The following discussion should be read in conjunction with our Unaudited Consolidated Financial Statements and accompanying Notes thereto included elsewhere herein and with our 2004 Annual Report on Form 10-K filed with the SEC on March 10, 2005. Unless otherwise noted, all dollar amounts are in millions.
Autoliv is one of the world's leading suppliers of automotive occupant safety restraint systems with a broad range of product offerings including modules and components for passenger and driver-side airbags, side-impact airbag protection systems, seat belts, steering wheels, safety seat components and other safety systems and products. Autoliv has production facilities in 30 countries and has as customers almost all of the world's largest car manufacturers.
Autoliv is a Delaware holding corporation with principal executive offices in Stockholm, Sweden, which owns two principal subsidiaries, Autoliv AB ("AAB") and Autoliv ASP, Inc.("ASP"). AAB, a Swedish corporation, is a leading developer, manufacturer and supplier to the automotive industry of car occupant restraint systems. Starting with seat belts in 1956, AAB expanded its product lines to include seat belt pretensioners (1989), frontal airbags (1991), side-impact airbags (1994), steering wheels (1995) and seat sub-systems (1996). ASP, an Indiana Corporation, pioneered airbag technology in 1968 and has since grown into one of the world's leading producers of airbag modules and inflators. It designs, develops and manufactures airbag inflators, modules and airbag cushions, seat belts and steering wheels. ASP sells inflators and modules for use in driver, passenger, side-impact and knee bolster airbag systems for worldwide automotive markets.
Shares of Autoliv common stock are traded on the New York Stock Exchange under the symbol "ALV" and Swedish Depositary Receipts representing shares of Autoliv common stock trade on the OM Stockholm Stock Exchange under the symbol "ALIV.sdr". Options in Autoliv shares are listed on the Chicago Board Options Exchange under the symbol "ALIV".
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2005 COMPARED WITH THREE MONTHS ENDED SEPTEMBER 30, 2004
Market overview
During the third quarter, light vehicle production in the Triad (i.e. Europe, North America and Japan) is estimated to have declined by less than half a percent compared to the same quarter 2004.
InEurope, (including Eastern Europe), where Autoliv generates more than half of its revenues, light vehicle production declined by 4% due to a 6% drop in Western Europe which was partially offset by an increase in Eastern Europe. This production mix was negative for Autoliv and the automotive safety industry, since East European cars generally have less safety content per vehicle than West European vehicles.
InNorth America, which accounts for a quarter of Autoliv's consolidated revenues, light vehicle production increased by nearly 3%, which was almost 2% better than expected. This was due to the fact that the "The Big 3" (i.e. GM, Ford and Chrysler) reduced their production only marginally and not by 3% as expected. The Asian and European vehicle manufacturers increased their production in North America by 10%. Since Autoliv has a higher sales value per vehicle with the Asian and European manufacturers than with an average Big-3 vehicle, the North American vehicle build mix was positive for Autoliv.
InJapan, which accounts for nearly one tenth of Autoliv's consolidated sales, light vehicle production increased by 2%.
The automotive safety market is also driven by new regulations and crash test programs that increase the demand for airbags and other safety products. For instance, the U.S. Congress is expected to consider the adoption of new side-impact regulations next year and in August 2005, a new Act was signed into law that mandates certain improvements for occupant safety (see Other Significant Events).
Consolidated Sales
During the third quarter, Autoliv's consolidated net sales rose slightly to $1,392 million compared to the third quarter 2004. Currency effects did not have any impact on consolidated sales.
Despite the 6% drop in West European light vehicle production, organic sales (i.e. sales excluding currency translation effect and acquisitions/divestitures) were maintained by the introduction of curtain airbags and other side airbags into an increasing number of new vehicle models and by continued market share gains in steering wheels. Sales were also driven by the favorable customer mix in North America and by a higher market share in Japan for safety electronics. However, these favorable trends were offset by the drop in West European light vehicle production, continued pricing pressure from customers and the phase-out of low-margin non-competitive inflators for airbags. Sales in the Rest of the World (RoW) (i.e. Asia and other markets outside the Triad) continued to grow but at a slower rate than expected partly due to labor-union strikes at almost all of our customers in South Korea.
Sales by Region
Sales from Autoliv'sEuropean companies declined by 7% to $719 million. Excluding a negative currency effect of 1%, organic sales decreased by 6% or at the same rate as the West European light vehicle production. The decline was most pronounced in frontal airbags and seatbelts, while other product lines managed to withstand most of the decline in vehicle production. Sales to Citroën's new C4; Opel's Corsa, Meriva and Zafira; and Skoda's Octavia continued to grow despite the strong decline in West European vehicle production. The success of Porsche's Cayman also contributed to offset the effect of the decline.
Sales from Autoliv'sNorth American companies rose by 12% to $421 million, which was nine percentage points better than the region's light vehicle production. This strong performance was not only due to Autoliv's favorable customer mix but also due to the sales of curtain airbags which doubled, while sales of side airbags for chest protection rose by 42% and sales of steering wheels surged by 59%. In addition, Autoliv increased its market shares in both seatbelts and electronics. Autoliv's sales increase was driven primarily by Honda's Civic, Odyssey, Ridgeline and Pilot; Hyundai's Sontana; Toyota's Sienna and Avalon; Nissan's Pathfinder; Chrysler's Jeep Commander; Volkswagen's Bora/Jetta; and Buick's LaCrosse. Sales continued to be adversely affected by the expiration of certain frontal airbag contracts and the continued phase-out of low-margin non-competitive inflators for airbag systems.
Sales from Autoliv's companies inJapan rose by 1% to $123 million. Excluding a 1% negative currency effect, the organic sales growth was 2%, in line with the light vehicle production in Japan. The organic growth was mainly driven by a 24% increase in the sales of steering wheels. Sales were particularly strong to Nissan's Serena, Tiida and LaFesta; Honda's CRV; Toyota's Vitz; and the Mazda 3.
Sales from Autoliv companies in theRest of the World (RoW) increased by 18% to $129 million. Excluding currency effects of 9% and 7% from the consolidation of the Chinese joint venture, sales grew by 1%. The slow down in the organic growth rate from the previous quarter is partly due to the labor-union strikes in Korea. Sales grew organically in all product areas, except for airbag components.
Sales by Product
Both reported and organic sales ofairbag products (including electronics and steering wheels) rose by 1% to $917 million, marginally better than the light vehicle production in the Triad. Organic sales of airbags were driven by side curtain airbags (up 23%), steering wheels (up 16%) and side airbags for chest protection (up 8%). Sales of knee airbags continued to grow, although from a low level. However, sales of frontal airbags declined, partly reflecting the drop in West European light vehicle production. Sales were also negatively affected by the phase-out of certain low-margin non-competitive contracts for airbag inflators.
Sales ofseatbelt products (including seat sub-systems) rose by 1% to $475 million due to the consolidation of a joint venture in China. Excluding this effect and a small currency effect, sales declined organically by 1% due to the drop in West European light vehicle production.
Earnings for the Three-Month Period Ended September 30, 2005
Gross profit rose by 7% or $18 million to $281 million and gross margin improved from 19.1% to 20.2%, the best third-quarter margin in six years. The improvements were achieved despite almost flat sales and additional costs of $23 million for higher raw material prices. The improvements were primarily driven by previous years plant closures, moves to low-cost countries and the phase-out of low-margin non-competitive products in parallel with strong sales growth for curtain airbags and other new products. The improvements were also due to a change in how customer-funded R,D&E is reimbursed. The increase in R,D&E expense mainly reflects a lower income from customer-funded engineering services as a consequence of many vehicle manufacturers wanting to pay for engineering work over the life of a vehicle model instead of as a lump sum at the end of the engineering project.
Additionally, improvements were a result of the reclassification of certain production overhead costs to R,D&E expense, which boosted gross margin by approximately .3 percentage points. These positive effects were partially offset by a 1.7 percentage point negative impact of higher raw material prices.
Operating income amounted to $104 million, the same amount as reported in the third quarter 2004. The income improved as a result of higher gross margin, but was negatively impacted by $9 million of higher R,D&E expense, $6 million of higher S,G&A expense and $5 million of higher costs for restructuring activities. The higher S,G&A expenses were primarily the result of establishing and strengthening administrative structures within low-cost countries; whereas higher R,D&E costs reflect lower engineering income in addition to the above-mentioned reclassification. The operating margin stood unchanged at 7.5% despite the higher restructuring costs, which reduced operating margin by .4 percentage points. Excluding these effects, operating margin rose to 7.9%.
Income before taxes amounted to $95 million compared to $97 million for the same quarter 2004. The decline was caused mainly by higher average net debt due to the accelerated share repurchase program; additionally, interest rates were higher than in 2004.
Net income declined to $59 million from $67 million in the third quarter 2004. The effective tax rate increased to 35.4% from 29.7% in the same quarter 2004 when the tax rate was exceptionally low due to a year-to-date catch-up effect. This year, the tax rate was affected by a similar negative year-to-date catch-up effect. The year-over-year impact of these catch-ups was approximately $3 million higher tax expense.
Earnings per share declined by 6 cents to 66 cents. The total change in the tax rate had a negative impact on earnings per share of 6 cents and the stock repurchase program had a favorable impact of 3 cents. (The average number of shares outstanding decreased by 5% to 89.3 million).
Due to higher restructuring costs, return on capital employed declined to 13.0% from 13.5%. Return on equity declined to 9.6% from 11.0% which was due to a higher tax rate and higher restructuring costs.
NINE MONTHS ENDED SEPTEMBER 30, 2005 COMPARED WITH NINE MONTHS ENDED SEPTEMBER 30, 2004
Market overview
During the nine-month period January through September 2005, light vehicle production in the Triad was flat compared to the same period 2004.
In Europe, light vehicle production decreased by just over 1% due to weak West European production.
In North America, light vehicle production decreased by nearly 1%. However, Asian and European vehicle manufacturers increased their North American production by 10%, while GM, Ford and Chrysler reduced their production by 5%. This customer and vehicle model mix was favorable for Autoliv due to the Company's strong market position with the Asian and European vehicle manufacturers.
In Japan, light vehicle production increased by nearly 4% in the nine-month period.
Consolidated Sales
For the year's first nine months, sales rose by 7% to $4,740 million. Currency translation effects and more reporting days contributed 2% each to consolidated sales, while acquisitions added 1%. Autoliv's organic growth of 2% was approximately two percentage points better than the vehicle production in the Triad. This performance reflects the impact of continued introduction of curtain airbags and other side airbags, and market share gains in steering wheels and seatbelts.
Sales of airbag products (including electronics and steering wheels) increased by 7% to $3,119 million including 4% from currency effects and more reporting days. The organic growth of 3% was achieved despite the fact that a number of low-margin contracts for airbag inflators were phased out and old frontal airbag contracts expired.
Sales of seatbelt products (including seat sub-systems) rose by 6% to $1,621 million due to currency effects, more reporting days and the consolidation in China. Organic growth as a result of new business in Asia and market share gains in North America was offset by the impact of the reduction in West European vehicle production.
Sales from Autoliv's European companies rose by 4% to $2,637 million due to currency effects and more reporting days. Excluding these effects, organic sales declined at the same rate as European light vehicle production or by 1% since the beginning of the year. The effect of the weak light vehicle production and a decline in frontal airbag sales were partly offset by continued market penetration of side curtain airbags, and market share gains in steering wheels.
Sales from Autoliv's North American companies increased by 6% to $1,295 million. Excluding the effect of more reporting days, organic sales rose by 4% compared to the 1% decline in the region's light vehicle production. The strong performance reflects increasing demand for curtain airbags and other side airbags, in addition to a favorable customer mix.
Sales from Autoliv companies in Japan by 12% to $401 million including 3% from currency effects and more reporting days. Organic sales growth of 9% was driven mainly by side airbags and higher market shares in steering wheels.
Sales from Autoliv companies in the Rest of the World jumped 28% to $407 million. Excluding currency effects of 8%, more reporting days of 2% and acquisitions of 7%, organic sales increased by 11%.
Earnings for the Nine-Month Period Ended September 30, 2005
Gross profit increased by 9% to $968 million and the gross margin rose to 20.4% from 19.9%. Currency effects and more reporting days boosted gross profit by 2% each. The improvements were also due to a change in how customer-funded R,D&E is reimbursed. Additionally, improvements were a result of the reclassification of certain production overhead costs to R,D&E expense.
Despite $25 million in charges related to plant closure costs, operating income rose by 3% or $10 million to $377 million. The reported operating margin decreased to 8.0% from 8.2% partially due to higher raw material prices. Additionally, the restructuring charges of $25 million had a negative impact on operating margin of .5 percentage points.
Net income before taxes improved by 1% to $351 million.
Due to a higher tax rate net income declined to $223 million from $233 million. The effective tax rate increased to 34.1% from 31.0%. In 2005, tax is being provided on the income of several former loss-generating companies. Most of any remaining benefit coming from the use of the losses generated in previous years was recognized in 2004. During the third quarter, Autoliv AB paid a $337 million dividend to Autoliv, Inc. under the U.S. Jobs Creation Act, which resulted in a one-time additional book expense of approximately $3 million. This one-time cost was fully offset by favorable adjustments to prior year estimates of tax costs and to adjustments to reserves for tax exposures (see Other Significant Events).
Earnings per share amounted to $2.45 versus $2.46 for the same period 2004. Earnings per share was favorably impacted by 11 cents from currency exchange effects and by 7 cents from the stock repurchase program. The higher tax rate reduced earnings per share by 12 cents.
Return on equity declined to 11.7% from 12.8% due to the higher effective tax rate and restructuring costs. Return on capital employed stood almost unchanged at 15.7%.
LIQUIDITY AND SOURCES OF CAPITAL
Operations generated a positive cash flow for the 16th quarter in a row. Cash flow amounted to $124 million before investing activities and to $59 million after these activities despite a $21 million increase in working capital caused by higher inventories, strong sales in September and lower payables due to the timing of supplier payments. The higher inventories are a reflection of ongoing restructuring activities and the labor strikes in South Korea. In the corresponding quarter 2004, cash flow amounted to $127 million before investing activities and to $68 million after these activities. Operations for the nine-month period generated $324 million in cash before investing activities and $94 million after these activities despite a $169 million increase in working capital since the beginning of the year, primarily due to tax effects and lower payables. In addition, working capital was exceptionally low at the beginning of the year.
Quarterly capital expenditures, net, increased by $3 million to $66 million but were $7 million lower than depreciation and amortization of $73 million. Capital expenditures for the nine months period, net amounted to $232 million compared to $235 million in depreciation and amortization and to capital expenditures of $222 million for the same period 2004.
At 9.1%, the Company continues to meet its target that working capital should not exceed 10% of sales.
In relation to sales days, both receivables and inventories increased seasonally during the quarter. The receivables rose to 86 days of sales from 79 days at the end of June and from 82 days a year ago. Days inventory rose to 36 from 29 at the beginning of the quarter and from 32 at the end of the third quarter 2004.
Due to $159 million of stock repurchases and dividends paid during the third quarter, net debt increased by $77 million to $814 million at the end of the quarter and gross interest-bearing debt by $77 million to $1,020 million. Net debt to capitalization increased to 25% during the quarter from 22%. Since the beginning of the year, net debt has increased by $215 million due to stock buy-backs and dividend payments totaling $310 million. In relation to capitalization, net debt increased to 25% from 18%. Gross interest-bearing debt rose by $39 million to $1,020 million.
The Company's policy is to maintain a leverage ratio significantly less than three times and an interest-coverage ratio significantly above 2.75 times. (Leverage ratio is measured as net interest-bearing debt in relation to EBITDA; Earnings Before Interest, Taxes, Depreciation and Amortization, while Interest-coverage ratio is measured as Operating profit in relation to net interest expense). At the end of the quarter, these ratios were 1.1 and 13.5, respectively. At the end of 2004, these ratios were 0.8 and 14.8, respectively.
Equity decreased $87 million during the quarter to $2,429 million or to $27.93 per share. Equity was negatively affected by share repurchases of $133 million and dividend payments of $27 million, while equity was favorably impacted by $59 million from net income, currency effects of $13 million and by $1 million from stock options exercised during the quarter. Since the beginning of the year, equity has decreased by $207 million due to currency effects of $128 million, repurchase of shares for $233 million and quarterly dividend payments of $77 million. The equity was positively impacted by $223 million from net income, by $4 million from changes in the market value of cash-flow hedges and by $4 million from proceeds from the exercise of stock options for the nine months period.
HEADCOUNT
Total headcount (employees plus temporary hourly workers) increased by less than 100 during the quarter to 39,700 and decreased by 100 since the end of last year. In high-cost countries headcount decreased by 600 during the quarter and by 1,300 during the nine-month period. Currently, 39% of headcount and 42% of employees are in low-cost countries.
PROSPECTS
The 5% favorable impact in the first quarter from a change in the number of reporting days will be offset, as previously announced, by a similar negative effect in the fourth quarter. Currency effects are expected to have a 4% negative effect, provided that current exchange rates prevail.
During the fourth quarter, light vehicle production in the Triad is expected to increase by 2%. In Europe the increase is expected to be 1%, despite a fall of 3% in Western Europe, where Autoliv generates more than 50% of its revenues. In North America and Japan light vehicle production is expected to increase by 2% and 4%, respectively. Based on these assumptions and excluding the difference in reporting days, daily organic sales are expected to remain flat, although reported sales are expected to decline by 9%.
Even though steel prices have fallen somewhat, raw material prices are still expected to have a negative impact. Despite this effect of approximately 1%, operating margin in the fourth quarter is expected to approach the margin of 8.6% recorded in the same quarter 2004.
Management believes that it is reasonably possible that it will be able to release certain tax reserves by the end of the year, resulting in a slightly lower effective tax rate for the full year than during the first nine months.
In the quarter, the Company will contribute $20 million to its U.S. Defined Benefit Plan, which will negatively affect operating cash flow.
OTHER RECENT EVENTS
Launches during Q3 2005
- Buick's new Lucerne; Side airbags
- Chrysler's PT Cruiser; Driver airbags, passenger airbags, Inflatable Curtains and seatbelts with pretensioners
- Fiat's new Punto: Seatbelts with pretensioners
- Ford's Explorer; Safety electronics
- Ford's new Fusion; Safety electronics
- Ford's Lincoln Zephyr; Safety electronics
- Ford's Mercury Mountaineer and Milan; Safety electronics
- Hyundai's new Accent; Seatbelts with pretensioners
- Honda's Pilot; Inflatable Curtains
- Honda's Civic; Driver airbag and steering wheel
- Pontiac's new Torrent; Seatbelts
- Porsche's new Cayman; Driver airbags, passenger airbags, side airbags, seatbelts with pretensioners, steering wheel and safety electronics
- Toyota's new Ractis; Seatbelts
- VW's new Jetta; Passenger airbags, Inflatable Curtains and seatbelts with pretensioners
Other Significant Events- Since October 1, 2004, Autoliv consolidates a joint venture in Nanjing, China. Autoliv's interest in the company, which had nearly $30 million in sales in 2004, remains at 50%, but following a change in the ownership agreement Autoliv has received a controlling interest in the company.
- Autoliv has accelerated the share buy-backs and repurchased nearly 3 million shares in the third quarter for $133 million at an average cost of $44.76 per share.
Since the repurchasing program was adopted in 2000, 16.7 million shares have been repurchased at an average cost of $33.13 per share. Under the existing authorizations, an additional 3.3 million shares can be repurchased. - Standard & Poor's has raised its long-term credit rating on Autoliv Inc. to "A- with a stable outlook" from BBB+. At the same time, the A2 short-term rating and the K-1 Nordic scale rating were affirmed.
- In accordance with the Jobs Creation Act, a one-time internal dividend of $337 million has been paid from Autoliv AB in Sweden to its U.S. parent company, Autoliv Inc. Given current exchange rates and the interest rates in Sweden and the U.S., the payment is expected to reduce interest and tax expenses by a total of $6 million annually.
- A cooperation agreement has been signed with Magneti Marelli, a wholly owned subsidiary of Fiat. The agreement mainly includes collaboration in airbag electronics and automatic emergency systems.
- At the Frankfurt Auto Show, BMW presented Autoliv's new Night Vision System in their 7-series, while Volvo showed Autoliv's new curtain airbags for convertible vehicles in their new C-70 model.
- In Romania two new plants have been opened; one weaving facility that will increase our capacity for seatbelt webbing by 20% in Europe and another plant that will double our seatbelt assembly capacity in Romania.
- Currently, there are four major restructuring activities ongoing in Autoliv. The UK airbag assembly plant will be closed and operations moved primarily to Turkey. Production in Australia will be restructured and most of it moved to China. One initiator plant in France will be closed. Parts of the European inflator production will be moved to a new plant under construction in Romania.
- The U.S. SAFETEA Act that recently was signed into law mandates several changes that could increase the demand for safety systems in vehicles. For instance, the Act directs the Department of Transportation to issue regulations about including safety ratings from its New Car Assessment Program (NCAP) in the labeling of new vehicles.
DIVIDEND AND NEXT REPORT
The quarterly dividend will be raised by 7% to 32 cents per share and paid on December 8 to shareholders of record as of November 10, 2005. The ex-date is November 8, 2005. The dividend per share has been raised by almost 200% in five steps since 2002.
The next report will be published on February 9, 2006.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
As of September 30, 2005, our future contractual obligations have not changed significantly from the amounts reported within our 2004 Annual Report on Form 10-K filed with the SEC on March 10, 2005.
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