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Executives

John C. Plant - Chairman, Chief Executive Officer and President

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

Mark Oswald - Director of Investor Relations

Analysts

Ravi Shanker - Morgan Stanley, Research Division

Brett D. Hoselton - KeyBanc Capital Markets Inc., Research Division

Rod Lache - Deutsche Bank AG, Research Division

Himanshu Patel - JP Morgan Chase & Co, Research Division

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Patrick Archambault - Goldman Sachs Group Inc., Research Division

TRW Automotive Holdings (TRW) Q3 2011 Earnings Call November 2, 2011 8:30 AM ET

Operator

Good morning, and welcome to the TRW Conference Call. [Operator Instructions] 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, Mr. 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 third quarter 2011 financial results conference call. This morning, 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 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 our presentation for our complete Safe Harbor statement.

The Risk Factors section of our 2010 Form 10-K and our first and second quarter 10-Qs, including the Risk Factors section in our Second Quarter 10-Q, contain additional information about the 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 third 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 also 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.

Finally, a replay of this call can be accessed via dial-in or through a webcast on our website. Replay instructions were included in the 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 C. Plant

Thank you, Mark, and good morning, everyone. As you can see from the results posted this morning, TRW's third quarter performance continued to build on the positive momentum established earlier this year, and this was in line with our expectations at the start of the quarter.

During the third quarter, sales, which totaled $3.9 billion, was some 14% higher compared with the prior-year quarter. Operating profit before special items was $240 million. Net income was $177 million and earnings per share were $1.37 on the same basis.

And in support of our planned growth, capital spending increased to $137 million. Cash was generated in the quarter, and this builds on a good first half and we now expect a very good cash outcome for the full year. 2011 will be another strong year for TRW.

I'll expand on the year-to-date results in just a few moments. First, I'll add a few additional comments regarding the third quarter. During the last 3 months, global production volumes held up well and were in line with expectations of most industry observers, which were established at the beginning of the quarter, despite many negative headlines such as slowing global economies and the European debt crisis and the waning consumer confidence.

In North America, overall vehicle production was up 6% compared with the third quarter of 2010. On a sequential basis compared with Q2, production was about flat. Looking at the detail, however, it's important to note that production for the Detroit 3 was down close to 9% sequentially as the positive production impact experienced by the group in the second quarter began to reverse due to improving production schedules of the Japanese vehicle manufacturers.

The September annual sales rate of 13.1 million units in the North America region was encouraging, as sales returned to pre-quake levels experienced in the January through April period. This is good news, as the result signals stable to increasing customer demand for automobiles and provides a foundation for the current production schedules.

In Europe, vehicle production was also in line with earlier expectations and held up relatively well. Production for total Europe was up 6% compared with last year's third quarter. Western European's production in the third quarter was up about 5% year-on-year. As expected, normal seasonality drove a sequential decline in production in the most recent quarter compared with the second quarter of the year. For Western Europe, the decline was approximately 15%.

Consumer demand continues to be resilient, especially in the northern countries, against the backdrop of the eurozone sovereign debt issues and banking concerns. European registrations were up about 1.5% in the third quarter. Sales in China and Brazil continue to advance as TRW outpaced industry production in both markets. Combined sales in these 2 markets accounted for 17% of TRW's total third quarter sales. Although the pace of growth has recently moderated in those markets, the outlook for vehicle sales and production remains robust.

With respect to our year-to-date results, we are pleased with TRW's performance. Operating profit, excluding special items for the first 9 months of the year, was $971 million on sales of $12.3 billion, which is an operating margin of 7.9%. Net income on the same basis was $733 million and earnings per share were $5.58. The performance achieved through September provides a solid foundation for not only the remainder of 2011 but also as we enter 2012.

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 will work hard to mitigate factors such as rising commodity prices.

Moving on to the third quarter and its business developments. Product launches during the quarter continued to strengthen our diversification and leadership in intelligent safety solutions. A few examples include the electric steering, the driver's airbag and rear seatbelt system on the Ford Focus in Europe. BMW launched its 1 Series with TRW's driver and passenger airbag modules, steering wheel and seatbelt system. And VW's all new Up! vehicle, which was introduced at the Frankfurt Auto Show is being launched with our anti-lock brake system and side airbag module.

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 just under 4 parts per million across all products and customers worldwide. In addition to the products launched during the third quarter, TRW highlighted a number of new technology innovations with an emphasis on developing advanced safety technologies which are suitable for all vehicle platforms for all markets at this year's international auto show in Frankfurt, Germany.

A few examples of these new products included TRW's future brake systems for electric hybrid and low-vacuum powertrains. The vacuum-independent brake boost and control system offers the full range of brake system functionality from electronic stability control to regenerative breaking in a single integrated package. The FBS system will be up to 4 kilograms lighter and will eliminate some components to make it more affordable. The development and testing program has been well received by customers who have experienced the results and is a great solution for replacing the power of the vacuum created by the additional internal combustion engine.

Keeping with the theme of advanced thinking, we also unveiled TRW's next-generation radar concept, the AC1000, which is a short range radar for 360-degree sensing applications to enable blind spot detection, lane change assist, cross-traffic alert, side-impact sensing and low-speed collision warning. The new sensor concept can also be integrated with the vehicle braking and electric power steering systems to provide limited emergency braking and traffic-jam assist.

Investing to expand these new technologies and our existing product portfolio will strengthen TRW's already-strong market position. In addition to the product launches and future products introduction during the quarter, TRW took action to divest certain of its non-safety businesses in Asia, and we entered into an agreement to sell our coal forming business in Japan. The planned divestitures, with annual sales of approximately $100 million, are expected to be finalized in the fourth quarter of this year. This will enable the company to concentrate its resources on the growing safety systems market in Asia.

Now let me comment on our expectations for the remainder of 2011. Overall, the fragile, broader macroeconomic environment has resulted in a weakening of global vehicle markets. Although the recovery remains headed in the right direction, it appears that the already-slow pace of recovery may be slower than originally anticipated. In North America, we expect fourth quarter production to be roughly 3.3 million units, an increase of about 12% compared to the fourth quarter of last year. For the full year, we expect production of -- to total 12.9 million units for an increase of 8% compared with 2010 but down slightly from our previous forecast.

In Europe, weakening macroeconomic conditions has resulted in industry observers lowering their vehicle production estimates for the region. During the fourth quarter, we estimate vehicle production in Western Europe to be about 3.3 million units, about equal to last year, while total European production forecasted at some 4.8 million units should be down 1% compared with last year.

Given our expectations for the fourth quarter, full year 2011 production is expected to be around 19.9 million units in Europe, down slightly from the 20 million units we forecasted some 3 months ago. Within this estimates, Western European production is 13.6 million units, which is an increase of 3% compared to last year.

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 compared to last year. As a result of the ongoing flooding in Thailand, which has already resulted in production disruptions and disruptions to that company's -- country's infrastructure, we continue to assess and keep a close eye on the potential impact on the supply chain. Although TRW's facilities have not been directly impacted, we are exposed to potential disruptions from our customers' production schedules. As you would expect, we will continue to monitor the production plans of our customers and make any necessary adjustments to our operations accordingly.

Based on the forecasted production estimates and our revised currency assumptions, we now expect sales of approximately $16.2 billion for 2011. Capital spending for the year is now expected to be about $570 million, which is slightly higher than the guidance we provided in August, primarily due to timing of certain projects. As mentioned throughout the year, this level of spend is necessary to support our future growth in the high-growth areas, namely China and Brazil, and the continued expansion of our new, innovative technologies in support of our robust business awards achieved in the past year.

And finally, after refining our restructuring plans, we now expect restructuring expense for the year to be between $20 million and $25 million. With regards to 2012, we have not finalized our operating plan assumptions. Our thoughts are for a continued slow recovery in North America and most likely, flat production in Europe. China and Brazil are expected to remain bright spots with continued expansion, albeit at a slower pace compared with prior years. We will provide our total assumptions when we report our 2011 full year results early next year. In summary, we are pleased with our performance to date and remain focused on finishing a very good 2011.

We are confident we are implementing the correct strategies to ensure long-term success for the company. Our solid balance sheet, innovative technologies and strong market momentum will enable TRW to maintain and build on its positive momentum. Before I turn the call over to Joe, just a quick comment on the ongoing investigations by antitrust authorities, which we first reported publicly in the early June month of this year. As you're aware, these investigations can take many months and even years to conclude. As a result of our commitment to cooperate in connection with the government investigations, we commenced a comprehensive internal investigation immediately after the authorities visited certain of our locations on June 7. That investigation is ongoing, and at this time there is no further information to report. And with that, I'll now hand the call across to Joe to comment further on our financial results.

Joseph S. Cantie

Thank you, John, and good morning to everyone. As John mentioned earlier, our results for the quarter were substantially in line with our business expectations that we had at the beginning of the quarter.

At a macro level, industry production volumes and, therefore, our sales were in line with our previous guidance while operating earnings and cash flow performed well in light of the cost headwinds discussed during our last conference call. As a reminder, we experienced margin compression compared to last year's third quarter due to 3 items: the increased level of investments for future growth, commodity inflation and the non-recurrence of approximately $20 million of income items that were realized in last year's results. In addition to those 3 items, our current quarter includes approximately $13 million of increased legal costs associated with the company's ongoing antitrust investigation. Despite the margin compression compared to last year, the absolute results for the current quarter were very good. Our sales were $3.9 billion, an increase of 14% compared to last year. Operating income before special items was $240 million, resulting in an operating margin of 6.1%; the second best level of profit and margin for any third quarter period for TRW, following only the level achieved last year, a quarter that was aided by a compressed summer shutdown period.

Earnings per share were $1.22 on a GAAP basis and $1.37 after excluding debt retirement charges. In continuing our trend of strengthening the balance sheet, we were very active during the quarter in terms of repurchasing debt, resulting in our total gross debt being reduced to $1,532,000,000. Net debt was $642 million, a reduction of $126 million since the beginning of the year. For the first 9 months of this year, we continued at a record pace as the company posted sales of $12.3 billion, up 15%, and earnings per share of $5.58, excluding special items, which sets us up for a strong 2011 year overall.

We're pleased with our year-to-date performance and expect to continue our strong results as we move through the final quarter of this year. Of course, the enthusiasm is tempered as we recognize the continued 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 third quarter and year-to-date results.

For the quarter, we reported sales of $3.9 billion, an increase of $489 million or 14% 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 $194 million compared to the prior year. As an example, the euro-to-dollar exchange rate averaged about 1.41 this quarter, an increase of over 9% compared with 1.29 last year.

Excluding the effects of currency translation, sales increased 8% 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 $240 million, which is a decrease from the prior year level of $269 million. In addition to having about $20 million in positive one-off items in last year's results, the decline in profit was driven by increased raw material prices and higher engineering development and infrastructure costs, which were in line with our expectations. Each of these negatively impacted the quarter by about $25 million. We also had the $13 million of antitrust legal fees in the current quarter.

These same factors will also impact our fourth quarter results by approximately the same magnitude as the quarter just completed. Moving down the income statement, interest expense totaled $26 million, which compares to $39 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 $19 million, resulting from the debt repurchase activity that was completed in the quarter, which I'll expand on later in my comments.

Finally, tax expense was $37 million in the quarter compared with $28 million last year. The 2010 period included one-off tax benefits totaling about $11 million. The corresponding Q3 effective tax rate of 17%, excluding special items, reflects the impact of our overall improvement in operating results and the geographic mix of our earnings.

As I mentioned on our second quarter call, 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 reverse, resulting in our effective tax rate moving closer to the U.S. statutory rate of 35%. At this point, it's difficult to predict when our valuation allowance position in the U.S. will reverse as it is dependent on many factors. However, if future results in the U.S. shows sustainable profitability, a reversal of the valuation allowance could occur within the next 12 months. Of course, despite the P&L impact of this, TRW will not pay cash taxes in the U.S. for many years, given our existing net operating loss position.

At the bottom line, we posted GAAP net earnings of $1.22 per diluted share compared with net earnings of $1.54 in the prior year. Now excluding the special items I've just discussed from both periods, basically the losses on debt retirement and the one-off tax benefit from last year, earnings were $1.37 per diluted share this year compared with $1.47 in last year's third quarter. You can find a 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 $354 million, excluding the special items, which compares to $385 million in the prior year measured on the same basis. Moving to a brief review of our year-to-date results. We reported sales of $12.3 billion, which is an increase of $1.6 billion or 15% compared with the previous year. Increased global vehicle production, continued growth resulting from our portfolio’s safety products and the positive impact of currency movements accounted for the year-on-year increase.

Our operating income in the first 9 months was $980 million, which compares to $891 million last year. The $89 million increase between the 2 periods was primarily the result of our operating leverage against higher level of sales between the 2 periods, partially offset by higher raw material prices, increased cost to support future growth and the higher legal fees.

Below operating income, interest expense was $90 million compared to $125 million last year. In the prior year period, we had a minor $2 million loss on retirement of debt compared to a $39 million loss this year, reflecting the increased bond repurchase activity in the current year. Tax expense for 2011 was $127 million, which compares to $130 million in 2010. One-off tax benefits totaling $20 million were recognized in the current year-to-date period compared with $23 million in the first 9 months of 2010.

So at the bottom line for the 9 months, reported GAAP net earnings of $5.57 per diluted share, which compares to net earnings of $4.93 per share last year. Again, excluding the special items, earnings were $5.58 per share for the first 9 months of this year. And again, you can find a reconciliation between GAAP and the adjusted earnings I just referenced here in our press release.

And finally, in terms of EBITDA, we had $1,313,000,000, which is a record for the first 9 months of the year compared to $1,247,000,000 in the prior year.

Let me shift now to our cash flows and capital structure. First on operating cash flow, for the quarter, we had $160 million, which compares to $267 million in 2010. Capital expenditures for the current quarter were $137 million, which is $76 million higher compared with last year. Free cash flow, which I'm defining as operating cash flow less capital expenditures, was a positive $23 million this quarter compared to $206 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 higher level of sales the company is experiencing.

For first 9 months, the company generated $208 million of free cash flow compared to $522 million in the prior year. Capital expenditures at $304 million during the year-to-date period was $136 million higher compared to last year's level. We continue to expect another strong year of cash generation despite a high level of reinvestment in the company. Historically, the fourth quarter is our strongest period for cash generation, and we expect that trend to continue this year. 2011 will mark the sixth consecutive year that the company has generated substantial positive free cash flow, a great achievement and evidence that the company is focused on managing every dollar earned.

At the end of our third quarter, our total gross debt and net debt outstanding were $1,532,000,000 and $642 million, respectively, both in great shape and down significantly compared to previous periods. During the quarter, the company used $213 million of cash to repurchase debt securities, including $97 million of face value straight bond debt and $66 million of face value exchangeable bonds. Year-to-date through September 30, we have now used $421 million of cash to repurchase our securities. Despite this activity, which improves the positioning of our balance sheet ahead of coming maturities, our liquidity remains robust at over $1.3 billion available to us.

Switching subjects now to the remainder of 2011. As John indicated, TRW's full year 2011 production forecasts are for 12.9 million units in North America and 19.9 million units in Europe. We have also updated our currency assumptions to current spot levels. The revised assumptions should translate to full year sales for TRW of about $16.2 billion, up $1.8 billion or 13% compared to last year. This would imply fourth quarter sales of $3.9 billion, about 5% higher compared with last year. As mentioned earlier, our capital spending forecast for the full year is about $570 million. Restructuring has also been refined, is now forecasted to be around $25 million for full year 2011, slightly lower than our typical run rate. I would expect our out-years to revert back to the historical average of between $35 million and $40 million.

Full year interest expense is forecasted to be about $117 million given the cost and level of debt for the company. And although difficult to predict, we expect net commodity and other inflationary headwinds to be about $100 million in 2011, which is at the lower end of our previous guidance and implies about $25 million in our fourth quarter. As you might expect, we're aggressively working to recover and minimize the negative impact of these rising costs. Consistent with the previous guidance, we expect engineering, development and infrastructure costs will increase by just under $100 million for the year, which implies about $25 million in our fourth quarter. We expect that legal expenses related to our antitrust investigations incurred in future quarters, while still significant, should decrease over time, compared to the $13 million incurred in our third quarter.

For taxes, given our expected results by geographic location, you should assume a full year 2011 effective tax rate of around 18% for modeling purposes. One final comment regarding future expectations relating to our legacy liabilities, given the recent interest rate environment. Although the measurement date for our pension plans is December 31, it's reasonable to assume that if interest rates remain at their current levels, the net unfunded status of TRW's pension plans will increase from the level reported in our 2010 10-K.

A sensitivity chart can be found on Pages 26 and 27 of our latest 10-K to help you dimension this movement based on your year-end expectations for interest rates and asset returns.

If we had to mark the plans today using current discount rates and asset returns, our net unfunded position will increase by under $300 million, a very manageable situation for us.

In closing, we're pleased with our record results posted during the first 9 months of this year and realize a lot of hard work lies ahead. Our strong underlying business performance, cash generation and outstanding capital structure not only positions TRW to close up 2011 well, but more importantly probably, positions the company for long-term success. Christie, we'll now move to the question-and-answer portion of the call.

Question-and-Answer Session

Operator

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

Himanshu Patel - JP Morgan Chase & Co, Research Division

Just 2 questions. First on Q3, it looks like there was a pretty decent amount of sequential cost inflation. If I look at the, kind of, decremental margin sequentially, it looks like it was about $0.30 on the $1 even excluding the legal fee increase. Can you just talk to some of those items, whether it's commodities or module mix or whatever? Was there quite a big step up Q-to-Q?

Joseph S. Cantie

When I go back to the discussion we had at the time of our second quarter conference call, it played out as we thought, if you look at the sequential margins or even compared to last year, the big factors, first of all, versus prior year, were the investment in the growth, which is $25 million, the commodity inflation, $25 million, and then of course, the $13 million in legal fees. So if you do that walk, together with the currency movement in sales, you can pretty much get close to the margin change between last year and this year. Of course, you have to take out the $20 million of one-times from last year. When I look at Q3 versus Q2, again, our volume -- sales declined, obviously, so we lost the contribution margin on that volume pull-through. And then, obviously, we had the legal fees that we incurred in the third quarter that we didn't incur in the second quarter. And then, Himanshu, there was an element of cost associated with the fact that we keep coming back to these 11 plants that we've been building. A lot of that activity is occurring in the second half of this year versus the first half so there was some cost third quarter versus second quarter there. But I think if you go back and do the walk, including the legal fees and the change in the sales line and contribution margin, you'll see that it holds together.

Himanshu Patel - JP Morgan Chase & Co, Research Division

Okay. And then Joe, I appreciate the cost variances for Q4. Can you just talk a little bit about how we should think about the revenue drop-through on Q4? It looks like you're guiding for about a $200 million year-over-year revenue growth. How should we think about the conversion on that? How much of that is FX? How much of that is module growth? Are you guys assuming any divestitures in that number? I guess I'm just trying to understand how much is the base kind of value-added production growth.

Joseph S. Cantie

No problem. I mean, right now at this point, we did speak to a couple of assets that we're hoping to close in the fourth quarter. We expect -- or, our assumption is that, that will happen at a later part of the quarter, so we have not assumed any divestiture change quarter-on-quarter. Clearly, when you look to next year, there will be that $100 million that's missing between the 2 years given the divestitures. So nothing on the divestitures in the fourth quarter, and right now, when you look at currency rates, we're not expecting a lot of movement between this year fourth quarter and last year's fourth quarter in terms of currency. So taking what I just said, we sat there and said $3.9 billion. Last year, we did just over the $3.7 billion, so there's about $180 million of what I'll call real volume increase there that you'd expect to pull through at the -- we always talk about a 23% to 25% contribution margin, so on depending on the mix, it should be somewhere in that zone.

Himanshu Patel - JP Morgan Chase & Co, Research Division

Any big changes on module mix year-over-year?

Joseph S. Cantie

We'll have a little bit of module -- more module business in the fourth quarter just as we had a little bit more in the third quarter. I think third quarter this year versus last year, we're up close to $100 million in modules. And when I look at fourth quarter, the increase won't be that much, but it will be slightly increased. We have a lot of module business at Chrysler, Chrysler seems to be doing well. We expect that to continue in the fourth quarter.

Himanshu Patel - JP Morgan Chase & Co, Research Division

Okay. And then some of these commodities have been moving around. I think aluminum, in particular, has started to move down. Just if you were to freeze at today's spot prices, do you have a tentative view on what next year's commodity picture looks like? Is it up, down or sideways?

John C. Plant

I don't think we are ready to mention that at the moment, Himanshu. I mean, clearly there is some indications of reductions, and yet we're still seeing the feed-through of some of the, I'll call, less well-known commodities like hides and rare earth metals and these sorts of things. So we're sort of trying to balance it all up right now. But in terms of the larger, metal-based commodities, I mean, there are indications of some improvements for us.

Operator

And your next question comes from the line of Rod Lache with Deutsche Bank.

Rod Lache - Deutsche Bank AG, Research Division

I was hoping you might be able to just help us understand the gross margin, the gross profit bridge a little bit here on a year-over-year basis. I guess we could do it on an operating profit basis as well, but you had roughly $300 million of organic growth and if you use the midpoint of your incremental margin range, that would be about a little bit over $70 million of positive. You talked about the $50 million of raw material costs and infrastructure, and I'm assuming that the legal fees were in SG&A, not in gross profit. Maybe I'm wrong there, but -- and I think the $12 million of the $20 million benefit that you cited was in gross profit last year. Is there something wrong with the math here? Can you just maybe elaborate a little bit more on why the gross profit would have declined on a year-over-year basis?

Joseph S. Cantie

Yes, sure. I can help you with that. You're right. When you look at sales, $200 million of the difference is down to currency. So you set that to one side and then that's where you got your $300 million. If you take the $300 million and multiply it by our typical contribution margin, I'm going to use the lower end of the range because we did have a $100 million more of module sales, which come through at a lower contribution margin and, in fact, very low contribution margin. So we picked that -- you would have expected us to pick up roughly $60 million of gross profit between the 2 periods. You then have to reduce that by the commodity inflation and the -- and substantially, our big portion of the growth investment, $25 million that we talked about, and you can see that you're in the zone. The other thing I'd like to highlight is the $20 million of one-off good guys that we had last year, a big portion of those was also in that cost of sales line, so when you put that into the frame, you can see that the walk works. Regarding the $13 million of legal expenses this year, that is in the administrative and selling expense line. So you saw that, that line has moved up. The other thing you have to consider when you're looking at administrative and selling expenses is the currency between the 2 quarters as well. So that should help you sort of get to that walk.

Rod Lache - Deutsche Bank AG, Research Division

Okay. I guess we could follow up on that. For the fourth quarter, you've got similar revenue expectations and, you did say, a little bit higher production. Is the difference there FX? Could you just elaborate on what's behind that, and would you be expecting similar profitability in Q3 -- in Q4 as you saw in Q3 just given that you said some of the headwinds are likely to be similar?

Joseph S. Cantie

Well, I think when you look at the fourth quarter, again, fourth quarter this year versus last year, there should be no -- based on today's currency rates, obviously, we're not planning on having any significant effect on the sales line at all. So you would take the difference between the $3.9 billion and the $3.7 billion, Rod. You'd apply a contribution margin. You get an increase. You then take the 25 25 and whatever you want to assume for our legal expenses, and you can see that you can do a pretty decent walk to have a mosaic, I guess I'll call it, for the fourth quarter. That would clearly show that our fourth quarter margin obviously moves up from our third quarter, which is always the case because the third quarter is the summer shutdown quarter, and there's a lot of inefficiencies that come with the summer shutdown period. So clearly, we'll move up from the third quarter level. You can do that walk, and when you look at our sales in the third quarter at 3915, there will be an FX factor -- currency factor when you compared third quarter to fourth quarter because we averaged 1.41 on the euro on the third quarter. Today, I think we're somewhere around 1.37, and there's a bunch of other currencies that have moved. So it's likely that our sales for currency will probably move down maybe close to $100 million between third quarter and fourth quarter. So we actually are getting volume increase compared to the third quarter, but it's masked by that currency movement.

Operator

And your next question comes from the line of Chris Ceraso of Credit Suisse.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

I think we've kind of tied out the walk here, and thanks for that. I guess one thing that occurs to me, you've raised your guidance for restructuring, yet you haven't spent any year-to-date. Are there plants that are underperforming that you need to address, or why do you think you're going to need to spend more than you thought last quarter, even though you haven't spent any yet on restructuring?

John C. Plant

We're just trying to position ourselves well for 2012. Originally, we thought we were going to spend 30 to 35 this year and then we began to reduce and reduce it because we saw the need for, I think, substantially increased production in 2012. We've commented on moderating the growth, so we're expecting growth as we move into 2012, but not quite at the level that we previously thought as, basically, you read European sovereign debt crisis on all the rest of it into that. And we've taken the opportunity of thinking more about what could we trim our cost base for, particularly in Europe, as we move into 2012. And that's really where we are aiming that restructuring because we think we can take an opportunity earlier than we had thought about because we were planning restructuring in '12, and we're saying we can actually accelerate that given what we think the volume position is likely to be with basically a more modest, or you could just call it a more muted growth outlook for the next year.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Okay. So nothing is underperforming right now? You're just getting ahead of the curve for 2012 and you're...

John C. Plant

No, I mean, we're not underperforming. We're -- I mean, we have not shed any labor, volumes continue to be robust. I mean, Joe has already commented that the fourth quarter will be higher than the third quarter. So nothing underperforming at all in any sense. I mean, it's just taking the opportunity of saying compared to our previous expectation of pick-up from '11 to '12, while we're expecting growth, it's probably not going to be quite as robust as we thought. And again, I'll come back to, if you look at the macroeconomic picture, which you can read every day about, even this morning -- you've seen, this morning, again, let's call it -- it gives you a shorthand of Greece, if you want to.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Right. So, okay, Joe, on working capital Q4, typically, you generate $300 million to $500 million, if not more. Is there anything that's changed in your payment terms or cycles or anything that would suggest that this Q4 is materially outside of that range?

Joseph S. Cantie

Yes, I mean, typically, I would have said we generate anywhere from $300 million to $400 million. Maybe there was a year we got to $500 million. I think the $300 million to $400 million is more normal. We've had term changes but nothing significant to affect that. So I would think we again should be in that zone. It all depends on where sales go here in the last couple of months, December not so much, but October, November. But it should be a robust working capital inflow for us, somewhere in that $300 million to $400 million zone.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Okay. And then just lastly on the pension. We can do the math on the funded status and that's helpful. Any expected change in your cash contributions next year to the pension?

John C. Plant

Not at this time, no. I mean, we actually accelerated some payments on a discretionary basis in 2010. That is not requiring us to do anything special that we think at this point for 2012, so it's going to be more in the, dare I say, just our normal range. I mean, if you had asked us maybe 3 years ago, we'd have thought we might have been substantially reducing them. We might not have that big reduction opportunity, but I don't believe we're talking about kicking them up at all at this point in terms of the required contribution.

Joseph S. Cantie

And Chris, I'll just take advantage of your question. I did make those comments in my prepared remarks because we got a lot of inflow incoming and people, I think, were fearing like a big number. And basically, what I tried to do is give you some comfort that, hey, it's not a big number. Is it a little bit higher? Yes, but something that's very manageable and hopefully, when you work through the variances, you'll be able to see that it's going to be something very manageable for us.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

You must be generating some pretty snazzy returns on the asset side there, Joe.

Joseph S. Cantie

We've got some -- we're doing well, and obviously, there's derivative strategies that have worked in our favor. We'd much rather have robust markets, but we've sort of put some downside protection into these plans, so we've done well.

John C. Plant

We've had a very cautious investing position, and -- but what you can see in terms of the movement that Joe talked about, about $300 million, so -- and is essentially the discount rate effect, which basically follows the extraordinary low interest rates and, of course, maybe those will continue for another year. I mean, nobody's really quite sure, Chris.

Operator

And your next question comes from the line of Brett Hoselton with KeyBanc.

Brett D. Hoselton - KeyBanc Capital Markets Inc., Research Division

First question, what is actually driving the reduction in your production schedules going into the fourth quarter? Are you actually seeing changes in your expectations from your customers? Or is it just maybe more conservatism on your part?

Joseph S. Cantie

Well, I think -- I mean, the first comment we've got to make is, clearly, in North America, when you think of us in North America, we're more tied to the Detroit 3. And when you look at production fourth quarter in North America versus third quarter, production's up about 200,000 units, but all of that is really with the transplants, not the Detroit 3. In fact, you look at the Detroit 3, right now, they're going to be down slightly. So it's more because of us being more tied to North America than the transplants, and that's -- I'm glad you asked the question, Brett, because that's an important point when you think about going into next year. If there really is going to be a recovery from the Japanese off the earthquake issue, we probably, just as we didn't suffer as much when it happened, we will not take advantage of their increase as much versus the Detroit 3.

Brett D. Hoselton - KeyBanc Capital Markets Inc., Research Division

And then Europe?

Joseph S. Cantie

Europe should be up about 300,000 units. I'll make the same comment that the Japanese are showing the most strength in that increase of 300,000 units between third quarter and fourth quarter. But we're doing fine there, and it's more the impact of North America than Europe on us.

Brett D. Hoselton - KeyBanc Capital Markets Inc., Research Division

Okay. And then legal fees. Did you not have any legal fees in the second quarter to speak of or were they fairly de minimis and so the $13 million is kind of representative of what you've incurred thus far this year or is...

John C. Plant

Essentially, the Q2 was de minimis because -- in fact -- while we know the other companies may have been talked to earlier, we were really -- into that June -- that mid-June time frame. And essentially, all of our costs were in Q3.

Brett D. Hoselton - KeyBanc Capital Markets Inc., Research Division

Okay. And then as we think about a potential decline going forward, is it a significant decline are you thinking or you maybe just not know at this point in time, but should we be thinking about a $10 million going forward or should we be thinking about $5 million going forward? Generally...

John C. Plant

We don't really know and have no fundamental ability to comment. We're just trying to take a very comprehensive approach to this across TRW. And that's it, basically. You'll note TRW is a large company, and we're just trying to make sure that we do a very comprehensive review.

Brett D. Hoselton - KeyBanc Capital Markets Inc., Research Division

And then as we think about engineering into next year, this year you chose to increase it, are you looking to increase it again next year or do you think you're going to be more along the lines of a steady state into next year?

John C. Plant

I'm going to really sort of finesse what I said at the last earnings call, which essentially was, the large step-up in 2011 won't be repeated. There may be a very modest fractional increase in '12, and we're trying to frame that at the moment and make adjustments as we think about our operating plan for next year. But essentially, the very large step-up this year, which we talked about and is evident in our walk, so when Joe talked about the walk from Q3 of '10 to Q3 of '11 and commenting on the commodity inflation then, basically in that upward -- in the infrastructure bucket add engineering and the new plants, I mean, essentially, that won't be -- we'll not be stepping up in 2012 to anything like that degree. So essentially, we're seeing it flat and off and just be more in line with our normal percentages. And essentially, the large step-up this year was in response to -- I think we've talked about the very successful time we've had in the markets winning business over the last 18 months or so and the ability for us to prosecute our intelligent safety solutions in, basically, in almost every region of the world. And so it's been an exciting time for us in that respect.

Operator

And your next question comes from the line of Patrick Archambault with Goldman Sachs.

Patrick Archambault - Goldman Sachs Group Inc., Research Division

Just wanted -- I know you guys are not going to give incremental or absolute margin guidance for next year, but I just wanted to make sure I was thinking about some of the main margins components correctly. It seems like engineering, just based on the last question, engineering expense, steps up by -- increases by less. It sounds like based on commodities where they've headed, there are some rare earths and things like that. But a lot of the base ones are potentially going to be less inflationary at the very least. And then presumably, a lot of the investments that you've made, those 11 plants, you're going to start to see those ramp up the margin curve. So it does seem like there's a lot of stuff going from 2011 into 2012 that could be accretive from a margin perspective.

John C. Plant

I mean, is that a statement? I mean, honestly, I don't think it is a question. I mean, we think at this stage that, I'll say, for 2012, we will see, I'll say, healthy increases in our growth. Not as much as we had thought because of the moderating effect of the macroeconomic conditions that we've talked about. And I guess what we'll see is the full flow-through of the contribution and then -- of those sales and net down of any change costs to do with infrastructure and inflation. So I don't think we want to say much more. We're not going to give margin guidance. We have not done that in the past and probably not going to do it for 2012, either. We're going to talk to the main constituent elements, and indeed, you've captured some of them. But probably nothing more to add, unless you want to say anything, Joe?

Joseph S. Cantie

Well, the only thing I'd add is -- I agree with John. We'll come out in early part of next year on our next results and provide you some guidance, but I would not see those things as being accretive to our margin. The things that we talked about, for example, the R&D and engineering, John indicated the increase would be less, but there will be an increase. Commodity inflation, if nothing moves from where it is today, you're going to have a carryover effect into next year versus this year. And when you look at those things, while you're correct they are less impactful in a negative way versus this year, but that still is margin -- that is not accretive to margin. That's the only thing I'd add.

Patrick Archambault - Goldman Sachs Group Inc., Research Division

Got you. Okay. That's helpful. One last one, just on Europe. You said that you're -- I believe that expectations could be broadly flat. I mean, you're still fine tuning that for next year. Can you just tell us a little bit about what some of your contingency or how you're approaching contingency plans there? I mean, you've taken an enormous amount of cost out already in that region. So what are some of the things that you can go after, for instance, if volumes end up being worse than flat?

John C. Plant

Since -- I'll say, since we've seen recovery from the fourth quarter of 2008 and moving into 2009, we've been very cautious regarding increasing fixed cost base, in particularly around labor. So we have built up temporary employment buffers against market dislocation. And I mean, we think we have very adequate buffers in place, but I mean, it depends what you mean by the word "dislocation." I mean, we thought we had, in the fourth quarter of 2008, had enough buffers to flex our production, but we saw the flexing requirement to be substantially greater than anticipated. And all I can say to you is we expect markets to be broadly flat. We can certainly cope with easily plus or minus a reasonable percentage, but if we had truly dramatic events, I mean, if -- I've seen press speculation to say that an uncoordinated Greek default position would be far worse than the aftershock of Lehman Brothers, and what does that mean? I mean, you can read all sorts of dramatic things in the press. But none of us really know what that means. And therefore, it's just -- it's more of an empty speculation, really. So all I can say to you is we have a very healthy position of buffers in place, we would flex our costs, and it's fundamentally a question of degree. I’ve already commented that we've decided to advance some of the restructuring opportunities that we were -- had in our line of sight for 2012. We'll be bringing those into the fourth quarter of 2011 because we can. And we're doing that against the backdrop of no reductions in vehicle build. And then Joe actually commented that year-on-year, the fourth quarter in Europe is broadly the same, but with a sequential improvement over Q3. So we're just taking a very cautious approach to our cost base because we don't know. We've given you our best guess of our expectation, which is a pretty flat outcome for 2012, which I think is different to many people's expectations. If you went back -- if you looked back 6 months or 12 months ago, people were forecasting, and many forecasting models had very substantial increases of 2012 production over 2011, both in North America and in Europe. And I think everybody is rather more cautious today based upon the macroeconomic climate that we have.

Operator

We'll take our final question from Ravi Shanker with Morgan Stanley.

Ravi Shanker - Morgan Stanley, Research Division

A couple of follow-ups on the legal fees here. Joe, can you give us a sense of what this means for you internally? What's going on, on a day-to-day basis? Are there -- is there paperwork that you're filing, or is it just, like, payments you're making to lawyers to handle -- to talk to the DOJ? What's going on internally, basically?

John C. Plant

We're not going to comment any further beyond what we've already said. So nothing to add, really.

Ravi Shanker - Morgan Stanley, Research Division

Okay. Fine. And on the -- final question. On the divestitures, is that something that was opportunistic and you just took the chance there? Or is there a strategic initiative that you have to get rid of some of your less-core business?

John C. Plant

We've never used the expression core or non-core. We have thought for some time about opportunities that we may have to focus even more on what we think we're really good at. And we clearly -- I mean, to be able to close a couple of transactions in the fourth quarter of this year and have the receipt of funds basically means you've been working on them for some time and so is part of the strategic direction of the company in terms of focus. And we felt that the time to take those entities to market was right, and clearly, at the moment, we think we've got this timed pretty good, considering what's going on.

Ravi Shanker - Morgan Stanley, Research Division

Right. And I'm sorry if I missed this, if you said it already, but what's the EBIT impact of this divestiture?

Joseph S. Cantie

We haven't said anything on that. We'll try to give you some guidance when we actually close the transactions.

Mark Oswald

Christie, if you could please move to conclude the call.

Operator

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

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