment. Autonet and Arada increased our wireless connectivity capabilities, and EXO Technologies provides us with industry leading accuracy of vehicle positioning for the autonomous and connected vehicle applications. Slide 18 shows the results of the investments we have made in our business over the last several years, and our disciplined approach to the financial returns. Over last five years, our sales have grown three times faster than the industry and our operating earnings have increased at an even faster rate than our sales. Today, we are delivering margins in both of our product segments that generate returns that are well above our cost of capital and superior to any of our direct competitors in these segments. At this level of financial performance, our return on invested capital is amongst the highest of the automotive suppliers. As slide 19 shows, we continue to generate significant free cash flow. Since 2012, we have generated over $4 billion in cumulative free cash flow, with a record $1.2 billion in 2017. Our cash flow yield of 11% is among the best in our peer group, and within the top 10% of all companies in the S&P 500. Based on our strong free cash flow, consistent earnings growth and history of returning cash to shareholders, we have consistently delivered shareholder returns well in excess of our peer group, and as well as the S&P 500. As I previously announced, I will be stepping down as President and CEO on February 28th, and Ray Scott will be my successor. Ray has 30 years of experience with Lear, including several international assignments. He has led both product segments and most recently transformed our seating business into the fastest growing and most profitable seat supplier in the industry. Previously, Ray was instrumental in establishing the turnaround strategy for E-Systems, putting that business on path to record performance it's achieving today, and accelerating sales growth for the future. I can think of no one more qualified to lead Lear going forward. We also have the most experienced and talented senior leadership team in the industry to support Ray, and I am confident, the best days lie in front of this company. And I'd like to turn it over to Ray for a few of his thoughts on our future.

Thanks Matt, and thank you. You truly have left this company in a place where our best days are ahead of us, and I appreciate your great leadership and what you have done for everyone here and for Lear. And as I look to the future, I can tell you one thing, we are going to continue to stay focused. We have the best team in the industry, where we continue to build on that great team. At the core of our business, the DNA of who we are, what has made this company great is our operational excellence. We are going to continue to focus on our operational excellence and continue to invest in building a value proposition for our customer and great efficiencies within our plans. The products that we have setup with innovation technology in both business segments are perfectly aligned with what we see in future growth opportunities; and we will remain diligent and focused on the financial disciplines we have put in place and profitable growth. And when we define profitable growth, we define it with returns in excess of cost of capital. We are going to make sure we are not chasing business just for the sake of growth, but making sure we are getting a fair return for our shareholders. As we enter a time of unprecedented change in opportunity with the trends that we see in our industry, it truly is exciting with how we position ourselves in both business segments. A transition to high contented [ph] crossovers and SUV perfectly aligned with our seating business, and the acceleration in penetration of electrification and connectivity, perfectly aligns with the product portfolio we have built in our E-Systems business. And the continued growth in the investment we have made in Asia and China is going to continue to see growth areas in both business segments. With the team that we have built, the investments that we have made in both two outstanding business segments, we are perfectly positioned for continued profitable growth. We have never been in a stronger competitive position, and I believe the future has never been brighter for the Lear Corporation. I am so excited to lead this great company. And with that, we will take your questions.

[Operator Instructions]. Your first question comes from the line of Itay Michaeli with Citi. Please go ahead.

Great, thanks. Good morning.

Good morning.

Good morning. First Matt, just congratulations. We will certainly miss you and look forward to staying in touch. So congrats on all that you have accomplished. Just two margin questions, if I may; the first on 2018, given the product turnover this year and launches, any sense of how we should think about the cadence of the margins and just the overall business this year? And secondly on margin, given the growth you have forecast this for China in 2022, [indiscernible] understand how would you think about the impact to Lear's long term margins from that kind of change in regional mix?

Yeah, in respect to the first question in the cadence, we are going through some launches, particularly here in North America with our jet [ph] business. So that' 30% or 40% we are seeing a turnover. But as far as the cadence of the margin, we are well positioned, we are much better diversified from the last time we were going through some significant launches, particularly with the large truck. So we are very well balanced. 60% of our total sales are outside of North America and really well balanced with the profitability. So we are well within the target margins that we have given, and on the E-Systems side, we continue to see growth and really, if there is any pressure on the systems side, it is with the growth that we are seeing and support the backlog that we have -- the tremendous backlog that we have in E-Systems, 40% of the record backlog is coming from E-Systems, and the continued expansion within Asia. As far as Asia, I am looking to hit the growth opportunities with the electrification and connectivity. I think the transition in how we have set ourselves up with our manufacturing footprints, we are well established. We have won the best cost bases out there. So I see a very similar margin cadence in Asia too.

Itay, I guess just from a -- sequentially, our margin guidance on seating is low to mid 8s. Margin guidance on E-Systems is low to mid 14s. Other than the seasonality that typically hits us in Q3, I think we will see the margin profile in both segments, kind of generally along that full year guidance in each of the quarters. Not significant changes between one and another.

That's very helpful. And then just two last just quick housekeeping questions; first, do you have the organic revenue growth in the fourth quarter, as well as just what the full year 2017 backlog contribution ended up as?

The backlog for 2017 came in at a little over $1.4 billion, and I think with respect to the organic growth, our growth between 2016 and 2017 was about $1 billion, $1.4 billion and we probably had organic growth of probably $1.2 billion.

Got you. Okay, great. Thanks. That's very helpful.

Your next question comes from the line of John Murphy with Bank of America Merrill Lynch. Please go ahead.

Good morning guys. And at the risk of being repetitive, Matt, we will very much miss you and look forward to catch up. Maybe we can grab a beer at Millers, maybe next time I am in Detroit. That would be lot of fun.

You got to buy, because you got accelerating on Lear.

I know. And there is two things that we agree on, and the stock is one. So I look forward to catching on and staying in touch.

Thanks.

Maybe just -- first, kind of stay on sort of Itay's margin question. Jeff, you kind of mentioned as you are going through, I think it was slide 9, that there were sort of higher development R&D and costs in China, that weighed a little bit on margins in the quarter. Is that the kind of thing that you think is just kind of ongoing, sort of necessary costs of driving the business going forward, and is there any way to sort of dimension what sounds like, slight headwinds in the quarter on margins, that you did a good job of offsetting. But just curious what those -- sort of the magnitude of those were?

Yeah, we talked about that a little bit, John, as you recall in the Deutsche Bank, as it relates to 2018 and the costs specifically in E-Systems to support the larger backlog and then, as the mix of that backlog, the electrification and connectivity programs. I think we will see that for certainly 2018, and the impact on margins, I'd put it in the 20 basis zip code, not significant, and I think we can still hold that 14 to 14.5 margin profile, even despite those additional investment costs.

I mean, and this is the kind of stuff, that it's necessary to drive the business for R&D going forward, so it's not like it's going to all of a sudden drop off, I mean, it's going to be a constant investment in the business?

I think you will get some leverage on that spend over time, given the --

Got it. And then a second question, I mean, structures and mechanism seems to be a hot or a not so hot topic in one of your big competitors. I am just curious on your view of what's going on in the market, how you are sourcing -- in particular, sort of what you are seeing on the raw material side, in addition to steel, maybe on foam and resins?

Yeah on the commodity side, we have got some headwinds. It's not significant. On the structure side specifically, we have talked about structures as a capability that we haven't gone out and aggressively growing, but we are growing it with an intention to making sure it's a profitable business and we can manage it. We believe that there is got to be, and we have to have some capabilities. But a very manageable business. And our structures business is solidly profitable today. We have more work to do in regions. I think [indiscernible] from a return standpoint, but we are in a good position with structures. We have the capabilities and the competencies that we need, to continue to grow the overall business. But we don't have any major issues, in respect to what some of our competitors are dealing with.

And I think John, we have said this before and just maybe round out the steel question. About 90% of our steel requirement is either directed by the customer or bought by us in a fabricated form. So our exposure is really only relegated to that remaining 10%. That said, yeah, we did see some steel pressures, slightly in the quarter, and I think overall, as you look at steel, it's probably more of a headwind in 2018. But its encapsulated in our guidance.

Okay. And then just lastly, I mean, Eagle Ottawa was something that looked like a good acquisition, that kind of shot the lights out. So it looks, in retrospect to be -- have been a fantastic acquisition. You just made the acquisitions of Arada and Autonet and a number of other smaller acquisitions. I mean, is there anything in that portfolio of acquisitions that you have executed on or that you see in the future, that may really shoot the gap, kind of like Eagle Ottawa has, and really surprise two to five years out, as something that was just really a spectacular acquisition that we just are missing right now?

Yeah, you know we are constantly looking at different kinds of opportunities. Grupo Antolin was a great tuck-in for us from a customer diversification, gave us some great exotic materials and capabilities that we were able to enhance our ability to grow globally. In respect to seating, we produce today -- we are vertically integrated. We are the most vertically integrated company, we could produce up to 85% of our content. So if we were to look in seating, there are opportunities that there is a captive type opportunity in seats that is where the -- particular OE might become available, might make sense for us; or regionally or geographically, how we can continue to accelerate our growth within a particular region like Asia or China. E-Systems, the acquisitions we have had, just continue to create value proposition for our customers, with the most recent one with EXO [ph], our ability from a GPS perspective is to continue to allow us to create connectivity modules that we are developing today for our customers, and we will continue to look in that area. So on both sides, we have the financial flexibility. If an opportunity does come up, you are absolutely right; Eagle Ottawa was a great acquisition and we are constantly looking at any type of opportunities that we continue to accelerate our growth.

Okay. Thank you very much and congratulations Matt. Thanks guys.

Thank you.

Your next question comes from the line of Emmanuel Rosner with Guggenheim. Please go ahead.

Hi, good morning everybody.

Good morning.

So you mentioned the $400 million of E-Systems backlog in electrification and connectivity. Can you please quantify what is the average CPV on some of these program wins, and how that compares with your typical E-Systems CPV?

Well why don't I give it a shot? Frank Orsini is here, who runs E-Systems, he can kind of give a little bit more detail. But to break down the $400 million, two thirds of that was electrification, and so that has really been a growth engine for us. Particularly, breaking it down into China. And so we have a great backlog in new business wins in China and obviously they are one of the leaders when we talk about legislation and change for electrification. The remaining portion of that was connectivity. The CPB, I mean, we -- like I said, we have a product portfolio that ranges from start-stop, all the way to a full EV capability with connectivity continuing to grow within some of the smart modules within the vehicles. And the CPB, Frank, it was a little mild, hybrid is $300 --

Yeah about $300 of incremental content for 48 volt applications. That scales all the way up, manual to about $2,000 worth of content on full EV. So like Ray said, backlog is very strong in these areas, we have had a lot of success in all the regions. With all of our product lines too, we have managed to gain share and improve our backlog in power electronics, high power wire, high power terminals and connectors, all of our product lines are benefitting from this growth trend. So yeah, we are really excited.

I think one point, and the way we look at it too, is one, just the performance and the growth that we have in our backlog. But the amount of quotes that we are getting, in electrification and connectivity. We have seen and it's just a few years ago, which was a minimal amount of quotes. This year, we are looking at $500 million to $700 million of quotes in electrification connectivity. In addition to that, we have had a number of key customers reach out to us, and ask about specific partnerships and how we can really invest in innovation for their future application. And so that increase of awareness -- well, activity from our customer, is a really telling sign of what we are going to be able to deliver in the future.

Okay, that's very helpful. And then I guess when they look at your E-Systems margins for the quarter, some of the factors behind sort of 50 bps of -- down year-over-year, seem to be a lot of the same factors that you are also mentioning for the outlook for 2018. So launch costs, commodities, investments, China. Is there a way for you to break it out for us, in terms of -- if you look at, margin progression in the fourth quarter, how much came from sort of each of these pockets?

Yeah. I think it's -- number one, it's important to note that, E-Systems in the fourth quarter, year-over-year, their earnings were up over 16% year-over-year, a significant improvement in the earnings profile. Some of the factors that influenced margin, we talked a little bit about the investment in R&D on the backlog, and specifically electrification and connectivity. We did have little margin headwinds with respect to copper. Copper had spiked and about 90% of our copper buy is covered. So it's relatively low in terms of the percentage of our buy that's at risk. But we did see a spike in the quarter, 10-ish basis points associated with that. And then you mentioned the China growth, which is a great business for us in China. Margin profile above 10%, a return well in excess of our cost of capital. But taking on that type of 10% plus business, as you look at that segment overall, that's in the 14.5% has a mathematical dilution to margins, albeit it's a great business. So we are happy to have business in China that is north of 10% and improving.

And is that a fundamental function of the structure of the business in China, that it is at these levels, or is there room to bring that up to the segment average over time?

It's more, I mean the mix. I mean, we have got a lot of different things going on. But the expectation is, we are going to move that up -- I mean, more aligned with what we see as far as our target margins.

But I think getting back to the return comment, which is -- it's wire business that we are talking about in China. And wire, by the nature of it, is less capital intensive than some of the other businesses in the E-Systems portfolio. So anything north of 5% margin gets us a return well in excess for cost of capital. So at 10.5%, we are well above that. So it's great business to have in a great region.

Great. Thanks a lot for the color.

Your next question comes from the line of David Tamberrino with Goldman Sachs. Please go ahead.

Great, thank you and congratulations Matt, [indiscernible] at that point. Sticking up to follow-ups from some [indiscernible] earlier in the conversation. On EXO Technologies, I mean, this follows on the back of your V2X and over-the-air update capabilities that were acquired from Arada Systems and Autonet. Can you kind of help us understand what the strategic plan is with these assets, and what incremental capabilities you might need to execute upon your vision?

So the EXO acquisition, we are really excited about it. You are completely in line with exactly what we were trying to accomplish with this. One of our goals has always been to enhance our software capabilities, especially in the area of connectivity; and EXO brought those exact capabilities to us. I will just kind of touch on exactly what we picked up there. But the technology is about very accurate vehicle positioning. The technology is instant, it's accurate and it's everywhere. It's instant, in the sense that the signaling comes into the vehicle much better than anything that's available on the market today. We are averaging about one to two seconds on signal communication versus about 30 seconds in the available technology that's on the market today. Accurate, in that it's 10 centimeters of accuracy where the current market technology is about one meter. That gives you not just road accuracy, but within lane accuracy, which is very unique, and it's something our customers are looking for. And then it's everywhere and that it's satellite based technology, which -- and it's compatible with everything. It's compatible with Europe, Asia and the North American systems. So the algorithms that EXO brings to the table, really round out our connected car strategy, in particular, as you mention with V2X. This puts us right in the sweet spot in enhancing our capabilities in those areas. And as I mentioned, software capabilities are something we are going to continue to take a look at. Vehicle positioning was one of the areas that we wanted to enhance our skills at. We are going to continue to look at wireless communication, signal data management, data prioritization, anything in those areas that will allow us to enhance our connected car strategy, as it relates to V2X, autonomy, any of those areas, are technologies that we are actively pursuing right now in the market, and looking at. But I will tell you, EXO comes with an incredible leadership team as well. We are very fortunate to have picked this up. We are very excited about the technology, and as Ray mentioned, we are quoting on a ton of connectivity business this year, and we do believe this will help position us for future growth.

And on the quotes, I think you said about $700 million earlier -- or $500 million to $700 million. How much of that is really broken down between electrification versus the connectivity business that you are looking at? And what's the margin profile of that software business? I mean, how much more accretive could that be, relative to you know, the overall corporate margins and the e-segment margin itself?

So the breakdown of the quoting activity that we have visibility over today, is about $500 million of it is in electrification, about $200 million of it is in connectivity. As far as the margin profile, we believe it's acquisitions like these that will allow us to continue to maintain the margin profile that we are talking about, while continuing to grow the business. So it's added capabilities that are going to give us opportunities to quoting larger pools of business, and from a margin standpoint, we think it's going to keep us right in this margin segment range that we have been talking about.

Got it. And then, one more different line of question from earlier, just on the electrification side of the business. Obviously, some launch costs, some R&D, you are winning business. What do you think of the margin profile of that electrification revenue is going to be when it begins? At what level do you have to grow it to, from a top line revenue perspective for it to be above corporate average, and when do you see that kind of crossing that threshold? Is it beyond 2020?

Well I will tell you, the business we are winning right now is all profitable business. In many ways, it's in line with our current margins that we have today. We are very disciplined on the growth, no matter what the trend is, whether it's connectivity or electrification. We are making sure that everything we bring in is returning well in excess of our cost to capital.

I think that's important, Frank, is that the way -- and looking at the backlog, the discipline we talk about how we look at business, we look at it with a return on invested capital, by platform, by the program. And so it has to generate the returns, as we are getting in the quote and as we are developing these programs. And so the enhancements we are making, the continued capabilities that we are bringing on, will differentiate our products. But the expectation is, we are still going to be able to deliver the returns on the invested capital that we have set, as far as targets. And the one thing that's important here, and we have talked about this before, is our engineering -- our engineering capabilities. We engineer our own products. 70% of our wiring, we engineer all of our products. And so we have that unique capability to scale unique products for our customers and drive value for our customers. On electronics, we engineer with the software capabilities we have and the product engineers we have. Nearly 100% of our products are engineered by Lear Corporation. So picking up those capabilities, the engineering capabilities are crucial to continuing to grow our business.

Okay, understood. I will pass it along.

Your next question comes from the line of Colin Langan with UBS. Please go ahead.

Oh, great. Thanks for taking my question. I just wanted to follow-up earlier on the structures and mechanisms question. You indicated that you don't major problems, but there is actually some work needed to be done. I mean, is there a structural issue with metals and structure that you see, that makes it much more challenging to get the return on invested capital? And is that part of the reason why you have actually seen it --

Okay, let me -- I mean, to go out and buy business, it creates a problem in the marketplace. And we are not going to do that. So the business that we have is very focused and selective on how we can drive a value proposition for a customer. Structures is a very difficult business, a very capital intensive business. And so, when you overstretch yourself, you don't have the resources, you don't have the manufacturing capabilities. That's a problem that's going to exist for a long time. And so, we want to make sure and I have said this before, this is very strategic, we are very selective on the programs we are going to take with our customers, and it's manageable, so that we can continue to grow profitably.

Okay, thank you for the color. And any color on your naphtha risk? I mean, any sort of framing -- if naphtha were to breakup, how that line impacts to your business?

Yeah. We alluded to this, Colin, as you know, when we presented at the Deutsche Bank Conference. As I said then, the expectations or the desires of the U.S., with respect to having either naphtha content, naphtha vehicles or domestic content in naphtha, [indiscernible] would suggest that there is no vehicle on the road right now, that could meet that level of content. That said, I think we are in a good position if naphtha -- the U.S. does with [indiscernible] naphtha on a couple of different fronts. One, a lot of the business that exists in Mexico today, existed a lifetime before in the U.S. So we have a footprint in the U.S. that could absorb business back, if it made sense. And secondly, and probably more importantly, if the U.S. withdraws from naphtha and we go back to the duty scheme that was in place at that time and see components carry a zero duty with it. With respect to our E-Systems business, wire harness does have a duty attached to it in the 0% to 5% range. So we'd have some exposure there. But given the amount of wire, that exposure is not that significant.

What was that, the zero duty would be on the seating [indiscernible]?

No. The duty would be on the wire harness, and seat components, outside of naphtha, pre-naphtha, the seat and seat components had no duty.

Okay. Thank you for that color. And just lastly, is there any change in the directed sourcing model in seating? I know years ago, there was a lot of concern about OEMs doing a direct thing, and I heard sort of chatter, maybe it's actually shifting back, you are seeing -- getting suppliers --

Shifting back to more directed, shifting back where?

Shifting back to allowing you to do the entire seat and doing subcomponents and some of the OEMs that are more focused on directed?

There is definitely a change. I think it's driven -- there is a lot going on in the auto space today, whether autonomous and electrification, and our customers have limited resources. And the investment that they are putting in and the megatrends that I mentioned, that they are rebalancing and relooking internally, where they need to really direct their engineering resources. And so, there are several customers that we are working with, that are looking at going back to more of a full service supplier. And I think there is the benefit, one from a cost efficiency standpoint that our customers will see, but there is efficiencies that, [indiscernible] is vertically integrated as we are, and being the only seat supplier with both leather and textile, to really establish a well crafted seat that can help them with their brands, we are seeing them open up to ideas, where we come into studios, and assist them with how they really want to project their seats from a brand NIM standpoint. But more importantly, we create a heck of a value proposition for them, when we can integrate all the components together, we can execute at another level. So yes, they are looking at that.

Thank you very much for taking my question.

Your next question comes from the line of Brian Johnson with Barclays. Please go ahead.

Yes, good morning. And Matt, wish you well with your kind of well earned break from the auto industry. Wanted to kind of talk about your execution goals, but also kind of where you think you are strategically focused within that kind of ranges, what structures and metals? Maybe a couple of things, one, what does the industry look like there, and are there good parts and bad parts to given that kind of how have you chosen, where to compete in that? And three, if a competitor were to decide that there were parts of the structures business that could be more capably managed to that side of their company, would you be open to picking up some of those factories or businesses?

Yeah, let me -- with our strategy. Like I said, we haven't had a strategy to grow that business just for the sake of growing it. So we have been very focused on, being very good at what we do, supply. And what we do a great job at, is rear seats and rear seat configurability. And the front seats, 80% of the customers have their own designs. And so we will still supply components on a build-to-print basis, if we get a fair return in the excess of our cost of capital. But the mechanisms do offer some value. I mean, there is some values where we have been able to integrate our components and help the customer outdrive cost and weigh it out. But at the same time, get a fair return for our products. So it starts, [indiscernible] strategy, a fair return for our components, be focused more on the mechanisms and the latch systems within the rear seats, which we have a leadership position. And no, we would not have any interest in helping out [indiscernible] and as they start to sell that business.

Okay, thanks.

Your next question comes from the line of Joseph Spak with RBC Capital Markets. Please go ahead.

Hi everyone. This is Joe Heidt on for Joe Spak. Just a quick question on top line guidance. You are saying about 5%, but when we are looking at it, we see backlog gives you about 6% growth, production is up 2%, and even if price offsets that, you get an extra 3% from FX. So that looks more like 8% or 9% growth. Can you kind of go through the offsets there?

You know, there is a bunch of pieces, and I think you hit on a couple of them. One, the backlog as you mentioned is about $1.2 billion of which 40% is in E-Systems 60% in seating. FX provides an increase of about $400 million, largely associated with the Euro assumption at $1.18. The Grupo acquisition that we had in seating, if you look at it on a year-over-year basis, there is about $200 million more sales in 2018 than there was in 2017. We acquired that business in May of 2017. We talked about the China growth in E-Systems, that's roughly $200 million. The pricing environment, we have mentioned before, pricing tends to be roughly in the 1.5% of sales range. And then kind of the missing ingredient is volume mix, and notwithstanding the fact that both in North America and in Europe, the industry production is forecasting to be up 2%. Some of our programs -- or some of key programs are down year-over-year. We have talked about the K2XXT1 [ph], that's down 10% year-over-year and the focus builds out in North America in the second quarter. So the mix is a bit of a headwind for us, in 2018, and that makes up the difference.

Okay, great. Thanks. And then just one last question, it looks like you guys might be repatriating some cash after tax form [ph]. Would you guys be keeping your same capital allocation policy, or should we be thinking about it a little bit differently?

We don't intend to change our capital allocation policy. I think first and foremost, investing in the business, is not an entitlement that you can generate $1.2 billion cash. You have to continue to invest in it. Look for strategic acquisitions, either niche or otherwise to develop capabilities, get regional diversification, customer diversification, product diversification. And then to the extent that there is cash leftover as we have demonstrated in the past, continue to return that back to shareholders. From a tax reform standpoint, it really doesn't change significantly, our ability to move cash around. We have had historically, efficient mechanisms to do that. So tax reform does not change that in any significant way.

Okay, thank you. I appreciate it.

Your next question comes from the line of Jeff Osborne with Cowen and Company. Please go ahead.

Hey, good morning guys. I might have missed this, but can you give us a sense of the percentage of the systems backlog that's from China?

In China, if you look at both from a consolidated and a non-consolidated perspective, we have got about $1.6 billion of that total in China. Of which, Joel, how much is in E-Systems?

In E-Systems, it's a little above 40%, 45% --

Of that total. So total consolidated, non-consolidated $1.6 billion for the company, of which 45%-ish is in E-Systems.

Got it. And then just some of the quoting activity, maybe for Frank. But can you give us a sense of -- is there any general mix shifts, either that are notable from either DSRC or cellular, as we think about V2X connectivity, I was just curious how you are positioning in both of those, and if there is any bias towards one or the other?

We are equally excited about both opportunities, because we have capabilities in both areas, whether technology remains DSRC here in North America, or if cellular is favored out in Europe or even potentially Asia, we have capabilities in both. When we picked up Autonet and Arada a couple of years ago, we actually purchased wireless capabilities in both areas. And the V2X modules we are designing today are being designed so that we can utilized either technology. So right now, it's a bit of a mixed bag. We are seeing a lot of cellular. We are seeing some interest in the DSRC work that we have done on predevelopments here in North America. But I just want to make sure you understand, Lear's capabilities in both areas are very strong, and we are well positioned in either way. So whether this NHTSA proposed rulemaking goes through for DSRC here in the states, we know we are extremely well positioned there, even from an infrastructure standpoint as well. So excited about both opportunities for that matter. I think we are designing our products to be capable in both technologies.

Perfect. Good to hear. Thank you.

And your final question will come from the line of Richard Hilgert from Morningstar. Please go ahead.

Thanks. Good morning everyone and thanks for taking my question.

Good morning.

On the backlog, just wanted to talk a little bit about directionally, how it progresses? And that outlying your -- you are picking up programs that are at the longer end of the development time range, the longer time to develop a vehicle program. And moving in, 2019, you are looking at programs that are 18 months, 2018, you are picking up programs that might be -- some a little bit last minute business here and there. But I am wondering about, directionally, we go from $1.2 billion to $1.4 billion in 2019. So is there a little bit of color that you can add to that, that gives us that directional bump up from 2018 to 2019, instead of the progression where it would probably be more normally, going down from year one to year two and then from year two to year three. And then as we rollover the next years, each one picks up a little bit more?

I guess, there is a couple themes there. One is, with respect to 2019, I think it's really all dependent by the timing of various awards. But I think what you are seeing in 2019 and the spike, let's say, versus 2018, is the onset of these electrification and connectivity programs. We saw these on the horizon, now they are more near term as they get actually implemented in vehicles and you are starting to see that in the back of 2018 and into 2019. So that certainly counts for part of the spike. But if you did the same -- if you asked the same question last year, which I think is your second question; when we put out our 2017, 2018 and 2019 backlog, 2019 being the third year at that time, that backlog was $650 million, now it's $1.4 billion. So part of your point is, given the timing of these things and the fact that some of these programs weren't awarded today, don't come into production for three years. Some of those programs are still not awarded. So that third year of our backlog, typically, based on the recent history, has come in at double, if not more than the initial view we had when we entered that year into the backlog. So we fully anticipate that happening, as 2020 becomes the second and the first year of the backlog.

Right. That's what I was saying. The first year and the third year looked correct, but directionally, the second year is that spike up. In between the two is what looked a little odd, and hey, all the more power to you. It looks great that you are picking that additional business. I was just curious if there is a little bit more business that you are picking up in the shorter term, that you hadn't picked up before, that made the difference. And it sounds like, you are talking about electrification. But you have got a nice bump-up on both sides, E-Systems and Seating; so you know, I am curious if it was additional penetration than what you have seen in prior years, to cause that spike in 2019 versus the natural progression of higher first year, a little lower the second year, lowest, the third year?

I think it's kind of all those things. We are gaining market share. The advent of these emerging trends that are coming out in quotes and becoming a reality in terms of going into production.

Great. Okay. Thank you very much.

You're welcome. Well, since that's the last question, I think the only people that remain on the line are Lear employees. And I just want to take a minute to say thank you for all your hard work and dedication. It has been an honor and a pleasure to serve as your CEO for these past six years. I am leaving in peace, because I know we have the right CEO in Ray Scott, the best management team in the business; an investment grade balance sheet, and a product portfolio that's extremely well positioned to take advantage of the unprecedented change in these industry opportunities that are just amazing in front of us. In short, our best days are truly in front of us. On behalf of my wife, Mona, my daughter Sidney, and I, I just want to say thank you again, and god bless all of you, all the Lear families around the world. I will be cheering you on from the sidelines, enjoying watching you continue to kick ass. So thank you very much. Bye-bye.

Thank you to everyone for attending today. This will conclude today's call and you may now disconnect.