TRW Automotive Q2 2007 Earnings Call Transcript

| About: TRW Automotive (TRW)
Wall Street Breakfast

TRW Automotive Holdings Corp. (NYSE:TRW)

Q2 2007 Earnings Call

August 1, 2007 8:30 am ET


Patrick R. Stobb - Investor Relations

John C. Plant - President, Chief Executive Officer, Director

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


Rod Lache - Deutsche Bank

Ron Tadross - Banc of America

Himanshu Patel - JP Morgan

Chris Ceraso - Credit Suisse

Jonathan Steinmetz - Morgan Stanley



Good morning and welcome to the TRW conference call. All lines have been placed on listen-only mode 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 Please download the material now if you have not already done so. After the speaker’s remarks, there will be a question-and-answer session. Due to today’s limitation on time, the company requests that participants limit follow-up questions to one per caller. (Operator Instructions)

I would now like to introduce your hosts for today’s conference call, Mr. Patrick Stobb, Director of Investor Relations. Mr. Stobb, you may begin.

Patrick R. Stobb

Thank you. I would like to welcome everyone to our second quarter conference call. Joining me are John Plant, our President and Chief Executive Officer, and Joe Cantie, our Chief Financial Officer. On today’s call, John will provide an overview of the financial results and discuss other related business matters. After John’s comments, Joe will provide an expanded review of the financial information and then we will open the call to your questions.

There are a few items I would like to cover before getting started. 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 3 of the presentation for our complete Safe Harbor statement. The risk factors section of our 2006 Form 10-K contains additional information about risks and uncertainties that could impact our business. You can access our 2006 10-K and other SEC filings by visiting the investor information section of our website at or through the SEC’s website at

On a related matter, we expect to file our 10-Q by the end of this week.

The next item, in addition to our GAAP results, 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 equivalence can be found in the conference call materials, posted to the investor information section on our website this morning.

Finally, we have not given our permission for any other recording of this call and do not approve or sanction any transcribing of the call. 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.

This concludes my comments. I’ll now turn over the call to John Plant.

John C. Plant

Thanks, Pat and good morning, everyone. As you can see from the results that were posted this morning, TRW's strong financial performance continued during the second quarter. During the quarter, we accomplished our operating objectives and executed the final step of our debt recapitalization plan, which provides TRW with a low-cost, flexible and efficient balance sheet. The results conclude a solid first-half of the year and reflect great strides that we have made moving the company forward.

Although our efforts have been impeded by difficult industry conditions, particularly in North America, we have been successful at reshaping the organization which can be measured by our customer and geographic diversification, new product innovations, our sales and our profits, and the impact of restructuring efforts, to name a few of the accomplishments.

The strategy has been straightforward and focused. We believe in what -- we operate in what I believe is currently the most exciting product space in the industry, namely safety. We expect the emphasis on safety by governments, vehicle manufacturers, and consumers will continue to drive demand for the foreseeable future.

Manufacturers in North America and Europe continue to add safety content to their vehicles at a steady pace and that is best evidenced by the level of new business that we expect to launch over the coming years.

We are benefiting from activity in the emerging markets also, of China, India and Brazil, where industry growth has helped considerably. In fact, our sales in the second quarter were up by over 30% in these regions. The increase in vehicle part and population in these markets has also heightened the awareness of vehicle safety and we believe the demand for safety content, which presents an excellent opportunity for future growth.

The company’s breadth of safety has allowed us to differentiate ourselves and for that matter, our customers’ products in the marketplace. In addition, TRW has become synonymous with technology. Technology is the life blood of our future growth and that is why we commit over $1 billion a year, in each and every year, in capital and engineering resources.

We aggressively manage our global manufacturing footprint, moving operations to regions with more competitive cost structures and adding new capacity to meet the product needs in the emerging markets.

Finally, our actions are guided by the four straight priorities of best quality, global reach, innovative technology, and lowest costs. These priorities have become ingrained in our daily business activities and are used to guide the allocation of resources to support research and development, manufacturing investments, and growth initiatives.

With a clear strategy, we believe the progress that we have made during difficult times has helped the company stand out as a leading supplier in the industry.

Having said all that, the transformation of TRW is far from complete. We’re [not a standing] organization and we expect to continue to develop as we explore strategies that will strengthen our competitiveness and help to achieve our goal of growing the company profitable.

Turning now specifically to the financial results, we reported second quarter sales of $3.8 billion, an increase of 8.5% compared to the prior year. Similar to the previous quarter, foreign currency translation accounted for a large portion of the increase.

In North America, industry production volumes declined 2%. Within this result, the big three production was down 9%, which is a point below what we expected for the quarter.

In Europe, vehicle production increased 3% during the second quarter, mainly as a result of higher industry volumes in Eastern Europe. In Western Europe, where the majority of our content is derived, production was flat versus the prior year.

Absent currency, our sales increased 3.4% for the previous year, which is a really good outcome when considering the impacts of lower North American industry volumes, as well as pricing provided to customers. This underlying sales growth can be attributed to our relative strength in Europe, growth in the emerging markets, and our new business content.

Net earnings for the second quarter, after excluding debt retirement costs, were $1.02 per share, which compares favorably to $0.88 per share in the prior year. With respect to the first-half, we posted year-to-date earnings after excluding debt retirement expenses of $1.62 per share on sales of $7.3 billion.

In summary, with the first-half of 2007 behind us, we have established a good pace and we believe we are on track to achieve our full year objectives.

Turning now to recent business developments, beginning with a new business summary, we recorded another steady quarter of business wins with a number of the world’s leading vehicle manufacturers. The book of new business we have in place provides a measure of our confidence in our ability to grow revenue at 4% compounded annual growth rate, which we use as a proxy for our future sales growth.

Underpinning the success at winning new business is investment in technology, where we continue to increase engineering spend each year, such that we are able to introduce new products to ensure future growth and sustainability.

One product which we are particularly proud of is our electric park brake, which replaces the conventional cable pull mechanism with an electronic system. With the push of a button, the system engaged actuate in the rear calipers, thereby eliminating the need for levers and cables. We recently reached a milestone for this first-to-market product, where we have now shipped over 2 million units.

Another of our technologies is electrically powered steering, or EPS. In addition to providing greater functionality and performance, the energy consumption of EPS is just 10% of conventional hydraulic power steering, hence providing fuel consumption benefits and reduced CO2 emissions.

We recently unveiled our belt drive EPS system, which broadens the application of electric steering to C and D class vehicles. With the belt drive system, power assist is applied directly to the rack, allowing for low inertia and reduced friction, which provides a direct steering feel to the driver.

Our market leadership in this product is providing advantages as the market acceptance of EPS has been exceptional. We are beginning to achieve significant volume, primarily in Europe, and we are preparing to launch high volume programs in North America.

As with all of our budding technologies, we are more efficient when production levels increase, so the high volumes of electric steering systems allows us the opportunity to improve throughput and asset utilization rates, which are presently running below capacitized levels.

We also made progress in other areas of our business. In June, we signed an agreement in China with the National of Center of Supervision and Vehicle Inspections to co-invest in dynamic test capabilities, thereby supporting the development of safety restraints for domestic Chinese vehicle manufacturers.

This marks the first such collaborative agreement between a Chinese national inspection agency and a multi-national automotive supplier in China.

Also in China, TRW’s local management team conducted three successful technology exhibitions for our fastest growing customers in the region. Visitors were shown the complete array of active and passive safety systems and approximately 3,000 of our customers’ employees, representing senior management, engineers and purchasing managers, took part in these events.

Moving on, the performance of our automotive components group was not a material factor in the quarter as the actions implemented to date have helped us stabilize the operations and we expect, hopefully, that progress to continue. However, heavy lifting remains and the group must continue to execute on their plans.

The last couple of items related to our capital structure. In May, we refinanced $2.5 billion of our credit facilities, which was the final piece of our debt recapitalization plan. As I mentioned previously, this was a successful program and marks a significant milestone for the company and Joe will provide more details in his remarks.

In June, Blackstone sold 10 million shares through a secondary offering. As a result of this sale, which lowered their ownership position to less than 50%, we are no longer considered a controlled company. This changed the composition of our board and its committees to a majority of independent directors.

I would like now to turn to our assumptions and outlook for the remainder of 2007. We have lowered our vehicle production estimate for North America to approximately 15.1 million units and we are holding Europe at 21 million units. Our current expectations assume flat big three production volumes in the second-half when compared to the previous year.

With respect to commodity inflation, we are experiencing pressures at a higher level than we anticipated at the beginning of the year. The unpredictable nature of a weakened supply base in North America and sharp increases in pricing for commodities such as magnesium, nickel and zinc, are the primary reasons for the difference.

Despite the lower production estimates and heightened commodity inflation pressures, our full-year 2007 earnings guidance after excluding debt retirement costs is unchanged. We have raised the range of our sales guidance to $14.1 billion to $14.5 billion, reflecting our expectation of a stronger Euro in the second-half of the year. As in the past, we do not expect this higher level of sales to have a material benefit to earnings due to our net currency exposures.

Earnings per diluted share, excluding debt retirement costs, are expected to be in the range of $2.05 to $2.35. Our estimate for pretax restructuring expenses holds at $45 million for the year and we continue to expect capital spending at approximately 4% of sales.

Finally, the full year effective tax rate, excluding debt retirement costs, is expected to be in the range of 40% to 44%.

In closing, we are pleased with the results in the first-half of the year and the prospects look good for the second-half. We are optimistic about the future and we believe our long-term focus has served us well and has positioned TRW for success in an ultra-competitive global environment.

With that, I’ll now hand over the call to Joe to discuss our financial results in further detail.

Joseph S. Cantie

Thank you, John and good morning to everyone. Our second quarter results released this morning, excluding charges related to the refinancing of our debt, were solid and when looked at collectively with our first quarter results, provide a strong first-half outcome. While we are pleased with our performance in the second quarter and first-half, we expect challenges facing our industry, including commodity inflation, to continue over the coming quarters, primarily in North America. I’ll expand on our guidance for the remainder of 2007 in a few minutes, after I review our second quarter and first-half results, including some comments on our capital structure and cash flows.

For the second quarter, we reported sales of $3.8 billion, an increase of $293 million, or 8.5% when compared to the previous year. Currency translation benefited the year-to-year sales comparison by $174 million. The Euro, our most significant translation exposure, averaged 1.35 against the dollar, which was about 7% higher than the average exchange rate we experienced in the prior year.

While our sales increased from currency translation, the impact to operating income was not material after considering the net impact of both our translation and transaction exposures. If currency exchange rates hold as they are, we expect currency will have a similar impact on our third quarter results.

Excluding the effects of currency translation, sales improved by about $119 million compared to the previous year. Sales in the quarter benefited from increased customer production volumes, primarily in Europe and China, and from a higher penetration of safety products in all markets.

North America continued to present challenges where the big three volumes were down 9% between the two periods, which had a negative impact on our sales in the quarter.

The combination of lower sales in North America and the impact of pricing provided to customers presented a significant headwind for us at both the sales and operating profit lines. Operating income in the quarter was $205 million, which is $4 million above the previous year. Higher overseas customer production volumes and new product growth were a positive in the quarter. Other factors also contributed included gains relating to property sales and the favorable resolution of certain supplier matters.

Net cost performance was solid in the quarter and helped to offset cost pressures related to customer pricing, unfavorable product related settlements and as John mentioned, heightened commodity inflation.

Below operating income, net interest and securitization expense was $57 million, which is below last year’s level of $61 million, mainly due to the benefits derived from our debt restructuring efforts.

Moving down the income statement, we incurred debt retirement expenses of $8 million in the second quarter related primarily to the refinancing of our credit facilities.

Tax expense for the second quarter was $45 million, which compares to $53 million in the prior year. Excluding debt retirement expenses, our effective tax rate in 2007 was 30%, which compares to a 37% rate in 2006.

Very briefly, this quarter’s tax rate of 30% is not indicative of the rate we are forecasting for the full year, primarily due to the impact of the company’s geographic earnings profile in the current quarter. The lower rate in the quarter should be viewed as a timing difference with the remaining quarters.

At the bottom line, we posted GAAP net earnings of $0.94 per share. When excluding debt retirement expenses from the 2007 quarter, net earnings were $1.02 per share, which compares to $0.88 in the prior year.

Finally, in terms of EBITDA, we had $344 million for the quarter compared to $326 million last year.

Moving to a brief review of our first-half results, we reported sales of $7.3 billion, which is an increase of $464 million, or 6.8%, compared to the previous year. Currency translation accounted for $327 million of the increase. The remaining variance, $137 million, can be attributed to increased vehicle production in Europe and China and continued growth of our safety products, including above trend module sales.

Our operating income in the first-half was $380 million, which is down $48 million from the prior year. Looking at the variance between periods, the 2007 results were negatively impacted by lower North American vehicle production, pricing provided to customers, and commodity inflation. Additionally, we experienced a negative product mix, a majority of which occurred during the first quarter. If you’ll recall, our 2006 first quarter benefited from a high quality mix of products sold, which translated favorably at the operating line.

The non-reoccurrence of this mix in the 2007 period, together with other unfavorable first quarter items primarily related to a roof collapse at a plant in Brazil and lower profits in our automotive components group, contributed to the first-half decline in operating income.

Savings generated from cost improvement and efficiency programs, higher industry volumes in overseas markets, and new business growth helped to offset a significant portion of these pressures.

Below operating income, interest expense was consistent between the two years. We incurred debt retirement expenses of $155 million in the first-half of 2007 related to the refinancing of our bonds and credit facilities. The prior year had $57 million associated with the Lucas bond tender.

Tax expense for the first-half was $98 million, which compares to $116 million in 2006. The effective tax rate after excluding debt retirement expenses was 37%, which is unchanged from the previous year. Our first-half rate is below the expected full year rate, which is presently in the range of 40% to 44%.

Similar to the situation we experienced in the previous year, we expect to see a higher tax rate in the second-half of this year as compared to the first-half. At the bottom line, we reported GAAP net earnings of $0.11 per share, which compares to net earnings of $1.34 per share in the previous year. Net earnings excluding debt retirement expenses from both periods were $1.62 per share this year and $1.89 per share in 2006.

And finally, in terms of EBITDA, we had $653 million this year compared to $686 million in the prior year.

Moving now to our capital structure, we are very proud of the complete refinancing of our debt that was accomplished during the first-half. We completed the refinancing of our $1.3 billion of LBO related bond debt in the first quarter. We eliminated outstanding interest rates swap positions that materially moved our fixed variable position, which now stands at approximately 50% of total gross debt being fixed.

In the second quarter, we completed the refinancing of our $2.5 billion credit facilities.

In addition to interest savings from these transactions, we were able to achieve increased covenant flexibility, liquidity, and extended maturities. The company now stands with a debt structure that is highly flexible, efficient, low cost, and well-positioned to support our future growth.

Second quarter net cash provided by operations was $290 million, which compares to $233 million in the previous year. The 2007 result includes proceeds of $127 million related to outstanding borrowings that were in place under our receivables facility at the end of the quarter.

Cash flow from operations excluding these proceeds was $163 million. Our current year quarter had a higher level of working capital outflow compared to last year, which we expect to substantially recover by the end of the year.

CapEx in the second quarter totaled $109 million, which compares to $119 million in the prior year. At this point, we expected to have a cash outflow for our third quarter, which is not unusual for us. This results from seasonal factors, including the effect of summer shutdowns. As is always the case, our fourth quarter will have a strong positive cash flow.

At quarter end, our net debt outstanding, including borrowings under the receivables facility, was $2.885 billion, which represents a decrease of about $70 million compared to the balance at the end of the first quarter.

Switching subjects now to our guidance, our prospects for the second-half remain positive, although our expectations are tempered by the risk of production volumes and persistent commodity inflation pressures.

For the third quarter, sales should be approximately $3.4 billion, which is higher than the previous year, primarily due to currency. This sales level is based on industry production of about 3.6 million units in North America and 4.7 million units in Europe, including Eastern Europe.

In the third quarter, we will experience lower class 8 builds in our commercial steering business and an increase in module sales, which have lower margins due to a high level of pass-through content. As you would expect, both will continue to restrict operating margins during the remainder of the year.

We expect pretax restructuring charges of approximately $12 million in the third quarter. Per my earlier comments, our tax rate in the quarter will be significantly higher than the full year rate.

Overall, we are pleased with the outcome of our first-half, especially with what we’ve accomplished in the debt area. The industry challenges that our business has faced are still front and center, especially in North America. You can expect that we will again look to mitigate the challenges by focusing on our cost base while making the appropriate investments to ensure we grow our business and remain globally competitive in the future. I look forward to updating you on our progress after the third quarter results.

We’ll now move to the question-and-answer portion of the call.

Question-and-Answer Session


(Operator Instructions) Your first question comes from the line of Rod Lache with Deutsche Bank.

Rod Lache - Deutsche Bank

Good morning, everyone. A couple of questions. First of all, maybe you can just touch on your thoughts from a strategic perspective -- what should we read into this discussion of plans to acquire VDO? Obviously it didn’t happen but is there a strategic change occurring from your perspective? Is there a competitive threat now that a competitor has taken that business on?

John C. Plant

Let me deal with that one. It is probably a really good question for me to be able to reiterate our strategy and then secondly, I’ll talk specifically to the Siemens VDO facts.

First of all, regarding our strategy, you’ll recall me saying repeatedly that we have a full product line in terms of all the things we need to be I’ll say whole in terms of our safety focus and our safety products, and that’s true. I’ve repeatedly said that now that we had paid down a significant amount of our LBO debt, we had the opportunity to look at further geographic and customer diversification strategies beyond I’ll say our normal organic growth, and so far each and every year, we’ve been growing at or above our stated compound annual growth targets and we have done the one add-on acquisition, a bolt-on acquisition of Dalphimetal, which was in the late fall of 2005.

Our principal focus continues to be on bolt-ons and if such bolt-on acquisitions meet the above criteria, the above criteria being principally in the safety product space and aiming at both further geographic and customer diversification, and most importantly above all meeting our criteria to enhance shareholder value, then of course we’ll give them serious consideration.

That’s a bit about our strategy and that’s indeed what you can expect.

Rod Lache - Deutsche Bank

Can I just follow on to that?

John C. Plant

And the specifically, I’m going to now talk about Siemens. Siemens VDO clearly was not a bolt-on. It was interesting to us to look at and consider, especially when stated its interest in acquiring the property and naturally our interest is peaked to see what they saw in that.

We did the evaluation and it did some things but not actually that much forward geographic diversity because in fact, there was not a lot of difference between the geographic dispersion of the sales because as you know, indeed our sales are principally in Europe and with a good and growing content in Asia-Pacific -- in fact, probably a higher content in Asia-Pacific than we have.

But when we came to evaluate value, in fact that, from my view, was an impossible hurdle and indeed the values that were talked about in the press was not correct and indeed we never made any binding offers, not at those values, and the one thing I am very clear about but we did express interest and we did follow that interest up to see whether there was something that we were missing.

As you know, the result was that an extremely full price has been paid -- and I mean extremely full -- and that is something that we could not and would not contemplate. And as and when that entity comes together, it will certainly be large. But I don’t believe that being big for big’s sake is the objective. I’ve always talked about relevant scale and certainly the wider electronics portfolio had some attractions but when you look at it, the value hurdles were impossible and secondly there’s nothing about it which impairs TRW's focus today and also tomorrow in any sense.

The danger on such things is that with size, you become defocused and that is something that we thought about but as it is, we don’t really have to think about it any further. But for us, it was the value hurdle which is the thing uppermost in our minds, and secondly I can assure you that in no sense are we impaired in terms of anything that we want to do, we’ll do over the coming years.

Rod Lache - Deutsche Bank

Okay, so from a technology perspective, there’s nothing here that you see as a competitive threat now that this is going to a competitor?

John C. Plant

No. I mean, when you look at it, Siemens VDO have an excellent position in power train and it is probably one of the -- in fact, it is their fastest-growing segment, I believe. That does not cause any angst in terms of what it means to our safety strategy. Being significant in instrumentation or commercial vehicle [inaudible] again doesn’t cause us any angst regarding our safety focus.

We thought long and hard about this further scale in electronics matter but the critical success of TRW is about our control strategies, our algorithms and it really is that which is vital for us to be able to have, and all of those are secure within us today and therefore, there’s nothing which impedes our execution of our technology plans and our products in the future.

The technology roadmap that we have been operating to and have had and do have is as intact in August of 2007 as it was before, and we see no impediment to its execution in the future. So we expect to continue to be a ferocious competitor in the market and indeed, as you see this, we are growing quite nicely.

Rod Lache - Deutsche Bank

I guess we can follow up on this later but maybe Joe, would you mind just talking a little bit about the gross profit year over year? Gross profit is down, revenue is up, even excluding FX. Just give us, if you don’t mind, some of the components there. I believe there was a product settlement somewhere in these numbers. Was that in the cost of goods? Is that part of this year-over-year walk?

Joseph S. Cantie

If you just look at the -- if you are talking about the quarter alone, we were about just over 10% on gross profit last year and just over 9% this year, so there’s a 1% decrement between the two quarters. A lot of factors coming into play there. You mentioned the largest one, which is currency, where we translate our exposures back into U.S. dollars and we don’t really pick up anything on the operating profit line but we do have an increase on the sales. That was part of it.

Part of it is the fact that we are growing. We’ve had some growth in our module sales, which we’ve mentioned. To put that in context, our module sales our up quarter on quarter, about $60 million, $70 million and those tend to carry lower margins just because they have passed through. It’s a good business for us because there is very little capital involved, so it is like I said, good business for us.

In addition to that, there were a number of, as we always have every quarter, there’s a number of one-off items that affect our gross profit line. In this quarter, we had some supplier issues in there and a settlement of a product-related issue and those are in the gross profit line.

You’ll see lower -- down the income statement in the other income line, we had a number of income items, the biggest one in there is a gain on a property sale and if you think of the one-off items that are up in my gross profit line and you think of the one-off items that in my other income line, they tend to net each other out. And this is a situation we usually have in a $14 billion global company. There’s always one-off things going both ways and I can assure you and the others that it is not overstated one way or the other on one-off items. They tended to net each other out in the quarter.

Rod Lache - Deutsche Bank

Okay, but on an absolute basis, Joe, the number went from 358 to 340, right? So the higher module sales, although they affect the margin, they should still be profitable, right?

Joseph S. Cantie

Yes, that’s correct.

Rod Lache - Deutsche Bank

So that wouldn’t contribute to that. Is it basically --

Joseph S. Cantie

Yes, but when I was walking down, I started by walking through the margin compression from 10.3 to 9.1, so if you want me to do it by absolute dollars, I can do it that way for you as well.

When I look at the $18 million decline in profit at the gross profit line, there’s a host of things in there. Again, I’ll point to a $14 billion company and I have a page in front of me with over 100 items that are going both ways there, so it includes everything from you’ll have transaction losses on currency up in that line, whereas the hedging income is down in my other income line down below, so the two tend to net but they are in different lines.

We have supplier settlements, we have the one-off product settlement in there. There’s the mix of sales across all of our businesses that has a factor between that. So there’s no one or two reasons that explain that $18 million. It’s a host of items that are going both ways.

Rod Lache - Deutsche Bank

Do you have the raw material estimate?

Joseph S. Cantie

Raw material estimate -- I have an estimate on inflation on products that we buy. Raw materials, if you think of what we buy, if you think of the $7 billion we buy each year, Rod, the majority of that is bought from tier two, tier three suppliers. It is not raw materials per se. A smaller percentage is raw materials.

If I think of the raw material piece along, I don’t have that number off the top of my head but if I look at all of our purchases, our inflation affect between the quarters, roughly call it $20 million, $25 million.

Rod Lache - Deutsche Bank

Thank you.


Our next question comes from Ron Tadross with Banc of America Securities.

Ron Tadross - Banc of America

Thanks. Good morning, guys. Just one detail question and then just one strategic here. On the detail, working capital, excluding the securitization for a minute in the quarter, I think you said $127 million. Are you guys still targeting working capital to be neutral for the year?

Joseph S. Cantie

Generally speaking, when we think of our forward years, we generally target a neutral effect on working capital. Some years it might be over, some years it might be under and while we are growing our sales, we have efficiency programs, programs that look to offset a lot of the natural capital, working capital increase you would get when you think about a growing sales business.

This year we are probably going to have an outflow for working capital when I think of the full year. I don’t expect it to be significant but I do expect it to be an outflow. Part of that, Rod, is because if you look at our business, where we are having strength this year is in Europe and Asia and where we are having weakness is North America. When you think of the customer profiles and just the geographic differences, your days receivable tend to be longer in Europe and Asia than they do in North America, so if you think of the business mix going on, that puts pressure on to the working capital line.

But like I said, we do expect to have a positive flow in the fourth quarter and expect to catch a lot of what we’ve flown out for the six months back by the end of the year.

Ron Tadross - Banc of America

Joe, again I assume we are talking without the securitization now but even if your line is $50 million or so, or $50 million or $100 million for the year, you are still talking like you are going to have -- it sounds like a plus 400 or so in the fourth quarter. Is that seasonally directionally accurate?

Joseph S. Cantie

If I look at 2006, we had $397 million to $400 million of an inflow. If I look at 2005, we had over $500 million of an inflow. Now, I can’t guarantee that that’s going to happen this year but it is not unusual with the pace of our working capital flows by quarter.

John C. Plant

I think the critical thing is we’re still expecting a cash inflow for the year.

Ron Tadross - Banc of America

Okay, and then just one thing on a -- on a free cash flow basis you mean, John, right?

John C. Plant

Yes. Every year we aim and we have been and we intend to continue is generating free cash flow.

Ron Tadross - Banc of America

Okay, and then just on this VDO thing, what I find interesting is that their customers, their big customers, Daimler and I think Volkswagen have actually supported the transaction publicly and yet have commented, I know [Zetra] said that there’s a bit too much -- there might be too much concentration here. It might be a little harder to work with them.

What are the customers telling you? Is there a chance here that you could gain share just because maybe there is too much business at VDO?

John C. Plant

One of the customers, one of the let’s say German-based customers who is not in the press -- I mean, the one I read in the press was Mercedes. One of the other customers I understand was not necessarily supportive of the transaction as it was consummated.

I really don’t know and it is quite difficult to comment on how the customers feel about it today. We have a good and growing relationship with each of the I’ll say German-based customers and indeed, when we look at our even auto wins in the second quarter and we can point to a growing position with our same customer set that you’ve just mentioned.

I don’t -- I think it is too early to say what the outcome is three to five years from now but as of today, then we see ourselves growing with our customer set and we have been growing as we’ve established our reputation over recent years for both technology and indeed excellent support and quality and delivery. Hopefully it will continue to be a positive for us.

Ron Tadross - Banc of America

Okay, thank you very much.


Our next question comes from Himanshu Patel with JP Morgan.

Himanshu Patel - JP Morgan

Good morning, guys. A few questions; Joe, what is a maximum level of leverage you would be comfortable with? Obviously we don’t know exactly how you guys would have financed VDO and what the split would have been with Blackstone, but it clearly would have really taken the leverage levels to fairly high levels. Do you have sort of a [target] you could give us that you would be comfortable with if the deal was right and the asset was strategically valuable to you guys?

Joseph S. Cantie

I won’t speak to the specifics of VDO because that has come and gone but it is a difficult one to answer because it is all about what you are acquiring and the cash flow of what you are acquiring.

So to that point, if we are acquiring a business that has extremely strong cash flow and you can see yourself to deleveraging very quickly as a result of that, we like anybody would consider leveraging the company a little bit higher than what I would call would be a normal for an automotive company in our space. So it is difficult to say here’s a target and we would never go below or above that because it all depends on the situation and really the cash flow and synergy level of whatever target that we are looking at.

To that end, I look at us right now, we are somewhere in the 2.5 net debt to EBITDA, which is very good, obviously. When we did the LBO back in 2003, we were closer to four. We know how to operate in that zone but it really depends on what we are acquiring and the cash flow prospects of it.

Himanshu Patel - JP Morgan

Would you consider going above 4?

John C. Plant

I’d like to come in on that one. I have no plan to go back to an LBO leverage type situation.

Himanshu Patel - JP Morgan

Okay, and then maybe a question for either Joe or John; you described VDO as clearly not a bolt-on. Are there any other assets out there that would fall into that similar category of being not a bolt-on that you guys would consider a combination with?

John C. Plant

I suspect that Siemens VDO was probably unique in that sense, in that it was large, it was of interest and certainly saw one of our competitors was very interested in it to the point of paying the -- I mean, I think the figure I’ve read is something like 115%, 120% of sales, which is quite high for an automotive parts supplier and that’s something which I certainly don’t see.

Neither do I see anything like that out there. I mean, [they always come to me and say] well, have you thought about this one but the answer is I don’t see anything.

I’ll go back to our principal focus in on bolt-ons. It has been. It is and I certainly think it is absolutely right of the company to consider the Siemens VDO opportunity and decide whether it was an opportunity for us or maybe, like most [inaudible], it could also be a threat, and the threat is on these things is when you get carried away and want to buy something at an inappropriate value when it doesn’t meet your fundamental criteria. And if it doesn’t really improve your geographic or customer diversification, if it doesn’t give you something that is a fundamental flaw in your business and we don’t have one, then you have to say the value question is paramount and the value question was paramount and there was no case for us ever paying anything like the suggested number that was in the press. There was no case for us paying anything like the suggested number which the transaction was completed at, or will be completed at the -- again, numbers in the press.

I mean, value reigns supreme and that is something which is just not in our purview.

Himanshu Patel - JP Morgan

I guess to ask differently -- I mean, I understand that it didn’t make sense for you guys from a valuation perspective but the strategic implications are kind of hard to ignore. Conti is a fairly well-run company that had several acquisitions, none this big but they’ve done a decent job of integrating most of them.

At a minimum, even if you don’t view it as a huge impact to you guys, do you think some of your competitors, either in North America or in Europe, now see a greater reason to accelerate consolidation in the industry because you’ve created -- I mean, there’s this 800-pound gorilla in Europe now with a very strong electronics capability that is basically 2X its original size now.

John C. Plant

When I think about our product specifics, I think about our participated products, of our seatbelts and our airbags and I don’t see the combined entity competing with us. I mean, I see Autoliv continuing to compete with us but I don’t see let’s say a reformatted Continental. I don’t see that they compete with us on steering. They didn’t acquire any steering assets, nor did they have any. The Tavis entity of Conti on the brake side, I think that they will continue to compete with us in exactly the same way as they have before. There again, for the major part of the products, whether it is let’s call it brake calipers or boosters or even the ESP systems, it is hard to see anything that is going to change in that respect, and neither on our suspension products, the carry on or [inaudible] steering wheel.

I just think the fundamental aspects of our company, I don’t think the -- if I said TRW today is $14 billion and tomorrow is $24 billion but added on let’s say -- I don’t know. I’ll make it up now, I acquired somebody else’s engine management business or I bought an engine management business from say another North American supplier, one which is today let’s say in bankruptcy, I don’t see as that actually makes any difference to the competitiveness of any of the products I’ve mentioned in the previous few statements.

I think you have clarity on what’s relevant scale and I don’t believe it makes any difference. I mean, you can have -- one of the largest automotive parts companies that has been around was Delphi, it still is around, but I mean the fact that it was larger didn’t necessarily mean it was more fundamentally capable, so I don’t think anything’s changed in that respect.

Himanshu Patel - JP Morgan

Okay, and then two questions for Joe; the $25 million year-on-year swing in other income, could you give us a little bit more granularity on how that is divvied up between the gain on asset sale, the supplier settlement, and any FX hedging issues?

Joseph S. Cantie

When I look at the $25 million swing, property sales was $12 million of it, currency swing was about $4 million of it, and then bad debt reserve movements was about $3 million of it, and then after that you are getting into all little bits and pieces.

And again, I just want to stress that you have to be careful because I am sure you are sitting there saying okay, property sale, one-time item. We have just as many one-time items that are up above in different lines and I will make the assertion that overall, when I look at my items that are non-recurring throughout my income statement, they tend to generally net off in the quarter.

Himanshu Patel - JP Morgan

Okay, and then full year tax rate guidance, still unchanged?

Joseph S. Cantie

We were at 40% to 44%. As you know, that’s a tough one to nail right to an exact amount but it is going to be -- we are pretty comfortable with 40% to 44%.

Himanshu Patel - JP Morgan

Thank you, guys.


Our next question comes from Chris Ceraso with Credit Suisse.

Chris Ceraso - Credit Suisse

Thanks. Good morning. I guess just a couple of quick ones left. You talked a little bit about the gross margin walk and what was an impact there. One thing that you didn’t touch on and maybe it wasn’t as much of an issue in Q2 as you might have thought, you did mention it as something to look out for in Q3 but the heavy truck steering business, was that a revenue hit in the quarter and how much of a profit hit then as a result?

John C. Plant

Commercial steering was a factor in the second quarter, Chris, for sure. There was a dramatic reduction around about the March time. Revenues year-on-year were down just over $40 million in Q2 for that segment, so we took a quite significant hit for that segment.

Joseph S. Cantie

We don’t give the specific margin levels on our products but that is one of our better earners when things are turning well.

Chris Ceraso - Credit Suisse

Okay, so you would have felt that for sure on the operating line.

John C. Plant

Basically, if you think about it, I mean, everybody knows the -- as you know, first of all, class 8 is not the biggest of business for ourselves but it is still a healthy business. And in the first-half of the year, particularly in the second quarter, [it was a significant hit] for that business, which takes its time to work out during the balance of this year. You are more than familiar with the change of emissions -- you’ve covered much bigger people who are exposed to the class 8 truck market than we are. I mean basically, it is expected that that comes back I think in 2008. Whether it comes back all the way, who knows but again it is not material for us but I mean, not that we expect anything like the hit in the first quarter of 2008 compared to the hit we’ve taken in the second quarter for our commercial steering business.

Chris Ceraso - Credit Suisse

On the raw materials, is the outlook worse than it was a quarter ago? Your comments sound like the second-half now, maybe things are a little bit worse on raw materials, or is this just your general caution on that subject?

John C. Plant

It’s more general caution. I mean, we have seen big increases. I think I mentioned nickel and magnesium and these sorts of things. Those have been significant items for us.

We always tend to be, if you go back over each one of our quarterly statements in recent times, we’ve always been rather cautious on the material commodity inflation front. I guess to a large extent, it’s probably been more right than wrong. We remain with a cautious stance towards it and when we see things like oil going up and at the moment, we’re not seeing huge capacities brought on, maybe normally with commodities there is a reversal in the commodity prices. But we are not predicting that -- certainly not predicting that in the second-half of 2007.

Chris Ceraso - Credit Suisse

But I guess if I think about a few of your comments, the outlook for volume, the comments about material costs, the fact that you maybe did a little bit better than you might have thought here in Q2, yet the full year guidance is the same. Is it fair to conclude that your view for TRW's second-half profitability now is maybe a little bit softer than it was say a quarter ago?

John C. Plant

I don’t think we’re at the point of saying our second-half is softer than we thought before. We’re just highlighting the risks that are out there, risks which may or may not materialize at this point. We’ve noted the weaker sales in North America, which is as you know, North America is only a small portion of our sales but we note that weakness. We were quite pleased actually with our sales in North America in the second quarter. I mean, it was stronger than the first quarter, and compared to the underlying vehicle volume was actually very good, particularly when you add the class 8 market.

So far, we believe our content growth is growing well but at the moment, we are just saying the correct stance for us as we think about things is that we should be cautious until we really see the North American sales volumes, and in particular the big three sales volumes over the next two or three months and we are taking a relatively cautious stance towards commodity inflation, and we’ll see how those things pan out. But at the moment, we are not really calling for anything particularly bad in the second-half at all. It is just a matter of -- I mean, I think the words reflect probably our natural caution and we’ll see how things turn out.

Chris Ceraso - Credit Suisse

Okay, fair enough. Thank you very much.


Our final question comes from the line of Jonathan Steinmetz with Morgan Stanley.

Jonathan Steinmetz - Morgan Stanley

Thanks. Good morning, everyone. Just a couple of housekeeping questions and then one more strategic. Joe, do you have a number on the favorable supplier settlement line item that you called out in the press release?

Joseph S. Cantie

I think it was around $9 million.

Jonathan Steinmetz - Morgan Stanley

Okay, and then that seemed like it was offset, or you had a negative on the unfavorable product related. First of all, is that warranty? And then secondly, is there a dollar amount on that one as well?

Joseph S. Cantie

Yes, it was in total between the warranty, that settlement, it was in excess of $10 million.

Jonathan Steinmetz - Morgan Stanley

Okay, so those sort of cancel each other out.

Joseph S. Cantie

Yes, and again I’ll come back to my broader statement that if I look at all my one-off items going both ways, they for the quarter have tended to net themselves out. If we ever do have a quarter where it is materially not the case, we will disclose it.

Jonathan Steinmetz - Morgan Stanley

Okay, and John, you talked about more geographic diversification. You also talked about technology from a bolt-on perspective. Which is paramount in your mind and does geographic diversification mean getting more exposure to Asian OEMs, whether it’s in Asia or in the U.S.?

John C. Plant

I use the word geographic as a proxy for further customer diversity. If you think about coming from our roots as an American supplier, then as an American company, we have vastly diversified ourselves into the European marketplace, such that Europe is now a bigger portion of our sales than the U.S. is. And that follows vehicle volume, as vehicle volumes in Europe are 21 million compared to this year’s 15.1 million we are calling out for North America.

While we are growing rapidly in Asia, I mean I did actually for the first time call out our rest of the world increase in the quarter, which as I said was over 30%, which is therefore very healthy and reflects the addition investments we have been making in that.

If you look at Asia as a total, then clearly we are still under-represented to the quantities of vehicle volumes that are made. Having said that, compared to the whole of Asia, our rate of growth is and has been substantially above the rate of growth in Asian vehicle volumes and we hope that continues.

So it isn’t a -- I mean, geography really is the word I use for further customer diversification and we see ourselves growing with the upward Asian based vehicle manufacturers, whether they are the domestic Chinese, the Japanese, the Korean or the Indian based vehicle manufacturers. We are clear that we need to do that. We have invested to that. We are achieving a rapid rate of increase and so that -- I mean, I think it really is more diversity of customer to achieve a greater balance than we have today, albeit in truth we are possibly already one of the most balanced, if not the most balanced vehicle parts companies or suppliers in the world. But having said that, I would certainly like to see that even greater balance than we have today and if that means further increase in our Asian segment, that would be great.

Jonathan Steinmetz - Morgan Stanley

Thank you.

Patrick R. Stobb

All right, that concludes today’s call. Thank you for joining. If you have any follow-up questions, please feel free to call me this afternoon. Thank you and Mandy, can you conclude the call?


Yes, sir. This does conclude today’s conference call. We appreciate your participation. You may disconnect at this time.

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