"We have returned a total of $483 million, which is 65% more than our 2005 net income."
Driving on
Dear Shareholder,
2005 was a challenging year for the automotive industry. Steel prices skyrocketed and vehicle production declined in Western Europe, our most important market. Several vehicle manufacturers were faced with heavy losses, and some suppliers (as well as Rover) even had to file for bankruptcy.
In this environment Autoliv fared comparably well because our consolidated sales rose by 1% and operating income was maintained despite an increase of about $90 million in raw material prices.
To cope with this tough environment, we continued to restructure our operations and "invested" $16 million more in 2005 than in 2004 in plant consolidations and other restructuring activities. Excluding this additional cost, operating margin improved to 8.5%. Thus continuing the underlying trends from prior years.
Since 2001, sales have jumped by 55% and organic sales (i.e. sales excluding currency effects and acquisitions/divestitures) have increased by 23%. During the same period, net income and earnings per share have tripled, even after adjusting for negative one-time items in 2001.
As in prior years strong cash generation also continued and hit $176 million before financing activities (but after voluntary pension plan contributions of $30 million). This means a free cash flow yield of more than 4% (cash flow relative to Autoliv's average market capitalization during 2005 of $4.1 billion).
All of this cash has been returned to shareholders. In addition, to create value for you and the other Autoliv shareholders, we have taken advantage of Autoliv's strong balance sheet and low borrowing cost to raise dividend payments and increase the level of share repurchases. As a result, we have returned a total of $483 million, which is 65% more than our 2005 net income.
Strategies for the future
Customer Mix
Over the past five years we have invested aggressively in Asia. With these investments, our market share in Japan has grown to nearly 20% and to even higher market shares in Korea and China. Equally important is the superior global customer mix that we have attained through this expansion (see graph). Many Asian vehicle manufacturers have set up production in North America and Europe and now take market share from our traditional customers. For continued success, it is therefore crucial that we have strengthened our presence in Asia and among the Asian vehicle manufacturers.
Market Mix
Our investments in Asia and Eastern Europe are also important because the Rest of the World region already produces more vehicles than any other region. In addition, the RoW vehicle production is expected to grow by 8-10% per year.
The average safety content in these vehicles is still much lower than in vehicles in our traditional markets. But increasingly these vehicles will be equipped with improved seatbelts, frontal airbags and even side airbags. As a consequence, the automotive safety market is expanding faster in these markets than in our traditional markets. Thanks to Autoliv's strong position in these regions, we will benefit from this trend.
However, this shift in mix will also slow down the growth in the average safety content per vehicle as more low-end cars will be produced globally for the emerging markets and relatively fewer premium vehicles for the established markets in Western Europe and the U.S. In parallel, we expect prices for safety products to continue to decline, partially as a result of the scramble for production capability in low-cost countries, which reflects the current trend in our industry as well as many others.
Cost Reductions
Our strategy to move production to low-cost countries has been pivotal in offsetting the pricing pressure from customers. In 2005, we decided to move our British airbag assembly primarily to Turkey and most of our Australian seatbelt and webbing production to China. In addition, we closed one plant in France.
We now have 40% of headcount in low-cost countries, compared to 35% a year ago and less than 10% in 1999 when the focus on production reallocation was initiated (see graph).
R,D&E Investments
In line with our strategy, we continued to invest in R,D&E. In 2005, these expenditures, net, rose by 5% and amounted to 6.2% of sales.
We launched the world's first curtain airbag for convertible vehicles and Autoliv's night vision system (see pages 4 and 15). We also introduced an "active hood" that protects pedestrians.
In addition, we entered into a cooperation agreement with Magneti Marelli for emergency call systems and other telematics systems.
Market Growth
Last year, we continued to expand our manufacturing capacity, mainly for side airbags. We expect a particularly strong demand for the Inflatable Curtain.
In 2004, the U.S. government proposed new regulations that could, in effect, mandate such curtain airbags on all new vehicles by 2011. As a result, we expect sales for this product to continue to grow during the rest of this decade.
Plans for 2006
In 2006, we expect to strengthen our superior presence in the Asian markets. We are currently building three new plants in China for steering wheels, electronics and gas generators.
We are committed to continuing consolidating our supplier base. As existing long-term contracts expire, we will gradually reduce the number of suppliers from over 2,000 to around 500. The move of our production to low-cost countries will continue, but the greatest cost-savings potential could be realized by purchasing more of the components we need in low-cost countries. Before the end of this decade, we intend to source 50% of our purchase cost in these countries compared to our current level of "only" 20% and less than 15% a year ago.
Outlook
During the first quarter, light vehicle production in the Triad is expected to increase by 2%. However, light vehicle production in Western Europe is expected to decline by 1% with a significant negative model mix effect for us. Currency effects are expected to reduce our sales by 5%. Consequently, sales are expected to decline by 8%. Despite this decline, operating margin is expected to improve from the 7.6% level recorded in the first quarter 2005, and operating income is expected to exceed the $129 million recorded in the same quarter 2005.
During the full year 2006, light vehicle production in the Triad is expected to increase by 1% despite a 2% decline in Western Europe with a negative vehicle model mix. The decline in our sales in the first quarter is expected to diminish already in the second quarter, and during the fall sales are expected to start to pick up gradually with a positive momentum into 2007. As a result, we expect organic sales for 2006 to be relatively flat.
Interest expense, net should be favorably impacted by the Jobs Act transaction in 2005 and by Autoliv's Eurobond coming to maturity in May 2006. These transactions could potentially reduce interest expense in 2006 by approximately $15 million, given current exchange rate and interest rate differences in Sweden and the U.S. However, this favorable effect may be offset by higher market interest rates and a higher average net debt due to the share repurchases. Consequently, we expect a healthy growth in earnings per share despite a challenging vehicle production.
Lars Westerberg
higher leverage
To take advantage of Autoliv's strong balance sheet and low borrowing cost, we increased our leveraged position during 2005.
Headcount allocation
Total headcount has increased by 37% since 2001 to nearly 39,000 compared to sales that have increased by 55% during the same period. Headcount in high-cost countries has been reduced to 60% of total headcount from 75% in 2001.
Sales mix
The rapidly-growing markets in the Rest of the World (RoW) (i.e. mainly Asia, excluding Japan) accounted for 11% of revenues compared to 5% in 2001. Autoliv's dependence on the "Big 3" in North America (GM, Ford and Chrysler) has declined from 24% to 15% of sales during the same period.