Executives
Joseph Cantie - Chief Financial Officer, Executive Vice President and Treasurer
John Plant - Chief Executive Officer, President and Director
Mark Oswald - Director of Investor Relations
Analysts
Rod Lache - Deutsche Bank AG
Patrick Archambault - Goldman Sachs Group Inc.
Christopher Ceraso - Crédit Suisse AG
Brett Hoselton - KeyBanc Capital Markets Inc.
John Murphy - BofA Merrill Lynch
Himanshu Patel - JP Morgan Chase & Co
TRW Automotive Holdings (TRW) Q2 2010 Earnings Call August 4, 2010 8:30 AM ET
Operator
Good morning, and welcome to the TRW Conference Call. [Operator Instructions] Presentation material for today's call was posted to the company's website this morning at trw.com/results. Please download the material now if you have not already done so. [Operator Instructions] I would now like to introduce your host for today's conference call, Mark Oswald, Director of Investor Relations. Sir, you may begin.
Mark Oswald
Thank you, and good morning. I'd like to welcome everyone to our Second Quarter 2010 Financial Results Conference Call. Joining me on the call this morning, as usual, are John Plant, our President and Chief Executive Officer; and Joe Cantie, our Chief Financial Officer.
On today's call, John will provide an overview of the current automotive environment and its impact on TRW. John will also provide a brief summary of the financial results and discuss other related business matters, including our outlook for the remainder of the year. After John's comments, Joe will provide an expanded review of the financial information. At the conclusion of Joe's comments, we will open the call to your questions.
Before I turn the call over to John and Joe, there are a few items I'd like to cover. First, today’s conference call will include forward-looking statements. These statements are based on the environment as we see it today and therefore involve risks and uncertainties. I would caution you that our actual results could differ materially from the forward-looking statements made on this call.
Please refer to Slide 2 of the presentation for our complete Safe Harbor Statement. The Risk Factors section of our 2009 Form 10-K and our first quarter 10-Q contain additional information about risks and uncertainties that could impact our business. You can access a copy of our 2009 10-K and 2010 quarterly SEC filings by visiting the Investors section of our website at trw.com or through the SEC’s website at sec.gov. On a related matter, we expect to file our second quarter 10-Q within the next day or so. Once filed, the 10-Q can also be accessed through either website.
In addition to the financial results presented on a GAAP basis, we will be discussing non-GAAP information that we believe is useful in evaluating the company’s operating performance. Reconciliations for these non-GAAP measures to the closest GAAP equivalent can be found on the conference call materials, which are posted on the Investors section of our website at trw.com.
And finally, a replay of this call can be accessed via dial-in or through a webcast on our website. Replay instructions were included in our release this morning. We have not given our permission for any other recording of this call and do not approve or sanction any transcribing of the call.
This concludes my comments. I'll now turn the call over to John Plant.
John Plant
Thank you, Mark, and good morning, everyone. As you can see from the results posted this morning, TRW's second quarter performance continued to build on the positive momentum established last year.
During the recent quarter, sales totaled $3.7 billion and were 34% higher compared with the prior year second quarter and about 2% higher compared with our first quarter. Operating profit was $322 million, resulting in an operating margin of 8.8%. Both of these are records for TRW. This marks the third consecutive quarter that the company has posted record profits and the second consecutive quarter with operating margins above 8%.
Net income was $227 million and earnings per share was $1.78. The company generated cash from operations, less capital expenditures, of $340 million. And finally, the strong operating and cash performance allowed TRW to continue its debt reduction trend. In fact, both our gross debt and our net debts reduced and reached historic lows at the quarter end.
TRW's second quarter results, combined with the impressive performance achieved in the first quarter has resulted in an excellent performance for the first half of 2010. I’ll expand on the year-to-date results in just a few minutes.
First just a few additional comments from the second quarter. During Q2, industry production volumes remained robust, especially in North America, and these made a positive contribution to our results. In North America, overall vehicle production was up 72% compared with the second quarter of 2009. On a sequential basis compared to the first quarter of this year, production was up 6%. Increased consumer demand, albeit slower than expected, has driven this fifth sequential quarter increase in production for the region.
In Europe, vehicle production was robust and exceeded the expectations of most industry observers that was set earlier in this quarter. Compared to last year's second quarter, vehicle production was up 13%. And on a sequential basis, production was up 3% compared with the first quarter, which I noted was better than expected only three months ago. For Western Europe, production is relatively flat when compared to Q1 of this year. Although demand and sales continue to fall in most countries following the exploration of government incentives, the larger volume of exports and inventory rebuilding has provided support for vehicle production.
In addition, Western Europe is also experiencing an improvement in vehicle mix, as the majority of exports tend to be larger and higher-content luxury vehicles, good news for manufacturers and suppliers alike with a strong presence in Europe.
In the developing markets of the world, such as China and Brazil, TRW continues to strengthen its position and capitalize on the dynamic growth that is occurring. For the quarter, TRW sales outpaced industry production in both China and Brazil.
With respect to the first half, we're quite pleased with our performance. Operating profit for the first six months was $622 million on sales of $7.2 billion, which resulted in a margin of 8.6%. This is the best operating performance and resulting margin in any six-months period in the history of the company.
Net income was $431 million and earnings per share was $3.38, once again records. The strong start in 2010 should provide a solid foundation for the full year. Of course, the second half of the year will see reduced production volumes compared to the first half given the seasonal shutdowns in Q3 and an expected cooling in second half vehicle sales in Europe. Despite the lower volumes, we plan to work hard to maintain our good momentum.
To ensure the goal of finishing a strong year, the company is clearly focused on upturn management to prevent costs creeping back into our operations during this period of gradual recovery in the industry. Rising prices for raw materials are one example of costs that we continue to watch closely to ensure that mitigating actions are implemented quickly to preserve our profitability.
Moving on to the second quarter business developments. A high level of product launches during the quarter, and this continued to strengthen our diversification and leadership in intelligence safety solutions. A few examples include: our innovative electric steering; driver and passenger airbags; seatbelt retractors and steering wheels on the Ford Fiesta, which was recently launched in North America; driver and passenger airbag modules; seat belt systems and steering wheels on VW’s Jetta in North America and Europe; electrically powered hydraulic steering, seat belts and inflators on Opel's Meriva; and in Asia Pacific, Daimler's E class was launched with TRW’s driver passenger and the airbags and steering wheels. These products continue to be delivered with world-class quality, resulting from our ongoing quality and six sigma programs.
For the quarter, our quality averaged a little over six parts per million across all products and customers. TRW's leading technology portfolio continues to gain recognition across the industry. During recent testing by the National Highway Traffic and Safety Administration, nearly 35% of vehicles earning NHTSA’s highest side-impact rating of five stars featured TRW's content.
Vehicle manufactures, customers and governments continue to demand increased safety in their vehicles, and TRW's technology portfolio provides them with a complete range of solutions. This safety theme has allowed TRW to out-perform the industry growth in prior years and is a clear driver for our future growth. A good example is the recent legislation passed in Brazil, requiring the fitment of 100% of driver’s airbags and antilock braking systems by 2014, and it is up from about a 5% fitment rate today.
In addition to the drivers air bag, additional contents, which is crash sensors and new steering wheels and in some cases, passenger airbags is also be added to these vehicles. And considering TRW's strong presence in Brazil where 2009 sales totaled about $0.5 billion, this represents another great opportunity to strengthen and grow in South America.
Within the Chassis [ph] (31:27)segment, TRWs winning new business and seeing a high level of interest from the vehicle manufactures for its belt drive electrically powered steering and our electronic part break technologies. These technologies as you know, not only saved fuel and reduced green house gas emissions, they can also be integrated with of a variety of other electronically controlled systems to enhance comfort and safety.
Overall, TRW's future growth opportunities appear bright when you consider the increasing safety content in vehicles. TRW's leading technology, the overall industry recovery, which includes a vehicle mix improvement in Europe and a dynamic growth in emerging markets all lead to a good conclusion. Before I turn the call over to Joe, let me comment on our expectations for the third quarter and for the remainder of 2010.
Overall, production forecasts have remained relatively steady since our last conference call. In North America, we expect third quarter production to be roughly 2.9 million units, an increase of 22% compared to last year and about equal to the second quarter. For the full year, we now expect North American production to be approximately 11.6 million units, an increase of 36% compared to 2009 and increased from our previous guidance. The gradual improvement in vehicle sales and well-managed dealer inventories appear to support this level of production.
In Europe, vehicle production continues to be difficult to predict. Although many industry observers have been forecasting production declines relating to the payback effective the cessation [ph] (33:06) of various scrappage programs, core to reproduction has remained relatively stable in the 4.5 to 4.8 million unit range since the fourth quarter of last year. During the third quarter of 2010, due to seasonal factors, vehicle production in Western Europe is projected to be about 2.6 million units, down about 12% compared with last year and roughly 750,000 units lower compared with Q2. Total European production is forecasted at 3.7 million units.
For full year 2010, we now expect year-over-year production to be up compared to last year due to the strong first half levels. However, we expect second half production to fall around 19% compared to the first six months of this year, which should translate into total European production of around 17.2 million units. Within this estimate, Western European production is 12.2 million units, an increase of about 4% compared with 2009.
As you would expect, we will continue to monitor the production plans of our customers closely and make any necessary adjustments. Beyond North America and Western Europe, we expect full year production levels in the developing markets of the world, such as China, India and South America, will remain very robust.
Based on our revised production estimates and an updated euro to U.S. dollar assumption, we now expect sales of approximately $13.2 billion to $13.6 billion, an increase for 2010. Sales in the third quarter are expected to be approximately $3.1 billion, which is about equal with last year. We still expect capital spending of approximately $325 million, as spending is aligned with the launch plans of our customers. This level continues to be well below our historical run rate.
In summary, we are very pleased with our second quarter and first half results. The low-cost base combined with our strengthened balance sheet and broad technology portfolio has allowed TRW to take full advantage of the gradual industry rebound that is currently occurring. Looking to the future, it's hard to remember a time when the underlying outlook for the automotive industry was brighter. Our team will continue to work diligently to finish the year in a strong manner and position the company for long-term success.
With that, I'll now hand the call to Joe to discuss our financial results in further detail.
Joseph Cantie
Thank you, John, and good morning to everyone. As you can see from our financial published this morning, our second quarter results continued the record setting pace we experienced in the first quarter. Reinforcing the key highlights, our absolute operating income of $322 million and margin level of 8.8% were both records for the company. Earnings per share were $1.78, the highest level achieved in any one quarter. And free cash flow was $340 million for the quarter, resulting in an all-time lowest net debt position below $1.3 billion.
As was the case in our first quarter, the favorable Q2 performance resulted primarily from higher vehicle production levels in North America, surprisingly strong European production levels and the benefits of our downturn management actions taken in 2009. The quarter completes an outstanding first half for TRW, which saw us posting earnings per share of $3.38 and as John mentioned, lays a firm foundation for the remainder of the year and beyond. We're obviously pleased with our second quarter and first-half performance. However, we remain cautious and recognize the continuing challenges that face our industry.
I'll expand on our outlook for the remainder of 2010 in a few minutes. But first, I'll review our second quarter and first half results with you in a bit more detail. For the quarter, we reported sales of $3.7 billion, an increase of $929 million compared to the same period a year ago and $78 million higher compared with our first quarter.
Currency translation, partially offset the higher production volumes we experienced, decreasing our sales by $54 million compared to the prior year. The euro to dollar exchange rate averaged $1.27 this quarter, which was about 7% lower than the same period a year ago. We expect the euro, despite its recent strength, to have a negative impact on our second half sales comparisons to the prior year. Excluding the effects of currency translation, sales increased about 36% compared to the previous year, with increases in each of our major geographic markets.
Moving down the income statement, for the quarter we had a record operating profit of $322 million compared to operating income of $44 million in the 2009 period. The dramatic increase was driven by a number of factors, including lower restructuring charges between the two periods. But essentially what you're seeing is the strong operating leverage driven by the positive impact of higher sales against our lower cost base. The result was a second quarter operating margin of 8.8%, the second consecutive quarter that we achieved an operating margin above 8%.
Another positive factor contributing to this result was the fact that commodity inflation for the most part was in check. Below operating income, interest expense totaled $41 million, about equal to last year's level and reflective of the cash generation and debt repayments that I'll discuss with you in a few minutes.
Finally, tax expense was $52 million in the quarter, which included a tax benefit of $10 million relating to the favorable resolution of various tax matters in foreign jurisdictions. Compared to the previous year, the increase of $38 million or $42 million excluding favorable benefits from both periods, was primarily the result of higher pretaxed earnings in the current quarter.
Similar to our first quarter, the Q2 effective tax rate, excluding the $10 million one-off I just referred to, was 22% and reflects the impact of our overall improvement in operating results and the geographic mix of our earnings, including the United States where we are currently in a valuation allowance position and therefore, do not recognize tax expense on U.S. income. This has the effect of driving our tax rate to a lower-level. I'll provide a revised full year tax expectations in just a few minutes.
At the bottom line, we posted GAAP net earnings of $1.78 per diluted share compared with a net loss of $0.11 in the 2009 period. Excluding restructuring, the impact of debt retirements and favorable tax benefits from both periods we reported net earnings of $1.73 per diluted share compared with net earnings of $0.08 in the prior year.
In terms of EBITDA for the quarter, we had $437 million, excluding special items, compared with $192 million in the prior year measured on the same basis, reflecting the significantly improved operating income between the two periods.
Moving to a brief review of our first half results, we reported sales of $7.2 billion, which is an increase of $2.1 billion or 41% compared with the previous year. Increased vehicle production, primarily in North America and Europe and continued growth resulting from our portfolio of safety products, accounted for approximately $2 billion of the year-on-year increase. The remaining variance, about $130 million, came from favorable currency translation in the first quarter.
Our operating income in the first half was $622 million, which compares to a loss of $81 million for the first half of 2009. The positive variance between the two periods was again driven by higher sales against our lower cost base. Below operating income, interest expense was $86 million compared to $84 million last year. In the prior year's six-month period, we had a $35 million gain on retirement of debt compared to a minor $1 million loss this year.
Tax expense was $102 million, which compares to $9 million in 2009. The increase was primarily the result of higher pretaxed earnings in the current year period. Both the current and the periods include tax benefits of $12 million and $10 million, respectively.
At the bottom line, we reported GAAP net earnings of $3.38 per diluted share, which compares to a GAAP net loss of $1.40 per share last year. Excluding the special items, earnings per share by coincidence was also $3.38 for the first half of this year. And finally, in terms of EBITDA, which is another record for us, we had $862 million compared to $235 million in the prior year.
Moving on now to our cash flow and capital structure. Overall, the positive earnings we experienced in the quarter and our first half have converted into cash flow, allowing us to take another step-change in advancing our capital structure towards investment-grade status.
For the quarter, operating cash flow was $402 million, which compares to $23 million in 2009. Free cash flow, and I'm defining that as operating cash flow less capital expenditures, was $340 million this quarter compared to a use of $14 million last year. For the six-month period, the company generated an impressive $316 million of free cash flow compared to a use of $303 million in the prior year. Although capital expenditures at $107 million during the first half was $35 million higher compared to last year, spending remains well below normalized levels. We'll continue to align spending with launch plans of our customers.
The year-over-year improvement in free cash flow of over $600 million is due primarily to the increased level of profitability between the periods and our continued focus on capital management, overall.
Our net debt of $1,277,000,000 at quarter end is $306 million lower compared with the balance at December 31 of 2009. Measured on a trailing 12-month basis, our net debt to EBITDA ratio is 0. 8x at the end of the quarter. Considering that we started at over 3.5x in 2003, we're feeling pretty good about our net debt levels right now and expect them to be even lower by the end of this year.
Compared with the balance at the end of the second quarter of last year, net debt has been reduced about $1.2 billion or about 48% in one year. The record first half performance and confidence in our ability to generate cash has allowed us to permanently pay down $150 million of our term loans during the second quarter and $251 million in the first half. Regarding liquidity, despite the term loan pay-downs at the end of the quarter, we had an excess of $1.7 billion available to us, consisting primarily of cash on hand and our undrawn revolver. Basic message, our capital structure is in great shape.
Switching subjects now to our expectations for the third quarter and remainder of 2010, in addition to our revised full year expectations for production in North America and Europe, up 36% and 6%, respectively, our forecast for the remainder of the year now anticipates a higher euro to dollar exchange rate than assumed three months ago. These revised assumptions should translate the full year sales for us in the range of $13.2 billion to $13.6 billion. At the midpoint of this range, our sales will be up about 16% from 2009 or about $1.8 billion.
For the third quarter, as John mentioned, we expect sales of about $3.1 billion which is about even with last year's level, but lower than our first and second quarter's, primarily due to Europe's normal seasonality of production. We expect capital spending to be about $325 million this year, which is consistent with our earlier projections.
With regards to restructuring, we still expect our full year expense to be somewhere in the range of $30 million to $40 million. Full year interest expense is expected to range between $165 million and $170 million, given our expectations of interest rates and our components of debt.
The lower-than-expected tax rate in the first half will result in the full year rate below our previous guidance. Based on our current forecast, it’s reasonable to expect that our full year effective tax rate will range between 23% and 28% for the full year.
And finally, we continue to expect the higher level of commodity inflation as we move through the year due to the rising commodity prices witnessed earlier this year. The recent pullback in spot prices over the past weeks is encouraging. However, as you’re aware, a time lag exists before rising or falling prices impact our results. Similar to prior periods of inflation, the company will aggressively work to reduce and minimize the impact on us.
In closing, our achievements through the first half of this year have been record-setting, leading to step change improvements in our capital structure and provide a strong foundation for the balance of the year. We'll continue to work hard to protect our profitability as we move through the second half of this year.
Thank you. We'll now move to the question-and-answer portion of the call.
Question-and-Answer Session
Operator
[Operator Instructions] We will now take our first question from Himanshu Patel with JP Morgan.
Himanshu Patel - JP Morgan Chase & Co
Wanted to see, Joe, if you could comment a little bit more on taxes. How much in pretax income can TRW shield, just given prior carry-forwards and tax credits? And my final question is just from a tax provisioning perspective you mentioned evaluation allowance. When would you, kind of, expect that to come off?
Joseph Cantie
I'll break it into two things, Himanshu. First of all, from a cash tax perspective, in the U.S., we have close to a $1 billion of NOLs that are available to us. So we expect to be shielding any kind of U.S. profitability for a long period of time going forward years. I think that other geographies clearly, we pay cash taxes on. So any income that we have in the U.S. is clearly favorable for us. From a provisioning standpoint, the effective tax rate benefits from the fact that when we have U.S. income, there is not an accounting tax expense on it and we are in a profitable position in the U.S. this year. So that's one of the drivers to why our effective tax rate is as low as it is. In terms of when that might flip, can't give you any specifics. I don't anticipate that happening in the near term, this year, next year. After that, it depends on how profitable we are, and what the forecast in the U.S. looks like going forward. So I think we'll enjoy this lower rate for a period of time yet, until we have any decision to make on that.
Himanshu Patel - JP Morgan Chase & Co
But I mean, just given all the cross-currents of eventually accruing some sort of normalized tax rate in the U.S., but maybe not near term and maybe the off-set is some of your lower tax jurisdiction income levels start rising as well. What do you just kind of see as the long-term direction of TRW's tax rate? Does it kind of stay where it is? Or sort of go higher or lower from here?
Joseph Cantie
Again, I think we enjoyed a very low effective tax rate for a number of years. And over the long term, let's say five years out, naturally, which is always the case, all of the tax rates will accrue to what I'll call a weighted average tax rate across all our jurisdictions, which is somewhere in that 30% zone.
Himanshu Patel - JP Morgan Chase & Co
Okay, helpful. There was another income item of $22 million on the P&L. Can you elaborate on that and then also discuss were there any kind of one-off issues that kind of went either positive or negative in the quarter that may not have been that apparent in the press release?
Joseph Cantie
Sure. The $22 million that’s in our other income expense line, primarily over half of that relates to derivatives, so currency hedges, gains on currency hedges. And really, the way you have to look at that is up in our SG&A and in our cost of goods sold, we’re experiencing currency losses that are then offset by the derivatives that we’ve placed. So you’ve really got to look at them together. I would not consider those one off, so we can go through quarters where we have currency gains up in cost of goods sold and the derivatives’ll have losses in that other income line. So they really should be looked at in unison and not one-off. We do have some derivatives pertaining to energy where we had some games that also run through that line. And again, we have higher energy costs up in the cost-of-goods-sold line. I would say in that regard, it's not a one-for-one dollar offset, but it's clearly not a one-off item there. Regarding your second question, as I look at our quarter, every quarter, we have items that are onetime in nature. Typically, when they are net to a large either plus or minus, we mention them to you. We haven't mentioned them in this quarter at all, which basically means that when I look at it in totality, it was one of those quarters where we were pretty close to even in that regard. So they’re unusual from an overall net basis in this quarter.
Himanshu Patel - JP Morgan Chase & Co
Okay, helpful. I'm just curious what you guys are hearing or seeing on the ground on production schedules outside of North America, particularly in Europe or any signals from the OEMs that maybe they're a little bit more nervous for the second half than they were before? Or is it still pretty much business as usual?
John Plant
So far, Himanshu, it seems to be business as usual. In fact, surprisingly positive noises out of the majority of European vehicle manufacturers at the moment. And so first quarter schedules obviously which we know very well now seem to be just fine. Clearly none of us know the absolute levels of sales during the third and fourth quarters’ vehicles. But at the moment, it seems okay. And probably the people are underestimating the vehicle exports and the, I'll say, the luxury nature of those exports into countries like China and also back into the U.S. So that's a positive certainly for TRW, I'm sure some other suppliers as well. Elsewhere in the world, everything, say China, Brazil at the moment seems strong.
Operator
Our next question is from Chris Ceraso with Credit Suisse.
Christopher Ceraso - Crédit Suisse AG
So just as a follow-up, Joe, on the comment about SG&A and some of the derivative gains. If I combine the two and say, "Okay. That's where your SG&A would be running." As a percent of sales, it's a pretty low number. It's in the low threes. Are you suggesting we model something in the low threes as a percent of sales on a go-forward basis because it’s...
Joseph Cantie
No, It’s primarily to cost of sales, not to the SG&A. There might be a little bit to SG&A, but it’s primarily into the cost of sales. Regarding our SG&A this quarter, we are at 3.6% and if you look at the absolute amount, 130. So I think if you model into that 3.6% to 3.9% of sales, you're going to be there. And it’ll triangulate with the absolute amounts as well.
Christopher Ceraso - Crédit Suisse AG
Okay. That makes more sense [indiscernible] (53:50) It looks like you have a lot of content on that new Fiesta. Do have that globally? Or is that just a North America version where you have that business?
John Plant
Globally.
Christopher Ceraso - Crédit Suisse AG
Would that make that a top 10 kind of platform for you now? Is there enough volume and enough revenue per unit?
John Plant
I haven't really gone back through that, Chris, so I can’t say to you yes or no because I actually don't know. It’s a good platform for us, so we do the electric steering for that vehicle around the world. And we have, I'll say, a lot of the restraint systems and some of the brake parts. Maybe lots of other stuff as well, but I actually can't remember the percentage. There's no one platform that we have which is more than I’d say 2% or 3% of our sales, so I don't want to over blow that. It's always just another strong platform for TRW.
Christopher Ceraso - Crédit Suisse AG
Given your comments about some of the regulatory changes in Brazil and some of the other growth and safety and so forth, what are you thinking now in terms of the normal rate of top line growth for the company? You've long held that it's a 4% growth company, and you’ve routinely done better than that. Have you changed your view, let’s say, over the next three to five years what you think revenue growth here can be outside of industry volume recovery?
John Plant
We spoke for some years about our revenue lines in its relationship to the underlying vehicle build. We actually have not come back out and said, I’ll say, post the financial or the global financial crisis, we haven’t actually come out and refined that at all at this point in time. So at some point, we will do so. We haven't done it yet, Chris. And so at this point in time, I'd say we haven't refreshed that, and it is probably stale now. Last time we talked, we seemed to be actually trending above that. I did say there was some [indiscernible] (56:03). I actually don't know right now. Or if I do know, I'm not willing to comment about it at this point in time. All I’ll just do is observe to you, if you look at our OE sales to vehicle production, whereas this year or indeed last year, it shows a pretty healthy trend.
Christopher Ceraso - Crédit Suisse AG
A housekeeping item. What is the new euro assumption that underpins your revenue expectation?
Joseph Cantie
We're using 130.
Christopher Ceraso - Crédit Suisse AG
Okay. And what was it previously, Joe?
Joseph Cantie
It was I think 125, 126, something like that.
Operator
Our next question is from Rod Lache with Deutsche Bank.
Rod Lache - Deutsche Bank AG
I was hoping you can give us a little bit more color on the incremental margins, either year-over-year or sequentially. Maybe it's easier to look at it sequentially. Your sales were roughly $100 million higher, but your gross margin was flat on an absolute basis. Looks like gross profit was about $10 million higher. What are some of the key drivers that you see? On a year-over-year basis, are the incremental margins now starting to moderate? And can you tell us how we should think about how those incrementals look as you start to incur some negative comparisons with them?
Joseph Cantie
Yes. Rod, I would say that when you look at the incremental margin between this year and last year, boy, that's tough because last year's second quarter, there was a lot of really extraneous stuff going on because we had the first quarter '09; second quarter '09 was really the height of what I'll call the downfall. So you had a lot of things going on including furloughs and one-off stuff. So it’s difficult to look at it that way. When I look at it sequentially to the first quarter, our sales were up $78 million. Our operating profit is up $17 million. So that's an incremental margin of 22%. I think you have to look at it on the operating income level. And I’m excluding restructuring charges out of that obviously. You have to look at it on a operating income rather than a gross profit because you have things like what we are just talked about. I’ll have my derivative gains down in an other-income line and my actual cost up in the cost of goods sold. And there's a lot of variations that run between SG&A and cost of goods sold. But if I look at it from an operating income level, incremental margin of 22%, I've always been talking about when we have additional sales or lower sales. We typically are in that 23% to 25% zone. We're a percentage point light on that, which is pretty good when you consider some of the costs that inevitably have gone up. So for example, merit increases occurred midway through the first quarter, so you have a full year quarter impact this quarter versus last quarter. We do have a bit of commodity inflation second quarter versus first quarter. So that sort of gives you some color on that. When I think about going forward, I start with the 23% to 25% and then I got to think about things like commodity inflation, maybe a little bit of increase in the fixed-cost base as things recover. And we would expect to be below the 23% to 25% if those things occur. And commodity inflation, as I said, has been held pretty much in check through the second quarter, and it’s certainly looking better now for the future than it did three, six month ago. So we'll see if we can continue to put up that 23% to 25%.
Rod Lache - Deutsche Bank AG
So if commodities were flat on a year-over-year basis in the first half, would you assume that they’re kind of flat in the back half, or is it ticking up a bit?
Joseph Cantie
No, it's ticking up slightly in the second half versus the first.
John Plant
It ticked up a bit, then it began to moderate. So difficult to say at this point in time.
Rod Lache - Deutsche Bank AG
And then I know you're not updating your organic growth forecast longer term. But can you maybe just give us a little bit of a feel. For the 36% growth that you had this quarter, excluding currency, how much of that would you say it's attributable to mix? How much of that would you say is attributable to just new business coming in from backlog, just new contracts?
John Plant
When I look at our sales comparisons to vehicle build, it seems to be heading pretty much every jurisdiction, particularly, I mean, I'll call that Rest of the World segment. I think we just completely blew it away in the first quarter. That continued in the second quarter. And if you look at the OE sales compared to production in Europe and North America -- I think one of the slides so I would rather not read it out to you again. But it’s pretty healthy on that one, Rod. So at the moment, sales growth – we obviously also look at it compared to a lot of other people in the industry. And it stands up very well on that comparative basis as well. I’d take it to those guys who say they’re going to grow at a rapid pace. We stand in an excellent manner. So at the moment, I think we’ve come back pretty well on the sales line. I think the outstanding I’ve observed for that second quarter was just the sheer amount of cash generated. I know I emphasized on the last call the net debt to EBITDA but I mean it’s not at 0.8x on a trading basis which is my perspective. And as you know, we actually historically have generated the majority of our cash in the second half. So that looks to me we’re set pretty well for the year on that metric as well.
Operator
Our next question is from Patrick Archambault with Goldman Sachs.
Patrick Archambault - Goldman Sachs Group Inc.
Number one, how would you characterize the state of inventories in Europe right now? You had mentioned that inventory builds was sort of one of the positive factors, I think, that people may have underestimated a little bit in the first half, which was clearly favorable. Is your impression that people are kind of fully stocked right now? Or might there be a little bit of production still to come from that even if obviously sales moderate a bit?
John Plant
As a generalization across the board at the moment, obviously different by vehicle manufacturer which, again, I probably prefer not to go into specific vehicle manufacturers, but generally speaking, the inventories are in reasonable shape at the end of Q2.
Patrick Archambault - Goldman Sachs Group Inc.
Okay, great. Just kind of a longer-term question. I think you certainly focused on the emerging market growth opportunity, which is obviously playing out really well for you now. Can you go into what some of the best sort of incremental content opportunities are in North America and Europe in terms of fitments of new products?
John Plant
I think probably the most exciting one in North America for us at the moment -- when we’re launching hundreds of new products every quarter, you have to be careful you don't go overboard. But just pick one out. And I'll pick out the electric steering in North America. As you know, we launched that on the Ford Fusion just about 18 months ago. And then just as a fit on the top end of the EcoBoost engines across Taurus and Flex, six months ago. And I mean that's going to go across the board as a standard fit in the next year or so. And then, of course, you've got the big launch coming up which is pretty public. It’s since going to go electric steering which is Focus. And so I’d pick that one out as a very significant product for TRW coming up, which -- and basically it's focused worldwide, not just in North America. So that one I’d pick out in Europe. I think one of the really exciting things for us is the electric part brake, which incorporates our rear calipers and basically captures the content of all of the cabling and levers that were in other people's contents. Basically, it more than doubles the value of that rear-brake systems of TRW. And we won't maintain this position, but at the moment , on the integrated system, while the cable pull which is fading away now, then right now, we basically have 100% of the market and it could be in the millions of units now. So that's really exciting for us. And I mean clearly, competition is going to come in against us in the next two or three years because it’s unnatural, the share we have of that. And so that’s an exciting one for us in Europe. [indiscernible] (1:05:27) when it comes on the emerging markets. Probably the most exciting one is the fitment for the first time of airbags and anti-lock braking in Brazil. I just said it’s100% by ’14. I didn't say there’s a dwell point of having 50% fitted by 2012, and so that's exciting for us as well. In China, well, I mean just everything there.
Patrick Archambault - Goldman Sachs Group Inc.
On the back of that, is it safe to say that from a regulatory standpoint, there's still a lot of – that’s kind of like the principal driver that's going on in a lot of Brazil, China, places like that, whereas I guess in the U.S., Europe, at this point, it's probably more like just demand-driven like safety sales kind of thing, right?
John Plant
Yes, it’s demand-driven in the West. Outside of that, I mean the thing which guard is, I’ll say, the fuel-efficient positions of our electric steering and the EBB system, but basically there’s still a long runway in terms of legislation and, say, what we call the developing markets. They seem pretty well developed right now. But there’s still a long way to go in places like Brazil and India and China in terms of that legislation in airbags and ABS and that sort of stuff.
Operator
Our next question is from John Murphy with Bank of America Merrill Lynch.
John Murphy - BofA Merrill Lynch
On a number of occasions, John, you’ve mentioned global platforms, and the Fiesta and the Focus are great examples at Ford. I was just wondering if you supply to those global platforms how we should think about margins? And is there potential for margins to be higher and returns to be higher? Or do you have some kind of give-back to get on those global platforms? I’m just trying to understand how this impacts margins in the long term.
John Plant
I think the global platform, I’d say, prosecution by some of the vehicle manufacturers is a good thing for the industry. It plays well for the engineering and engineering reuse for the vehicle manufacturer and the standardization. And that standardization helps not just the efficient use of engineering but also the efficient use of, I'll say, builds and material. And that very much applies for the supplies as well. I mean clearly for the people who can supply around of the world, no matter what the jurisdiction is, then it’s an important feature of the future competitive landscape. And so clearly TRW is in that mode because out of our network of 140, 150 manufacturing plants, we can supply pretty much anywhere around the world and to the one standardized product that we will design for that vehicle manufacturer and enable as best we can to try to make sure that we have a standardized global supply base ourselves. So increasingly, we are seeking to use the same supplier around the world. So I think it builds efficiencies throughout the whole of the supply chain and the whole of the engineering really is now. I think it's a net good thing. But I mean if you're saying to me, does that mean you’re going to say you’re going to have higher margins in the future in your company got the answers, I’m not going to comment on margin percentages. I never have and because I just don’t believe the message put the hostage out there. But I mean now I would observe the margins are today are in a very healthy state which allowed us to drip a lot of cash at the bottom to repay net debt. And my guess is it’ll be lower again at the end of the year.
John Murphy - BofA Merrill Lynch
And then second on backlog. We've heard a lot of explicit higher guidance for backlog from companies. You seem to be alluding that it sounds like quoting activity in some of your comments is picking up quite a bit. I was just wondering if that’s a fair characterization, the quoting activity is picking up and really how you see wins going forward. Is this quoting activity increasing because the industry is getting better, you're gaining market share or there’s increased content. Really, what is the major factor that might be driving that?
John Plant
I mean clearly, compared to 2009, which I think 2009 was a bit of an aberration because I mean certain of the customer base as you know, were going through bankruptcy and we weren't exactly thinking a lot about letting new platforms. So clearly the activity in 2010 is higher than last year. We’ve comped this position across the last four years to make sure that we can see it on a more stabilized basis. And the one thing which is of note, as of the six-month stage, when we look at our six-month position of net new contracts, I mean it is in a very good compared to any of the previous four years. I mean very significantly higher this year than anything from 2006 onwards. I didn't go back before because I just thought the last four years have been going up. And so 2010 year-to-date has been a very good thing for TRW.
Operator
Our next question is from Brett Hoselton with KeyBanc.
Brett Hoselton - KeyBanc Capital Markets Inc.
John, margin question, naturally. Well, I wanted to ask it a little bit different. 8% plus obviously is a very, very number, by the way. As we think about that 8% plus margin and sustainability over the next two or three years, what would you characterize, John, as being the top maybe two or three risks to those margins that might cause those margins to decline?
John Plant
Well, I think the most significant one really is fundamental volume. And I think clearly because of the cost take-out we’ve taken, if volume drops, then it’s unlikely we're going to what’s called Play It Again, Sam, on the cost structure. But neither then do we think we have to because it's unlikely we think that over the next three or four years the vehicle build is going to dip. I mean, it may dip in a quarter or a half in a region. But then, I mean despite the conundrum of Europe at the moment, I mean if we were that it would be lower production in the second half from the first, which is probably what we do think, but it's going to pick up as we go through the balance of 2011. We aren’t likely to go and fundamentally change our employment level significantly because we wouldn’t want to bear the fundamental exit costs compared to the payback periodness [ph] (1:12:44) of that. So I mean in terms of what’s the biggest risk, so its production in North America with the drop back to $8 2009 or $6 million run rate to the first quarter last year and clearly our margins would reduce. So that's the biggest one.
Brett Hoselton - KeyBanc Capital Markets Inc.
How do you think, about over the next year or two or three years, how do you think about the pricing environment? As you look at your competitors, as you look at your customers, do you feel that the pricing environment -- I mean it appears to be healthy today. Do you feel that it's going to continue to be at kind of, status quo, moving forward? Or do you think it might get tougher? Or do you think it might actually improve?
John Plant
Well, I don't specifically subscribe to the fact that it's got healthier today. I think it's just the same. And so it’s just the same as it was before. I don't expect any change in the future either.
Brett Hoselton - KeyBanc Capital Markets Inc.
And then, Joe, obviously you're doing a very good job generating cash. As this continues, what are your expectations, let's say, over the next year or so, assuming you continue to generate cash? What are your expectations for the use of that cash?
John Plant
I'll go first and then let Joe supplement that because I mean if you look at what we've done, in the first half of this year we've paid down a lot of gross debt, so a majority of that cash to be generated. So if you anticipate that we're going to generate some more cash in the second half which is basically what I’ve said that we’re going to, and in fact, Joe said in his script, that we're going to be lowering that debt at the end of the year which we are, then I imagine we’ll have lower net debt and probably lower gross debt at the end of 2010. So that's going to be the first thing we’re going to do is continue to pay down debt and drive ourselves to a level where we think – clearly, we believe we are an investment-grade company already. It’s just that we’re not rated that way. And I just think to be on that march to that position and – but I mean we say we want to acquire, it’s in that reasonable bolt-on though [ph] (1:14:48), which will also take ends up. So we should think about debt reduction as our use of our cash generated over the next short period of time. And with that, I'll hand it across to Joe.
Joseph Cantie
I'm not sure I have much more to add other than that. I think we’re going to be in a very good position when we finish this year to have a capital structure that is in great shape. As you know, Brett, the cost of capital has changed, so we were going to make sure that we have the right liquidity position to withstand anything that might occur. And then it gives us choices, choices for the future. But we're going to wait till we get to the end of this year and knock that debt down as low as we can. And then we will decide what to do going forward.
Brett Hoselton - KeyBanc Capital Markets Inc.
Finally, content of vehicle trends in emerging markets and particularly China, obviously they've been increasing. As you look forward, do you see those content per vehicle trends -- and again, China's of particular interest. Do you see those content per vehicle trends not only continuing to increase? Do you think they might actually accelerate as we go forward?
John Plant
I mean some of that question is really wrapped up in the success of the China or Chinese vehicle manufacturers as well as the I call the follow source vehicle manufacturer because they’re clearly today an Audi-producing China is pretty much fully contented, the same as a Mercedes Benz, which I mean to put these vehicles out, I’d say they’re obviously lower production levels than the average, let's say, VW Jetta or a Ford Focus. But in the Chinese vehicle manufacturers, then we see a substantial increase in the level of sophistication of the seatbelts, the prospective, hopefully good prospective fitment of airbags. In fact, I think the we made a press release today about we’ve just started the production of electric steering in China. So I think we’ll see a substantial increase in that steering content because it’s roughly doubled in value by capture of the things like pumps and pulleys and hydraulic fluids and that sort of thing. So I mean I think that as we see the good prospective of sales of the Chinese vehicle manufacturers, then the average content will probably further accelerate just on a mix basis compared to the follow source vehicles.
Operator
This does conclude today's conference call. We appreciate your participation. You may disconnect at this time.
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