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TRW Automotive Holdings (NYSE:TRW)

Q2 2011 Earnings Call

August 03, 2011 8:30 am ET

Executives

Joseph Cantie - Chief Financial Officer, Executive Vice President and Treasurer

Mark Oswald - Director of Investor Relations

John Plant - Chairman, Chief Executive Officer and President

Analysts

Rod Lache - Deutsche Bank AG

Christopher Ceraso - Crédit Suisse AG

John Murphy - BofA Merrill Lynch

Brett Hoselton - KeyBanc Capital Markets Inc.

Himanshu Patel - JP Morgan Chase & Co

Operator

Good morning, and welcome to the TRW Conference Call. [Operator Instructions] And as a reminder this conference call is being recorded. 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 2011 financial results conference call. This morning, as usual, I'm joined by John Plant, our Chairman 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 2010 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 2010 10-K and 2011 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 again are posted on the Investors section of our website at trw.com.

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 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 good performance achieved earlier this year. During the second quarter, sales, which totaled $4.2 billion, were 16% higher compared with the prior year quarter. Operating profits before special items was $349 million and marked the highest level of operating profit for any second quarter in our history. Net income was $264 million, and earnings per share were $1.99 on the same basis.

Regarding cash, the company generated cash from operations of $271 million and free cash flow of $171 million. We continue to be pleased with our cash performance for the quarter and the first half of the year, especially considering the increasing investments that we've made required to fund our growth.

And finally, TRW ended the most recent quarter with net debt of $554 million. This outcome marks a new low net debt for the company and highlights the continued importance being placed on further strengthening of the balance sheet.

Combining TRW's second quarter performance with its record first quarter results provide a solid foundation as we head into the second half of 2011. I'll explain on the year-to-date results in just a few minutes.

First, just a few additional comments on the second quarter. During the most recent quarter, global production volumes exceeded the expectations of most industry observers as TRW and the industry worked hard to avoid and mitigate the negative impact of production disruptions caused by supply shortages due to the Japanese earthquake. It was a very substantial effort considering the many diverted labor hours and frictional costs associated with the mitigation plan.

In North America, the headline numbers were solid, as overall vehicle production was up a modest 1% compared with the second quarter of 2010. However, looking at the details, it's important to point out that Detroit 3 production was up 11% year-on-year and 5% sequentially compared with the first quarter. TRW's results clearly benefited from this production mix. Most industry observers believe consumer demand remains strong in North -- in the North American region, even though the annual sales rate in the second quarter dropped below the first quarter's 13 million unit level due to the constrained vehicle build from the Japanese vehicle manufacturers.

In Europe, vehicle production remained robust, as a modest year-on-year increase in Western Europe was supplemented by strong growth in Eastern Europe. Production for total year was up 4% compared with last year's second quarter. And on a sequential basis compared to the first quarter, production was approximately flat. Western Europe's second quarter production was up 1% year-on-year but down a little more than 4% compared to the first quarter of 2011.

Despite the sequential decline in production for Western Europe, we are encouraged that consumer demand continues to stabilize, especially in the larger markets. For the quarter, the Western European passenger car market was down 2%, which shows a strong resilience against the backdrop of the sovereign debt concerns and a slowing economic recovery. This is positive news, especially when you consider exports out of the region continue at a very robust pace.

China and Brazil continue to be regions of growth for TRW. For the quarter TRW sales outpaced industry production in both markets. Combined sales in those 2 markets accounted for over 14% of TRW's total second quarter sales.

With respect to our year-to-date results, we're pleased with our performance. Operating profit, excluding special items for the first half of the year, was $731 million on sales of $8.3 billion and operating margin of 8.8%. Net income on the same basis was $556 million, and earnings per share were $4.20. This is a record first half for the company.

The performance achieved through June provides a solid foundation for the remainder of 2011, as our earnings and cash flow generation allow us to further position the company for long-term success. We remain committed to protecting our profitability, and we'll work hard to mitigate factors such as rising commodity prices that are expected to continue through the second half of this year. And this is especially notable in the nontraditional spike in commodities that impact our business, such as yarn and rare earth metals. Our first half results demonstrates that commitment.

Moving on to the second quarter business developments. Product launches during the quarter continued to strengthen our diversification and leadership in intelligent safety solutions. A few examples include the stability control and electric park brake and an array of airbag modules, including driver, passenger and curtain airbags on the VW Magotan in China. In North America, Mercedes Benz launched its M Class (sic) [ML Class] vehicle with TRW's electric park brakes, stability control, driver's airbag and active electronic seat belt control retractors. And Lancia launched its Ypsilon in Europe, with our electric steering, driver's airbag and steering wheel.

As a result of our ongoing quality and Six Sigma programs, we continue to launch our products with world class quality. For the quarter, our quality averaged at just over 4 parts per 1 million across all products and customers worldwide.

In addition to the product launched during the second quarter, TRW's research, design and engineering ensure technologies are developed to meet the future needs of our customers. Future technologies highlighted during the quarter, include TRW's innovative roof airbag technology, which replaces passenger airbags typically mounted in the IP. In addition to providing enhanced styling flexibility for interiors, the bag-in-roof design can significantly reduce development costs. The company has undertaken predevelopment work for the bag-in-roof technology for several years, which has recently resulted in the award of a significant production contract with the European vehicle manufacturer.

Also within TRW's occupancy safety business the company demonstrated its curtain airbags with X-Tether technology at the 22nd Annual Enhanced Safety of Vehicles Conference. The X-Tether technology is designed to assist in keeping occupants inside the vehicle. This airbag technology is likely to plan important role in the future, as U.S. legislation focuses on occupant ejection mitigation.

And finally, the customer -- the company demonstrated its advanced Driver Assist Systems at Safety Days near Paris during the quarter. The Driver Assist Systems, which are based on TRW's latest generation of affordable, radar and camera products include lane assist and guidance technologies, pedestrian protection and automatic emergency braking. A key component of this affordable technologies is TRW's 24 gigahertz radar, which is about half the price of our production 77 gigahertz product. And it's suitable for the majority of driving conditions, which makes it ideal for today's need of the mass market.

As governments and industry bodies around the world are recognizing the benefits of these technologies and actively encouraging vehicle manufacturers to fit such systems, TRW has been awarded major new contracts to develop these technologies worldwide. Investing to expand these new technologies and our existing product portfolio will strengthen TRW's already strong market position. We're building or expanding 11 manufacturing plants this year, increasing capital expenditures by roughly 90% year-on-year and spending an incremental $80 million on engineering in 2011 to support our long-term growth.

Now let me comment on our expectations for the third quarter and the remainder of 2011. Overall, the negative impact on global production, resulting from supply chain disruptions stemming from the earthquake in Japan is expected to have a diminishing impact on production schedules as we move through the third and fourth quarters of the year.

In North America, we expect third quarter production to be roughly 3.1 million units, an increase of about 6% compared to the third quarter of last year and up about 50,000 units compared with the recent second quarter. For the full year, we expect production to total 13 million units, an increase of about 9% compared with 2010. Within this forecast, we are assuming second half production increases -- increasing modestly compared with the first half efforts.

In Europe, stabilizing and increasing consumer demand in the region, combined with robust exports out of the region, supported the strong first half production levels. However, normal seasonality is expected to have a negative impact in our production customer schedules in the third quarter.

During the third quarter, vehicle production in Western Europe is projected to be about 3 million units, up about 5% compared to last year but down roughly 470,000 units compared with the second quarter. Total European production is forecasted at 4.4 million units.

For the full year, our forecast for production is 20 million units for total Europe. Within this estimate, Western European production is 13.8 million units, which is an increase of 5% compared with last year. As you would expect, we'll continue to monitor the production plans of our customers and make any necessary adjustments to our operations accordingly.

Beyond North America and Western Europe, we expect full year production levels in the high-growth markets of the world, such as China and Brazil to continue to expand, albeit at a slower pace of growth compared to last year, primarily due to actions implemented by these countries to slow the pace and growth of inflation.

Based on the forecasted production estimates and our revised currency assumptions, we now expect sales of approximately $16.2 billion to $16.4 billion in 2011. Sales in the third quarter are expected to be approximately $3.9 billion or 14% higher than the prior year, as positive currency movements between the 2 periods provide a significant benefit.

We now expect capital spending for the year will be about $560 million, which is at the high end of guidance we provided earlier, primarily due to timing factors and foreign currency movements. This level of spend is necessary to support our growth in the strategic high-growth areas, which are mainly China and Brazil and continued expansion of our newer innovative technologies and to support our robust business awards achieved in the last year. With regards to restructuring, we expect 2011 restructuring expense to be about $15 million.

In summary, we are pleased with our second quarter and first half results. The team remained focused on finishing the year well, while executing our growth strategy. We are confident we are implementing the correct strategies to ensure the long-term success of the company. Our solid balance sheet, innovative technologies and strong market position will enable TRW to maintain and build on its positive momentum.

Before I turn the call over to Joe, I'd like to comment on the ongoing investigations by antitrust authorities. As stated in our June and July releases, certain of the company's occupant safety locations in Germany were visited and received request for information from European antitrust authorities in connection with an investigation of anticompetitive conduct in the European Union, a related subpoena was received in the U.S. from the Department of Justice. We understand that these inquiries are part of ongoing investigations by these authorities of automotive parts suppliers concerning possible violations of antitrust laws. Often, these investigations continue for several years and can result in substantial penalties being imposed by the European authorities and as well as the Department of Justice. The company's policy is to comply with all laws and regulations, including all antitrust and competition laws. TRW's cooperating fully with the authorities.

At this point, we cannot estimate the financial impact resulting from these investigations. We will evaluate developments in this matter on a regular basis and will record an accrual as and when appropriate. Of course, while the investigations proceed, the company will remain focused on executing its day-to-day operations and our long-term growth strategy.

And 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, everyone. We published another very solid quarter this morning, building on the positive momentum we established earlier in the year with our first quarter results. The second quarter benefited from a bit stronger production than we anticipated at the beginning of the quarter, primarily in Europe. Otherwise, the quarter generally played out as we thought.

Let me list a few of the key highlights for the quarter. Sales were $4.2 billion, an increase of 16% compared to last year and the highest level of sales in any quarter since the early part of 2008. Operating income before special items was $349 million, the best level of absolute profit for any second quarter period. Earnings per share were $2.21 on a GAAP basis and $1.99 after excluding a few special items, which is an increase of 15% compared to last year. And continuing our trend of debt reduction, both total and net debt levels, again, reached historic lows, reflecting positive cash generation and debt repurchase activity in the quarter. More on the capital structure later in my comments.

For the first half of this year, we continued at a record pace, as the company posted sales of $8.3 billion, up 15%, earnings per share of $4.34 on a GAAP basis, $4.20 excluding special items and positive cash flow. No doubt a strong first half set of results. We're obviously pleased with our first 2 quarters and expect to continue the solid operating performance, as we move into the second half of this year. Of course, the enthusiasm is tempered a bit, as we recognize the continuing challenges that face our industry.

I'll expand on our outlook for the remainder of 2011 shortly, but first, let me provide some further detail and comments on our second quarter and first half results. For the quarter, we reported sales of $4.2 billion, an increase of $573 million or 16% compared to the same period a year ago. Currency translation had a significant positive impact on sales during the quarter, increasing our sales by about $325 million compared to the prior year.

As an example, the euro to dollar exchange rate averaged $1.44 this quarter, an increase of over 13% compared with $1.27 last year. Excluding the effects of currency translation, sales increased 6% with increases in each of our major geographic markets. China continued to set the pace and helped boost sales in our rest-of-world region by 13% year-on-year.

For the quarter, we had an operating profit of $368 million compared to $322 million in the 2010 period. Included in this quarter's operating profit was a $19 million gain related to a favorable resolution of a commercial matter. The prior year period included $3 million of restructuring charges. Excluding these items from both periods, operating income in the second quarter of the year was $349 million from margin of 8.2% compared with $325 million or a margin of 8.9% last year. The majority or 50 basis points of the margin difference was due to the effect of sales currency translations in the quarter.

The improvement in absolute profit reflects the contribution from higher sales between the 2 quarters, offset by inflationary pressures, including higher raw material prices and increased costs to support future growth. Headwinds impacting our second quarter results, such as increased raw material prices and higher engineering and development costs, were in line with our expectations, with each negatively impacting the quarter by about $25 million. These items, together with the effect of currency movements referred to earlier, were the primary drivers to the compression in operating margins between the 2 periods. These same factors will also contribute to margin compression that is expected to occur in our third quarter.

Moving down the income statement. Interest expense totaled $30 million, which compares to $41 million last year. The reduced expense is reflective of our cash flows and reduced levels of debt between the 2 periods. The current quarter included a loss on retirement of debt, totaling $10 million, as the company repurchased about $42 million face value in straight bond debt and $19 million of our exchangeable debt during the quarter.

Finally, tax expense was $34 million in the quarter compared with $52 million last year. Both the 2011 and 2010 periods included tax benefits totaling $20 million and $10 million, respectively. The corresponding Q2 effective tax rate of 16% reflects the impact of our overall improvement in operating results and the geographic mix of our earnings.

As a reminder, in various locations, but most notably in the United States, we are currently in a valuation allowance position. As a result, we do not recognize tax expense on pretax income, which is benefiting our tax rate. At some point in time, this position will likely reverse, resulting in our effective tax rate more closely approximating the U.S. statutory rate of 35%. At this point, we cannot predict when our valuation allowance position in the U.S. will reverse, as it's dependent on many factors. Of course, despite the P&L impact of this, TRW will not pay cash taxes in the U.S. for many years due to our existing NOL position.

At the bottom line, we posted GAAP net earnings of $2.21 per diluted share compared with net earnings of $1.78 in the prior year. Excluding the special items I've just discussed from both periods, earnings were $1.99 per share compared with $1.73 in last year's second quarter. You can find the reconciliation between the GAAP and adjusted results I've just referenced in the schedules included in our press release this morning. In terms of EBITDA, for the quarter, we had $461 million, excluding special items, compared with $437 million in the prior year, measured on the same basis.

Moving to a brief review of our first half results. We reported sales of $8.3 billion, which is an increase of $1.1 billion or 15% compared with the previous year. Increased global vehicle production, continued growth resulting from our portfolio of safety products and the positive impact of currency movements accounted for the year-on-year increase.

Our operating income in the first half of 2011 was $740 million, which compares to $622 million last year, with similar operating margins between the 2 periods. The $118 million increase between the 2 periods was primarily the result of our operating leverage against our higher level of sales between the 2 periods. Below operating income, interest expense was $64 million compared to $86 million last year.

In the first -- in the prior year, first half period, we had a minor $1 million loss on retirement of debt compared to a $20 million loss this year. Tax expense for 2011 was $90 million, which compares to $102 million in 2010. Nonrecurring tax benefits totaling $20 million were recognized in the current period compared with $12 million in the first half of 2010.

And then at the bottom line, we reported GAAP net earnings of $4.34 per diluted share, which compares to GAAP net earnings of $3.38 last year. Excluding special items, earnings were $4.20 per share for the first half of this year. And finally, in terms of EBITDA, we had $959 million, which is a first half record for us, compared to $862 million in the prior year.

Let me shift now to our cash flow and capital structure. First, on operating cash flow, for the quarter, we had $271 million, which compares to $402 million in 2010. Capital expenditures for the current quarter were $100 million, which is $38 million higher compared with last year. Free cash flow, which I'm defining as operating cash flow less capital expenditures, was a positive $171 million this quarter compared to $340 million last year. The year-on-year decline is not unexpected, as the company invests incremental capital to support its future growth, and working capital has moved higher in tandem with the increased level of sales the company is experiencing.

For the first half, the company generated $185 million of free cash flow. Capital expenditures at $167 million during the first half was $60 million higher compared to last year's level. The year-to-date cash flow result lays the foundation for another strong year of cash generation despite a high level of reinvestment in the company. At this point, we're expecting the good level of positive free cash flow for the year, as our second half is traditionally stronger than our first.

At the end of our second quarter, our total gross debt and net debt outstanding were $1,705,000,000 and $554 million, respectively, both establishing record lows for the company. As I mentioned earlier, the company repurchased $42 million in straight bond debt and $19 million in exchangeable bonds during the second quarter, as we continue to focus on further positioning our balance sheet ahead of coming maturities and to support future growth and near-term derisking initiatives.

Regarding liquidity, at the end of the second quarter, the company had an excess of $1.5 billion available to us, consisting primarily of cash on hand and our undrawn revolver, which was modified during the quarter and reported on during our last conference call. So in the interest of time, I won't repeat the details here. You can find a summary of the changes in our first quarter's 10-Q.

Switching subjects now to our third quarter and the remainder of 2011, as John just discussed, TRW's full year 2011 production forecast are for 13 million units in North America and 20 million units in Europe. Based on revised production forecasts and updated currency rates, full year sales are now expected to be in the range of $16.2 billion to $16.4 billion. At this time, we're expecting third quarter sales of about $3.9 billion, which is about 14% above last year's level. Compared to the prior year, the Q3 sales forecasts will benefit from currency translation of about $250 million to $275 million, which will carry little to no corresponding profit contribution.

I would also like to remind you that we called out approximately $20 million of positive items in last year's third quarter results that will not repeat this year. Sequentially, compared with the quarter just completed, Q3 sales will be down about $330 million and consistent with our historical results, we expect seasonality factors to have a greater impact on the results and margins compared with last year.

Capital spending is forecasted at $560 million, which is at the higher end of our earlier projections. Restructuring, on the other hand, will be lower than our previous guidance at about $15 million. Full year interest expense is forecasted to range between $124 million and $128 million, given the cost and level of debt for the company.

And although difficult to predict, we still expect net commodity and other inflationary headwinds of about $100 million to $120 million in 2011. As you might expect, we're aggressively working to recover and minimize the negative impact of these rising costs.

Finally, given our expected results by geographic location, you should continue to assume a full year 2011 effective tax rate of around 18% to 20% for modeling purposes.

In closing, we're pleased with the record results posted during the first half of this year and realize a lot of hard work lies ahead. We'll continue to focus on protecting TRW's profitability and to mitigate the negative impact of industry headwinds, as we move through the second half 2011.

Heather, we'll now move to the question-and-answer portion of the call.

Question-and-Answer Session

Operator

[Operator Instructions] We'll take our first question from Himanshu Patel with JPMorgan.

Himanshu Patel - JP Morgan Chase & Co

Just a couple of questions on some of the numbers. Joe, can you tell us what the EBIT contribution was year-over-year from foreign exchange?

Joseph Cantie

De minimis. We actually did have a little bit of positive impact in the second quarter, but it was just a few million.

Himanshu Patel - JP Morgan Chase & Co

Okay. And then, one of your earlier comments, I think, you indicated there was a $25 million hit in the quarter from engineering costs and another item. What was the second item you mentioned?

Joseph Cantie

It was the commodity inflation -- commodity and other inflationary pressures. So consistent with what we've been saying in previous calls, those 2 factors are affecting us as we move through the year.

Himanshu Patel - JP Morgan Chase & Co

Okay. So the -- and I think you indicated commodities for the full year were kind of $100 million to $120 million. So are you -- basically, I'm just trying to understand. Have we kind of reached the halfway point on that cost inflation through the first half of the year?

Joseph Cantie

Yes. It's -- our first quarter -- when we talked to you about our first quarter, it's somewhere around that $20 million to $25 million, $25 million again in the second quarter. So again, we're expecting a similar run rate, as we go forward in the next 2 quarters.

Himanshu Patel - JP Morgan Chase & Co

Okay. And I know it's a little bit early, but do you guys have an initial view on -- I mean, commodities can go anywhere, but just sort of the controllable expenses on engineering cost, do you have a preliminary view on 2012? Should we think of this sort of $100 million rate increase that you saw this year repeating itself again in 2012? Or does it go even higher? Or does it go lower from this level?

John Plant

I'll take that one, Himanshu. And basically, we don't see anything like the increase in 2012 that we've had from '10 to '11. At this stage, I'd just say we would expect the normal metric sales to apply year-on-year. So nothing like the order that we've seen this year. And basically, this year's a reflection of, I think, upon the a, the decisionables which we had to accelerate some spend. And also, you may recall we had -- I think, I referred last year to the extraordinary high level of bookings that we had. I mean, this year's also a very healthy level, but it's not going to require us to have to increase in '12 anything like -- that we have to increase this year.

Himanshu Patel - JP Morgan Chase & Co

Okay. That's useful. And then just on some of the product comments. I think in one of your media or press releases, you guys provided a electric steering penetration rate forecast of -- correct me if I'm wrong, but I think it was greater than 80% by 2016 or something like that. First of all, are those numbers correct? But number two, can you just tell us where is that this year? And what is the slope of that curve over the next 5 years?

John Plant

Himanshu, actually, I don't recall such a press release, so I'd have to go and research with our PR department if we did make such a release. I don't recall it, and I don't think so. The only thing I can say to you about electric steering is that it clearly is increasing. It is one of the technologies which both provides additional dynamic performance to the vehicle. But even more importantly, right now, it’s one of the opportunities that the vehicle manufacturers are seeing that also improves the fuel efficiency of vehicle. So it's getting a lot of attention because of that, and it's right up there with one of the main contributors to fuel-efficiency improvement. I mean, I'm not, in any sense, putting it in the category into, let's say, I've heard, turbo-charge, or something like that. It's a very significant improvement. And when you look at the penetration -- I mean, this really started some years ago for park assist in Japan, and it was adopted in Europe tremendously because of the high cost of fuel there. And I mean, you've seen the rollout within the U.S., and we shall see an increasing penetration on a quarter's fit[ph] basis in the U.S. as well, particularly for the Belt Drive technologies, which have the -- able to drive the higher axle weights of vehicles that we have in the U.S. So I mean, TRW's well positioned. We've had substantial new contracts. I think we've made everybody aware of what those are, and there's more in the pipeline.

John Plant

The only press release that I do recall was the one we made in the early part of 2011, which centered on China. And I think we referred that to the fact that we had one for sequential contracts for column drive electric steering with the Chinese domestic manufacturers. And actually, in fact, that has continued. I mean, we have obtained additional awards since then, basically, because the drive for fuel efficiency is very important. China, they will see the wider benefits of the adoption of EPS. And in fact, it’s one of the ways -- on the smaller vehicles, it allows you to make the -- reduced drag on the engine, which enables you to put air conditioning and other things in the vehicle, as well, more electric drive systems. So I mean, it's basically -- it's broadening. It's deepening, and fitment rates are going up. But I don't recall a report issued by us. But I will research, and obviously, I'll ask someone to come back to you on that, if we find it.

Himanshu Patel - JP Morgan Chase & Co

No worries. Just one small, I guess, engineering type of question. I think JCI has a forecast for roughly 50% of North American auto production to have start-stop powertrains in a couple of years. That's up a lot, obviously, from a current level. Does a start-stop vehicle -- where, obviously, the motors not working at a red light, does that necessitate electric steering?

John Plant

No, you can actually have start-stop on a vehicle without EPS. But in terms of the sequence through, what you'll find is that normally EPS will be seen to be fitted to vehicles as probably -- as an earlier adoption than a start-stop system. The received benefit in fuel efficiency on the numbers that I understand is that much higher for the additional cost involved to provide that functionality. So what I expect is, on the curve of adoption, that EPS is an advance to start-stop.

Operator

Your next question is from the line of Rod Lache with Deutsche Bank.

Rod Lache - Deutsche Bank AG

Just a couple of things. Could you just remind us what is the FX component that you've incorporated into the full year guidance? Is this still around the $600 million?

Joseph Cantie

It's slightly higher, actually. So I'm going to say closer to the $700 million. So if you take what we've incurred so far, which is $325 million to $350 million in the first half, we'd already talked about $250 million to $275 million in the third quarter, so you can see what we're going to be getting towards that $700 million number.

Rod Lache - Deutsche Bank AG

Okay. And did you provide what R&D and engineering did on a year-over-year basis in the quarter?

Joseph Cantie

We indicated that it's $25 million, but that $25 million includes both our engineering R&D and some other infrastructure cost that we've added to -- in places like China and Brazil. So it's not the full $25 million, but it's the majority of it.

Rod Lache - Deutsche Bank AG

Okay. So the $25 million -- so there was a separate $25 million for this and a separate $25 million for the commodity in the quarter?

Joseph Cantie

Correct.

Rod Lache - Deutsche Bank AG

Okay. All right. That clears that up. And what's driving the sort of these mid-year upward revisions in capital spending plans? Is there something that is more imminent or some change in planning that's going on?

John Plant

Fundamentally, no, Rod. I mean, we've indicated a higher increase or higher map for 2011 over 2010. And just the same as the Euro rate affects the top line, clearly, when we spend money, in let's say, Europe or spend money indeed in China, where we've dedicated -- or indeed in Brazil, because Chinese RMB, the Brazilian real and the Euro, I can say, are all strengthening into dollar or the dollar's weaken. And so just the physical translation of that equipment into a dollar number, naturally gives a higher fixed asset dollar figure.

Rod Lache - Deutsche Bank AG

Okay. And just last question is -- and I know you have almost $700 million of debt maturing in 2014, and Joe, you've mentioned that as a factor behind the elevated cash levels. But can you give us some sense of when you might begin considering deploying cash? What we should be thinking externally about the appropriate long-term leverage level for the company?

John Plant

I'll go first, Rod, and pass it across to Joe. I mean, our, say, mantra in the company I think, as you know, is being -- to generate cash. It's been a consistent theme for us. And one of the things that we've been conscious of is, as we see our way through 2011, as we did 2010 and 2012, we'll have a measured growth rate, a measured margin rate to allow us to consistently to be able to produce cash. So at the moment, what we're not seeking to do is to drive any other factor which would absorb, say, working capital to such a degree that our margin performance couldn't overcome that to working capital drag. So I think what we've tried to do is to put ourselves in this good zone of growth, margin and cash generation, which naturally, if you -- when you work it all through, leads us to the relatively high returns on capital that you see for the business, particularly, if you eliminate the goodwill, you see we're now at very high returns. When we think about cash flow going forward, I mean one of the things that we have been doing, when you look at this is we've been spending significant sums each quarter, taking out parts of our debt structure in terms of trying to improve the overall capital structure of the company and also being cognizant of -- we do need to address, at some point, the 2014 maturities, albeit our cash on hand, in fact, substantially exceeds those maturities. So I think we're in a fairly good zone, but we'll continue to -- I'll say, to peck away at that. I mean, at this stage, we haven't come out and said anything broader than that, in terms of use of funds. But I think the important thing is before I had to pass to Joe is that the important mantra of the company is we'll drive growth, we'll drive our margin, and we'll generate cash and give ourselves a good return. And with that, I'll pass it to Joe.

Joseph Cantie

Yes. The only thing I'll add to that, Rod, is you're right about the fact that we have a little over $700 million of bonds maturing. But please don't lose sight of the fact that we have $1 billion revolver that also matures. It's not drawn, but obviously, it's the package of my capital structure that I need to be cognizant of. And I'd like to put myself in the best position for that next step. Obviously, we're still a non-investment-grade company, and we have to make sure that we're positioned in the best light to get through that period. So that's one factor, and then of course, more importantly, I look to the liquidity needs of the company to support its growth and to give me an appropriate buffer, if you will, against things that could possibly happen, everything from strikes to double-dip recessions, things like that. And then once I -- we determine that -- and quite frankly, there's a little bit of clarity that's needed on that front. And we hope to have that clarity as we exit the year this year. And then, when we get past all that, of course, we have to look to what's the right position of the capital structure for the future. We've said before we will not run long-term with an inefficient capital structure. That's a statement about the long term. Of course, you will always have pockets of time where you're running either inefficiently like we are, with the cash balance, or quite frankly stretched, as we were back in the earlier years. But we'll get it right after we get some clarity on some of the near-term things that are out there that are confusing about the liquidity needs.

John Plant

And that involves resolution for the European sovereign debt. And as you know, we have all the negotiations still to come from this latest political wrangling over the debt, and there's more to come in the next 6 months. I think, hopefully, by the time we get into 2012, a much clearer picture will be -- even though, quite honestly, we think that the underlying sort of general directions are for GDP growth. And also, there will be increase in vehicles, because I think we've already had, is it 2 or 3 consecutive years of our production of vehicles below scrappage rate. I mean, probably this year, it'll get back into the positive territory. But I mean, we've been at very low levels of production, and hopefully, we'll see that continue to increase.

Operator

Your next question is from Christopher Ceraso of Crédit Suisse.

Christopher Ceraso - Crédit Suisse AG

A couple of items. Joe, you talked about the first half margin, I think, around 8.8%. As I think about the second half, outside of seasonal volume levels and revenue levels and their associated utilization, which should be a little bit lower there, what are some of the moving parts that you said that were kind of on a regular pace here with the commodity cost? Will there be any increase in launch costs? Maybe the elimination of some of the frictional cost, which maybe you could quantify for us, associated with Japan. Any differences in mix either by product or geography? I'm just trying to gauge what are of the pluses and minuses from a profit standpoint in Q -- in the second half relative to the first half?

Joseph Cantie

Yes. I would say, I think, you've got the pieces. We tried to lay them out in our comments that we went through on the call. I mean, the pieces are the commodity inflation of the $100 million to $120 million. The $80 million give or take plus or minus on what I'll call increased engineering and infrastructure cost to support our growth in the future. So you have those 2 that will play out in the second half. I think that, Chris, you've got to really focus on this currency movement thing that's going on, because obviously, that's going to have an effect on the margins, as our sales benefit from currency. And it doesn't really give us a profit contribution. When you factor those in, and when you talk about friction costs -- we're building or expanding 11 plants. We've never done that. The majority of the activity around that is happening in our second half. I consider that to be a good thing, because we're putting those plants in place for a reason. It says something about the future for TRW. But unfortunately, there's friction when you're putting those plants up, so a little bit of that. Other than that, I think you got the pieces and you just got to watch the macros and make sure that the production that everybody's forecasting now comes through like it's supposed to come through. If we have consumer recessionary issues and people aren't buying the cars like either we or CSM or anybody else believes, that obviously, will have an impact on our second half.

Christopher Ceraso - Crédit Suisse AG

So all right, let me just recap to make sure I got it. It sounds like commodity, R&D engineering, really no change, second half versus first half. You're already on pace for your full year numbers, right? You've already felt the dilutive effect of FX, so maybe that's not very different in the back half from the first half. You will have increased costs associated with these plants. But what about the Japan thing? You mentioned that in your comments that there were some cost associated with workarounds for Japan on a supply chain front. Did those go away? And how much were they in Q2?

John Plant

Yes. I mean, basically, on this one, Chris, I think, we're going to see the normal seasonality that we have and we've talked to previously in the third quarter and then more like a return to normal -- I'd say, in the fourth quarter, I think, you'll see 2 effects going on. I think you'll see the lack of those frictional costs associated with managing through the Japanese crisis in which we incurred in Q2. And so those will fall away. And then, they may be balanced. I'm not really sure we've got an exact number, but they'll probably be balanced by the additional costs that we have, because, as Joe said, we are increasing our footprint. And, in particular, within that -- '11, I think we're putting something like 7 plants or expanding plants in China, because we need to accommodate the future growth that we have there. So I think that's overall, you're going to see nothing out of the -- say, it's a balanced approach to commodities on the year, but we can judge it. We've talked about engineering. You'll see fall away of some of those Japan friction costs in Q4. But on the other hand, I think you have a pick up of other costs. So I wouldn't -- I don't think you should be thinking that TRW increases anything. And again, our fourth quarter will just depend on the cadence of vehicle production sales, and I guess to some degree, consumer sentiment and where did we end up for the year the inventories for the vehicle manufacturers and what really their cadence is into 2012. So I think it's more the big macro picture that you got to think about in terms of where it impacts us. And that's about it really.

Joseph Cantie

Yes. The only other thing, as Mark Oswald's poking me in the ribs here is to remind you that second half versus first half, you have to account for the seasonality and the things around summer shutdowns and things like that.

Christopher Ceraso - Crédit Suisse AG

Right. That's a given. The -- just one follow-up on the taxes. I guess, sometime in 2012, you'll come to a point where you've been profitable for about 3 years, so maybe that's when you start to unwind this valuation allowance. You mentioned 35% as the U.S. statutory rate, but you guys do a lot of business in countries outside the U.S. So what should we think about as a blended corporate average, once you're fully free from the valuation allowance? Is it 30? Is it 28? What are you expecting, Joe?

Joseph Cantie

Yes. You're absolutely right. We do a lot of business around the world, elsewhere. So I would expect that we'd be somewhere in that 30% to 35% zone. Again, it's all dependent on the geographic mix of our sales and earnings and all that kind of good stuff, but somewhere in that zone should be a good planning assumption.

Operator

Your next question is from Brett Hoselton with KeyBanc.

Brett Hoselton - KeyBanc Capital Markets Inc.

Following Chris's question into tax. Does 2012 sound like a reasonable timeframe for the valuation allowance reversal, on your opinion Joe? Or is it possibly shorter or longer than that?

Joseph Cantie

Can't -- don't know. There's a number of factors that have to be considered. Chris mentioned one, which is the historical profitability level in that 3-year mark that's in the accounting literature, but that's not the only thing. You have to look at a number of factors. And I really don't know at this point. Obviously, if we did know, there'll be a different accounting answer to it.

Brett Hoselton - KeyBanc Capital Markets Inc.

And this is -- my personal expectation was that, if you kind of move to the back half of the year, you're building your cash position. Your net debt was coming down here. And you might consider some shareholder friendly actions like a dividend or a share repurchase. But it kind of sounds to me as though maybe the timing of some of those considerations maybe getting pushed back to that 2012 timeframe, given some of the uncertainty in the economy. Is that a fair assessment?

John Plant

We haven't really commented, Brett, on timing of any such things, so I don't expect us to do so today. I mean, the things I've tried to emphasize -- I think, it was Rod that was asking the question, as to what the basic tenant we hold in the company about cash generation. Joe's already commented that we expect to generate more cash in the second half than in the first half. And that follows, as you know, the normal pattern for TRW. So again, we look forward to doing that. We've already commented that until we really see, I guess, better clarity over getting through -- is there a final outcome, or in terms of what really happens in Europe, regarding this Greek and Ireland, et cetera, sovereign debt crisis. And also I think that we probably like to see where this commission of 6 people is going for the U.S. debt. Because I think all of us will realize it is not solved yet, and we need to see that. So I think TRW, amongst many corporations will want to see where all of that lands, such that we can have pretty good planning base for next year and beyond. And does it fit with our current view, which is that there's an expansion of GDP, and there's an expansion of vehicle production and, therefore, an expansion of TRW sales. I mean that's where we go into our planning round with. So in terms of the main indicators, we see them as positive. But until -- I think some of those confirmed, I don't know if we're going to be see seeing much in the next quarter anyway about what we're going to do regarding our net debt and cash position. I mean, Joe?

Joseph Cantie

Nothing more to add other than we've -- I think we've never -- at least I've tried to not let anybody think that anything was going to happen in the 2011 timeframe. I don't think we've ever put ourselves out there for that. But nothing really to add to what John said.

Brett Hoselton - KeyBanc Capital Markets Inc.

And then, John, and kind of longer term, as you think about kind of the, I guess, maybe call it, convergence of active and passive safety, at this point, are there any particular intellectual properties that you think are going to give one competitive advantage or competitive advantage of one company versus another company? What do you think are -- maybe is there 1 or 2 key intellectual properties that allow one company to outperform the other company, as you're trying to fight for business?

John Plant

When I look at the landscape of tried had this[ph] active safety really come together with influencing and really providing a safe driving environment, I mean, we've got the slip control thing under our belts. We've got the EPS thing under our belts. We've done all the work on crash and pressure sensors, regarding the occupant safety systems, and everybody configure the restraint systems doing that. The frontier, really, has been, for us, we needed to have both radar and camera to give us the lane assist and moving towards some form of collision mitigations/avoidance. And we recognize that, I mean, no one company can actually do all of these technologies, because there's such an array of them. But there are, I think, 2 things which are vital in terms of component technology and then there's one much wider thing. This -- so I think, these 2 component technologies which are important are the radar and camera and putting those into an affordable configuration. And that's why I commented in my comments earlier about the 24 gigahertz, which is basically a much more affordable product for the mass market than the 77 gigahertz radar. We spent a lot of time working on cameras. We've gained a significant order base for our cameras. And then once you got those 2 -- and bear in mind, you're still going to be integrating many other systems around the car. The critical feature then is systems integration. So what we had -- as TRW had been doing is to try to make sure that we have a group of engineers, and their role really is to be able to take all those component parts, all of the systems that we provide, and indeed other features of the vehicle and be able to integrate those in a -- I'll say, a set of control algorithms and a functionality, where it's in a separate ECU, which embedded in one of the electronics things that we already provide and be able to integrate all of those technologies. So I think the critical thing comes -- is that what is the system integration? Not trying to take over from the vehicle manufacturer, because it is according to what he wants in terms of the dynamic driving performance and crash features. But how do we, TRW, take all those component elements and provide that seamless transition in terms of the sequence that you go through in a crash event from observation through to tensioning of seatbelt, through to, let's say, adjusting the steering, so you've got to reduce stopping distance, and so there's so many things going on. They got systems integration work that TRW is able to provide and I think is the final differentiator, because we really tried to focus on what are the building blocks, and make sure we've got those, and then to provide that overlay.

Operator

We'll now take our final question from John Murphy from Bank of America.

John Murphy - BofA Merrill Lynch

I'll sneak 2 quick ones in here. First, just a follow up on your -- the remarks you made on the antitrust issue. I'm just curious, the lack of accrual for expense right now, is that just a timing issue? And as we look at this inquiry, I'm just trying to understand, I mean, really, the evidence would be that you'd be earning excess economic profits in return somewhere in your business to really prove some kind of collusion or antitrust actions. I mean, do you really see any place in your business or auto lease business or the rest of the supply chain, where that's the case? I mean, it seems like this is kind of an errant issue, and you may have some nuisance legal fees but not really any penalties?

John Plant

Well, John, I mean, I don't think we've got anything to add to those disclosures we've made. And that really is about it today. And I don't think we're going to be saying anything until we know something that's sayable. And so that's about it, really. So I'd just say, nothing to add to disclosures made.

John Murphy - BofA Merrill Lynch

Okay. Then a second question on the increasing ER&D. Does any of that have to do with an increasing in coating activity at the automakers, particularly on global platforms? Is there any increase for that?

John Plant

I don't think there's any cadence of increase. I think in 2010, a certain of the -- I mean, I'm going to be say, particularly the North America-based OEMs got to the other side of the bankruptcies and therefore, wanted to refresh some of the model drivers. There's probably an increasing cadence last year, and beyond that, I don't think there's anything exceptional this year. There's more of a normal cadence. So our build up of engineering has really been a measured approach. One is because, as I think, we declared earlier we did have a good and have had for a couple of years a very good level of contract wins, took accounts at the additional cadence last year. We've been cognizant of those areas we wanted to expand and we've talked back on in the last question to Brett about the Driver Assist Systems and the system integration to make sure that we have the fundamental component technologies and the systems integration ability. So that's been the frontier that we've really wanted to spend on, such that we were really well positioned for this again for future growth. And then, there's the commentary we gave, I think last year in the early part of this year, but the legislation has been enacted in Brazil regarding the fitments of airbags, and of course, that's also produced some work additional this year, because of the requirement for, I think, half of all the vehicles by the end of '12 and 100% by the end of '14 to have the frontal airbags fitted plus the antilock -- yes, the Slip Control breaking. And so that's really been the major effects of why we've been spending additional funds this year. And I've already commented that next year, we don't see anything like this increase and it'll fall to the more of the normal cadence. And as when we have to say, we'll be talking to you about it, the world about it, because we try to keep people informed, just the same as this quarter. We've reduced our restructuring, because we're seeing the underlying fundamentals being relatively healthy, and that we don't see the need this year to have even our normal cadence of restructuring, which has been about that $30 million to $40 million mark, just the underlying demand and the plans that we have, with our long line of site restructuring. We don't see that need. And we'll try to inform you as soon as we feel as though it's -- we've got exactly a line of sight that we want.

John Murphy - BofA Merrill Lynch

And then just one last question on the schedule that you're looking at for the third quarter, North America, 3.1 million units. We've seen some buildup schedules that look like they're closer to 3.3 million to 3.4 million units. Is just that the source of data you're using is IHS, which appears to be somewhat more of a conservative forecast? Or is there something that has changed recently in customer schedules that you'd been receiving?

Joseph Cantie

We have a bunch of guys within our company, obviously, that looks at customer schedules and call-offs as we get them. We analyze that. We look at the external guys like, CMS -- or CSM or IHS, whatever they call themselves, and others as well. And we come to what we think our view is. It just, by chance, happens to be somewhat similar to CSM, but that's literally what we're seeing right now.

John Murphy - BofA Merrill Lynch

But no marked change in schedules, really?

Joseph Cantie

Not really.

Mark Oswald

Heather, that concludes the call today. If you want to move to wrap the call up?

Operator

This does conclude today's conference call. We appreciate your participation. You may disconnect at this time.

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