Annual Report

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549-1004

 

 

Form 10-K

 

 

 

12001 Tech Center Drive
Livonia, Michigan 48150
(734) 855-2600
(Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant’s Principal Executive Offices)

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:
None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  o      No  þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes  o      No  þ

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  þ      No  o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “larger accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o      No  þ

 

As of June 27, 2008, the last day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the registrant’s Common Stock, $0.01 par value per share, held by non-affiliates of the registrant was approximately $1,758,785,050 based on the closing sale price of the registrant’s Common Stock as reported on the New York Stock Exchange on that date. As of February 12, 2009, the number of shares outstanding of the registrant’s Common Stock was 101,172,769.

 

Documents Incorporated by Reference

 

Certain portions, as expressly described in this report, of the Registrant’s Proxy Statement for the 2009 Annual Meeting of the Stockholders, to be filed within 120 days of December 31, 2008, are incorporated by reference into Part III, Items 10-14.

 

 

TRW Automotive Holdings Corp.

 

Index

 

 

from an affiliate of Northrop, as referenced above. On May 3, 2005, a portion of the proceeds from these share issuances was then used to repurchase the €48 million principal amount of the Company’s 10 1 / 8 % Senior Notes.

 

On November 10, 2006, we issued 6,743,500 shares of Common Stock in a registered public offering pursuant to our universal shelf registration statement filed with the SEC. We used the net proceeds of $153 million, together with cash on hand, to make the 2006 repurchase of shares of Common Stock from an affiliate of Northrop.

 

Secondary Offering in 2007.   On May 29, 2007, the Company, AI LLC and certain management stockholders entered into an underwriting agreement with Banc of America Securities LLC (the “Underwriter”) pursuant to which AI LLC and certain executive officers of the Company agreed to sell to the Underwriter 11,000,000 shares of the Company’s Common Stock in a registered public secondary offering (the “Offering”) pursuant to the Company’s shelf registration statement on Form S-3 filed with the SEC on November 6, 2006. The Company did not receive any proceeds related to the Offering, nor did its total number of shares of Common Stock outstanding change as a result of the Offering. Immediately following the Offering the percentage of shares of the Company’s Common Stock held by AI LLC decreased from approximately 56% to approximately 46%.

 

 

See “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 20 to the consolidated financial statements included under “Item 8 — Financial Statements and Supplementary Data” below for further information on our segments.

Sales by Product Line.   Our 2008 sales by product line are as follows:

 

 

Sales by Geography.   Our 2008 sales by geographic region are as follows:

 

 

See Note 20 to our consolidated financial statements under “Item 8 — Financial Statements and Supplementary Data” below for additional product sector and geographical information.

 

Business Developments and Industry Trends

 

References in this Annual Report on Form 10-K (this “Report”) to our being a leading supplier or the world’s leading supplier, and other similar statements as to our relative market position are based principally on calculations we have made. These calculations are based on information we have collected, including company and industry sales data obtained from internal and available external sources, as well as our estimates. In addition to such quantitative data, our statements are based on other competitive factors such as our technological capabilities, the breadth of our product offerings, our research and development efforts and innovations and the quality of our products and services, in each case relative to that of our competitors in the markets we address.

 

Business Development and Strategy.   We have become a leader in the global automotive parts industry by capitalizing on the strength of our products, technological capabilities and systems integration skills. Over the last decade, we have experienced sales growth in many of our product lines due to an increasing focus by both governments and consumers on safety and fuel efficiency. We believe that such focus on safety and fuel economy is continuing as evidenced by ongoing regulatory activities and given uncertainty over fluctuating fuel costs, and will enable us to experience growth in the most recent generation of advanced safety and fuel efficient products. Such advanced products include vehicle stability control systems, curtain and side air bags, occupant sensing systems, electrically assisted power steering systems, electric park brake and tire pressure monitoring systems.

 

Throughout our long history as a leading supplier to major OEMs, we have focused on products in which we have a technological advantage. We have extensive technical experience in a focused range of safety-related product lines and strong systems integration skills. These traits enable us to provide comprehensive, systems-based solutions for our OEM customers. We have a broad and established global presence and sell to major OEMs across the world’s major vehicle producing regions, including the expanding Chinese and Indian markets. We believe our business diversification mitigates our exposure to the risks of any one geographic economy, product line or major

customer concentration. It also enables us to extend our portfolio of products and new technologies across our customer base and geographic regions, and provides us the necessary scale to optimize our cost structure.

 

The Automotive Industry Climate.   The following key trends have been affecting the automotive parts industry over the past several years, many of which we expect will continue in the near term. ( The statements regarding industry outlook, trends, the future development of certain automotive systems and other non-historical statements contained in this section are forward-looking statements as that term is defined by the federal securities laws .)

 

General economic and automotive industry conditions changed significantly during 2008. During the first half of the year, consumer confidence remained stable and production volumes of automobiles were continuing to increase compared to corresponding prior year periods. During the second half of the year, however, consumer confidence fell drastically in response to sharp declines in general economic conditions, which ultimately significantly impacted the demand for, and production of, automobiles.

 

These developments and trends include:

 

General Economic Factors:

 

 

Production Levels and Product Mix:

 

 

Inflation and Pricing Pressure:

 

 

Foreign Currencies:

 

 

These developments and trends are discussed in “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

In addition, the following are significant characteristics of the automotive and automotive supply industries.

 

 

 

In November 2008, the National Highway Safety Traffic Administration (“NHTSA”) finalized a rule requiring standard fitment of electronic stability control (“ESC”) on all North American vehicles under 10,000 lbs. gross vehicle weight. The rule includes a phase-in plan, with ESC to be fitted on 55% of new vehicle production by September 2009, 75% by September 2010, 95% by September 2011 and on all vehicles thereafter. Similarly, in November 2007, the European Commission approved an amendment to the European braking regulation to require ESC on heavy commercial trucks by 2010. The European Commission is also considering regulation that would require compulsory fitment of ESC on all cars sold in Europe by 2012.

 

Advances in technology by us and others have led to a number of innovations in our product portfolio, which will allow us to benefit from this trend. Such innovations include rollover sensing and curtain and side air bag systems, occupant sensing systems, ESC systems and tire pressure monitoring systems.

 

 

Advances in technology by us and others have led to a number of innovations in our product portfolio, which will allow us to benefit from this trend. Such innovations include electric and electro-hydraulic power steering systems, brake controls for regenerative braking systems, efficient HVAC control systems and advanced-material/heat-resistant engine valves.

 

 

We have also seen certain vehicle manufacturers shift away from their funding of development contracts for new technology.

 

 

Competition

 

The automotive supply industry is extremely competitive. OEMs rigorously evaluate us and other suppliers based on many criteria such as quality, price/cost competitiveness, system and product performance, reliability and timeliness of delivery, new product and technology development capability, excellence and flexibility in operations, degree of global and local presence, effectiveness of customer service and overall management capability. We believe we compete effectively with leading automotive suppliers on all of these criteria. For example, we generally follow manufacturing practices designed to improve efficiency and quality, including but not limited to, one-piece-flow machining and assembly, and just-in-time scheduling of our manufacturing plants, all of which enable us to manage inventory so that we can deliver quality components and systems to our customers in the quantities and at the times ordered. Our resulting quality and delivery performance, as measured by our customers, generally meets or exceeds their expectations.

 

Additionally, due to the current negative economic environment, OEMs have been, and we expect will continue to be, increasingly focused on the financial strength and viability of their supply base. We believe that such scrutiny of suppliers will result in a general contraction in the supply base and may force combinations of some suppliers. We feel that this will provide us with the opportunity to win additional business.

 

Within each of our product segments, we face significant competition. Our principal competitors include Advics, Bosch, Continental-Teves, JTEKT, and ZF in the Chassis Systems segment; Autoliv, Bosch, Delphi, Key Safety, and Takata in the Occupant Safety Systems segment; and Delphi, Eaton, ITW, Kostal, Nifco, Raymond, Tokai Rika, and Valeo in the Automotive Components segment.

 

Products.   The following tables describe the principal product lines by segment, in order of 2008 sales levels:

 

 

 

Chassis Systems.   Our Chassis Systems segment focuses on the design, manufacture and sale of product lines relating to steering, foundation brakes, brake control, linkage and suspension, and modules. We sell our Chassis Systems products primarily to OEMs and other Tier 1 suppliers. We also sell these products to OEM service organizations and in the independent aftermarket, through a licensee in North America, and in the rest of the world, to independent distributors. We believe our Chassis Systems segment is well positioned to capitalize on growth trends toward (1) increasing active safety systems, particularly in the areas of electric steering, electronic vehicle stability control and other advanced braking systems and integrated vehicle control systems; (2) increasing electronic content per vehicle; and (3) integration of active and passive safety systems.

 

Occupant Safety Systems.   Our Occupant Safety Systems segment focuses on the design, manufacture and sale of air bags, seat belts, safety electronics, steering wheels and security electronic systems. We sell our Occupant Safety Systems products primarily to OEMs and also to other Tier 1 suppliers. We also sell these products to OEM service organizations. We believe our Occupant Safety Systems segment is well positioned to capitalize on growth trends toward (1) increasing passive safety systems, particularly in the areas of side and curtain air bag systems, occupant sensing systems, active seat belt pretensioning and retractor systems, and tire pressure monitoring systems; (2) increasing electronic content per vehicle; and (3) integration of active and passive safety systems.

 

Automotive Components.   Our Automotive Components segment focuses on the design, manufacture and sale of engine valves, body controls, and engineered fasteners and components. We sell our Automotive Components products primarily to OEMs and also to other Tier 1 suppliers. We also sell these products to OEM service organizations. In addition, we sell some engine valve and body control products to independent distributors for the automotive aftermarket. We believe our Automotive Components segment is well positioned to capitalize on growth trends toward multi-valve engines and increasing electronic content per vehicle.

 

Customers

 

We sell to all the major OEM customers across the world’s major vehicle producing regions. Our long-standing relationships with our customers have enabled us to understand global customers’ needs and business opportunities. We believe that we will continue to be able to compete effectively for our customers’ business because of the high quality of our products, our ongoing cost reduction efforts, our strong global presence and our product and technology innovations. Although business with any given customer is typically split among numerous contracts, the loss of or a significant reduction in purchases by one or more of those major customers could materially and adversely affect our business, results of operations and financial condition.

 

Recent, significant declines in economic and industry conditions, including the impact of restrictions on liquidity available to consumers, have caused the demand for automobiles to decrease considerably. This decrease in demand, together with relatively inflexible cost structures, has dramatically impacted the financial health and solvency of our customers. Recently, Chrysler and GM have sought loans, and Ford has sought a line of credit, from the U.S. government due to the significant financial challenges they face. Also, several of our European customers have obtained, or are seeking loans from their home governments.

Primary end-customer sales (by OEM group) for the years ended December 31, 2008 and 2007 were:

 

 

 

 

We also sell products to the global aftermarket as replacement parts for current production and older vehicles. For each of the years ended December 31, 2008 and 2007, our sales to the aftermarket represented approximately 8% of our total sales. We sell these products through both OEM service organizations and independent distribution networks.

 

Sales and Marketing

 

We have a sales and marketing organization of dedicated customer teams that provide a consistent interface with our key customers. These teams are located in all major vehicle-producing regions to best represent their respective customers’ interests within our organization, to promote customer programs and to coordinate global customer strategies with the goal of enhancing overall customer service, satisfaction and TRW Automotive growth. Our ability to support our customers globally is further enhanced by our broad global presence in terms of sales offices, manufacturing facilities, engineering/technical centers, joint ventures and licensees.

 

Our sales and marketing organization and activities are designed to create overall awareness and consideration of, and to increase purchases of, our systems, modules and components. To further this objective, we participate in an international trade show in Frankfurt. We also provide on-site technology demonstrations at our major OEM customers on a regular basis.

 

Customer Support

 

Our engineering, sales and production facilities are located in 26 countries. With the appropriate level of dedicated sales/customer development employees, we provide effective customer solutions, products and service in any region in which these facilities operate or manufacture.

 

Joint Ventures

 

Joint ventures represent an important part of our business, both operationally and strategically. We have used joint ventures to enter into new geographic markets, such as China and India, to gain new customers and/or strengthen positions with existing customers, or to develop new technologies such as direct tire pressure monitoring systems or radar.

 

In the case of entering new geographic markets where we have not previously established substantial local experience and infrastructure, teaming with a local partner can reduce capital investment by leveraging pre-existing infrastructure. In addition, local partners in these markets can provide knowledge and insight into local customs and practices and access to local suppliers of raw materials and components. All of these advantages can reduce the risk, and thereby enhance the prospects for the success, of an entry into a new geographic market.

Joint ventures can also be an effective means to acquire new customers. Joint venture arrangements can allow partners access to technology they would otherwise have to develop independently, thereby reducing the time and cost of development. More importantly, they can provide the opportunity to create synergies and applications of the technology that would not otherwise be possible.

 

The following table shows our significant unconsolidated joint ventures in which we have a 49% or greater interest that are accounted for under the equity method:

 

 

Intellectual Property

 

We own a significant quantity of intellectual property, including a large number of patents, trademarks, copyrights and trade secrets, and are involved in numerous licensing arrangements. Although our intellectual property plays an important role in maintaining our competitive position in a number of the markets that we serve, no single patent, copyright, trade secret or license, or group of related patents, copyrights, trade secrets or licenses, is, in our opinion, of such value to us that our business would be materially affected by the expiration or termination thereof. However, we view the name TRW Automotive and primary mark “TRW” as material to our business as a whole. Our general policy is to apply for patents on an ongoing basis in the United States, Germany and, as appropriate, other countries to protect our patentable developments.

 

Our portfolio of patents and pending patent applications reflects our commitment to invest in technology and covers many aspects of our products and the processes for making those products. In addition, we have developed a substantial body of manufacturing know-how that we believe provides a significant competitive advantage in the marketplace.

 

We have entered into numerous technology license agreements that either strategically capitalize on our intellectual property rights or provide a conduit for us into third party intellectual property rights useful in our businesses. In many of these agreements, we license technology to our suppliers, joint venture companies and other local manufacturers in support of product production for our customers and us. In other agreements, we license the technology to other companies to obtain royalty income.

 

We own a number of secondary trade names and trademarks applicable to certain of our businesses and products that we view as important to such businesses and products as well.

 

Seasonality

 

Our business is moderately seasonal because our largest North American customers typically halt operations for approximately two weeks in July and one week in December. Additionally, customers in Europe historically shut

down vehicle production during portions of August and one week in December. As new models are typically introduced during the third quarter, automotive production traditionally is lower during that period. Accordingly, our third and fourth quarter results may reflect these trends.

 

In the fourth quarter of 2008, due to significant declines in general market and automotive industry conditions, several of our customers shut down vehicle production for longer periods than normal, therefore impacting our fourth quarter results more than would normally be expected.

 

Additionally, considering the current economic conditions and actions of our customers, the normal seasonality of the automotive industry as described above may not be experienced in 2009.

 

Research, Development and Engineering

 

We operate a global network of technical centers worldwide where we employ several thousand engineers, researchers, designers, technicians and their supporting functions. This global network allows us to develop active and passive automotive safety technologies while improving existing products and systems. We utilize sophisticated testing and computer simulation equipment, including computer-aided engineering, noise-vibration-harshness, crash sled, math modeling and vehicle simulations. We have advanced engineering and research and development programs for next-generation products in our Chassis Systems, Occupant Safety Systems and Automotive Component segments. We are disciplined and innovative in our approach to research and development, employing various tools to improve efficiency and reduce cost, such as Six Sigma, “follow-the-sun” (a 24-hour a day engineering program that utilizes our global network) and other e-Engineering programs, and by outsourcing non-core activities.

 

We believe that continued research, development and engineering activities are critical to maintaining our leadership position in the industry and will provide us with a competitive advantage as we seek additional business with new and existing customers. Company-funded research, development and engineering costs were approximately 6% of sales for each of the years ended December 31, 2008, 2007, and 2006. Recently, we have seen certain vehicle manufacturers shift away from their funding of development contracts for new technology.

 

For research and development expenditures in each of the years ended December 31, 2008, 2007 and 2006, see “— Research and Development” in Note 2 to the consolidated financial statements included in “Item 8 — Financial Statements and Supplementary Data”.

 

Supply Base — Manufactured Components and Raw Materials

 

We purchase various manufactured components and raw materials for use in our manufacturing processes. The principal components and raw materials we purchase include castings, electronic parts, molded plastic parts, finished subcomponents, fabricated metal, aluminum, steel, resins, textiles, leather and wood. All of these components and raw materials are available from numerous sources. Despite recent declines, we see a continued rise in inflationary pressures impacting certain commodities such as petroleum-based products, resins, yarns, ferrous metals, base metals, and certain chemicals. Additionally, because we purchase various types of equipment, raw materials and component parts from our suppliers, we may be adversely affected by their failure to perform as expected or their inability to adequately mitigate inflationary, industry, or economic pressures. These pressures have proven to be insurmountable to some of our suppliers and we have seen the number of bankruptcies and insolvencies increase. The unstable condition of some of our suppliers or their failure to perform has caused us to incur additional costs which negatively impacted certain of our businesses in 2008. The overall condition of our supply base may possibly lead to delivery delays, production issues or delivery of non-conforming products by our suppliers in the future. As such, we continue to monitor our vendor base for the best source of supply and work with those vendors and customers to attempt to mitigate the impact of the pressures mentioned above.

 

Although we have not, in recent years, experienced any significant shortages of manufactured components or raw materials, and normally do not carry inventories of these items in excess of those reasonably required to meet our production and shipping schedule, the possibility of shortages exist especially in light of the weakened state of the supply base described above.

Employees

 

As of December 31, 2008, we had approximately 65,200 employees (including approximately 3,000 contract employees, but excluding employees who were on approved forms of leave).

 

As of December 31, 2007, we had approximately 73,100 employees (including approximately 6,800 contract employees, but excluding employees who were on approved forms of leave).

 

During 2008, approximately 2,000 employees were added to the Company through growth resulting from an acquisition and the vertical integration of certain operations. Considering these employees, there was a reduction of approximately 9,900 employees, or 13%, from December 31, 2007 to December 31, 2008. This reduction was primarily the result of our global workforce reduction initiatives in light of current economic and industry conditions.

 

Environmental Matters

 

Governmental requirements relating to the discharge of materials into the environment, or otherwise relating to the protection of the environment, have had, and will continue to have, an effect on our operations and us. We have made and continue to make expenditures for projects relating to the environment, including pollution control devices for new and existing facilities. We are conducting a number of environmental investigations and remedial actions at current and former locations to comply with applicable requirements and, along with other companies, have been named a potentially responsible party for certain waste management sites. Each of these matters is subject to various uncertainties, and some of these matters may be resolved unfavorably to us.

 

A reserve estimate for each matter is established using standard engineering cost estimating techniques on an undiscounted basis. In the determination of such costs, consideration is given to the professional judgment of our environmental engineers, in consultation with outside environmental specialists, when necessary. At multi-party sites, the reserve estimate also reflects the expected allocation of total project costs among the various potentially responsible parties. As of December 31, 2008, we had reserves for environmental matters of $45 million. In addition, the Company has established a receivable from Northrop for a portion of this environmental liability as a result of the indemnification provided for in the Master Purchase Agreement under which Northrop has agreed to indemnify us for 50% of any environmental liabilities associated with the operation or ownership of TRW Inc.’s automotive business existing at or prior to the Acquisition, subject to certain exceptions. During 2008 and 2007, the Company received settlement payments of $5 million and $2 million, respectively, for environmental matters related to obligations that have been incurred and paid.

 

We do not believe that compliance with environmental protection laws and regulations will have a material effect upon our capital expenditures, results of operations or competitive position. Our capital expenditures pertaining to environmental control during 2009 are not expected to be material to us. We believe that any liability that may result from the resolution of environmental matters for which sufficient information is available to support cost estimates will not have a material adverse effect on our financial position or results of operations. However, we cannot predict the effect on our financial position of expenditures for aspects of certain matters for which there is insufficient information. In addition, we cannot predict the effect of compliance with environmental laws and regulations with respect to unknown environmental matters on our financial position or results of operations or the possible effect of compliance with environmental requirements imposed in the future.

 

International Operations

 

We have significant manufacturing operations outside the United States and, in 2008, approximately 75% of our sales originated outside the United States. See Note 20 to our consolidated financial statements included under “Item 8. Financial Statements and Supplementary Data” for financial information by geographic area. Also, see “Item 1A. Risk Factors” for a description of risks inherent in such international operations.

 

Available Company Information

 

TRW Automotive Holdings Corp.’s Internet website is www.trw.com . Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished

pursuant to section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge through our website as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission. Our Audit Committee Charter, Compensation Committee Charter, Corporate Governance and Nominating Committee Charter, Corporate Governance Guidelines and Standards of Conduct (our code of business conduct and ethics) are also available on our website and available in print to any shareholder who requests it.

 

Detroit Three can also affect our financial condition. In order to address market share declines, reduced production levels, negative industry trends (such as the change in mix of vehicles) and other structural issues specific to their companies (such as significant overcapacity and pension and healthcare costs), the Detroit Three are undergoing or may undergo various forms of restructuring initiatives (including, in certain cases, reorganization under bankruptcy laws). Chrysler and GM have sought funding and Ford has sought a line of credit from the U.S. government due to the significant financial challenges they face. There can be no assurance that the Detroit Three will be able to meet the conditions imposed on them in connection with any such government funding or that any financial arrangements provided will enable them to remain viable. A bankruptcy filing by one or more of the Detroit Three is a possibility which would impact the collectability of receivables owed to us by such company. In addition, our United States receivables facility (the “Receivables Facility”) is subject to early termination under certain circumstances, including a default ratio of eligible receivables in excess of an established threshold, which could be triggered by the bankruptcy of one or more of our customers that are included in that facility, including the Detroit Three. Further, since many of our suppliers also supply product directly to the Detroit Three, they may face similar consequences which could increase pressure on the supplier’s own viability. As a result, the financial condition of the Detroit Three may adversely affect our financial condition and that of our suppliers. In addition, the decrease in global production levels as a result of lower vehicle demand could also adversely impact the financial condition of other OEMs and, in turn, could adversely affect our financial condition and that of our suppliers.

 

Disruptions in the financial markets are adversely impacting the availability and cost of credit which could negatively affect our business.

 

Disruptions in the financial markets, including the bankruptcy, insolvency or restructuring of certain financial institutions, and the lack of liquidity generally are adversely impacting the availability and cost of incremental credit for many companies and may adversely affect the availability of credit already arranged including, in our case, credit already arranged under our revolving and receivables facilities. These disruptions are also adversely affecting the U.S. and world economy, further negatively impacting consumer spending patterns in the automotive industry. In addition, as our customers and suppliers respond to rapidly changing consumer preferences, they may require access to additional capital. Several of our customers have sought, or are in various stages of discussions regarding, possible financing from their respective governments where financing is not otherwise available. If required capital is not obtained or its cost is prohibitively high, their business would be negatively impacted which could result in further restructuring or even reorganization under bankruptcy laws. Any such negative impact, in turn, could negatively affect our business either through loss of sales to any of our customers so affected or through inability to meet our commitments (or inability to meet them without excess expense) because of loss of supplies from any of our suppliers so affected. There are no assurances that government responses to these disruptions will restore consumer confidence or improve the liquidity of the financial markets.

 

Our available cash and access to additional capital may be limited by our substantial debt.

 

We are a non-investment grade company with a significant level of debt. This amount of debt may limit our ability to obtain additional financing for our business. In addition, we need to devote substantial cash to the payment of interest on our debt, which means that cash may not be used for other of our business needs. We may be more vulnerable to an economic or industry downturn and to rising interest rates than a company with less debt.

 

Escalating pricing pressures from our customers may adversely affect our business.

 

Pricing pressure in the automotive supply industry has been substantial and is likely to continue. Virtually all vehicle manufacturers seek price reductions in both the initial bidding process and during the term of the contract. Price reductions have impacted our sales and profit margins and are expected to do so in the future. If we are not able to offset continued price reductions through improved operating efficiencies and reduced expenditures, those price reductions may have a material adverse effect on our results of operations.

Commodity inflationary pressures may adversely affect our profitability and the viability of our Tier 2 and Tier 3 supply base.

 

Despite recent declines, the cost of most of the commodities we use in our business has generally increased over the past few years. Ferrous metals, base metals, resins, yarns, energy costs and other petroleum-based products have become more expensive. This has put significant operational and financial burdens on us and our suppliers. It is usually difficult to pass increased prices for manufactured components and raw materials through to our customers in the form of price increases and, even if passed through to some extent, the recovery is typically on a delayed basis. Furthermore, our suppliers may not be able to handle the commodity cost increases and continue to perform as we expect. The unstable condition of some of our suppliers or their failure to perform has caused us to incur additional costs which negatively impacted certain of our businesses in 2008. The continuation or worsening of these industry conditions together with the overall condition of our supply base may lead to further delivery delays, additional costs, production issues or delivery of non-conforming products by our suppliers in the future, which may have a negative impact on our results of operations.

 

Our business would be materially and adversely affected if we lost any of our largest customers.

 

For the year ended December 31, 2008, sales to our four largest customers on a worldwide basis were approximately 53% of our total sales. Although business with each customer is typically split among numerous contracts, if we lost a major customer or that customer significantly reduced its purchases of our products, there could be a material adverse affect on our business, results of operations and financial condition.

 

We have recorded a significant amount of goodwill and other identifiable intangible assets, which may become impaired in the future.

 

We have recorded a significant amount of goodwill, which represents the excess of cost over the fair value of the net assets of the business acquired, and other identifiable intangible assets, including trademarks, developed technologies, and customer relationships. Impairment of goodwill and other identifiable intangible assets may result from, among other things, deterioration in our performance, adverse market conditions, adverse changes in applicable laws or regulations, including changes that restrict the activities of or affect the products sold by our business, and a variety of other factors. The amount of any quantified impairment must be expensed immediately as a charge that is included in operating income. As the result of our annual impairment analysis, we adjusted goodwill and other identifiable intangible assets by $787 million. After such adjustment, as of December 31, 2008, goodwill and other identifiable intangible assets totaled $2,138 million or 23% of our total assets. We remain subject to future financial statement risk in the event that goodwill or other identifiable intangible assets become further impaired.

 

We may incur material losses and costs as a result of product liability, warranty and recall claims that may be brought against us.

 

In our business, we are exposed to product liability and warranty claims. In addition, we may be required to participate in a recall of a product. Vehicle manufacturers are increasingly looking to their suppliers for contribution when faced with product liability, warranty and recall claims and we have been subject to continuing efforts by our customers to change contract terms and conditions concerning warranty and recall participation. In addition, vehicle manufacturers have experienced increasing recall campaigns in recent years. Product liability, warranty and recall costs may have a material adverse effect on our financial condition.

 

Strengthening of the U.S. dollar and other foreign currency exchange rate fluctuations could materially impact our results of operations.

 

In 2008, approximately seventy-five percent of our sales originated outside the United States. We translate sales and other results denominated in foreign currencies into U.S. dollars for our consolidated financial statements. This translation is based on average exchange rates during a reporting period. During times of a strengthening U.S. dollar, our reported international sales and earnings would be reduced because foreign currencies may translate into fewer U.S. dollars.

Separately, while we generally produce in the same geographic markets as our products are sold, our sales are more concentrated in U.S. dollars and in euros than our expenses, and therefore our profit margins and earnings could be reduced due to fluctuations or adverse trends in foreign currency exchange rates. While we employ financial instruments to hedge certain of these exposures, this does not insulate us completely from currency effects.

 

Our pension and other postretirement benefits expense and the funding requirements of our pension plans could materially increase.

 

Most of our employees participate in defined benefit pension plans or retirement/termination indemnity plans. The rate at which we are required to fund these plans depends on certain assumptions which depend in part on market conditions. As market conditions change, these assumptions may change, which could materially increase the necessary funding status of our plans, and may require us to contribute more to these plans earlier than we anticipated. Also, this could significantly increase our pension expenses and reduce our profitability.

 

We also sponsor other postretirement benefit (“OPEB”) plans for most of our U.S. and some of our non-U.S. employees. We fund our OPEB obligations on a pay-as-you-go basis and have no plan assets. If health care costs in the future increase more than we anticipated, our actuarially determined liability and our related OPEB expense could increase along with future cash outlays.

 

We are subject to risks associated with our non-U.S. operations.

 

We have significant manufacturing operations outside the United States, including joint ventures and other alliances. Operations outside of the United States, particularly operations in emerging markets, are subject to various risks which may not be present or as significant for operations within U.S. markets. Economic uncertainty in some geographic regions in which we operate, including certain emerging markets, could result in the disruption of markets and negatively affect cash flows from our operations in those areas.

 

Risks inherent in our international operations include social plans that prohibit or increase the cost of certain restructuring actions; exchange controls; foreign currency exchange rate fluctuations including devaluations; the potential for changes in local economic conditions; restrictive governmental actions such as restrictions on transfer or repatriation of funds and trade protection matters, including antidumping duties, tariffs, embargoes and prohibitions or restrictions on acquisitions or joint ventures; changes in laws and regulations, including the laws and policies of the United States affecting trade and foreign investment; the difficulty of enforcing agreements and collecting receivables through certain foreign legal systems; variations in protection of intellectual property and other legal rights; more expansive legal rights of foreign unions; the potential for nationalization of enterprises; unsettled political conditions and possible terrorist attacks against United States’ or other interests. In addition, there are potential tax inefficiencies in repatriating funds from non-U.S. subsidiaries.

 

These and other factors may have a material adverse effect on our international operations and, therefore, on our business, results of operations and financial condition.

 

Work stoppages or other labor issues at our facilities or the facilities of our customers or suppliers could adversely affect our operations.

 

Due to normal and ordinary labor negotiations or as a result of a specific labor dispute, a work stoppage may occur in our facilities or those of our customers or other suppliers. The turbulence in the automotive industry and actions being taken to address negative industry trends may have the side effect of exacerbating labor relations problems which could increase the possibility of such a work stoppage. If any of our customers experience a material work stoppage, either directly or as a result of a work stoppage at another supplier, that customer may halt or limit the purchase of our products. Similarly, a work stoppage at our facilities or one of our own suppliers could limit or stop our production of the affected products. Such interruptions in our production could have a material adverse effect on our business, results of operations and financial condition.

Our annual effective tax rate could be volatile and materially change as a result of changes in mix of earnings and other factors.

 

The overall effective tax rate is equal to our total tax expense as a percentage of our total earnings before tax. However, tax expense and benefits are not recognized on a global basis but rather on a jurisdictional or legal entity basis. Losses in certain jurisdictions provide no current financial statement tax benefit. As a result, changes in the mix of earnings between jurisdictions, among other factors, could have a significant impact on our overall effective tax rate.

 

We may be adversely affected by environmental and safety regulations or concerns.

 

Laws and regulations governing environmental and occupational safety and health are complicated, change frequently and have tended to become stricter over time. As a manufacturing company, we are subject to these laws and regulations both inside and outside the United States. We may not be in complete compliance with such laws and regulations at all times. Our costs or liabilities relating to them may be more than the amount we have reserved, of which the difference may be material. We have spent money to comply with environmental requirements. In addition, certain of our subsidiaries are subject to pending litigation raising various environmental and health and safety claims, including certain asbestos-related claims. While our annual costs to defend and settle these claims in the past have not been material, we cannot assure you that this will remain so in the future.

 

Developments or assertions by or against us relating to intellectual property rights could materially impact our business.

 

We own significant intellectual property, including a large number of patents, trademarks, copyrights and trade secrets, and are involved in numerous licensing arrangements. Our intellectual property plays an important role in maintaining our competitive position in a number of the markets that we serve. Developments or assertions by or against us relating to intellectual property rights could materially impact our business.

 

Because Blackstone owns a substantial percentage of our stock, the influence of our public shareholders over significant corporate actions will be limited, and conflicts of interest between Blackstone and us or our public shareholders could arise in the future.

 

Currently an affiliate of The Blackstone Group L.P. (“Blackstone”) beneficially owns approximately 45% of our outstanding shares of common stock. As a result, Blackstone has a significant voting block with respect to all matters submitted to our stockholders, including the election of our directors and our decisions to enter into any corporate transaction, and its vote may be difficult to overcome on any transaction that requires the approval of stockholders.

 

 

Of the total number of principal facilities operated by us, approximately 60% of such facilities are owned and 40% are leased.

 

A summary of our principal facilities, by segment, type of facility and geographic region, as of January 31, 2009 is set forth in the following tables. Additionally, where more than one segment utilizes a single facility, that facility is categorized by the purposes for which it is primarily used.

 

 

 

 

 

 

general, these claims seek damages for illnesses alleged to have resulted from exposure to asbestos used in certain components sold by our subsidiaries. We believe that the majority of the claimants were assembly workers at the major U.S. automobile manufacturers. The vast majority of these claims name as defendants numerous manufacturers and suppliers of a wide variety of products allegedly containing asbestos. We believe that, to the extent any of the products sold by our subsidiaries and at issue in these cases contained asbestos, the asbestos was encapsulated. Based upon several years of experience with such claims, we believe that only a small proportion of the claimants has or will ever develop any asbestos-related illness.

 

Neither our settlement costs in connection with asbestos claims nor our annual legal fees to defend these claims have been material in the past. These claims are strongly disputed by us and it has been our policy to defend against them aggressively. We have been successful in obtaining the dismissal of many cases without any payment whatsoever. Moreover, there is significant insurance coverage with solvent carriers with respect to these claims. However, while our costs to defend and settle these claims in the past have not been material, we cannot assure you that this will remain so in the future.

 

We believe that the ultimate resolution of the foregoing matters will not have a material effect on our financial condition, results of operations or cash flows.

 

PART II

 

incentive plan permits payment of an option exercise price by means of cashless exercise through a broker and permits the satisfaction of the minimum statutory tax obligations upon exercise of options through stock withholding. Further, while our stock incentive plan also permits the satisfaction of the minimum statutory tax obligations upon the vesting of restricted stock through stock withholding, the shares withheld for such purpose are issued directly to us and are then immediately retired and returned to our authorized but unissued reserve. The Company does not believe that the foregoing purchases or transactions are issuer repurchases for the purposes of Item 5 of this Report on Form 10-K.

 

Dividend Policy

 

We do not currently pay any cash dividends on our common stock, and instead intend to retain any earnings for debt repayment, future operations and expansion. The amounts available to us to pay cash dividends are restricted by our debt agreements. Under TRW Automotive’s senior credit facilities, we have a limited ability to pay dividends on our common stock pursuant to a formula based on our consolidated net income after January 1, 2005 and our leverage ratio as specified in the amended and restated credit agreement. The indentures governing the notes also limit our ability to pay dividends. Any decision to declare and pay dividends in the future will be made at the discretion of our board of directors and will depend on, among other things, our results of operations, cash requirements, financial condition, contractual restrictions and other factors that our board of directors may deem relevant.

 

 

 

Stock Performance Graph

 

The graph below provides an indicator of our cumulative total stockholder return as compared with Standard & Poor’s 500 Stock Index and the Standard & Poor’s Supercomposite Auto Parts & Equipment Index (formerly known as the Standard & Poor’s 1500 Auto Parts & Equipment Index) based on currently available data. The graph assumes an initial investment of $100 on February 3, 2004, the date our common stock first traded on the New York Stock Exchange, through December 31, 2008, which represents the last trading day of the year.

 

 

 

 

Financial Results

 

Our net sales for the year ended December 31, 2008 were $15.0 billion, which represents an increase of 2% over the prior year. The increase in sales was driven by favorable foreign currency exchange and a higher level of lower margin module sales, significantly offset by lower production volumes, primarily in North America and Europe, and price reductions provided to customers.

 

Operating losses for the year ended December 31, 2008 were $468 million compared to operating income of $624 million for the prior year. The decline in operating results of $1,092 million resulted primarily from the impairment of goodwill and intangible assets of $787 million, higher restructuring and fixed asset impairment charges of $94 million, the profit impact of lower sales due to lower production volumes and adverse mix as compared to the prior year.

 

Net losses for the year ended December 31, 2008 were $779 million as compared to net earnings of $90 million for the year ended December 31, 2007. This decrease of $869 million was primarily the result of the significant decrease in operating results of $1,092 million, as described above, offset by a loss on retirement of debt of $155 million that was included in net earnings for the year ended December 31, 2007. Additionally, interest expense decreased by $46 million for the year ended December 31, 2008 compared to the year ended December 31, 2007, primarily due to the debt refinancing in 2007 and lower interest rates.

 

Despite the decline in sales and net income, the Company generated positive operating cash flow of $773 million, which exceeded capital expenditures of $482 million. The Company also reduced its level of debt during 2008.

 

Recent Trends and Market Conditions

 

The automotive and automotive supply industries experienced significantly unfavorable developments during the year 2008 (primarily the second half of 2008), particularly in North America and Europe. These trends include:

 

General Economic Factors:

 

Disruptions in financial markets and restrictions on liquidity are adversely impacting the availability and cost of incremental credit for many companies. These disruptions are also adversely affecting the global economy, further negatively impacting consumer spending patterns in the automobile industry. As our customers and suppliers respond to rapidly changing consumer preferences, restricted liquidity or increased cost of capital could negatively impact their business, which could result in further restructuring or even reorganization or liquidation under bankruptcy laws. Any such negative impact could, in turn, negatively affect our business either through loss of sales to our customers or through our inability to meet our commitments (or inability to meet them without excess expense), due to the loss of supplies from any of our suppliers so affected.

 

Production Levels and Product Mix:

 

In the U.S. and Europe, overall negative economic conditions, including the deterioration of global financial markets, reduced credit availability and lower consumer confidence have significantly impacted the automotive industry. As such, automotive production and sales have deteriorated substantially and are not expected to rebound significantly in the near term. Therefore, considering the drastic changes to consumer demand for automobiles, and corresponding decrease in automobile production and demand for our products, we assessed the recoverability of our long-lived assets, resulting in intangible asset impairment charges of $329 million and fixed asset impairment charges of $87 million during 2008. Additionally, as a result of our annual testing of goodwill for impairment, we recognized goodwill impairment charges of $458 million.

 

There has been a dramatic shift in the North American market away from sport utility vehicles, light trucks and heavy-duty pickup trucks, which tend to be higher margin products for OEMs and suppliers, to more fuel-efficient passenger cars. Similarly, in Europe, there has been a more recent shift from large and mid-size passenger cars to small cars. These changes have negatively impacted the mix of our product sales.

In recent years, and continuing into 2008, the Detroit Three have seen a steady decline in their market share for vehicle sales in North America, with Asian OEMs increasing their share in this market. Although we have business with the Asian OEMs, our customer base in North America is more heavily weighted toward the Detroit Three. Declining market share, inherent legacy issues with the Detroit Three and the impact of declining consumer confidence have led to recent, unprecedented production cuts and permanent capacity reductions. During 2008, the Detroit Three North American production levels declined approximately 21% compared to 2007. These declines will have a continuing negative impact on our sales, liquidity and results of operations.

 

In addition, in order to address market share declines, reduced production levels, negative industry trends (such as change in mix of vehicles), general macroeconomic conditions and other structural issues specific to their companies (such as significant overcapacity and pension and healthcare costs), the Detroit Three and certain of our other customers continue to implement or may implement various forms of restructuring initiatives (including, in certain cases, reorganization under bankruptcy laws). These restructuring actions have had and may continue to have a significant impact throughout our industry, including our supply base.

 

Inflation and Pricing Pressure:

 

Throughout 2008 commodity inflation continued to negatively impact the industry. Costs of petroleum-based products were volatile, and the per barrel price of oil reached record highs in July. Further, ferrous metals and other base metal prices, resins, yarns and energy costs increased significantly. It is unclear whether the recent decline of the spot price of certain commodities is sustainable, or when, or if, we could expect to benefit from such declines. In general, overall commodity inflation pressures remain a significant concern for our business and have placed a considerable operational and financial burden on the Company. We have continued to work with our suppliers and customers to mitigate the impact of increasing commodity costs. However, it is generally difficult to pass increased prices for manufactured components and raw materials through to our customers in the form of price increases.

 

Additionally, pricing pressure from our customers is characteristic of the automotive parts industry. This pressure is substantial and will continue. Virtually all OEMs have policies of seeking price reductions each year. Consequently, we have been forced to reduce our prices in both the initial bidding process and during the terms of contractual arrangements. We have taken steps to reduce costs and resist price reductions; however, price reductions have negatively impacted our sales and profit margins and are expected to do so in the future. In addition to pricing concerns, we continue to be approached by our customers for changes in terms and conditions in our contracts concerning warranty and recall participation and payment terms on products shipped. We believe that the likely resolution of these proposed modifications will not have a material adverse effect on our financial condition, results of operations or cash flows.

 

Furthermore, because we purchase various types of equipment, raw materials and component parts from our suppliers, we may be adversely affected by their failure to perform as expected or their inability to adequately mitigate inflationary, industry, or economic pressures. These pressures have proven to be insurmountable to some of our suppliers and we have seen the number of bankruptcies and insolvencies increase. While the unstable condition of some of our suppliers or their failure to perform has not led to any material disruptions thus far, it has caused us to incur additional costs which have negatively impacted certain of our businesses in 2008. The overall condition of our supply base may possibly lead to delivery delays, additional costs, production issues or delivery of non-conforming products by our suppliers in the future. As such, we continue to monitor our vendor base for the best source of supply.

 

Labor Relations:

 

Work stoppages or other labor issues are inherent in our industry and may potentially occur at our customers’ or their suppliers’ facilities or at our or our suppliers’ facilities, which may have a material adverse effect on us. During 2008, a labor disruption occurred at a supplier of General Motors Corporation during the renegotiation of a labor agreement with one of its major unions. The disruption impacted the production at General Motors Corporation and, as a result, its purchases from us. While this disruption did not have a material impact on our business in 2008, other work stoppages could occur that may negatively impact our operations.

Foreign Currencies:

 

Through the third quarter of 2008, currency trends of prior years continued, with a favorable impact on our reported earnings in U.S. dollars resulting from the translation of results denominated in other currencies, mainly the euro, which appreciated against the U.S dollar, partially offset by the negative impacts of certain other currency fluctuations. In the fourth quarter of 2008 these trends reversed and volatilities spiked at the same time as automotive sales declined. As a result, in the fourth quarter the Company incurred a negative translation impact, losses on hedging of forecasted transactions, as well as losses on other unhedged smaller exposures, resulting in an aggregate negative impact from currency fluctuations for the full year. In the case of weakening foreign currencies in our manufacturing base, our hedge positions as of December 31, 2008 will limit potential improvements in our margins throughout 2009.

 

Company Strategy

 

Significant declines in general economic conditions and production levels of automobiles, an unfavorable change in the mix of our product sales and continuing inflationary and pricing pressures have forced us to re-evaluate all aspects of our business and determine the best approach to mitigate these negative conditions. We continually evaluate our competitive position in the automotive supply industry and whether actions are required to maintain or improve our standing. Such actions may include plant rationalization or global capacity optimization across our businesses.

 

During the fourth quarter of 2008, as a result of the negative conditions mentioned above, automobile manufacturers significantly reduced production volumes to better align supply with demand. This significant reduction in production volumes along with our revised production outlook resulted in the recognition of impairments for goodwill, other identifiable intangible assets and long-lived assets in the amount of $458 million, $329 million and $87 million, respectively, during 2008.

 

Consequently, we have undertaken a number of restructuring and cost reduction initiatives in efforts to further improve our cost base. Such initiatives include the closure of several facilities in addition to a general reduction of our global workforce (including our corporate infrastructure) resulting in a reduction of approximately 9,900, or 13%, of our employees during 2008.

 

While we continue our efforts to mitigate the impact of the market conditions and declining demand described above, we expect the negative conditions to continue in the near future, thereby impacting 2009. We will continue to evaluate our global footprint to ensure that we are properly configured and sized, considering the changes in market conditions. Plant rationalization beyond the facilities we have closed or announced for closure, and additional global workforce reduction efforts, may be warranted.

 

Additionally, we will continue to focus on our four strategic priorities, which include achieving world-class quality, reducing costs, leveraging our global reach and developing innovative technology. We believe that these priorities, along with continued focus on our Six Sigma and business excellence programs, can be effectively used to manage our cost structure and ensure efficiency in our day-to-day operations.

 

Our Debt and Capital Structure

 

On an ongoing basis we monitor, and may modify, our debt and capital structure to reduce associated costs and provide greater financial and covenant flexibility.

 

We refinanced our debt in 2007, which provided us with increased liquidity. We believe that our current financial position and financing plans will provide flexibility in worldwide financing activities and permit us to respond to changing conditions in credit markets. However, the ability to fully utilize our facilities may be subject to the financial strength of the underlying participants of the agreements and, in the case of our receivables facilities, the underlying financial strength of our customers. Additionally, our primary credit facilities contain certain covenants including a maximum total leverage ratio and a minimum interest coverage ratio that would impact our ability to borrow on these facilities if not met. These ratios are calculated on a trailing four quarter basis.

As of December 31, 2008, the Company was in compliance with these financial covenants. As a result of the current automotive industry environment, it is uncertain whether the Company will be in compliance with its debt covenants throughout 2009. In the event of noncompliance, the Company believes that it will be able to obtain a waiver from the lender group or successfully amend the covenants.

 

In May 2007, we entered into an amended and restated credit agreement whereby we refinanced $2.5 billion of existing senior secured credit facilities with new facilities consisting of a secured revolving credit facility (the “Revolving Credit Facility”) and various senior secured term loan facilities (collectively with the Revolving Credit Facility, the “Senior Secured Credit Facilities”). In March 2007, we commenced, and in April 2007 we completed, a tender offer for our then outstanding $1.3 billion of senior and senior subordinated notes (the “Old Notes”). In March 2007, we also issued new senior notes for approximately $1.5 billion (the “New Senior Notes”), and used the proceeds to fund the repurchase of the Old Notes.

 

On February 15, 2008, the Company redeemed all of its then remaining Old Notes for $20 million.

 

On March 13, 2008, the Company entered into a transaction to repurchase $12 million in principal amount of the 7% Senior Notes outstanding. The repurchased notes were retired upon settlement on March 18, 2008.

 

As market conditions warrant, we and our major equity holders, including The Blackstone Group L.P. and its affiliates (the “Blackstone Investors”), may from time to time repurchase debt securities issued by the Company or its subsidiaries, in privately negotiated or open market transactions, by tender offer, exchange offer or otherwise.

 

Restructuring Charges and Asset Impairments

 

As a result of our global strategy, we have closed or announced the closure of 24 facilities since the beginning of 2005. During 2008, we closed four facilities and announced two others. For the year ended December 31, 2008, we recorded restructuring charges and asset impairments of $37 million related to the closure or announced closure of various facilities and $42 million primarily related to the global workforce reduction in 2008.

 

Restructuring charges for the year ended December 31, 2008 included cash charges of $69 million for severance and other costs, $11 million of curtailment gains, and $21 million of net non-cash asset impairments related to restructuring activities. Also in 2008, we incurred $66 million of net other asset impairments not related to restructuring.

 

Goodwill and Intangible Assets

 

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”), we performed our annual impairment test at the reporting unit level during the fourth quarter of 2008. During our annual impairment testing process we identified that there was a goodwill impairment indicator as of October 31, 2008 (the date of our annual impairment test). Based on testing performed we identified impairments of intangible assets of $329 million and goodwill of $458 million. Also, as of December 31, 2008 we identified an additional goodwill impairment indicator, but based on our analyses no additional impairments were required.

 

Other Matters

 

During the third quarter of 2007, we signed an agreement with Delphi Corporation to purchase a portion of its North American brake component machining and module assembly assets. As of January 2, 2008, we closed the purchase and took possession of the former Delphi braking facility located in Saginaw, Michigan.

 

Critical Accounting Estimates

 

The critical accounting estimates that affect our financial statements and that use judgments and assumptions are listed below. In addition, the likelihood that materially different amounts could be reported under varied conditions and assumptions is noted.

 

Goodwill.   Goodwill, which represents the excess of cost over the fair value of the net assets of the businesses acquired, was approximately $1.8 billion as of December 31, 2008, or 19% of our total assets.

In accordance with SFAS No. 142, we perform annual impairment testing at a reporting unit level. To test goodwill for impairment, we estimate the fair value of each reporting unit and compare the estimated fair value to the carrying value. If the carrying value exceeds the estimated fair value, then a possible impairment of goodwill exists and requires further evaluation. Estimated fair values are based on the cash flows projected in the reporting units’ strategic plans and long-range planning forecasts (see “— Impairment of Long-Lived Assets and Intangibles” below), discounted at a risk-adjusted rate of return.

 

See Note 6 to the consolidated financial statements included under “Item 8. Financial Statements and Supplementary Data” for further information on our annual impairment analysis of goodwill.

 

Impairment of Long-Lived Assets and Intangibles.   We evaluate long-lived assets and definite-lived intangible assets for impairment when events and circumstances indicate that the assets may be impaired and the undiscounted cash flows to be generated by those assets are less than their carrying value. If the undiscounted cash flows are less than the carrying value of the assets, the assets are written down to their fair value. We also evaluate the useful lives of intangible assets each reporting period.

 

The determination of undiscounted cash flows is based on the businesses’ strategic plans and long-range planning forecasts. The revenue growth rates included in the plans are based on industry specific data. We use external vehicle build assumptions published by widely used external sources and market share data by customer based on known and targeted awards over a five-year period. The projected profit margin assumptions included in the plans are based on the current cost structure and anticipated cost reductions. If different assumptions were used in these plans, the related undiscounted cash flows used in measuring impairment could be different and additional impairment of assets might be required to be recorded.

 

We test indefinite-lived intangible assets, other than goodwill, for impairment on at least an annual basis, or when events and circumstances indicate that the indefinite-lived intangible assets may be impaired, by comparing the estimated fair values to the carrying values. If the carrying value exceeds the estimated fair value, the asset is written down to its estimated fair value. Estimated fair value is based on cash flows as discussed above, discounted at a risk-adjusted rate of return.

 

See Notes 6 and 14 to the consolidated financial statements included under “Item 8. Financial Statements and Supplementary Data” for our evaluation of long-lived assets for impairment and further information on our annual impairment analysis of intangibles, respectively.

 

Product Recalls.   We are at risk for product recall costs. Recall costs are costs incurred when the customer or we decide to recall a product through a formal campaign, soliciting the return of specific products due to a known or suspected safety concern. In addition, the NHTSA has the authority, under certain circumstances, to require recalls to remedy safety concerns. Product recall costs typically include the cost of the product being replaced, customer cost of the recall and labor to remove and replace the defective part.

 

Recall costs are recorded based on management estimates developed utilizing actuarially established loss projections based on historical claims data. Based on this actuarial estimation methodology, we accrue for expected but unannounced recalls when revenues are recognized upon shipment of product. In addition, we accrue for announced recalls based on our best estimate of our obligation under the recall action when such an obligation is probable and estimable.

 

Valuation Allowances on Deferred Income Tax Assets.   In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. Management considers historical taxable income, projected future taxable income, the expected timing of the reversals of existing temporary differences and tax planning strategies. We determined that we could not conclude that it was more likely than not that the benefits of certain deferred income tax assets would be realized. As such, the valuation allowance we recorded reduced the net carrying value of deferred tax assets to the amount that is more likely than not to be realized. We expect the deferred tax assets, net of the valuation allowance, to be realized as a result of the reversal of existing taxable temporary differences in the United States and as a result of projected future taxable income and the reversal of existing taxable temporary differences in certain foreign jurisdictions.

Environmental.   Governmental regulations relating to the discharge of materials into the environment, or otherwise relating to the protection of the environment, have had, and will continue to have, an effect on our operations. We have made and continue to make expenditures for projects relating to the environment, including pollution control devices for new and existing facilities. We are conducting a number of environmental investigations and remedial actions at current and former locations to comply with applicable requirements and, along with other companies, have been named a potentially responsible party for certain waste management sites.

 

A reserve estimate for each matter is established using standard engineering cost estimating techniques on an undiscounted basis. In the determination of such costs, consideration is given to the professional judgment of our environmental engineers, in consultation with outside environmental specialists, when necessary. At multi-party sites, the reserve estimate also reflects the expected allocation of total project costs among the various potentially responsible parties. Each of the environmental matters is subject to various uncertainties, and some of these matters may be resolved unfavorably to us. We believe that any liability, in excess of amounts accrued in our consolidated financial statements, that may result from the resolution of these matters for which sufficient information is available to support cost estimates, will not have a material adverse affect on our financial position, results of operations or cash flows. However, we cannot predict the effect on our financial position, results of operations or cash flows for aspects of certain matters for which there is insufficient information. In addition, we cannot predict the effect of compliance with environmental laws and regulations with respect to unknown environmental matters.

 

Pensions.   We account for our defined benefit pension plans in accordance with SFAS No. 87, “Employers’ Accounting for Pensions” (“SFAS No. 87”), which requires that amounts recognized in financial statements be determined on an actuarial basis. This determination involves the selection of various assumptions, including an expected rate of return on plan assets and a discount rate.

 

A key assumption in determining our net pension expense in accordance with SFAS No. 87 is the expected long-term rate of return on plan assets. The expected return on plan assets that is included in pension expense is determined by applying the expected long-term rate of return on assets to a calculated market-related value of plan assets, which recognizes changes in the fair value of plan assets in a systematic manner over five years. Asset gains and losses will be amortized over five years in determining the market-related value of assets used to calculate the expected return component of pension income. We review our long-term rate of return assumptions annually through comparison of our historical actual rates of return with our expectations, and consultation with our actuaries and investment advisors regarding their expectations for future returns. While we believe our assumptions of future returns are reasonable and appropriate, significant differences in our actual experience or significant changes in our assumptions may materially affect our pension obligations and our future pension expense. The weighted average expected long-term rate of return on assets used to determine net periodic benefit cost for 2008 was 6.97% as compared to 6.96% for 2007 and 6.97% for 2006.

 

Another key assumption in determining our net pension expense is the assumed discount rate to be used to discount plan liabilities. The discount rate reflects the current rate at which the pension liabilities could be effectively settled. In estimating this rate, we look to rates of return on high quality, fixed-income investments that receive one of the highest ratings given by a recognized ratings agency, and that have cash flows similar to those of the underlying benefit obligation. The weighted average discount rate used to calculate the benefit obligations as of December 31, 2008 was 6.42% as compared to 5.74% as of December 31, 2007. The weighted average discount rate used to determine net periodic benefit cost for 2008 was 5.74% as compared to 5.08% for 2007 and 5.04% for 2006.

 

The Company adopted the measurement date provisions of SFAS No. 158, “Employers’ Accounting for Defined Benefit and Other Postretirement Plans — an amendment of FASB Statements No. 87, 88, 106, and 132(R)” (“SFAS No. 158”), effective January 1, 2008 using the one-measurement approach. As a result, the Company changed the measurement date for its pension and other postretirement plans from October 31 to its year end date of December 31. Under the one-measurement approach, net periodic benefit cost of the Company for the period between October 31, 2007 and December 31, 2008 is being allocated proportionately between amounts recognized as an adjustment of retained earnings at January 1, 2008, and net periodic benefit cost for the year ended December 31, 2008. The Company recorded an adjustment, which increased retained earnings by approximately $3 million, net of tax, in relation to this allocation.

Based on our assumptions as of December 31, 2008, the measurement date, a change in these assumptions, holding all other assumptions constant, would have the following effect on our pension costs and obligations on an annual basis:

 

 

SFAS No. 87 and the policies we have used (most notably the use of a calculated value of plan assets for pensions as described above), generally reduce the volatility of pension expense that would otherwise result from changes in the value of the pension plan assets and pension liability discount rates. A substantial portion of our pension benefits relate to our plans in the United States and the United Kingdom.

 

Our 2009 pension income is estimated to be approximately $9 million in the U.S. and $93 million in the U.K.; our pension expense is estimated to be approximately $38 million for the rest of the world (based on December 31, 2008 exchange rates). During 2008, an executive supplemental retirement plan was amended which will increase future service costs. During 2006, certain amendments reducing future benefits for nonunion participants were adopted that will reduce future service costs. We expect to contribute approximately $42 million to our U.S. pension plans and approximately $43 million to our non-U.S. pension plans in 2009.

 

The U.K. pension plan undergoes triennial actuarial funding valuations. The plan was in a surplus position for funding purposes as of March 31, 2006, the date of the last triennial valuation. The date of the next actuarial funding valuation will be March 31, 2009. Given the recent declines in global financial markets, the funding valuation is likely to result in an overall deficit as of that date. This may result in the need for the Company to enter into discussions on a “deficit recovery plan” with the plan fiduciaries/trustees, with the potential for the Company to be required to commence contributions to the plan. Such discussions, including the finalization of a “deficit recovery plan” would need to be concluded no later than June 30, 2010. In the finalization process, allowances could be made for any changes or recoveries in asset values over the 15 month period following March 31, 2009, as well as future expected investment returns over the full length of the agreed upon recovery plan. Should Company contributions be required, the fiduciaries/trustees would consider the affordability of such contributions to the U.K. business and will make appropriate allowances for this in the formal deficit recovery plan.

 

Other Postretirement Benefits.   We account for our OPEB in accordance with SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions,” (“SFAS No. 106”) which requires that amounts recognized in financial statements be determined on an actuarial basis. This determination involves the selection of various assumptions, including a discount rate and health care cost trend rates used to value benefit obligations. The discount rate reflects the current rate at which the OPEB liabilities could be effectively settled at the end of the year. In estimating this rate, we look to rates of return on high quality, fixed-income investments that receive one of the highest ratings given by a recognized ratings agency and that have cash flows similar to those of the underlying benefit obligation. We develop our estimate of the health care cost trend rates used to value the benefit obligation through review of our recent health care cost trend experience and through discussions with our actuary regarding the experience of similar companies. Changes in the assumed discount rate or health care cost trend rate can have a significant impact on our actuarially determined liability and related OPEB expense.

The following are the significant assumptions used in the measurement of the accumulated projected benefit obligation (“APBO”) as of the measurement date for each year:

 

 

Based on our assumptions as of December 31, 2008, the measurement date, a change in these assumptions, holding all other assumptions constant, would have the following effect on our OPEB expense and obligation on an annual basis:

 

 

Our 2009 OPEB expense is estimated to be approximately $9 million (based on December 31, 2008 exchange rates), and includes the effects of the adoption of certain 2008, 2007 and 2006 amendments which reduce future benefits for participants. We fund our OPEB obligation on a pay-as-you-go basis. We expect to contribute approximately $46 million on a pay-as-you-go basis in 2009.

RESULTS OF OPERATIONS

 

The following consolidated statements of operations compare the results of operations for the years ended December 31, 2008, 2007 and 2006.

 

 

Year Ended December 31, 2008 Compared to Year Ended December 31, 2007

 

Sales for the year ended December 31, 2008 increased by $293 million as compared to the year ended December 31, 2007. Foreign currency exchange had a $730 million net favorable effect on sales due to the relative weakness of the dollar against other currencies (most notably the euro). This was partially offset by lower volume and price reductions provided to customers, together which totaled $437 million. Increased module sales in the current period were more than offset by lower sales of core products in both North America and Europe resulting from reduced light vehicle production volumes.

 

Gross profit for the year ended December 31, 2008 decreased by $190 million as compared to the year ended December 31, 2007. The decrease was driven primarily by lower volume and adverse mix in excess of favorable supplier resolutions that occurred in the prior year, together which net to $281 million. Also contributing to the decline in gross profit were higher engineering expenses, coupled with lower recoveries, totaling $27 million and the net unfavorable impact of foreign currency exchange of $20 million. These unfavorable items were partially offset by cost reductions (in excess of inflation and price reductions provided to customers) and the non-recurrence of certain prior period product-related settlements, together which totaled $82 million. Net insurance recoveries in the current period of $17 million related to a business disruption at our brake line production facility in South America and the non-recurrence of associated costs (net of insurance recoveries) which negatively impacted the

prior period by $6 million also offset the decrease in gross profit, as did a reduction in pension and postretirement benefit expense of $18 million and lower warranty costs of $14 million. Gross profit as a percentage of sales for the year ended December 31, 2008 was 6.8% compared to 8.2% for the year ended December 31, 2007.

 

Administrative and selling expenses for the year ended December 31, 2008 decreased by $14 million as compared to the year ended December 31, 2007. The decrease was driven primarily by cost reductions in excess of inflation and other costs which in total net to $24 million and merger and acquisition activity costs of $9 million in 2007 which did not recur in 2008. These items were partially offset by the unfavorable impact of foreign currency exchange of $19 million. Administrative and selling expenses as a percentage of sales for the year ended December 31, 2008 were 3.5% as compared to 3.7% for the year ended December 31, 2007.

 

Restructuring charges and fixed asset impairments increased by $94 million for the year ended December 31, 2008 compared to the year ended December 31, 2007. The increase was driven primarily by an increased level of restructuring activities of $34 million for severance and other charges related to plant closures and the global workforce reduction, which was offset by net curtailment gains of $11 million as a result of the decrease in pension and retiree medical benefit obligations related to the headcount reductions. Additionally, fixed asset impairments increased by $71 million, primarily due to the impact of declines in general economic and industry conditions.

 

Intangible asset impairments were $329 million for the year ended December 31, 2008. During the fourth quarter of 2008, due to the impact of significant declines in economic and industry conditions, impairment charges of $329 million were recorded as a result of testing the recoverability of our customer relationships.

 

Goodwill impairments were $458 million for the year ended December 31, 2008. On October 31, 2008, the Company performed its annual impairment analysis of goodwill, which resulted in the full impairment of goodwill in three reporting units within its Automotive Components segment.

 

Other income — net decreased by $40 million for the year ended December 31, 2008 compared to the year ended December 31, 2007. This was primarily due to an unfavorable increase in foreign currency exchange losses of $20 million, a decrease in net gains on sales of assets of $15 million, a decrease in royalty and grant income of $5 million, and an unfavorable change to the net provision for bad debts of $8 million. This was offset by an increase in miscellaneous other income of $8 million.

 

Interest expense — net decreased by $46 million for the year ended December 31, 2008 compared to the year ended December 31, 2007, primarily as a result of lower interest rates on variable rate debt and lower interest rates on the New Senior Notes compared to the Old Notes.

 

Loss on retirement of debt was $155 million for the year ended December 31, 2007. During the year ended December 31, 2007, the Company recognized a loss of $148 million in association with payments to note holders who tendered their Old Notes. In addition, in conjunction with the May 9, 2007 refinancing, the Company recognized a loss of $7 million related to the write off of debt issuance costs associated with the former senior secured credit facilities.

 

Income tax expense for the year ended December 31, 2008 was $126 million on a pre-tax loss of $653 million as compared to income tax expense of $155 million on pre-tax earnings of $245 million for the year ended December 31, 2007. Income tax expense for the year ended December 31, 2008 includes a net one time charge of approximately $15 million resulting from changes in determinations relating to the potential realization of deferred tax assets in certain foreign subsidiaries. Income tax expense for the year ended December 31, 2007 includes no tax benefit related to the $155 million loss on retirement of debt due to the Company’s valuation allowance position in the United States. The income tax rate varies from the United States statutory income tax rate due primarily to the items noted above, and the impact of losses in the United States and certain foreign jurisdictions, without recognition of a corresponding income tax benefit, partially offset by favorable foreign tax rates, holidays, and credits.

 

Year Ended December 31, 2007 Compared to Year Ended December 31, 2006

 

Sales increased $1,558 million for the year ended December 31, 2007 as compared to the year ended December 31, 2006. Favorable currency effects contributed to an increase in sales of $856 million, as the dollar weakened against other currencies (most notably the euro). Higher volume (net of price reductions provided to customers) of $702 million also contributed to the sales increase, driven by an expansion in customer vehicle production in Europe and China, an increase in module sales in North America and Asia, and the general growth of safety products in all markets, partially offset by the decline in North American customer vehicle production.

 

Gross profit increased $20 million for the year ended December 31, 2007 as compared to the year ended December 31, 2006. The increase was driven primarily by an increase in volume (net of adverse product mix) and supplier resolutions, together which totaled $120 million, a reduction in pension and postretirement benefit expense of $47 million, net favorable currency effects of $34 million, lower warranty costs of $13 million and other performance improvements. These items were partially offset by price reductions and other costs related to our customers, including the net unfavorable impact of certain product-related settlements, and higher inflation in excess of cost reductions, of $136 million, and a larger investment in engineering expenses of $28 million. Other drivers negatively impacting the gross profit comparison included the favorable resolution of certain business and patent matters of $22 million in 2006 that did not recur in 2007, net costs incurred from property damage at our brake line production facility located in South America of $6 million, and incremental costs related to a first quarter acquisition of $3 million. Gross profit as a percentage of sales for the year ended December 31, 2007 was 8.2% compared to 9.0% for the year ended December 31, 2006.

 

Administrative and selling expenses increased $23 million for the year ended December 31, 2007 as compared to the year ended December 31, 2006. The increase was driven primarily by unfavorable currency effects of $29 million, costs of $9 million related to merger and acquisition activity, an increase in share-based compensation expense of $6 million, and the favorable resolution of certain patent matters of $6 million in 2006 that did not recur in 2007. These items were partially offset by cost reductions, and performance improvements of $22 million, as well as a reduction in pension and postretirement benefit expense of $4 million. Administrative and selling expenses as a

percentage of sales for the year ended December 31, 2007 were 3.7% as compared to 3.9% for the year ended December 31, 2006.

 

Restructuring charges and asset impairments were $51 million for the year ended December 31, 2007 as compared to $30 million for the year ended December 31, 2006. Charges for the year ended December 31, 2007 included $35 million for severance and other costs, $7 million of asset impairments related to restructuring activities and $9 million of other asset impairments. Charges for the year ended December 31, 2006 consisted of $37 million for severance and other costs, $7 million of asset impairments related to restructuring, $6 million of other asset impairments, offset by $20 million of postretirement benefit curtailment gains at closed facilities.

 

Other income — net increased $13 million for the year ended December 31, 2007 as compared to the year ended December 31, 2006. The increase was driven primarily by net gains on the sale of assets of $13 million, a decrease in bad debt expense of $9 million, and an increase in royalty income of $4 million. These items were partially offset by unfavorable currency effects of $11 million.

 

Interest expense — net for the year ended December 31, 2007 decreased $19 million compared to the year ended December 31, 2006. The decrease in interest expense was primarily due to lower interest rates on the New Senior Notes compared to the Old Notes, partially offset by the effect of higher outstanding debt balances on the New Senior Notes, largely as a result of financing the redemption premium relating to the tender transactions in early 2007.

 

Loss on retirement of debt for the year ended December 31, 2007 totaled $155 million as compared to $57 million for the year ended December 31, 2006. During the year ended December 31, 2007, we recognized a loss of $148 million in association with payments to note holders who tendered their Old Notes. In addition, in conjunction with the May 9, 2007 refinancing, we recognized a loss of $7 million related to the write off of debt issuance costs associated with our former revolving facility and our former syndicated term loans. On February 2, 2006 we repurchased all of our subsidiary Lucas Industries Limited’s £94.6 million 10 7 / 8 % bonds due 2020, for £137 million, or approximately $243 million. The repayment of debt resulted in a pretax charge of £32 million, or approximately $57 million, for loss on retirement of debt.

 

Income tax expense for the year ended December 31, 2007 was $155 million on pre-tax income of $245 million as compared to income tax expense of $166 million on pre-tax earnings of $342 million for the year ended December 31, 2006. Income tax expense for the year ended December 31, 2007 includes no tax benefit related to the $155 million loss on retirement of debt due to the Company’s valuation allowance position in the United States. Income tax expense for the year ended December 31, 2006 includes a one-time charge of approximately $49 million resulting from the recognition of a valuation allowance against certain deferred tax assets in our Canadian operations that the Company determined were no longer more likely than not to be realized. Income tax expense for the year ended December 31, 2006 also includes a one-time benefit of approximately $35 million related to the reversal of certain tax reserves recorded in 2004 and 2005 with respect to interest expense in a foreign jurisdiction. The income tax rate varies from the United States statutory income tax rate due primarily to the items noted above, and the impact of losses in the United States and certain foreign jurisdictions, without recognition of a corresponding income tax benefit, partially offset by favorable foreign tax rates, holidays, and credits.

 

 

Sales increased $739 million for the year ended December 31, 2008 as compared to the year ended December 31, 2007. The increase was driven primarily by the favorable impact of foreign currency exchange of $443 million and increased volume (including net favorable price recoveries from customers) of $296 million. The higher volume is attributed primarily to increased module sales in North America and Asia.

 

Earnings before taxes decreased by $102 million for the year ended December 31, 2008 as compared to the year ended December 31, 2007. The decrease was driven mainly by adverse mix in excess of favorable volume of $65 million, which is primarily related to the increase in sales of lower margin modules. Also contributing to the decrease in earnings are increased restructuring and impairment costs of $61 million, the net unfavorable impact of foreign currency exchange of $32 million, and higher engineering expense of $5 million. These unfavorable items were partially offset by cost reductions and net price recoveries from our customers (in excess of inflation) of $27 million and net insurance recoveries in the current period of $17 million related to a business disruption at our brake line production facility in South America and the non-recurrence of associated costs (net of insurance recoveries) which negatively impacted the prior period by $6 million. Other favorable drivers included lower warranty costs of $9 million and a reduction in pension and postretirement benefit expense of $2 million.

For the year ended December 31, 2008, this segment recorded restructuring charges and asset impairments of $91 million in connection with severance, retention and outplacement services at various production facilities, net of curtailment gains, as well as net fixed asset impairment charges to write down certain machinery and equipment to fair value. For the year ended December 31, 2007, this segment recorded restructuring charges and asset impairments of $30 million in connection with severance and costs related to the consolidation of certain facilities, as well as net asset impairment charges to write down certain assets to fair value.

 

 

Sales increased $901 million for the year ended December 31, 2007 as compared to the year ended December 31, 2006. The increase was driven primarily by favorable currency effects of $482 million, as well as favorable volume, including higher module sales in North America and Asia (net of price reductions provided to customers) of $419 million.

 

Earnings before taxes decreased $12 million for the year ended December 31, 2007 as compared to the year ended December 31, 2006. The decrease was driven primarily by higher engineering expenses of $20 million, the favorable resolution of business settlements in 2006 that did not recur in 2007 of $19 million, higher restructuring charges and asset impairments of $16 million, the favorable resolution of certain patent matters of $9 million in 2006 that did not recur in 2007, the net unfavorable impact of property damage at our brakeline production facility in South America of $6 million, a gain of $5 million on the sale of a facility in Asia in 2006 that did not recur in 2007, and incremental costs related to a first quarter 2007 acquisition of $3 million. These items were partially offset by a reduction in pension and postretirement benefit expense of $28 million, favorable volume (net of adverse mix) of $26 million, and lower warranty costs of $14 million.

 

For the year ended December 31, 2007, this segment recorded restructuring charges and asset impairments of $30 million in connection with severance and costs related to the consolidation of certain facilities, as well as net asset impairment charges to write down certain assets to fair value. For the year ended December 31, 2006, this segment recorded restructuring charges and asset impairments of $14 million in connection with severance and costs related to the consolidation of certain facilities, offset by postretirement benefit curtailment gains.

 

 

Sales decreased $292 million for the year ended December 31, 2008 as compared to the year ended December 31, 2007. The decrease was driven primarily by unfavorable volume and price reductions provided to customers of $494 million, partially offset by the favorable impact of foreign currency exchange of $202 million. The decrease in volume is attributed to lower sales in both North America and Europe resulting from reduced light vehicle production volumes.

Earnings before taxes decreased $414 million for the year ended December 31, 2008 as compared to the year ended December 31, 2007. The decrease was driven primarily by increased restructuring and impairment costs of $215 million and lower volume and adverse mix net of favorable supplier resolutions that occurred in the prior period, which combined amounted to $152 million. Also contributing to the decrease in earnings were the net unfavorable impact of foreign currency exchange of $29 million, higher engineering expense coupled with lower recoveries totaling $17 million, the non-recurrence of a $7 million gain on the sale of an idle facility that occurred in the prior period, and price reductions and inflation in excess of cost reductions of $1 million. These items were partially offset by lower warranty costs of $5 million and reduced pension and other postretirement benefit expense of $2 million.

 

For the year ended December 31, 2008, this segment recorded restructuring charges and asset impairments of $219 million, primarily in connection with the impairment of customer relationship intangible assets of $174 million and severance and other costs of $17 million associated with the closure of a facility in Europe. Severance and other costs of $14 million, offset by net curtailment gains of $2 million, and an increase in fixed asset impairments of $12 million, also contributed to the $215 million increase in restructuring and impairment costs. For the year ended December 31, 2007, this segment recorded restructuring charges and asset impairments of $4 million in connection with the write down of certain machinery and equipment to fair value.

 

 

Sales increased $388 million for the year ended December 31, 2007 as compared to the year ended December 31, 2006. The increase was driven primarily by favorable currency effects of $252 million, and favorable volume (net of price reductions provided to customers) of $136 million.

 

Earnings before taxes increased $33 million for the year ended December 31, 2007 as compared to the year ended December 31, 2006. The increase was driven primarily by the favorable impact of volume (net of adverse mix) and favorable supplier resolutions, which together totaled $57 million, a gain on the sale of a facility of $7 million, a reduction in net pension and postretirement benefit expense of $6 million, and lower restructuring and impairment costs of $5 million. These items were partially offset by price reductions to our customers and inflation (net of cost reductions) of $33 million, higher engineering expenses of $8 million, and unfavorable foreign currency exchange of $3 million.

 

For the year ended December 31, 2007, this segment recorded restructuring charges and asset impairments of $4 million in connection with the write down of certain machinery and equipment to fair value. For the year ended December 31, 2006, we recorded restructuring charges and asset impairments of $9 million in connection with severance and costs related to the consolidation of certain facilities.

 

Sales decreased by $154 million for the year ended December 31, 2008 as compared to the year ended December 31, 2007. The decrease was driven primarily by unfavorable volume and price reductions provided to customers of $238 million, partially offset by the favorable impact of foreign currency exchange of $84 million. The decrease in volume is attributed to lower sales of core products in both North America and Europe resulting from reduced light vehicle production volumes.

 

(Losses) earnings before taxes decreased by $674 million for the year ended December 31, 2008 as compared to the year ended December 31, 2007. The decrease was driven primarily by increased restructuring and impairment costs of $604 million, lower volume and adverse mix which totaled $68 million and the non-recurrence of a $10 million gain on the sale of an Engine Components manufacturing facility which occurred in the prior period. These unfavorable items were partially offset by cost reductions (in excess of inflation and price reductions provided to customers) of $4 million and the net favorable impact of foreign currency exchange of $3 million.

 

For the year ended December 31, 2008, this segment recorded restructuring charges and asset impairments of $621 million, primarily in connection with the impairment of goodwill of $458 million, customer relationship intangible assets of $155 million, and increased fixed asset impairments of $1 million. This charge was partially offset by a decrease in severance and other costs of $8 million and recording of net curtailment gains of $2 million. For the year ended December 31, 2007, this segment recorded restructuring charges of $17 million.

 

 

Sales increased $269 million for the year ended December 31, 2007 as compared to the year ended December 31, 2006. The increase was driven primarily by favorable volume (net of price reductions provided to customers) of $148 million and favorable foreign currency exchange of $121 million.

 

Earnings before taxes increased $15 million for the year ended December 31, 2007 as compared to the year ended December 31, 2006. The increase was driven primarily by higher volume (net of adverse mix) of $29 million, the gain on the sale of an Engine Components manufacturing facility of $10 million, the favorable currency effects of $6 million, and other performance improvements. These items were partially offset by price reductions to our customers and inflation (net of cost reductions) of $18 million, higher restructuring charges of $10 million, and higher warranty costs of $2 million.

 

For the year ended December 31, 2007, this segment recorded restructuring charges and asset impairments of $17 million primarily related to severance and other charges at various production facilities. For the year ended December 31, 2006, this segment recorded restructuring charges of $7 million.

 

with its debt covenants throughout 2009. In the event of noncompliance, the Company believes that it will be able to obtain a waiver from the lender group or successfully amend the covenants.

 

Cash Flows

 

Operating Activities.   Cash provided by operating activities for the year ended December 31, 2008, was $773 million, as compared to $737 million for the year ended December 31, 2007. The improvement is primarily the result of:

 

 

Offsetting the improvements noted above was the significant deterioration of our results of operations during the fourth quarter of 2008, primarily as a result of reduced production volumes in North America and Europe.

 

Investing Activities.   Cash used in investing activities for the year ended December 31, 2008 was $507 million as compared to $468 million for the year ended December 31, 2007.

 

For the years ended December 31, 2008 and 2007, we spent $482 million and $513 million, respectively, in capital expenditures, primarily in connection with upgrading existing products, continuing new product launches in 2008 and 2007, and infrastructure and equipment at our facilities to support our manufacturing and cost reduction efforts. We expect to spend approximately $350 million, or approximately 3% of sales, for such capital expenditures during 2009.

 

During 2008, we spent approximately $41 million in conjunction with an acquisition in North America in our Chassis Systems segment. We also spent approximately $6 million on a joint venture in India to facilitate access to the Indian market and support our global customers. We received proceeds from the sale of various assets of $15 million and $39 million for the years ended December 31, 2008 and 2007, respectively.

 

Financing Activities.   Cash used in financing activities was $287 million for the year ended December 31, 2008 as compared to $11 million provided by financing activities for the year ended December 31, 2007. During the year ended December 31, 2008 we redeemed all of the remaining Old Notes in the amount of $20 million and repurchased and retired $12 million in principal amount of the 7% Senior Notes outstanding for $11 million. Additionally, we had net cash repayments of $229 million on our Revolving Credit Facility and a redemption of debt of $68 million.

 

During the year ended December 31, 2007, we repurchased substantially all of our Old Notes for approximately $1,396 million and issued the New Senior Notes for cash proceeds of approximately $1,465 million. Proceeds from the issuance of the New Senior Notes were used to fund the repurchase of the Old Notes and for general corporate purposes. On May 9, 2007, the entire $1.1 billion principal amount of term loans under our Senior Secured Credit Facilities was funded, and we drew down $461 million of the Revolving Credit Facility and used such proceeds, together with approximately $15.6 million of available cash on hand, to refinance $2.5 billion of existing senior secured credit facilities and to pay interest along with certain fees and expenses related to the refinancing. During the year ended December 31, 2007, the amount outstanding under our Revolving Credit Facility increased by $429 million, including the initial draw of $461 million.

 

Debt and Commitments

 

Sources of Liquidity.   Our primary source of liquidity is cash flow generated from operations. We also have availability under our revolving credit facility and receivables facilities described below, subject to certain

conditions. See “— Senior Secured Credit Facilities,” “Off-Balance Sheet Arrangements” and “Other Receivables Facilities” below. Our primary liquidity requirements, which are significant, are expected to be for debt service, working capital, capital expenditures, research and development costs and other general corporate purposes.

 

As of December 31, 2008, we had outstanding $2.9 billion in aggregate indebtedness. We intend to draw down on, and use proceeds from, the Revolving Credit Facility and our United States and European accounts receivables facilities (collectively, the “Liquidity Facilities”) to fund normal working capital needs from month to month in conjunction with available cash on hand. As of December 31, 2008, we had approximately $1.1 billion of availability under our Revolving Credit Facility, after certain reductions primarily consisting of $200 million of revolver borrowings and $58 million in outstanding letters of credit and bank guarantees. The available amount, indicated above, also includes a reduction of $29 million for the unfunded commitment of Lehman Commercial Paper Inc., a lender under the Revolving Credit Facility that filed for bankruptcy protection.

 

Additionally, our primary credit facilities contain certain covenants, including a maximum total leverage ratio and a minimum interest coverage ratio, that would impact our ability to borrow on these facilities if not met. As of December 31, 2008, the Company was in compliance with these financial covenants. These ratios are calculated on a trailing four quarter basis. As a result, a material decline in operating results could negatively impact our ability to comply with these financial covenants in the future.

 

As of December 31, 2008, approximately $110 million of our total reported accounts receivable balance was considered eligible for borrowings under our United States receivables facility, of which approximately $77 million was available for funding. As of December 31, 2008, we had no outstanding borrowings under this receivables facility. The receivables facility is subject to early termination under certain circumstances, including a default ratio of eligible receivables in excess of an established threshold, which could be triggered by the bankruptcy of one or more of our customers that are included in this facility. In addition, as of December 31, 2008, we had approximately €97 million and £25 million available for funding under our European accounts receivables facilities. We had no outstanding borrowings under the European accounts receivables facilities as of December 31, 2008.

 

Under normal working capital utilization of liquidity, portions of the amounts drawn under the Liquidity Facilities typically will be paid back throughout the month as cash from customers is received. We would then draw upon such facilities again for working capital purposes in the same or succeeding months. However, during any given month, upon examination of economic and industry conditions, we may draw fully down on our Liquidity Facilities. On February 13, 2009, the Company drew down additional funds under its Revolving Credit Facility. See Item 9B “Other Information” below for further detail.

 

In addition, we own a 78.4% interest in Dalphi Metal España, S.A. (“Dalphimetal”). Dalphimetal and its subsidiaries have approximately €15 million of uncommitted credit facilities, of which the entire €15 million was available as of December 31, 2008. Our subsidiaries in the Asia Pacific region also have various uncommitted credit facilities totaling approximately $154 million, of which, on December 31, 2008, $115 million was available after borrowings of $39 million. Although these borrowings are primarily in the local currency of the country where our subsidiaries’ operations are located, some are also in U.S. dollars. We expect that these additional facilities will be drawn on from time to time for normal working capital purposes.

 

Debt Repurchases.   On March 26, 2007, we repurchased substantially all of the Old Notes for $1,386 million resulting in a loss on retirement of debt of $147 million. On April 18, 2007, we repurchased additional Old Notes tendered after the consent date, but on or before the tender expiration date, for $10 million and recorded a loss on retirement of debt of $1 million. We funded these repurchases from the March 2007 issuance of the New Senior Notes. On May 9, 2007, we refinanced approximately $1,561 million outstanding under the existing senior secured credit facilities and recorded a loss on retirement of debt of $7 million.

 

On February 15, 2008, we redeemed all the remaining Old Notes in the amount of $20 million and recorded a loss on retirement of debt of $1 million. We funded the redemption of the remaining Old Notes from cash on hand.

 

On March 13, 2008, the Company entered into a transaction to repurchase $12 million in principal amount of the 7% Senior Notes outstanding and recorded a gain on retirement of debt of $1 million. The repurchased notes were retired upon settlement on March 18, 2008.

Credit Ratings.   Set forth below are our credit ratings and ratings outlook for Standard & Poor’s Ratings Services (“S&P”), Moody’s Investors Service (“Moody’s”) and Fitch Ratings (“Fitch”) as of December 31, 2008.

 

 

 

 

In the event of a downgrade, we believe we would continue to have access to sufficient liquidity; however, the cost to increase our borrowing capacity could be higher and our ability to access certain financial markets could be limited.

 

Senior Secured Credit Facilities.   As of December 31, 2008, the term loan facilities, with maturities ranging from 2013 to 2014, consisted of an aggregate of $1.1 billion dollar-denominated term loans and the Revolving Credit Facility provided for borrowing of up to $1.4 billion. See “— Senior Secured Credit Facilities” in Note 13 to the consolidated financial statements included in “Item 8 — Financial Statements and Supplementary Data” for a description of these facilities.

 

Debt Covenants.   The Senior Secured Credit Facilities generally restrict the payment of dividends or other distributions by TRW Automotive, subject to specified exceptions. The exceptions include, among others, the making of payments or distributions in respect of expenses required for us and our wholly-owned subsidiary, TRW Automotive Intermediate Holdings Corp., to maintain our corporate existence, general corporate overhead expenses, tax liabilities and legal and accounting fees. Since we are a holding company without any independent operations, we do not have significant cash obligations, and are able to meet our limited cash obligations under the exceptions to our debt covenants. See Note 13 to the consolidated financial statements included in “Item 8 — Financial Statements and Supplementary Data” for further information on debt covenants.

 

Interest Rate Swap Agreements.   The Company enters into interest rate swap agreements from time to time to hedge either the variability of interest payments associated with variable rate debt or to effectively change fixed rate debt obligations into variable rate obligations. See “— Other Borrowings” in Note 13 to the consolidated financial statements included in “Item 8 — Financial Statements and Supplementary Data” for information on the interest rate swap transactions that occurred during the years ended December 31, 2008 and 2007.

 

Contractual Obligations and Commitments

 

As indicated above, on February 15, 2008, we redeemed all of the remaining Old Notes for $20 million and in March 2008, we repurchased and retired $12 million of the 7% Senior Notes outstanding for $11 million.

The following table reflects our significant contractual obligations as of December 31, 2008:

 

 

 

 

Reasonable estimates cannot be made regarding the period of cash settlement with the applicable taxing authority pertaining to unrecognized tax benefits amounting to $213 million due to a high degree of uncertainty regarding the timing of such future cash outflows.

 

In addition to the obligations discussed above, we sponsor defined benefit pension plans that cover most of our U.S. employees and certain non-U.S. employees. Prior to 2008, our funding practice provided that annual contributions to the pension plans in the U.S. would be equal to the minimum amounts required by the Employee Retirement Income Security Act (“ERISA”). Commencing in 2008, the Company’s pension plans in the U.S. are funded in conformity with the Pension Protection Act of 2006. Funding for our pension plans in other countries is based upon actuarial recommendations or statutory requirements. We expect to contribute approximately $42 million to our U.S. pension plans and approximately $43 million to our non-U.S. pension plans in 2009.

 

The U.K. pension plan undergoes triennial actuarial funding valuations. The plan was in a surplus position for funding purposes as of March 31, 2006, the date of the last triennial valuation. The date of the next actuarial funding valuation will be March 31, 2009. Given the recent declines in global financial markets, the funding valuation is likely to result in an overall deficit as of that date. This may result in the need for the Company to enter into discussions on a “deficit recovery plan” with the plan fiduciaries/trustees, with the potential for the Company to be required to commence contributions to the plan. Such discussions, including the finalization of a “deficit recovery plan” would need to be concluded no later than June 30, 2010. In the finalization process, allowances could be made for any changes or recoveries in asset values over the 15 month period following March 31, 2009, as well as future expected investment returns over the full length of the agreed upon recovery plan. Should Company contributions be required, the fiduciaries/trustees would consider the affordability of such contributions to the U.K. business and could make appropriate allowances for this in the formal deficit recovery plan.

 

We sponsor OPEB plans that cover the majority of our U.S. and certain non-U.S. employees and provide for benefits to eligible employees and dependents upon retirement. We are subject to increased OPEB cash costs due to, among other factors, rising health care costs. We fund our OPEB obligations on a pay-as-you-go basis. We expect to contribute approximately $46 million to our OPEB plans in 2009.

We also have liabilities recorded for various environmental matters. As of December 31, 2008, we had reserves for environmental matters of $45 million. We expect to pay approximately $6 million in 2009 in relation to these matters.

 

In addition to the contractual obligations and commitments noted above, we have contingent obligations in the form of severance and bonus payments for our executive officers. We have no unconditional purchase obligations other than those related to inventory, services, tooling and property, plant and equipment in the ordinary course of business.

 

Other Commitments.   Escalating pricing pressure from customers is characteristic of the automotive parts industry. Virtually all OEMs have policies of seeking price reductions each year. We have taken steps to reduce costs and resist price reductions; however, price reductions have impacted our sales and profit margins. If we are not able to offset continued price reductions through improved operating efficiencies and reduced expenditures, those price reductions may have a material adverse effect on our financial condition, results of operations and cash flows.

 

In addition to pricing concerns, we continue to be approached by our customers for changes in terms and conditions in our contracts concerning warranty and recall participation and payment terms on product shipped. We believe that the likely resolution of these proposed modifications will not have a material adverse effect on our financial condition, results of operations or cash flows.

 

Off-Balance Sheet Arrangements

 

We do not have guarantees related to unconsolidated entities, which have, or are reasonably likely to have, a material current or future effect on our financial position, results of operations or cash flows.

 

We have entered into a receivables facility, which, as amended (the “Receivables Facility”), provides the Company with a flexible source of cost efficient liquidity. The Company periodically uses the Receivables Facility to manage its daily cash requirements. As more fully described below, the Company’s receivables that originate in the United States are used as collateral to support funding from the Receivables Facility.

 

The Receivables Facility extends to December 2009 and provides up to $209 million in funding from commercial paper conduits sponsored by commercial lenders, based on availability of eligible receivables and other customary factors. As of December 31, 2008, based on the terms of the Receivables Facility and certain criteria, approximately $110 million of our reported accounts receivable were considered eligible to support borrowings under the Receivables Facility, of which approximately $77 million was available for funding.

 

The Receivables Facility can be treated as a general financing agreement or as an off-balance sheet financing arrangement. Whether the funding and related receivables are shown as liabilities and assets, respectively, on our consolidated balance sheet, or, conversely, are removed from the consolidated balance sheet depends on the fair value of the multi-seller conduits’ loans to the borrower. When such level is at least 10% of the fair value of all of the borrower’s assets (consisting principally of receivables sold by the sellers), the securitization transactions are accounted for as a sale of the receivables under the provisions of SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” and are removed from the consolidated balance sheet. The proceeds received, net of repayments disbursed, are included in cash flows from operating activities in the statements of cash flows.

 

However, at such time as the fair value of the multi-seller commercial paper conduits’ loans are less than 10% of the fair value of all of the borrower’s assets, we are required to consolidate the borrower, resulting in the funding and related receivables being shown as liabilities and assets, respectively, on our consolidated balance sheet. We had no outstanding borrowings under the Receivables Facility as of December 31, 2008 and December 31, 2007. As such, the fair value of the multi-seller conduits’ loans was less than 10% of the fair value of all of the borrower’s assets and, therefore, the financial statements of the borrower were included in the Company’s consolidated financial statements at December 31, 2008 and December 31, 2007.

Other Receivables Facilities

 

In addition to the Receivables Facility described above, certain of our European subsidiaries entered into receivables financing arrangements. These financing arrangements provide short-term financing to meet our liquidity needs. We have three receivable financing arrangements with our French, German and U.K. subsidiaries with availabilities of up to €80 million, €75 million and £25 million, respectively. Each of these arrangements is available for a term of one year. Each of the German and French arrangements involves a separate wholly-owned special purpose vehicle which purchases trade receivables from its domestic affiliates and sells those trade receivables to a domestic bank. As of December 31, 2008, approximately €97 million and £25 million were available for funding under our European accounts receivable facilities. There were no borrowings under any of these arrangements as of December 31, 2008 and 2007.

 

Environmental Matters

 

Governmental requirements relating to the discharge of materials into the environment, or otherwise relating to the protection of the environment, have had, and will continue to have, an effect on our operations and us. We have made and continue to make expenditures for projects relating to the environment, including pollution control devices for new and existing facilities. We are conducting a number of environmental investigations and remedial actions at current and former locations to comply with applicable requirements and, along with other companies, have been named a potentially responsible party for certain waste management sites. Each of these matters is subject to various uncertainties, and some of these matters may be resolved unfavorably to us.

 

A reserve estimate for each matter is established using standard engineering cost estimating techniques on an undiscounted basis. In the determination of such costs, consideration is given to the professional judgment of our environmental engineers, in consultation with outside environmental specialists, when necessary. At multi-party sites, the reserve estimate also reflects the expected allocation of total project costs among the various potentially responsible parties. As of December 31, 2008, we had reserves for environmental matters of $45 million. In addition, the Company has established a receivable from Northrop for a portion of this environmental liability as a result of the indemnification provided for in the Master Purchase Agreement under which Northrop has agreed to indemnify us for 50% of any environmental liabilities associated with the operation or ownership of Old TRW’s automotive business existing at or prior to the Acquisition, subject to certain exceptions.

 

We do not believe that compliance with environmental protection laws and regulations will have a material effect upon our capital expenditures, results of operations or competitive position. Our capital expenditures for environmental control activities during 2009 are not expected to be material to us. We believe that any liability that may result from the resolution of environmental matters for which sufficient information is available to support cost estimates will not have a material adverse effect on our financial position or results of operations. However, we cannot predict the effect on our financial position of expenditures for aspects of certain matters for which there is insufficient information. In addition, we cannot predict the effect of compliance with environmental laws and regulations with respect to unknown environmental matters on our financial position or results of operations or the possible effect of compliance with environmental requirements imposed in the future.

 

Contingencies

 

Information concerning various claims, lawsuits and administrative proceedings is contained in Note 19 to the consolidated financial statements included in “Item 8 — Financial Statements and Supplementary Data.”

 

Recently Issued Accounting Pronouncements

 

See Note 2 to the consolidated financial statements included in “Item 8 — Financial Statements and Supplementary Data” for a discussion of recently issued accounting pronouncements.

 

Outlook

 

We expect full year 2009 sales to be in the range of $10.9 billion to $11.3 billion, including first quarter sales of approximately $2.4 billion.

The 2009 guidance primarily reflects the steep production declines expected in North America and Europe (our primary markets) and our expectation of foreign currency exchange rate fluctuations. The Company continues to evaluate actions that may be necessary in reaction to the current environment.

 

We are concerned about the ongoing financial health and solvency of our major customers as they address negative economic and industry conditions through various restructuring activities. Such restructuring actions, if significant, could have a negative impact on our financial results. In addition, a prolonged contraction in automotive sales and production would negatively affect our results of operations and liquidity. Notwithstanding recent price declines in certain commodities, given our annual purchases of large quantities of ferrous metals, aluminum, base metals, resins, and textiles for use in our manufacturing process either indirectly as part of purchased components or directly as raw materials, we continue to be exposed to commodity price risk on petroleum-based products, resins, yarns, ferrous metals, base metals, and certain chemicals on a worldwide basis. We are also concerned about the viability of the Tier 2 and Tier 3 supply base as they face these inflationary pressures and other financial difficulties in the current automotive environment, particularly in the event of an extended contraction in automotive sales and production. We expect these trends to continue, further pressuring the Company’s performance in the near future. While we continue our efforts to mitigate the impact of these negative conditions on our financial results, including earnings and cash flows, our efforts may be insufficient and the pressures may worsen, thereby potentially having a negative impact on our future results.

 

Given the nature of our global operations, we maintain an inherent exposure to fluctuations in foreign currency exchange rates. A strengthening of the U.S. dollar against other currencies would have a negative currency translation impact on our results of operations due to our proportional concentration of sales volumes in countries outside the United States. A weakening of mainly the U.S. dollar against the Mexican peso, the Canadian dollar, the Chinese renminbi or the Brazilian real or a weakening of the euro against the British pound, the Polish zloty, or the Czech koruna would, even after hedging, have a negative impact on gross profit and earnings. In addition, while we generally benefit through translation from the weakening of the dollar, over the long term such weakening may have a material adverse affect on the competitiveness of our manufacturing facilities located in countries whose currencies are appreciating against the dollar.

 

Forward-Looking Statements

 

This Report includes “forward-looking statements,” as that term is defined by the federal securities laws. Forward-looking statements include statements concerning our plans, intentions, objectives, goals, strategies, forecasts, future events, future revenue or performance, capital expenditures, financing needs, business trends and other information that is not historical information. When used in this Report, the words “estimates,” “expects,” “anticipates,” “projects,” “plans,” “intends,” “believes,” “forecasts,” and future or conditional verbs, such as “will,” “should,” “could” or “may,” as well as variations of such words or similar expressions are intended to identify forward-looking statements, although not all forward-looking statements are so designated. All forward-looking statements, including, without limitation, management’s examination of historical operating trends and data, are based upon our current expectations and various assumptions, and apply only as of the date of this Report. Our expectations, beliefs and projections are expressed in good faith and we believe there is a reasonable basis for them. However, there can be no assurance that management’s expectations, beliefs and projections will be achieved.

 

There are a number of risks, uncertainties and other important factors that could cause our actual results to differ materially from those suggested by our forward-looking statements, including those set forth in “Item 1A. Risk Factors” in this Report on Form 10-K and in our other filings with the Securities and Exchange Commission. All forward-looking statements are expressly qualified in their entirety by such cautionary statements. We undertake no obligation to update or revise forward-looking statements which have been made to reflect events or circumstances that arise after the date made or to reflect the occurrence of unanticipated events.

 

Our primary market risk arises from fluctuations in foreign currency exchange rates, interest rates and commodity prices. We manage foreign currency exchange rate risk, interest rate risk, and to a lesser extent commodity price risk, by utilizing various derivative instruments and limit the use of such instruments to hedging activities. We do not use such instruments for speculative or trading purposes. If we did not use derivative instruments, our exposure to such risks would be higher. We are exposed to credit loss in the event of nonperformance by the counterparty to the derivative financial instruments. We attempt to limit this exposure by entering into agreements directly with a number of major financial institutions that meet our credit standards and that are expected to fully satisfy their obligations under the contracts.

 

In September 2008, Lehman Brothers Holdings Inc., a guarantor of Lehman Brothers Special Financing Inc. (“LBSF”), the counterparty to several of the Company’s foreign currency forward contracts and interest rate swap contracts, filed for bankruptcy protection. The bankruptcy filing may have limited LBSF’s ability to perform under the terms of the contracts and required that we assume these derivative contracts were ineffective for hedge accounting purposes. As such, the Company terminated all such contracts in September 2008. The impact resulting from accounting for the fair value of these contracts and the cost of terminating these contracts was not considered material.

 

Foreign Currency Exchange Rate Risk.   We utilize derivative financial instruments to manage foreign currency exchange rate risks. Forward contracts, and to a lesser extent options, are utilized to protect our cash flow from adverse movements in exchange rates. Foreign currency exposures are reviewed monthly and any natural offsets are considered prior to entering into a derivative financial instrument. As of December 31, 2008, approximately 17% of our total debt was in foreign currencies as compared to 18% as of December 31, 2007.

 

Interest Rate Risk.   We are subject to interest rate risk in connection with the issuance of variable- and fixed-rate debt. In order to manage interest costs, we may occasionally utilize interest rate swap agreements to exchange fixed- and variable-rate interest payment obligations over the life of the agreements. Our exposure to interest rate risk arises primarily from changes in LIBOR. As of December 31, 2008, approximately 46% of our total debt was at variable interest rates (or 36% when considering the effect of the interest rate swaps), as compared to 49% (or 40% when considering the effect of the interest rate swaps) as of December 31, 2007.

 

Sensitivity Analysis.   We utilize a sensitivity analysis model to calculate the fair value, cash flows or statement of operations impact that a hypothetical 10% change in market rates would have on our debt and derivative instruments. For derivative instruments, we utilized applicable forward rates in effect as of December 31, 2008 to calculate the fair value or cash flow impact resulting from this hypothetical change in market rates. The analyses also do not factor in a potential change in the level of variable rate borrowings or derivative instruments

outstanding that could take place if these hypothetical conditions prevailed. The results of the sensitivity model calculations follow: