UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549-1004

 

 

Form 10-K

 

 

Commission File No. 001-31970

 

 

TRW Automotive Holdings Corp.

(Exact name of registrant as specified in its charter)

 

 

12001 Tech Center Drive
Livonia, Michigan 48150
(734) 855-2600
(Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant’s Principal Executive Offices)

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:
None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.

Large accelerated filer þ     Accelerated filer o     Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

As of June 30, 2006, the last day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the registrant’s Common Stock, $0.01 par value per share, held by non-affiliates of the registrant was approximately $1,181,505,981 based on the closing sale price of the registrant’s Common Stock as reported on the New York Stock Exchange on that date. As of February 14, 2007, the number of shares outstanding of the registrant’s Common Stock was 98,289,051.

 

Documents Incorporated by Reference

 

Certain portions, as expressly described in this report, of the Registrant’s Proxy Statement for the 2007 Annual Meeting of the Stockholders, to be filed within 120 days of December 31, 2006, are incorporated by reference into Part III, Items 10-14.

 

 

TRW Automotive Holdings Corp.

 

Index

 

 

The Company

 

TRW Automotive Holdings Corp. (together with its subsidiaries, “we,” “our,” or the “Company”) is among the world’s largest and most diversified suppliers of automotive systems, modules and components to global automotive original equipment manufacturers (“OEMs”) and related aftermarkets. We conduct substantially all of our operations through subsidiaries. These operations primarily encompass the design, manufacture and sale of active and passive safety related products. Active safety related products principally refer to vehicle dynamic controls (primarily braking and steering), and passive safety related products principally refer to occupant restraints (primarily air bags and seat belts) and safety electronics (electronic control units and crash and occupant weight sensors). We are primarily a “Tier 1” supplier, with approximately 86% of our end-customer sales in 2006 to major OEMs. We operate our business along three segments: Chassis Systems, Occupant Safety Systems, and Automotive Components.

 

Acquisition of the Company.  Prior to the acquisition (as defined below), our predecessor operated as a segment of the former TRW Automotive Inc. (which we did not acquire and was renamed Richmond TAI Corp.) and its subsidiaries and the other subsidiaries, divisions and affiliates of TRW Inc. (“Old TRW”), and constituted the automotive business of Old TRW for the periods prior to February 28, 2003, the date the Acquisition was consummated. Old TRW was acquired by Northrop Grumman Corporation (“Northrop”) on December 11, 2002.

 

Old TRW entered into an Agreement and Plan of Merger with Northrop, dated June 30, 2002, whereby Northrop would acquire all of the outstanding common stock of Old TRW, including Old TRW’s automotive business, in exchange for Northrop shares. The acquisition of Old TRW by Northrop was completed on December 11, 2002 (the “Merger”).

 

Additionally, on November 18, 2002, an entity controlled by affiliates of The Blackstone Group, L.P. (“Blackstone”), entered into a master purchase agreement, as amended, (the “Master Purchase Agreement”) pursuant to which the Company, a newly-formed entity, would cause its indirect wholly-owned subsidiary, TRW Automotive Acquisition Corp., to purchase the shares of the subsidiaries of Old TRW engaged in the automotive business from Northrop (the “Acquisition”). The Acquisition was completed on February 28, 2003. Subsequent to the Acquisition, TRW Automotive Acquisition Corp. changed its name to TRW Automotive Inc. (referred to herein as “TRW Automotive”). As a result of the Acquisition, Automotive Investors L.L.C., or AIL, an affiliate of Blackstone, originally held approximately 78.4%, an affiliate of Northrop held approximately 19.6% and our management group held approximately 2.0% of our common stock. The successor and registrant, TRW Automotive Holdings Corp. and its subsidiaries, own and operate the automotive business of Old TRW as a result of the Acquisition.

 

Initial Public Offering.  On February 6, 2004, we completed an initial public offering of 24,137,931 shares of our common stock (the “Common Stock”). After our initial public offering, including the use of a portion of the net proceeds from our initial public offering to repurchase a portion of the shares held by an affiliate of Blackstone, our majority shareholder, an affiliate of Blackstone held approximately 56.7%, an affiliate of Northrop held approximately 17.2% and our management group held approximately 1.7% of our Common Stock.

 

Share Repurchases in 2005 and 2006.  On March 11, 2005, we repurchased from an affiliate of Northrop 7,256,500 shares of Common Stock for approximately $143 million in cash. On November 10, 2006, we repurchased an additional 9,743,500 shares of Common Stock from an affiliate of Northrop for approximately $209 million. The shares from the repurchases were immediately retired following repurchase. As a result of these repurchases, Northrop and its affiliates hold no shares of our Common Stock.

 

Share Issuances in 2005 and 2006.  On March 11, 2005, we sold to two investment institutions 7,256,500 newly issued shares of Common Stock for approximately $143 million in cash. We filed a registration statement with the Securities and Exchange Commission (“SEC”) for the registration of the resale of these newly issued shares. Pursuant to the registration statement, the holders of those shares are able to sell their shares of Common Stock into the market from time to time.

 

We used the $143 million of proceeds we received from the 2005 share issuances initially to return cash and/or reduce liquidity line balances to the levels that existed immediately prior to the time the 2005 share purchase from an affiliate of Northrop referenced above took place. On May 3, 2005, a portion of the proceeds from these share issuances was then used to repurchase €48 million principal amount of the Company’s 101/8% Senior Notes.

 

On November 10, 2006, we issued 6,743,500 shares of Common Stock in a registered public offering pursuant to our universal shelf registration statement filed with the SEC. We used the net proceeds of $153 million, together with cash on hand, to make the 2006 repurchase of shares of Common Stock from an affiliate of Northrop.

 

Financial and Operating Information

 

Segment Information.  We conduct substantially all of our operations through our subsidiaries and along three segments: Chassis Systems, Occupant Safety Systems and Automotive Components. The table below summarizes certain financial information for our segments.

 

 

See “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 21 to the consolidated financial statements for a discussion of segment earnings before taxes.

 

Sales by Product Line.  Our 2006 sales by product line are as follows:

 

 

Sales by Geography.  Our 2006 sales by geographic region are as follows:

 

 

See Note 21 to our consolidated financial statements included in this report for additional product sector and geographical information.

 

Business Developments and Industry Trends

 

Business Development and Strategy.  We have become a leader in the global automotive parts industry by capitalizing on the strength of our products, technological capabilities and systems integration skills. Over the last decade, we have experienced sales growth in many of our product lines due to an increasing focus by both governments and consumers on safety and fuel efficiency. We believe that this trend is continuing as evidenced by ongoing regulatory activities and escalating fuel costs, and will enable us to experience growth in the most recent generation of advanced safety and fuel efficient products. Such advanced products include vehicle stability control systems, curtain and side air bags, occupant sensing systems, electrically assisted power steering systems and tire pressure monitoring systems.

 

Throughout our long history as a leading supplier to major OEMs, we have focused on products where we have a technological advantage. We have extensive technical experience in a focused range of safety-related product lines and strong systems integration skills. These traits enable us to provide comprehensive, systems-based solutions for our OEM customers. We have a broad and established global presence and sell to major OEMs across all of the world’s major vehicle producing regions, including the rapidly expanding Chinese and Indian markets. We believe our business diversification mitigates our exposure to the risks of any one geographic economy, product line or major customer concentration. It also enables us to extend our portfolio of products and new technologies across our customer base and geographic regions, and provides us the necessary scale to optimize our cost structure.

 

The Automotive Industry Climate.  The following key trends have been affecting the automotive parts industry over the past several years, many of which we expect to continue in the near term. (The statements regarding industry outlook, trends, the future development of certain automotive systems and other non-historical statements contained in this section are forward-looking statements.)

 

These developments and trends include:

 

 

These developments and trends are discussed in detail in “Part II, Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

In addition, the following are significant characteristics of the automotive and automotive supply industries.

 

 

In September 2006, the National Highway Safety Traffic Administration (“NHTSA”) issued a Notice of Proposed Rulemaking proposing standard fitment of electronic stability control (“ESC”) on all North American vehicles under 10,000 lbs. gross vehicle weight no later than September 2011. The proposal includes a phase-in plan, with ESC to be fitted on 30% of new vehicle production by September 2008, 60% by September 2009, and 90% by September 2010. The final rule is expected to be issued in the first quarter of 2008.

 

In October 2005, NHTSA updated its mandate for the assembly onto vehicles of a direct tire pressure monitoring system, capable of detecting when one or more tires are significantly under-inflated. The phase-in period for compliance is as follows: 20% of light vehicles are required to comply with the standard during the period from October 5, 2005 to August 31, 2006; 70% during the period from September 1, 2006 to August 21, 2007; and all light vehicles thereafter.

 

Advances in technology by us and others have led to a number of innovations in our product portfolio, which will allow us to benefit from this trend. Such innovations include electronic vehicle stability control systems, tire pressure monitoring systems, occupant sensing systems, rollover sensing and curtain air bag systems.

 

 

 

We have also seen certain vehicle manufacturers shift away from their funding of development contracts for new technology. We expect this trend to continue in 2007, thereby causing our engineering and research and development expenses to increase.

 

 

Competition

 

The automotive parts industry is extremely competitive. OEMs rigorously evaluate us and other suppliers based on many criteria such as quality, price/cost competitiveness, system and product performance, reliability and timeliness of delivery, new product and technology development capability, excellence and flexibility in operations, degree of global and local presence, effectiveness of customer service and overall management capability. We believe we compete effectively with leading automotive suppliers on all of these criteria. For example, we generally follow manufacturing practices designed to improve efficiency, including but not limited to, one-piece-flow machining and assembly, and just-in-time scheduling of our manufacturing plants, all of which enable us to manage inventory so that we can deliver components and systems to our customers in the quantities and at the times ordered. Our resulting delivery performance, as measured by our customers, generally meets or exceeds our customers’ expectations.

 

Within each of our product segments, we face significant competition. Our principal competitors include Advics, Bosch, Continental-Teves, Delphi, JTEKT, Visteon, and ZF in the Chassis Systems segment; Autoliv, Bosch, Delphi, Key Safety, and Takata, in the Occupant Safety Systems segment; and Delphi, Eaton, ITW, Kostal, Nifco, Raymond, Textron, Tokai Rika, and Valeo in the Automotive Components segment.

 

Sales and Products by Segment

 

Sales.  The following table provides sales for each of our segments:

 

 

Products.  The following tables describe the principal product lines by segment in order of 2006 sales:

 

Chassis Systems

 

 

Occupant Safety Systems

 

Automotive Components

 

 

Chassis Systems.  Our Chassis Systems segment focuses on the design, manufacture and sale of product lines relating to steering, foundation brakes, brake control, linkage and suspension, and modules. We sell our Chassis Systems products primarily to OEMs and other Tier 1 suppliers. We also sell these products to OEM service organizations and in the independent aftermarket, through a licensee in North America, and in the rest of the world, to independent distributors. We believe our Chassis Systems segment is well positioned to capitalize on growth trends towards (1) increasing active safety systems, particularly in the areas of electric steering, electronic vehicle stability control and other advanced braking systems and integrated vehicle control systems; and (2) integration of active and passive safety systems.

 

Occupant Safety Systems.  Our Occupant Safety Systems segment focuses on the design, manufacture and sale of air bags, seat belts, safety electronics, steering wheels and security electronic systems. We sell our Occupant Safety Systems products primarily to OEMs and also to other Tier 1 suppliers. We also sell these products to OEM service organizations for service parts. We believe our Occupant Safety Systems segment is well positioned to capitalize on growth trends towards (1) increasing passive safety systems, particularly in the areas of side and curtain air bag systems, occupant sensing systems, active seat belt pretensioning and retractor systems, and tire pressure monitoring systems; and (2) integration of active and passive safety systems.

 

Automotive Components.  Our Automotive Components segment focuses on the design, manufacture and sale of engine valves, body controls, and engineered fasteners and components. We sell our Automotive Components products primarily to OEMs and also to other Tier 1 suppliers. We also sell these products to OEM service organizations. In addition, we sell some engine valve and body control products to independent distributors for the automotive aftermarket. We believe our Automotive Components segment is well positioned to capitalize on growth trends toward multi-valve engines and increasing electronic content per vehicle.

 

Customers

 

We sell to all the major OEM customers across all of the world’s major vehicle producing regions. Our long-standing relationships with our customers have enabled us to understand global customers’ needs and business opportunities. We believe that we will continue to be able to compete effectively for our customers’ business because of the high quality of our products, our ongoing cost reduction efforts, our strong global presence and our product and technology innovations. Although business with any given customer is typically split among numerous contracts, the loss of or a significant reduction in purchases by, one or more of those major customers could materially and adversely affect our business, results of operations and financial condition.

 

End-customer sales (by OEM group) that constitute 10% or more of our sales for the years ended December 31, 2006 and 2005 were:

 

 

We also sell products to the global aftermarket as replacement parts for current production and older vehicles. For each of the years ended December 31, 2006 and 2005, our sales to the aftermarket represented approximately 7% of our total sales. We sell these products through both OEM service organizations and independent distribution networks.

 

Sales and Marketing

 

We have a sales and marketing organization of dedicated customer teams that provide a consistent interface with our key customers. These teams are located in all major vehicle-producing regions to best represent their respective customers’ interests within our organization, to promote customer programs and to coordinate global customer strategies with the goal of enhancing overall customer service and satisfaction. Our ability to support our customers globally is further enhanced by our broad global presence in terms of sales offices, manufacturing facilities, engineering/technical centers, joint ventures and licensees.

 

Our sales and marketing organization and activities are designed to create overall awareness and consideration of, and to increase purchases of, our systems, modules and components. To further this objective, we participate in an international trade show in Frankfurt. We also provide on-site technology demonstrations at our major OEM customers on a regular basis.

 

Customer Support

 

Our engineering, sales and production facilities are located in 26 countries. With hundreds of dedicated sales/customer development employees, we provide effective customer solutions, products and service in any region in which these facilities operate or manufacture.

 

Joint Ventures

 

Joint ventures represent an important part of our business, both operationally and strategically. We have often used joint ventures to enter into new geographic markets such as China and India, or to acquire new customers or to develop new technologies such as direct tire pressure monitoring systems.

 

In the case of entering new geographic markets where we have not previously established substantial local experience and infrastructure, teaming with a local partner can reduce capital investment by leveraging pre-existing infrastructure. In addition, local partners in these markets can provide knowledge and insight into local customs and practices and access to local suppliers of raw materials and components. All of these advantages can reduce the risk, and thereby enhance the prospects for the success, of an entry into a new geographic market.

 

Joint ventures can also be an effective means to acquire new customers. Joint venture arrangements can allow partners access to technology they would otherwise have to develop independently, thereby reducing the time and cost of development. More importantly, they can provide the opportunity to create synergies and applications of the technology that would not otherwise be possible.

 

The following table shows our unconsolidated joint ventures in which we have a 49% or greater interest that are accounted for under the equity method:

 

 

Intellectual Property

 

We own significant intellectual property, including a large number of patents, trademarks, copyrights and trade secrets, and are involved in numerous licensing arrangements. Although our intellectual property plays an important role in maintaining our competitive position in a number of the markets that we serve, no single patent, copyright, trade secret or license, or group of related patents, copyrights, trade secrets or licenses, is, in our opinion, of such value to us that our business would be materially affected by the expiration or termination thereof. However, we view the name TRW Automotive and primary mark “TRW” as material to our business as a whole. Our general policy is to apply for patents on an ongoing basis in the United States, Germany and appropriate other countries to protect our patentable developments.

 

Our portfolio of patents and pending patent applications reflects our commitment to invest in technology and covers many aspects of our products and the processes for making those products. In addition, we have developed a substantial body of manufacturing know-how that we believe provides a significant competitive advantage in the marketplace.

 

We have entered into numerous technology license agreements that either strategically capitalize on our intellectual property rights or provide a conduit for us into third party intellectual property rights useful in our businesses. In many of these agreements, we license technology to our suppliers, joint venture companies and other local manufacturers in support of product production for our customers and us. In other agreements, we license the technology to other companies to obtain royalty income.

 

We own a number of secondary trade names and marks applicable to certain of our businesses and products that we view as important to such businesses and products as well.

 

Seasonality

 

Our business is moderately seasonal because our largest North American customers typically halt operations for approximately two weeks in July and one week in December. Additionally, customers in Europe historically shut down vehicle production during portions of August and one week in December. As new models are typically introduced during the third quarter, automotive production traditionally is lower during that period. Accordingly, our third and fourth quarter results may reflect these trends.

 

Research, Development and Engineering

 

We operate a global network of technical centers worldwide where we employ approximately 5,000 engineers, researchers, designers, technicians and their supporting functions. This global network allows us to develop automotive active and passive technologies while improving existing products and systems. We utilize sophisticated testing and computer simulation equipment, including computer-aided engineering, noise-vibration-harshness, crash sled, math modeling and vehicle simulations. We have advanced engineering and research and development programs for next-generation components and systems in our Chassis, Occupant Safety and Automotive Component product areas. We are disciplined and innovative in our approach to research and development, employing various tools to improve efficiency and reduce cost, such as Six Sigma, “follow-the-sun” (a 24-hour a day engineering program that utilizes our global network) and other e-Engineering programs, and outsourcing non-core activities.

 

Company-funded research, development and engineering costs totaled $825 million, $780 million, and $714 million for the years ended December 31, 2006, 2005, and 2004 respectively. Total research, development and engineering costs as a percentage of sales were 6.3%, 6.2% and 5.9% for the years ended December 31, 2006, 2005, and 2004, respectfully.

 

We believe that continued research, development and engineering activities are critical to maintaining our leadership position in the industry and will provide us with a competitive advantage as we seek additional business with new and existing customers. Recently, we have seen certain vehicle manufacturers shift away from their funding of development contracts for new technology. We expect this trend to continue, thereby causing our engineering and research and development expenses to increase.

 

Manufactured Components and Raw Materials

 

We purchase various manufactured components and raw materials for use in our manufacturing processes. The principal components and raw materials we purchase include castings, electronic parts, molded plastic parts, finished subcomponents, fabricated metal, aluminum, steel, resins, textiles, leather and wood. All of these components and raw materials are available from numerous sources. We continue to see significant inflationary pressures in the cost of ferrous metals, resin/yarn and other petroleum-based products, as well as higher energy costs. At this time, we are working with our suppliers and customers to attempt to mitigate the impact that this inflation may have on our financial results, but there can be no assurance that such continued inflation will not have a material adverse effect. Although we have not, in recent years, experienced any significant shortages of manufactured components or raw materials, and normally do not carry inventories of these items in excess of those reasonably required to meet our production and shipping schedule, the possibility of shortages exist especially in light of the weakened state of the supply base described above.

 

Employees

 

As of December 31, 2006, we had approximately 63,800 employees (including employees of our majority-owned joint ventures but excluding temporary employees and employees who are on approved forms of leave), of whom approximately 21,400 were employed in North America, approximately 33,800 were employed in Europe, approximately 4,400 were employed in South America and approximately 4,200 were employed in Asia. Approximately 16,800 of our employees are salaried and approximately 47,000 are hourly.

 

Environmental Matters

 

Governmental requirements relating to the discharge of materials into the environment, or otherwise relating to the protection of the environment, have had, and will continue to have, an effect on our operations and us. We have made and continue to make expenditures for projects relating to the environment, including pollution control devices for new and existing facilities. We are conducting a number of environmental investigations and remedial actions at current and former locations to comply with applicable requirements and, along with other companies, have been named a potentially responsible party for certain waste management sites. Each of these matters is subject to various uncertainties, and some of these matters may be resolved unfavorably to us.

 

A reserve estimate for each matter is established using standard engineering cost estimating techniques on an undiscounted basis. In the determination of such costs, consideration is given to the professional judgment of our environmental engineers, in consultation with outside environmental specialists, when necessary. At multi-party sites, the reserve estimate also reflects the expected allocation of total project costs among the various potentially responsible parties. As of December 31, 2006, we had reserves for environmental matters of $57 million. In addition, in the 2003 agreement (the “Master Purchase Agreement”) under which an affiliate of Blackstone purchased the shares of the subsidiaries of TRW Inc. (“Old TRW”) engaged in the automotive business from Northrop (the “Acquisition”), Northrop agreed to indemnify us for 50% of any environmental liabilities associated with the operation or ownership of Old TRW’s automotive business existing at or prior to the Acquisition, subject to certain exceptions. The Company has established a receivable from Northrop for a portion of this environmental liability as a result of the indemnification provided for in the Master Purchase Agreement.

 

We do not believe that compliance with environmental protection laws and regulations will have a material effect upon our capital expenditures, results of operations or competitive position. Our capital expenditures for environmental control facilities during 2007 and 2008 are not expected to be material to us. We believe that any liability that may result from the resolution of environmental matters for which sufficient information is available to support cost estimates will not have a material adverse effect on our financial position or results of operations. However, we cannot predict the effect on our financial position of expenditures for aspects of certain matters for which there is insufficient information. In addition, we cannot predict the effect of compliance with environmental laws and regulations with respect to unknown environmental matters on our financial position or results of operations or the possible effect of compliance with environmental requirements imposed in the future.

 

Available Company Information

 

TRW Automotive Holdings Corp.’s Internet website address is www.trwauto.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge through our website as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission. Our Audit Committee Charter, Compensation Committee Charter, Corporate Governance and Nominating Committee Charter, Corporate Governance Guidelines and Standards of Conduct (our code of business conduct and ethics) are also available on our website and available in print to any shareholder who requests it.

 

Loss of market share by the Big Three may adversely affect our results in the future.

 

Ford Motor Company, General Motors and the Chrysler group of DaimlerChrysler AG (the “Big Three”) have been losing market share for vehicle sales in North America and, to a lesser extent, Europe. At the same time, Asian vehicle manufacturers have increased their share in such markets. Although we do have business with the Asian vehicle manufacturers, our customer base is more heavily weighted towards the Big Three. In addition, declining market share and inherent structural issues with the Big Three have led to recent announcements of an unprecedented level of production cuts. In order to address market share declines, reduced production levels, negative industry trends and other structural issues specific to their companies (such as significant overcapacity and pension and healthcare costs), the Big Three and certain of our other customers are undergoing various forms of restructuring initiatives (including, in certain cases, reorganization under bankruptcy laws). In the case of Ford, North American restructuring actions were accelerated and expanded during 2006 to remove additional production capacity over the next several years. In the case of the Chrysler group, in February 2007, Chrysler announced restructuring actions to significantly reduce overall North American production capacity. Such substantial restructuring initiatives undertaken by our major customers will have a ripple effect throughout our industry and may have a severe impact on our business and our common suppliers.

 

Escalating pricing pressures from our customers may adversely affect our business.

 

Pricing pressure in the automotive supply industry has been substantial and is likely to continue. Virtually all vehicle manufacturers seek price reductions in both the initial bidding process and during the term of the contract. Price reductions have impacted our sales and profit margins and are expected to do so in the future. If we are not able to offset continued price reductions through improved operating efficiencies and reduced expenditures, those price reductions may have a material adverse effect on our results of operations.

 

Commodity inflationary pressures may adversely affect our profitability and the viability of our Tier 2 and Tier 3 supply base.

 

The cost of some of the commodities we use in our business has increased. Ferrous metals, base metals, resins, yarns, energy costs and other petroleum-based products have become more expensive. This has put significant operational and financial burdens on us and our suppliers. It is usually difficult to pass increased prices for manufactured components and raw materials through to our customers in the form of price increases. Furthermore, our suppliers may not be able to handle the commodity cost increases and still perform as we expect. In fact, we have seen the number of bankruptcies or insolvencies increase due in part to the recent inflationary pressures. The unstable condition of some of our suppliers or their failure to perform has led to certain delivery delays and production issues and has negatively impacted certain of our businesses in 2006. The overall condition of our supply base may possibly lead to further delivery delays, production issues or delivery of non-conforming products by our suppliers in the future.

 

Our business would be materially and adversely affected if we lost any of our largest customers.

 

For the year ended December 31, 2006, sales to our four largest customers on a worldwide basis were approximately 55% of our total sales. Although business with each customer is typically split among numerous contracts, if we lost a major customer or that customer significantly reduced its purchases of our products, there could be a material adverse affect on our business, results of operations and financial condition.

 

Work stoppages or other labor issues at the facilities of our customers or other suppliers could adversely affect our operations.

 

The turbulence in the automotive industry and actions taken by our customers and other suppliers to address negative industry trends may have the side effect of exacerbating labor relations problems at those companies. If any of our customers experience a material work stoppage, that customer may halt or limit the purchase of our products. Similarly, a work stoppage at another supplier could interrupt production at our customer which would have the same effect. This could cause us to shut down production facilities relating to those products, which could have a material adverse effect on our business, results of operations and financial condition.

 

We may incur material losses and costs as a result of product liability, warranty and recall claims that may be brought against us.

 

In our business, we are exposed to product liability and warranty claims. In addition, we may be required to participate in a recall of a product. Vehicle manufacturers are increasingly looking to their suppliers for contribution when faced with product liability, warranty and recall claims and we have been subject to continuing efforts by our customers to change contract terms and conditions concerning warranty and recall participation. In addition, vehicle manufacturers have experienced increasing recall campaigns in recent years. Product liability, warranty and recall costs may have a material adverse effect on our financial condition.

 

Our variable rate indebtedness exposes us to interest rate risk, which could cause our debt costs to increase significantly.

 

A majority of our borrowings, including borrowings under TRW Automotive Inc.’s senior credit facilities, are at variable rates of interest and expose us to interest rate risk. As of December 31, 2006, approximately 55% of our total debt was at variable interest rates (or 71% when considering the effect of interest rate swaps). In view of recent

rising interest rates, the amount we are required to pay on our variable rate indebtedness has increased and may increase further even though the amount borrowed remained the same.

 

Strengthening of the U.S. dollar could materially impact our results of operations.

 

In 2006, over half of our sales originated outside the United States. We translate sales and other results denominated in foreign currencies into U.S. dollars for our consolidated financial statements. This translation is based on average exchange rates during a reporting period. During times of a strengthening U.S. dollar, our reported international sales and earnings would be reduced because foreign currencies may translate into fewer U.S. dollars.

 

Our available cash and access to additional capital may be limited by our substantial debt.

 

We have a significant amount of debt. This amount of debt may limit our ability to obtain additional financing for our business. It may also limit our ability to adjust to changing market conditions because of the covenants and restrictions in the debt. In addition, we have to devote substantial cash to the payment of interest and principal on the debt, which means that cash may not be used for other of our business needs. We may be more vulnerable to an economic or industry downturn than a company with less debt.

 

The cyclicality of automotive production and sales could adversely affect our business.

 

Automotive production and sales are highly cyclical and depend on general economic conditions, consumer spending and preferences, labor relations issues, regulatory requirements, trade agreements and other factors. The volume of automotive production has fluctuated from year to year, which leads to fluctuations in the demand for our products. Any significant economic decline that results in a reduction in automotive production and sales by vehicle manufacturers could have a material adverse effect on our results of operations.

 

Our pension and other post-retirement benefits expense and the funding requirements of our pension plans could materially increase.

 

Most of our employees participate in defined benefit pension plans or retirement/termination indemnity plans. The rate at which we are required to fund these plans depends on certain assumptions which depend in part on market conditions. As market conditions change, these assumptions may change, resulting in a decline in pension asset values. Future declines could materially increase the necessary funding status of our plans, and may require us to contribute more to these plans earlier than we anticipated. Also, this could significantly increase our pension expenses and reduce our profitability.

 

We also sponsor other post-retirement benefit (“OPEB”) plans for most of our U.S. and some of our non-U.S. employees. We fund our OPEB obligations on a pay-as-you-go basis and have no plan assets. If health care costs in the future increase more than we anticipated, our actuarially determined liability and our related OPEB expense could increase along with future cash outlays.

 

We are subject to risks associated with our non-U.S. operations.

 

We have significant manufacturing operations outside the United States, including joint ventures and other alliances. International operations involve risks, including exchange controls and currency restrictions, currency fluctuations and devaluations, changes in local economic conditions, changes in laws and regulations and unsettled political conditions and possible terrorist attacks against United States’ or other interests.

 

These and other factors may have a material adverse effect on our international operations or on our business, results of operations and financial condition.

 

We have recorded a significant amount of goodwill and other identifiable intangible assets, which may become impaired in the future.

 

We have recorded a significant amount of goodwill and other identifiable intangible assets, including customer relationships, trademarks and developed technologies. Goodwill and other net identifiable intangible assets were approximately $3.0 billion as of December 31, 2006, or 27% of our total assets. Goodwill, which represents the

excess of cost over the fair value of the net assets of the businesses acquired, was approximately $2.3 billion as of December 31, 2006, or 20% of our total assets.

 

Impairment of goodwill and other identifiable intangible assets may result from, among other things, deterioration in our performance, adverse market conditions, adverse changes in applicable laws or regulations, including changes that restrict the activities of or affect the products sold by our business, and a variety of other factors. The amount of any quantified impairment must be expensed immediately as a charge that is included in operating income. We are subject to financial statement risk in the event that goodwill or other identifiable intangible assets become impaired.

 

Our expected annual effective tax rate could be volatile and materially change as a result of changes in mix of earnings and other factors.

 

The overall effective tax rate is equal to our total tax expense as a percentage of our total earnings before tax. However, tax expense and benefits are not recognized on a global basis but rather on a jurisdictional or legal entity basis. Losses in certain jurisdictions provide no current financial statement tax benefit. In addition, certain taxing jurisdictions have statutory rates greater than or less than the United States. As a result, changes in the mix of projected earnings between jurisdictions, among other factors, could have a significant impact on our overall effective tax rate.

 

We may be adversely affected by environmental and safety regulations or concerns.

 

Laws and regulations governing environmental and occupational safety and health are complicated, change frequently and have tended to become stricter over time. As a manufacturing company, we are subject to these laws and regulations both inside and outside the United States. We may not be in complete compliance with such laws and regulations at all times. Our costs or liabilities relating to them may be more than the amount we have reserved, which difference may be material. We have spent money to comply with environmental requirements. In addition, certain of our subsidiaries are subject to pending litigation raising various environmental and human health and safety claims, including certain asbestos-related claims. While our annual costs to defend and settle these claims in the past have not been material, we cannot assure you that this will remain so in the future.

 

Developments or assertions by or against us relating to intellectual property rights could materially impact our business.

 

We own significant intellectual property, including a large number of patents, trademarks, copyrights and trade secrets, and are involved in numerous licensing arrangements. Our intellectual property plays an important role in maintaining our competitive position in a number of the markets that we serve. Developments or assertions by or against us relating to intellectual property rights could materially impact our business.

 

Because Blackstone controls us, the influence of our public shareholders over significant corporate actions will be limited, and conflicts of interest between Blackstone and us or our public shareholders could arise in the future.

 

Currently an affiliate of The Blackstone Group L.P. (“Blackstone”) beneficially owns approximately 57% of our outstanding shares of common stock. As a result, Blackstone has the power to control all matters submitted to our stockholders, elect our directors and exercise control over our decisions to enter into any corporate transaction and has the ability to prevent any transaction that requires the approval of stockholders regardless of whether or not other stockholders believe that any such transactions are in their own best interests.

 

None.

 

Our principal executive offices are located in Livonia, Michigan. Our operations include numerous manufacturing, research and development, warehousing facilities and offices. We own or lease principal facilities located in 12 states in the United States and in 25 other countries as follows: Austria, Brazil, Canada, China, the Czech Republic, France, Germany, Italy, Japan, Malaysia, Mexico, Poland, Portugal, Romania, Singapore, Slovakia, South Africa, South Korea, Spain, Sweden, Switzerland, Thailand, Tunisia, Turkey, and the United Kingdom. Approximately 51% of our principal facilities are used by the Chassis Systems segment, 26% are used by the Occupant Safety Systems segment and 23% are used by the Automotive Components segment. Our corporate headquarters are contained within the Chassis Systems numbers below.

 

Of the total number of principal facilities operated by us, approximately 57% of such facilities are owned and 43% are leased.

 

A summary of our principal facilities, by segment, type of facility and geographic region, as of January 31, 2007 is set forth in the following tables. Additionally, where more than one segment utilizes a single facility, that facility is categorized by the purposes for which it is primarily used.

 

Chassis Systems

 

 

Occupant Safety Systems

 

 

Automotive Components

 

 

 

 

Various claims, lawsuits and administrative proceedings are pending or threatened against our subsidiaries, covering a wide range of matters that arise in the ordinary course of our business activities with respect to commercial, patent, product liability, environmental and occupational safety and health law matters. We face an inherent business risk of exposure to product liability and warranty claims in the event that our products actually or allegedly fail to perform as expected or the use of our products results, or is alleged to result, in bodily injury and/or property damage. Accordingly, we could experience material warranty or product liability losses in the future. In addition, our costs to defend the product liability claims have increased over time.

 

While certain of our subsidiaries have been subject in recent years to asbestos-related claims, we believe that such claims will not have a material adverse effect on our financial condition or results of operations. In general, these claims seek damages for illnesses alleged to have resulted from exposure to asbestos used in certain components sold by our subsidiaries. We believe that the majority of the claimants were assembly workers at the major U.S. automobile manufacturers. The vast majority of these claims name as defendants numerous manufacturers and suppliers of a wide variety of products allegedly containing asbestos. We believe that, to the extent any of the products sold by our subsidiaries and at issue in these cases contained asbestos, the asbestos was encapsulated. Based upon several years of experience with such claims, we believe that only a small proportion of the claimants has or will ever develop any asbestos-related impairment.

 

Neither our settlement costs in connection with asbestos claims nor our annual legal fees to defend these claims have been material in the past. These claims are strongly disputed by us and it has been our policy to defend against them aggressively. We have been successful in obtaining the dismissal of many cases without any payment whatsoever. Moreover, there is significant insurance coverage with solvent carriers with respect to these claims. However, while our costs to defend and settle these claims in the past have not been material, we cannot assure you that this will remain so in the future.

 

We believe that the ultimate resolution of the foregoing matters will not have a material effect on our financial condition or results of operations.

 

During the fourth quarter of the year covered by this report, no matters were submitted to a vote of security holders.

 

Our common stock is listed on the New York Stock Exchange under the symbol “TRW”. As of February 14, 2007, we had 98,289,051 shares of common stock, $.01 par value, outstanding (98,293,719 shares issued less 4,668 shares held as treasury stock) and 181 holders of record of such common stock. The transfer agent and registrar for our common stock is National City Bank.

 

The tables below show the high and low sales prices for our common stock as reported by the New York Stock Exchange, for each quarter in 2006 and 2005.

 

 

 

Issuer Purchases of Equity Securities

 

The independent trustee of our 401(k) plans and similar plans purchases shares in the open market to fund investments by employees in our common stock, one of the investment options available under such plans, and matching contributions in Company stock to employee investments. In addition, our stock incentive plan permits payment of an option exercise price by means of cashless exercise through a broker and for the satisfaction of tax obligations upon exercise of options and the vesting of restricted stock units through stock withholding. However, the Company does not believe such purchases or transactions are issuer repurchases for the purposes of this Item 5 of this Report on Form 10-K. In addition, although our stock incentive plan also permits the satisfaction of tax obligations upon the vesting of restricted stock through stock withholding, there was no such withholding in the fourth quarter of 2006.

 

Dividend Policy

 

We do not currently pay any cash dividends on our common stock, and instead intend to retain any earnings for debt repayment, future operations and expansion. The amounts available to us to pay cash dividends are restricted by our debt agreements. Under TRW Automotive Inc.’s senior credit facilities, we have a limited ability to pay dividends on our common stock pursuant to a formula based on our consolidated net income after January 1, 2005 and our leverage ratio as specified in the amended and restated credit agreement. The indentures governing the notes also limit our ability to pay dividends, except that payment of dividends up to 6.0% per annum of the net proceeds received by TRW Automotive Inc. from any public offering of common stock or contributed to TRW Automotive Inc. by us or TRW Automotive Intermediate Holdings from any public offering of common stock is allowed. Any decision to declare and pay dividends in the future will be made at the discretion of our board of directors and will depend on, among other things, our results of operations, cash requirements, financial condition, contractual restrictions and other factors that our board of directors may deem relevant.

 

Equity Compensation Plan Information

 

The following table provides information about our equity compensation plans as of December 31, 2006.

 

 

 

Stock Performance Graph

 

The graph below provides an indicator of our cumulative total stockholder return as compared with Standard & Poor’s 500 Stock Index and the Standard & Poor’s 1500 Auto Parts & Equipment Index. The graph assumes an initial investment of $100. The graph covers a period of time beginning in February 2004, when our common stock first traded on the New York Stock Exchange, through December 29, 2006, which represents the last trading day of the year.

 

Stock Performance Graph

 

 

 

 

 

Predecessor and Successor Company.  As a result of the Acquisition, all references in this report to “TRW Automotive,” the “Company,” “we,” “our” and “us” mean, unless the context indicates otherwise, (i) our predecessor, which is the former TRW Automotive Inc. (which we did not acquire and was renamed Richmond TAI Corp.) and its subsidiaries and the other subsidiaries, divisions and affiliates of Old TRW that together constituted the automotive business of Old TRW, for the periods prior to February 28, 2003, the date the Acquisition was consummated, and (ii) the successor and registrant, TRW Automotive Holdings Corp. and its subsidiaries, that own and operate the automotive business of Old TRW as a result of the Acquisition. Our predecessor’s 51% interest in the joint venture, TRW Koyo Steering Systems Company (“TKS”), was not transferred to us as part of the Acquisition. In addition, when the context so requires, we use the term “Predecessor” to refer to the historical operations of our predecessor prior to the Acquisition and “Successor” to refer to our historical operations following the Acquisition, and we use the terms “we,” “our” and “us” to refer to the Predecessor and the Successor collectively. The historical financial data for the periods prior to the Acquisition appearing below are those of our predecessor and represent the combined financial statements of Old TRW’s automotive business. Prior to the Acquisition, our predecessor operated as a segment of Old TRW, which was acquired by Northrop on December 11, 2002.

 

The selected financial data of the Successor as of and for the years ended December 31, 2006, December 31, 2005, December 31, 2004 and for the ten months ended December 31, 2003 have been derived from our audited consolidated financial statements, and have been prepared on a different basis of accounting than used by the Predecessor in its annual combined financial statements as a result of the consummation of the Acquisition on February 28, 2003. The selected financial data of the Predecessor for the two months ended February 28, 2003, the year ended December 31, 2002, and as of December 31, 2002 have been derived from the audited combined financial statements of our Predecessor company.

 

The tables should be read in conjunction with “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations,” our consolidated financial statements included elsewhere in this report and the combined financial statements of our predecessor company for discussion of items affecting the comparability of results of operations. The following financial information for the periods prior to the Acquisition may not reflect what our results of operations, financial position and cash flows would have been had we operated as a separate, stand-alone entity during the periods presented, or what our results of operations, financial position and cash flows will be in the future.

 

 

 

 

 

Executive Overview

 

Our Business.  We are among the world’s largest and most diversified suppliers of automotive systems, modules and components to global automotive original equipment manufacturers, or OEMs, and related aftermarkets. We conduct substantially all of our operations through subsidiaries. These operations primarily encompass the design, manufacture and sale of active and passive safety related products. Active safety related products principally refer to vehicle dynamic controls (primarily braking and steering), and passive safety related products principally refer to occupant restraints (primarily air bags and seat belts) and safety electronics (electronic control units and crash and occupant weight sensors). We are primarily a “Tier 1” supplier, with over 86% of our end-customer sales in 2006 made to major OEMs. We operate our business along three segments: Chassis Systems, Occupant Safety Systems and Automotive Components.

 

Despite a difficult business environment in the automotive supply industry, especially in North America, the Company performed well for the year ended December 31, 2006. During 2006, we achieved net sales growth of 4%, to $13.1 billion in 2006 from $12.6 billion in 2005. The increase resulted primarily from a higher level of sales from new product areas and higher volumes on certain platforms, the consolidation of Dalphi Metal Espana, S.A. (“Dalphimetal”), which was acquired in October 2005, into our operations for a full year, and foreign currency translation, partially offset by pricing provided to customers and lower industry production volumes. Operating income for 2006 was $636 million, an increase of $83 million as compared to the prior year. The increase in operating income resulted primarily from a decrease of $79 million in charges related to restructuring actions and asset impairments, which reflects approximately $15 million of higher net curtailment gains related to restructuring in 2006. Operating income for 2006 also includes a decrease in earnings before taxes of $25 million in our Automotive Components segment driven primarily by excessive launch related costs, commodity inflation, price reductions and supplier quality issues. Net earnings for 2006 were $176 million as compared to $204 million in 2005. Results for 2006 included a pre-tax loss on retirement of debt of $57 million related to the repurchase of certain bonds.

 

The Unfavorable Automotive Climate.  The automotive and automotive supply industries continued to experience unfavorable developments during 2006 and the last several years, many of which we expect to remain in the near term. These developments and trends include:

 

 

In recent years and throughout 2006, the Big Three have seen a steady decline in their market share for vehicle sales in North America and, to a lesser extent, Europe, with Asian OEMs increasing their share in such markets. The Big Three’s North American operations, in particular, continue to suffer significantly in this regard. Although we do have business with the Asian OEMs, our customer base is more heavily weighted toward the Big Three. In addition, declining market share and inherent structural issues with the Big Three have led to recent announcements of unprecedented levels of production cuts, the most significant of which occurred in the fourth quarter of 2006. In order to address market share declines, reduced production levels, negative industry trends and other structural issues specific to their companies (such as significant overcapacity and pension and healthcare costs), Ford, GM and certain of our other customers are undergoing various forms of restructuring initiatives (including, in certain cases, reorganization under bankruptcy laws). In the case of Ford, North American restructuring actions have been accelerated and expanded during 2006 to remove additional production capacity over the next several years. In the case of the Chrysler group, in February 2007, Chrysler announced restructuring actions to significantly reduce overall North American production capacity. Such substantial restructuring initiatives undertaken by our major customers will have a ripple effect throughout our industry and may have a severe impact on our business and our common suppliers.

 

In addition, work stoppages or other labor issues that may potentially occur at these customers’ or their suppliers’ facilities may have a material negative effect on us. Such work stoppages, shutdowns, or other labor issues would have a material adverse affect on us.

 

Throughout 2006, commodity inflation continued, albeit at a more moderate pace than in 2005. Costs of petroleum-based products, resins, yarns and energy costs continued to increase through the end of 2006, while the costs of ferrous metals once again began to rise. Furthermore, despite the recent stabilization of aluminum and other base metal prices which increased during the first half of 2006, such costs remain inflated compared to the same period of 2005. Consequently, overall commodity inflation pressures remain a significant concern for our business and have placed a considerable operational and financial burden on the Company. We expect such inflationary pressures to continue into the foreseeable future, and continue to work with our suppliers and customers to mitigate the impact of increasing commodity costs. However, it is generally difficult to pass increased prices for manufactured components and raw materials through to our customers in the form of price increases.

 

Furthermore, because we purchase various types of equipment, raw materials and component parts from our suppliers, we may be adversely affected by their failure to perform as expected or if they are unable to adequately mitigate inflationary pressures. These pressures have proven to be insurmountable to some of our suppliers and we

have seen the number of bankruptcies or insolvencies increase due in part to the recent inflationary pressures. While the unstable condition of some of our suppliers or their failure to perform has not led to any material disruptions thus far, it has led to certain delivery delays and production issues, and has negatively impacted certain of our businesses in 2006. The overall condition of our supply base may possibly lead to further delivery delays, production issues or delivery of non-conforming products by our suppliers in the future. As such, we continue to monitor our vendor base for the best source of supply.

 

Fuel price fluctuations, while recently declining from record highs, have continued to concern consumers. As a result, there remains a shift in the North American market to more fuel-efficient vehicles away from sport utility vehicles and light trucks. This shift has accelerated in the last half of 2006, extending into heavy duty pickup trucks. Sport utility and light and heavy duty truck platforms tend to be higher margin products for OEMs and suppliers than car platforms. While this change has negatively impacted the mix of our product sales, we provide content for both passenger car and sport utility/light truck platforms and therefore the effect to TRW is somewhat mitigated.

 

Pricing pressure from our customers is characteristic of the automotive parts industry. This pressure is substantial and will continue. Virtually all OEMs have policies of seeking price reductions each year. Consequently, we have been forced to reduce our prices in both the initial bidding process and during the terms of contractual arrangements. We have taken steps to reduce costs and resist price reductions; however, price reductions have negatively impacted our sales and profit margins and are expected to do so in the future. In addition to pricing concerns, we continue to be approached by our customers for changes in terms and conditions in our contracts concerning warranty and recall participation and payment terms on product shipped. We believe that the likely resolution of these proposed modifications will not have a material adverse effect on our financial condition, results of operations or cash flow.

 

Company Efforts in Response to the Automotive Climate.  Despite the aforementioned ongoing negative trends, we were able to achieve solid operating results during 2006. The effect of the unfavorable industry trends and developments was mitigated by, among other things, our customer, product and geographic diversity. We also benefited from sales growth, continued demand for safety products, continued implementation of previously announced restructuring actions and targeted cost reductions throughout our businesses.

 

We have significant exposure to the European market, with approximately 57% of our 2006 sales generated from that region. Our geographic diversity and presence in this region has helped offset many of the negative industry pressures and sales declines experienced in the North American market. The European market remains extremely competitive, and similar to the North American market, has also experienced the major inroads made by Asian manufacturers into the region over the past few years. While many of our major OEM customers have implemented, or are in the process of implementing varying levels of restructuring actions in North America, no significant actions have been experienced over the past few years in the European market. We are not aware of, nor do we anticipate, any major restructuring aimed at eliminating vehicle assembly capacity at our major European customers.

 

While we continue our efforts to mitigate the risks described above, we expect the negative industry trends to continue in the near future, thereby impacting the first half of 2007. There can be no assurances that the results of our ongoing efforts will continue to be successful in the future or that we will not experience a decline in sales, increased costs or disruptions in supply or a significant strengthening of the U.S. dollar compared to other currencies, or that these items will not adversely impact our future earnings. We will continue to evaluate the negative industry trends referred to above, including the deteriorating financial condition of certain of our customers and suppliers, and whether additional actions may be required to mitigate those trends. Such actions may include further plant rationalization above the 17 facilities we have closed or announced for closure since the beginning of 2005, as well as additional global capacity optimization efforts across our businesses.

 

Our Debt and Capital Structure.  On an ongoing basis we monitor, and may modify, our debt and capital structure to reduce associated costs and provide greater financial and covenant flexibility. During 2006, we repurchased all of our subsidiary Lucas Industries Limited’s £94.6 million 107/8% bonds due 2020, for £137 million, or approximately $243 million. We also reduced the committed amount of our U.S. receivables facility from $400 million to $250 million due to decreased availability under the facility as a result of certain customer credit rating downgrades below investment grade. On January 19, 2007, we further reduced the committed amount of the

receivables facility to $209 million and amended certain of its terms to increase the availability of funding under the U.S. facility. We may make further repurchases of notes or other debt securities or refinance our outstanding debt from time to time as conditions warrant.

 

Our variable rate indebtedness exposes us to interest rate risk, which could cause our debt costs to increase significantly. A majority of our borrowings, including borrowings under TRW Automotive Inc.’s senior credit facilities, are at variable rates of interest and expose us to interest rate risk. As of December 31, 2006, approximately 55% of our total debt was at variable interest rates (or 71% when considering the effect of interest rate swaps). As interest rates increase, the amount we are required to pay on our variable rate indebtedness increases even though the amount borrowed remains the same.

 

Effective Tax Rate.  Changes in our debt and capital structure, among other items, may impact our effective tax rate. Our overall effective tax rate is equal to consolidated tax expense as a percentage of consolidated earnings before tax. However, tax expense and benefits are not recognized on a global basis but rather on a jurisdictional or legal entity basis. We are in a position whereby losses incurred in certain tax jurisdictions provide no current financial statement benefit. In addition, certain jurisdictions have statutory rates greater than or less than the United States statutory rate. As such, changes in the mix of earnings between jurisdictions could have a significant impact on our overall effective tax rate in future periods. Changes in tax law and rates could also have a significant impact on the effective rate in future periods.

 

Restructuring Charges and Asset Impairments.  We continually evaluate our competitive position in the automotive supply industry and whether actions are required to maintain or improve our standing. Such actions may include plant rationalization or global capacity optimization across our businesses. Accordingly, we have closed or announced the closure of 17 facilities since the beginning of 2005.

 

For the year ended December 31, 2006, we recorded restructuring charges of $24 million related to the closure or announced closure of various facilities. During 2006, we closed six facilities resulting in employee reductions of approximately 1,200. Restructuring charges included cash charges of $37 million for severance and other costs and $7 million of net non-cash asset impairments related to restructuring actions, offset by $20 million of net curtailment gains. Also in 2006, we incurred $6 million of other asset impairments not related to restructuring actions.

 

For the year ended December 31, 2005, we recorded charges of $94 million for actions that resulted in the closing of five plants and employee reductions of approximately 1,400. For the year ended December 31, 2005, cash charges were $85 million for severance and costs related to the consolidation of certain facilities and non-cash asset impairments were $14 million related to restructuring actions, offset by $5 million of net curtailment gains. Also in 2005, we incurred $15 million of other asset impairments not related to restructuring actions.

 

For the year ended December 31, 2004, we recorded charges of $38 million for actions that resulted in the closing of two plants and employee reductions of approximately 770. For the year ended December 31, 2004, cash charges were $37 million for severance and costs related to the consolidation of certain facilities, and non-cash asset impairment charges were $1 million.

 

Critical Accounting Estimates

 

The critical accounting estimates that affect our financial statements and that use judgments and assumptions are listed below. In addition, the likelihood that materially different amounts could be reported under varied conditions and assumptions is noted.

 

Product Recalls.  We are at risk for product recall costs. Recall costs are costs incurred when the customer or we decide to recall a product through a formal campaign, soliciting the return of specific products due to a known or suspected safety concern. In addition, the National Highway Traffic Safety Administration (“NHTSA”) has the authority, under certain circumstances, to require recalls to remedy safety concerns. Product recall costs typically include the cost of the product being replaced, customer cost of the recall and labor to remove and replace the defective part.

 

Recall costs are recorded based on management estimates developed in conjunction with independent third-party actuaries engaged by us to establish loss projections based on historical claims data. Based on this actuarial estimation methodology, we accrue for expected but unannounced recalls when revenues are recognized upon shipment of product. In addition, we accrue for announced recalls based on our best estimate of our obligation under the recall action when such an obligation is probable and estimable.

 

Valuation Allowances on Deferred Income Tax Assets.  In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. Management considers historical losses, the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. We determined that we could not conclude that it was more likely than not that the benefits of certain deferred income tax assets would be realized. The valuation allowance we recorded reduced to zero the net carrying value of all United States and certain foreign net deferred tax assets. We expect the deferred tax assets, net of the valuation allowance, to be realized as a result of the reversal of existing taxable temporary differences in the United States and as a result of projected future taxable income and the reversal of existing taxable temporary differences in certain foreign jurisdictions.

 

Environmental.  Governmental regulations relating to the discharge of materials into the environment, or otherwise relating to the protection of the environment, have had, and will continue to have, an effect on our operations. We have made and continue to make expenditures for projects relating to the environment, including pollution control devices for new and existing facilities. We are conducting a number of environmental investigations and remedial actions at current and former locations to comply with applicable requirements and along with other companies, have been named a potentially responsible party for certain waste management sites.

 

A reserve estimate for each matter is established using standard engineering cost estimating techniques on an undiscounted basis. In the determination of such costs, consideration is given to the professional judgment of our environmental engineers, in consultation with outside environmental specialists, when necessary. At multi-party sites, the reserve estimate also reflects the expected allocation of total project costs among the various potentially responsible parties. Each of the environmental matters is subject to various uncertainties, and some of these matters may be resolved unfavorably to us. We believe that any liability, in excess of amounts accrued in our consolidated financial statements, that may result from the resolution of these matters for which sufficient information is available to support cost estimates, will not have a material adverse affect on our financial position, results of operations or cash flows. However, we cannot predict the effect on our financial position, results of operations or cash flows for aspects of certain matters for which there is insufficient information. In addition, we cannot predict the effect of compliance with environmental laws and regulations with respect to unknown environmental matters.

 

Pensions.  We account for our defined benefit pension plans in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 87, “Employers’ Accounting for Pensions” (“SFAS No. 87”), which requires that amounts recognized in financial statements be determined on an actuarial basis. This determination involves the selection of various assumptions, including an expected rate of return on plan assets and a discount rate.

 

A key assumption in determining our net pension expense in accordance with SFAS No. 87 is the expected long-term rate of return on plan assets. The expected return on plan assets that is included in pension expense is determined by applying the expected long-term rate of return on assets to a calculated market-related value of plan assets, which recognizes changes in the fair value of plan assets in a systematic manner over five years. Asset gains and losses will be amortized over five years in determining the market-related value of assets used to calculate the expected return component of pension income. We review our long-term rate of return assumptions annually through comparison of our historical actual rates of return with our expectations, and consultation with our actuaries and investment advisors regarding their expectations for future returns. While we believe our assumptions of future returns are reasonable and appropriate, significant differences in our actual experience or significant changes in our assumptions may materially affect our pension obligations and our future pension expense. The weighted average expected long-term rate of return on assets used to determine net periodic benefit cost for 2006 was 6.97% as compared to 7.60% for 2005 and 7.82% for 2004.

 

Another key assumption in determining our net pension expense is the assumed discount rate to be used to discount plan liabilities. The discount rate reflects the current rate at which the pension liabilities could be effectively settled. In estimating this rate, we look to rates of return on high quality, fixed-income investments that receive one of

the two highest ratings given by a recognized ratings agency, and that have cash flows similar to those of the underlying benefit obligation. The weighted average discount rate used to calculate the benefit obligations as of December 31, 2006 was 5.08% as compared to 5.04% as of December 31, 2005. The weighted average discount rate used to determine net periodic benefit cost for 2006 was 5.04% as compared to 5.53% for 2005 and 5.64% for 2004.

 

Based on our assumptions as of October 31, 2006, the measurement date, a change in these assumptions, holding all other assumptions constant, would have the following effect on our pension costs and obligations on an annual basis:

 

 

 

SFAS No. 87 and the policies we have used (most notably the use of a calculated value of plan assets for pensions as further described above), generally reduce the volatility of pension expense that would otherwise result from changes in the value of the pension plan assets and pension liability discount rates. A substantial portion of our pension benefits relate to our plans in the United States and the United Kingdom.

 

Our 2007 pension (income) expense is estimated to be approximately less than $(1) million in the U.S., $(53) million in the U.K. and $47 million for the rest of the world (based on December 31, 2006 exchange rates). During 2006 and 2005, certain amendments reducing future benefits for nonunion participants were adopted that will reduce future service costs. We expect to contribute approximately $73 million to our U.S. pension plans and approximately $47 million to our non-U.S. pension plans in 2007.

 

Other Post-Retirement Benefits.  We account for our Other Post-Retirement Benefits (“OPEB”) in accordance with SFAS No. 106, “Employers’ Accounting for Post-Retirement Benefits Other Than Pensions,” which requires that amounts recognized in financial statements be determined on an actuarial basis. This determination requires the selection of various assumptions, including a discount rate and health care cost trend rates used to value benefit obligations. The discount rate reflects the current rate at which the OPEB liabilities could be effectively settled at the end of the year. In estimating this rate, we look to rates of return on high quality, fixed-income investments that receive one of the two highest ratings given by a recognized ratings agency and that have cash flows similar to those of the underlying benefit obligation. We develop our estimate of the health care cost trend rates used to value benefit obligations through review of our recent health care cost trend experience and through discussions with our actuary regarding the experience of similar companies. Changes in the assumed discount rate or health care cost trend rate can have a significant impact on our actuarially determined liability and related OPEB expense.

 

The following are the significant assumptions used in the measurement of the accumulated projected benefit obligations (“APBO”) as of the October 31 measurement date:

 

Based on our assumptions as of October 31, 2006, the measurement date, a change in these assumptions, holding all other assumptions constant, would have the following effect on our OPEB expense and obligations on an annual basis:

 

 

 

Our 2007 OPEB expense is estimated to be approximately $25 million (based on December 31, 2006 exchange rates), and includes the effects of the adoption of certain 2006 and 2005 amendments which reduce future benefits for nonunion participants. We fund our OPEB obligation on a pay-as-you-go basis. We expect to contribute approximately $53 million on a pay-as-you-go basis in 2007.

 

Goodwill.  In connection with the Acquisition, we applied the provisions of SFAS No. 141, “Business Combinations” (“SFAS No. 141”). Goodwill, which represents the excess of cost over the fair value of the net assets of the businesses acquired, was approximately $2.3 billion as of December 31, 2006, or 20% of our total assets.

 

In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”), we perform annual impairment testing at a reporting unit level. To test goodwill for impairment, we estimate the fair value of each reporting unit and compare the estimated fair value to the carrying value. If the carrying value exceeds the estimated fair value, then a possible impairment of goodwill exists and requires further evaluation. Estimated fair values are based on the cash flows projected in the reporting units’ strategic plans and long-range planning forecasts (see “— Impairment of Long-Lived Assets and Intangibles”), discounted at a risk-adjusted rate of return.

 

As the estimated fair values of our reporting units have exceeded their carrying values at each testing date since adoption of SFAS No. 142 in 2002, we have recorded no goodwill impairment. While we believe our estimates of fair value are reasonable based upon current information and assumptions about future results, changes in our businesses, the markets for our products, the economic environment and numerous other factors could significantly alter our fair value estimates and result in future impairment of recorded goodwill. We are subject to financial statement risk in the event that goodwill becomes impaired.

 

Impairment of Long-Lived Assets and Intangibles.  We evaluate long-lived assets and definite-lived intangible assets for impairment when events and circumstances indicate that the assets may be impaired and the undiscounted cash flows to be generated by those assets are less than their carrying value. If the undiscounted cash flows are less than the carrying value of the assets, the assets are written down to their fair value. We also evaluate the useful lives of intangible assets each reporting period.

 

The determination of undiscounted cash flows is based on the businesses’ strategic plans and long-range planning forecasts. The revenue growth rates included in the plans are based on industry specific data. We use external vehicle build assumptions published by widely used external sources and market share data by customer based on known and targeted awards over a five-year period. The projected profit margin assumptions included in the plans are based on the current cost structure and anticipated cost reductions. If different assumptions were used in these plans, the related undiscounted cash flows used in measuring impairment could be different and additional impairment of assets might be required to be recorded.

 

We test indefinite-lived intangible assets, other than goodwill, for impairment on at least an annual basis by comparing the estimated fair values to the carrying values. If the carrying value exceeds the estimated fair value, the asset is written down to its estimated fair value. Estimated fair value is based on cash flows as discussed above, discounted at a risk-adjusted rate of return. We are subject to financial statement risk in the event that intangible assets become impaired.

 

RESULTS OF OPERATIONS

 

The following consolidated statements of earnings compare the results of operations for the years ended December 31, 2006, 2005 and 2004.

 

TOTAL COMPANY RESULTS OF OPERATIONS

 

CONSOLIDATED STATEMENTS OF EARNINGS
For the Years Ended December 31, 2006 and 2005

 

 

Year Ended December 31, 2006 Compared to Year Ended December 31, 2005

 

Sales for the year ended December 31, 2006 were $13.1 billion, an increase of $501 million compared to $12.6 billion for the year ended December 31, 2005. The increase was driven by the favorable impact of the consolidation of Dalphimetal of $336 million and the favorable impact of currency exchange of $172 million, offset by unfavorable price reductions to customers (net of favorable volume) of $7 million.

 

Gross profit for the year ended December 31, 2006 was $1,201 million, an increase of $2 million compared to $1,199 million for the year ended December 31, 2005. The increase was driven primarily by cost reductions and benefits from restructuring activities (net of inflation and price reductions to customers) of $47 million, and the favorable resolution of certain business settlement and patent matters of $22 million. Partial offsets include higher costs resulting from inefficient product launches within the Automotive Components segment of $19 million, lower customer vehicle production in North America and adverse mix, net of the favorable impact of the consolidation of Dalphimetal of $18 million, higher warranty costs of $18 million, higher engineering expenses of $8 million, and the unfavorable effect of currency exchange of $7 million. Gross profit as a percentage of sales for the year ended December 31, 2006 was 9.1% as compared to 9.5% for the year ended December 31, 2005.

 

Administrative and selling expenses for the year ended December 31, 2006 were $527 million, an increase of $37 million compared to $490 million for the year ended December 31, 2005. The increase was driven primarily by a reduction in litigation reserves in 2005 of $18 million which did not recur in 2006, an increase in share-based compensation expense of $8 million, the unfavorable effect of currency exchange of $8 million and the

consolidation of Dalphimetal of $6 million. Offsets include the favorable resolution of certain patent matters of $6 million. Administrative and selling expenses as a percentage of sales for the year ended December 31, 2006 were 4.0% as compared to 3.9% for the year ended December 31, 2005.

 

Amortization of intangible assets was $35 million for the year ended December 31, 2006, as compared to $33 million for the year ended December 31, 2005.

 

Restructuring charges and asset impairments were $30 million for the year ended December 31, 2006 as compared to $109 million for the year ended December 31, 2005. Charges for the year ended December 31, 2006 consisted of $37 million for severance and other costs, $7 million of asset impairments related to restructuring, $6 million of other asset impairments, offset by $20 million of post-retirement benefit curtailment gains at closed facilities. Charges for the year ended December 31, 2005 consisted of $85 million for severance costs and expenses to consolidate certain facilities, $14 million of asset impairments related to restructuring, $15 million for other asset impairments and $6 million of pension curtailment loss at a closed facility, partially offset by $11 million of post-retirement benefit curtailment gains at closed facilities.

 

Other expense (income) — net for the year ended December 31, 2006 was income of $27 million, an increase of $41 million compared to an expense of $14 million for the year ended December 31, 2005. The increase was driven primarily by the favorable effect of currency exchange of $17 million, an increase in net gains on asset sales of $9 million, a decrease in bad debt expense of $8 million, and an increase in royalty income, coupled with other miscellaneous adjustments, that together net to $7 million.

 

Interest expense — net for the year ended December 31, 2006 was $247 million as compared to $228 million for the year ended December 31, 2005. The increase in interest expense primarily resulted from the unfavorable effect of higher interest rates on variable rate debt, and to a lesser extent, higher average debt balances including Dalphimetal acquisition related debt.

 

Loss on retirement of debt for the year ended December 31, 2006 totaled $57 million as compared to $7 million for the year ended December 31, 2005. On February 2, 2006 we repurchased all of our subsidiary Lucas Industries Limited’s £94.6 million 107/8% bonds due 2020, for £137 million, or approximately $243 million. The repayment of debt resulted in a pretax charge of £32 million, or approximately $57 million, for loss on retirement of debt. On May 3, 2005, the Company repurchased approximately €48 million principal amount of its 101/8% Senior Notes with a portion of the proceeds from the issuance of common stock. The Company recorded a loss on retirement of debt of approximately $6 million for the related redemption premium on the 101/8% Senior Notes, and approximately $1 million for the write-off of deferred issue costs.

 

Accounts receivable securitization costs were $3 million for the years ended December 31, 2006 and 2005.

 

Equity in earnings of affiliates was $26 million for the year ended December 31, 2006, an increase of $6 million as compared to $20 million for the year ended December 31, 2005. The increase was driven primarily by a higher level of earnings from affiliates in Asia.

 

Minority interest was $13 million for the year ended December 31, 2006 as compared to $7 million for the year ended December 31, 2005. The increase of $6 million was driven primarily by the acquisition of Dalphimetal, which is not wholly-owned.

 

Income tax expense for the year ended December 31, 2006 was $166 million on pre-tax income of $342 million as compared to income tax expense of $124 million on pre-tax earnings of $328 million for the year ended December 31, 2005. Income tax expense for the year ended December 31, 2006 includes a one-time charge of approximately $49 million resulting from the recognition of a valuation allowance against certain deferred tax assets in our Canadian operations that the Company has determined are no longer more likely than not to be realized. Income tax expense for the year ended December 31, 2006 also includes a one-time benefit of approximately $35 million related to the reversal of certain tax reserves recorded in 2004 and 2005 with respect to interest expense in a foreign jurisdiction. This benefit was recorded during the third quarter of 2006 in the amount of $46 million, consisting of the reversal of the reserves recorded in prior years ($35 million) and the reversal of additional reserves recorded in the first two quarters of 2006 ($11 million). This benefit was recorded as a result of a published Letter Memorandum by the German tax authorities, which provided additional guidance and support

related to the deductibility of interest in our German subsidiary. Income tax expense for the year ended December 31, 2005 included a one-time benefit of $17 million resulting from a tax law change in Poland related to investment tax credits for companies operating in certain special economic zones within the country. The income tax rate varies from the United States statutory income tax rate due primarily to the items noted above, and the impact of losses in the United States and certain foreign jurisdictions, without recognition of a corresponding income tax benefit, partially offset by favorable foreign tax rates, holidays, and credits.

 

CONSOLIDATED STATEMENTS OF EARNINGS
For the Years Ended December 31, 2005 and 2004

 

 

Year Ended December 31, 2005 Compared to Year Ended December 31, 2004

 

Sales for the year ended December 31, 2005 of $12.6 billion increased $632 million from $12.0 billion for the year ended December 31, 2004. The increase resulted primarily from higher volume and sales of new products (net of price reductions provided to customers) of $431 million, the favorable effect of foreign currency exchange of $137 million, and the two-month impact of consolidating Dalphimetal in the fourth quarter of 2005 of $64 million. Sales volumes increased despite lower Big Three production in North America and flat industry production in Europe.

 

Gross profit for the year ended December 31, 2005 of $1,199 million increased $27 million from $1,172 million for the year ended December 31, 2004. The increase resulted primarily from the positive impact of higher sales volume, net of adverse product mix, of $90 million, a reduction in net pension and OPEB expense of $23 million, and lower product warranty cost, primarily in Europe, of $16 million. The net increase was partially offset by the unfavorable impact of inflation (which included higher commodity prices) and price reductions to our customers (net of savings from cost reductions) of $43 million, the unfavorable impact of foreign currency exchange of $31 million, and additional engineering cost to support new programs and growth in emerging markets, as well as lower cost recovery from our customers for prototypes and engineering charges, totaling $29 million. Gross profit as a percentage of sales for the year ended December 31, 2005 was 9.5% compared to 9.8% for the year ended December 31, 2004.

 

Administrative and selling expenses for the year ended December 31, 2005 of $490 million decreased $23 million from $513 million for the year ended December 31, 2004. The decrease primarily reflected a reduction in litigation-related reserves of approximately $18 million, and a reduction in net pension and OPEB expense related to retiree medical buyouts, and savings from cost reductions, totaling $9 million, partially offset by the unfavorable impact on foreign currency exchange, of $5 million. Administrative and selling expenses as a percentage of sales for the year ended December 31, 2005, were 3.9% compared to 4.3% for the year ended December 31, 2004.

 

Amortization of intangible assets was $33 million for the years ended December 31, 2005 and 2004.

 

Restructuring charges and asset impairments were $109 million for the year ended December 31, 2005 compared to $38 million for the year ended December 31, 2004. Charges for the year ended December 31, 2005 consisted of $85 million for severance costs and expenses to consolidate certain facilities, $14 million of asset impairments related to restructuring, $15 million for other asset impairments and $6 million of pension curtailment loss at a closed facility, partially offset by $11 million of post-retirement benefit curtailment gains at closed facilities. Charges for the year ended December 31, 2004 of $38 million were primarily costs related to severance and consolidation of certain facilities.

 

Other expense — net for the year ended December 31, 2005 was expense of $14 million compared to expense of $8 million for the year ended December 31, 2004. The change resulted primarily from a reduction in gains from asset sales of $8 million, an increase in foreign currency exchange loss of $6 million, and higher expense in connection with the bankruptcy and administration proceedings of certain customers of $5 million. Offsets include higher royalty and grant income coupled with other miscellaneous adjustments that net to $13 million.

 

Interest expense — net for the year ended December 31, 2005 was $228 million as compared to $250 million for the year ended December 31, 2004. The decrease in interest expense primarily resulted from lower average debt balances and various refinancing activities including the purchase of the seller note from Northrop, partially offset by the unfavorable effect of higher interest rates on variable rate debt.

 

Loss on retirement of debt for the year ended December 31, 2005 totaled $7 million as compared to $167 million for the year ended December 31, 2004. On May 3, 2005, the Company repurchased approximately €48 million principal amount of its 101/8% Senior Notes with a portion of the proceeds from the issuance of common stock. The Company recorded a loss on retirement of debt of approximately $6 million for the related redemption premium on the 101/8% Senior Notes, and approximately $1 million for the write-off of deferred issue costs.

 

During 2004, we incurred the following losses on various refinancing transactions:

 

 

Accounts receivable securitization costs were $3 million for the year ended December 31, 2005 as compared to $2 million for the year ended December 31, 2004.

 

Equity in earnings of affiliates was $20 million for the year ended December 31, 2005 as compared to $15 million for the year ended December 31, 2004.

 

Minority interest was $7 million for the year ended December 31, 2005 as compared to $12 million for the year ended December 31, 2004.

 

Income tax expense for the year ended December 31, 2005 was $124 million on pre-tax income of $328 million as compared to income tax expense of $135 million on pre-tax earnings of $164 million for the year ended December 31, 2004. The income tax rate varies from the United States statutory income tax rate due primarily to the impact of non-deductible interest expense in certain foreign jurisdictions partially offset by favorable foreign tax rates, holidays, and credits.

 

SEGMENT RESULTS OF OPERATIONS

 

The following table reconciles segment sales and earnings before taxes to consolidated sales and earnings before taxes for 2006, 2005, and 2004. See Note 21 to the consolidated financial statements for a description of segment earnings before taxes for the periods presented.

 

 

CHASSIS SYSTEMS

 

Year Ended December 31, 2006 Compared to Year Ended December 31, 2005

 

 

Sales for the Chassis Systems segment for the year ended December 31, 2006 were $7,096 million, a decrease of $110 million as compared to $7,206 million for the year ended December 31, 2005. The decrease was driven primarily by lower North American customer vehicle production and price reductions provided to customers of $216 million, partially offset by the favorable effect of currency exchange of $106 million.

 

Earnings before taxes for the Chassis Systems segment for the year ended December 31, 2006 were $288 million, an increase of $15 million as compared to $273 million for the year ended December 31, 2005.

The increase was driven primarily by the favorable impact of cost reductions and benefits of restructuring activities (in excess of inflation and price reductions provided to customers) of $75 million, the favorable resolution of certain business settlements of $19 million, lower restructuring costs of $18 million, a reduction in bad debt expense of $10 million, the favorable resolution of certain patent matters of $9 million, and a gain on the sale of a facility in Asia of $5 million. These results were partially offset by the effect of lower North America customer vehicle production and adverse mix of $88 million, higher warranty costs of $18 million, higher product and Asian customer development costs of $9 million, and the unfavorable impact of currency exchange of $8 million. For the year ended December 31, 2006, Chassis Systems recorded restructuring charges and asset impairments of $14 million in connection with severance and costs related to the consolidation of certain facilities, offset by post-retirement benefit curtailment gains. For the year ended December 31, 2005, Chassis Systems recorded restructuring charges and asset impairments of $33 million in connection with severance and costs related to the consolidation of certain facilities, offset by post-retirement benefit curtailment gains.

 

Year Ended December 31, 2005 Compared to Year Ended December 31, 2004

 

 

Sales for the Chassis Systems segment for the year ended December 31, 2005 of $7,206 million increased $256 million from $6,950 million for the year ended December 31, 2004. The increase resulted primarily from higher volume (net of price reductions to customers) of $159 million, as well as the favorable effect of foreign currency exchange of $97 million.

 

Earnings before taxes for the Chassis Systems segment for the year ended December 31, 2005 were $273 million, an increase of $15 million as compared to $258 million for the year ended December 31, 2004. The increase was driven primarily by the positive impact of higher volume, net of adverse product mix, of $27 million, lower product warranty in Europe of $14 million, and savings from cost reductions, net of inflation and pricing, of $7 million. These results were offset by an increase in bad debt expense and other costs related to the bankruptcy and administration proceedings of certain customers totaling $15 million, the unfavorable effect of foreign currency exchange of $10 million, and an increase in restructuring charges of $8 million. For the year ended December 31, 2005, Chassis Systems recorded restructuring charges and asset impairments of $33 million in connection with severance and costs related to the consolidation of certain facilities, which were partially offset by post-retirement benefit curtailment gains. Chassis Systems recorded restructuring charges and asset impairments of $25 million for the year ended December 31, 2004 related to severance and consolidation of certain facilities.

 

OCCUPANT SAFETY SYSTEMS

 

Year Ended December 31, 2006 Compared to Year Ended December 31, 2005

 

 

Sales for the Occupant Safety Systems segment for the year ended December 31, 2006 of $4,326 million, an increase of $581 million compared to $3,745 million for the year ended December 31, 2005. The increase was driven primarily by the consolidation of Dalphimetal acquired in October 2005, which contributed incremental sales of $336 million, favorable volume (net of price reductions provided to customers) of $216 million, and the favorable effect of currency exchange of $29 million.

 

Earnings before taxes for the Occupant Safety Systems segment for the year ended December 31, 2006 were $420 million, an increase of $124 million as compared to $296 million for the year ended December 31, 2005. The increase was driven primarily by higher production volume, net with favorable impact of the consolidation of Dalphimetal, of $84 million, lower restructuring charges and asset impairments of $36 million, and a reduction in pension and other post-employment benefit spending of $3 million. For the year ended December 31, 2006, Occupant Safety Systems recorded restructuring charges and asset impairments of $9 million in connection with severance and costs related to the consolidation of certain facilities. For the year ended December 31, 2005, Occupant Safety Systems recorded restructuring charges and asset impairments of $45 million in connection with severance and costs related to the consolidation of certain facilities, primarily the Burgos, Spain facility, and other asset impairment charges.

 

Year Ended December 31, 2005 Compared to Year Ended December 31, 2004

 

 

Sales for the Occupant Safety Systems segment for the year ended December 31, 2005 of $3,745 million increased $307 million from $3,438 million for the year ended December 31, 2004. The increase primarily reflected higher customer volume and growth in the new product areas, (net of price reductions to our customers) of $236 million, the consolidation of Dalphimetal for two months during the fourth quarter of 2005 of $64 million, and the favorable impact of foreign currency exchange of $7 million.

 

Earnings before taxes for the Occupant Safety Systems segment for the year ended December 31, 2005 of $296 million decreased $31 million from $327 million for the year ended December 31, 2004. The decrease resulted primarily from price reductions to customers and inflation that exceeded savings from cost reductions of $53 million, higher restructuring charges and asset impairments of $37 million, and the unfavorable impact of foreign currency exchange of $19 million. These changes were partially offset by higher volume of $61 million and a reduction in pension and litigation expenses of $17 million. For the year ended December 31, 2005, Occupant Safety Systems recorded restructuring charges and asset impairments of $42 million in connection with severance and costs related to the consolidation of certain facilities, primarily the Burgos, Spain facility, and other asset impairment charges of $3 million, as compared to $8 million of restructuring charges and asset impairments for the year ended December 31, 2004.

 

AUTOMOTIVE COMPONENTS

 

Year Ended December 31, 2006 Compared to Year Ended December 31, 2005

 

 

Sales for the Automotive Components segment for the year ended December 31, 2006 of $1,722 million increased $30 million as compared to $1,692 million for the year ended December 31, 2005. The increase was driven primarily by the favorable effect of currency exchange of $36 million, offset by price reductions provided to customers, net of higher volume, of $6 million.

 

Earnings before taxes for the Automotive Components segment for the year ended December 31, 2006 were $67 million, $25 million lower compared to $92 million for the year ended December 31, 2005. The decrease was

driven primarily by unfavorable mix of products sold (offset by higher volume) of $25 million, higher costs resulting from inefficient product launches of $19 million, and higher inflation, price reductions, and supplier quality issues (net of cost reductions) of $17 million. These items were partially offset by lower restructuring charges and asset impairments of $24 million, the favorable effect of currency exchange of $3 million, lower warranty costs of $3 million, and a decrease in pension and other post-retirement benefit expense of $2 million. For the year ended December 31, 2006, Automotive Components recorded restructuring charges of $7 million. For the year ended December 31, 2005, Automotive Components recorded restructuring charges of $19 million which consisted primarily of $19 million in severance costs and expenses to consolidate certain facilities and $2 million of asset impairments, partly offset by $2 million of post-retirement benefit curtailment gains. Automotive Components also recorded $12 million in other asset impairments not related to restructuring in 2005.

 

Year Ended December 31, 2005 Compared to Year Ended December 31, 2004

 

 

Sales for the Automotive Components segment for the year ended December 31, 2005 of $1,692 million increased $69 million from $1,623 million for the year ended December 31, 2004. The increase primarily reflected the favorable impact of foreign currency exchange of $33 million and higher customer volume (net of price reductions to our customers) of $36 million.

 

Earnings before taxes for the Automotive Components segment for the year ended December 31, 2005 of $92 million decreased $10 million from $102 million for the year ended December 31, 2004. The decrease resulted primarily from an increase in restructuring and asset impairment charges totaling $26 million, unfavorable price reductions, net of higher volume, of $13 million, and the unfavorable impact of foreign currency exchange of $2 million, offset by savings from cost reductions of $20 million, the reduction of warranty expenses of $7 million and a reduction of pension and OPEB costs of $3 million. For the year ended December 31, 2005, Automotive Components recorded restructuring charges of $19 million which consisted primarily of $19 million in severance costs and expenses to consolidate certain facilities and $2 million of asset impairments, partly offset by $2 million of post-retirement benefit curtailment gains. Automotive Components also recorded $12 million in other asset impairments not related to restructuring. Restructuring charges and asset impairments for the year ended December 31, 2004 totaled $5 million.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Cash Flows

 

Operating Activities.  Cash provided by operating activities for the year ended December 31, 2006 was $649 million as compared to $502 million for the year ended December 31, 2005. This increase resulted primarily from increased operating profits and net working capital improvements.

 

Investing Activities.  Cash used in investing activities for the year ended December 31, 2006 was $459 million as compared to $639 million for the year ended December 31, 2005.

 

In 2006, we spent $529 million in capital expenditures, primarily in connection with upgrading existing products, continuing new product launches started in 2005 and 2006 and providing for incremental capacity, infrastructure and equipment at our facilities to support our manufacturing and cost reduction efforts. We expect to spend approximately $540 million, or approximately 4% of sales, in such capital expenditures during 2007.

 

In 2006, we spent approximately $26 million for an additional 10% interest in Dalphimetal and other final purchase price adjustments related to that original 2005 acquisition. We received approximately $43 million from various asset sales, primarily related to the sale of certain closed manufacturing facilities and to the divestiture of an

investment formerly held by Dalphimetal. We also received approximately $54 million in proceeds from various sale leaseback transactions related to certain of our management, engineering and production facilities during 2006.

 

Financing Activities.  Cash used in financing activities was $340 million for the year ended December 31, 2006 compared to cash provided of $38 million in the year ended December 31, 2005. In 2006, we repurchased all of our subsidiary Lucas Industries Limited’s £94.6 million 107/8% bonds due 2020, for £137 million, or approximately $243 million.

 

In 2005, we borrowed approximately $1,638 million, net of debt issue costs, and used approximately $1,603 million to pay down long-term debt, primarily in conjunction with the initial draw down of the credit facilities under our December 2004 amendment and restatement of our credit agreement.

 

Debt and Commitments

 

Sources of Liquidity.  Our primary source of liquidity is cash flow generated from operations. We also have availability under our revolving credit facility and receivables facilities described below, subject to certain conditions. See “Senior Secured Credit Facilities,” “Off-Balance Sheet Arrangements” and “Other Receivables Facilities.” Our primary liquidity requirements, which are significant, are expected to be for debt service, working capital, capital expenditures, research and development costs, taxes and other general corporate purposes.

 

In connection with the Acquisition by an affiliate of Blackstone of the shares of the subsidiaries of Old TRW engaged in the automotive business from Northrop, our wholly-owned subsidiary TRW Automotive issued the senior notes and the senior subordinated notes, entered into senior secured credit facilities, consisting of a revolving credit facility and term loan facilities, and initiated a trade accounts receivable securitization program, or the United States receivables facility.

 

As of December 31, 2006, we had outstanding $3.0 billion in aggregate indebtedness. We intend to draw down on, and use proceeds from, the revolving credit facility under our senior secured credit facilities, as amended, and our United States and European accounts receivables facilities (collectively, the “Liquidity Facilities”) to fund normal working capital needs from month to month in conjunction with available cash on hand. As of December 31, 2006, we had an additional $830 million of availability under our revolving credit facility after giving effect to $70 million in outstanding letters of credit and guarantees, which reduced the amount available. As of December 31, 2006, approximately $191 million of our total reported accounts receivable balance was considered eligible for borrowings under our United States receivables facility, of which approximately $104 million would have been available for funding. We had no outstanding borrowings under this receivables facility as of December 31, 2006. As of January 26, 2007, approximately $196 million would have been available for funding after giving effect to a January 2007 amendment to this facility. In addition, as of December 31, 2006, we had approximately €140 million and £11 million available for funding under our European accounts receivable facilities. We had no outstanding borrowings under the European accounts receivable facilities as of December 31, 2006.

 

During any given month, we anticipate that we will draw as much as an aggregate of $400 million from the Liquidity Facilities. The amounts drawn under the Liquidity Facilities typically will be paid back throughout the month as cash from customers is received. We may then draw upon such facilities again for working capital purposes in the same or succeeding months. These borrowings reflect normal working capital utilization of liquidity. In addition, Dalphimetal and its subsidiaries and various subsidiaries in the Asia Pacific region have liquidity available to them under various credit facilities. Dalphimetal and its subsidiaries have approximately €47 million of credit facilities, of which €30 million was available as of December 31, 2006. Our subsidiaries in the Asia Pacific region have various credit facilities totaling approximately $92 million (US dollar equivalent), of which $55 million (US dollar equivalent), was available as of December 31, 2006. These borrowings are primarily in the local currency of the country where our subsidiary’s operations are located. We expect that these additional facilities will be drawn from time to time for normal working capital purposes.

 

Debt Repurchases.  On February 2, 2006, we repurchased all of our subsidiary Lucas Industries Limited’s £94.6 million 107/8% bonds due 2020 for approximately £137 million, or approximately $243 million. The repayment of debt resulted in a pretax charge of approximately £32 million, or approximately $57 million, for loss