UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

FORM 10-K

(Mark One)

 

x

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2006, or

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                   to                  

 

Commission file number 1-15827

 

VISTEON CORPORATION

(Exact name of Registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code: (800)-VISTEON

 

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

 

 

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes   ü    No     

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.

Yes       No   ü  

 

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   ü    No     

 

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.   ü  

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Act.

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes       No   ü  

 

The aggregate market value of the registrant’s voting and non-voting common equity held by non-affiliates of the registrant on June 30, 2006 (the last business day of the most recently completed second fiscal quarter) was approximately $923 million.

 

As of February 23, 2007, the registrant had outstanding 129,013,936 shares of common stock.

 

Document Incorporated by Reference*

* As stated under various Items of this Report, only certain specified portions of such document are incorporated by reference in this Report.

 

 

 

INDEX

 

 

The Company’s Business

 

Visteon Corporation (“Visteon” or the “Company”) is a leading global supplier of automotive systems, modules and components to global vehicle manufacturers and the automotive aftermarket. The Company is headquartered in Van Buren Township, Michigan, with regional headquarters in Kerpen, Germany and Shanghai, China. The Company has a workforce of approximately 45,000 employees and a network of manufacturing sites, technical centers, sales offices and joint ventures located in every major geographic region of the world.

 

The Company was incorporated in Delaware in January 2000 as a wholly-owned subsidiary of Ford Motor Company (“Ford” or “Ford Motor Company”). Subsequently, Ford transferred the assets and liabilities comprising its automotive components and systems business to Visteon. The Company separated from Ford on June 28, 2000 when all of the Company’s common stock was distributed by Ford to its shareholders.

 

In September 2005, the Company transferred 23 of its North American facilities and certain other related assets and liabilities (the “Business”) to Automotive Components Holdings, LLC (“ACH”), an indirect, wholly-owned subsidiary of the Company and its subsidiaries. On October 1, 2005, the Company sold to Ford all of the capital stock of the parent company of ACH in exchange for Ford’s payment to the Company of approximately $300 million, as well as the forgiveness of certain other postretirement employee benefit liabilities and other obligations relating to hourly employees associated with the Business and the assumption of certain other liabilities (together, the “ACH Transactions”). The transferred facilities included all of the Company’s plants that leased hourly workers covered by Ford’s Master Agreement with the UAW. The Business accounted for approximately $6.1 billion of the Company’s total product sales for 2005, the majority being products sold to Ford.

 

The Company’s Industry

 

The Company supplies a range of integrated systems, modules and components to vehicle manufacturers for use in the manufacture of new vehicles, as well as to the aftermarket for use as replacement and enhancement parts. Historically, large vehicle manufacturers operated internal divisions to provide a wide range of component parts for their vehicles. Vehicle manufacturers have moved toward a competitive sourcing process for automotive parts, including increased purchases from independent suppliers, as they seek lower-priced and/or higher-technology products. Additional significant factors and trends in the automotive industry include:

 

 

 

 

The Company’s Business Strategy

 

By leveraging the Company’s extensive experience, innovative technology and geographic strengths, the Company aims to grow leading positions in its key climate, interiors and electronics product groups and to improve overall margins, long-term operating profitability and cash flows. To achieve these goals and respond to industry factors and trends, the Company is working to improve its operations, restructure its business and achieve profitable growth.

 

Improve Operations

 

 

Restructure the Business

 

 

 

Achieve Profitable Growth

 

 

 

 

Financial Information about Segments

 

In late 2005, the Company announced a new operating structure to manage the business following the ACH Transactions. This operating structure is comprised of the following global product groups: Climate, Electronics, Interiors and Other. Additionally, the Company established and commenced operations of Visteon Services, a centralized administrative function to monitor and facilitate transactions with ACH for the costs of leased employees and other services provided to ACH by the Company. In 2006, the Company completed the process of realigning systems and reporting structures to facilitate financial reporting under the revised organizational structure. Accordingly, segment disclosures have been updated to reflect the current operating structure and comparable prior period segment data has been revised.

 

Further information relating to the Company’s reportable segments can be found in Item 8, “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K (Note 20, “Segment Information,” to the Company’s consolidated financial statements).

 

The Company’s Products

 

The following discussion describes the major product lines within each of the Company’s segments that the Company produces or offers as of the date of this report.

 

Electronics Products & Systems

 

The Company is one of the leading global suppliers of advanced in-vehicle entertainment, driver information, wireless communication, safety and security electronics technologies and products.

 

 

Climate Control Products & Systems

 

The Company is one of the leading global suppliers in the design and manufacturing of components, modules and systems that provide automotive heating, ventilation and air conditioning and powertrain cooling.

 

 

Interior Products & Systems

 

The Company is one of the leading global suppliers of cockpit modules, instrument panels, door and console modules and interior trim components.

 

 

Other Products & Systems

 

The Company designs and manufactures an array of chassis-related products, from driveline systems for popular all-wheel drive vehicles to steering and suspension systems, as well as powertrain products and systems, which are designed to provide the automotive customer with solutions that enhance powertrain performance, fuel economy and emissions control.

 

The Company’s Customers

 

The Company sells its products primarily to global vehicle manufacturers as well as to other suppliers and assemblers. In addition, it sells products for use as aftermarket and service parts to automotive original equipment manufacturers and others for resale through their own independent distribution networks. The Company records revenue when persuasive evidence of an arrangement exists, delivery occurs or services are rendered, the sales price or fee is fixed or determinable and collectibility is reasonably assured.

 

Vehicle Manufacturers

 

The Company sells to all of the world’s largest vehicle manufacturers including BMW, DaimlerChrysler, Ford, General Motors, Honda, Hyundai/Kia, Mazda, Nissan, Peugeot, Renault, Toyota, and Volkswagen. Ford is the Company’s largest customer, and product sales to Ford, including those sales to Auto Alliance International, a joint venture between Ford and Mazda, accounted for approximately 45% of 2006 total product sales. In addition, product sales to Hyundai/Kia accounted for approximately 12% of 2006 total product sales, primarily concentrated in the Company’s Climate product group. Sales to customers other than Ford include sales to Mazda, of which Ford holds a 33.4% equity interest.

 

Price reductions are typically negotiated on an annual basis between suppliers and vehicle manufacturers. Such reductions are intended to take into account expected annual reductions in the overall cost to the supplier of providing products and services to the customer, through such factors as overall increases in manufacturing productivity, material cost reductions, and design-related cost improvements. The Company has agreed to provide specific average price reductions to its largest customer, Ford, for most North America sales through 2008. The Company has an aggressive cost reduction program that focuses on reducing its total costs, which are intended to offset customer price reductions. However, there can be no assurance that such cost reduction efforts will be sufficient to do so, especially considering recent increases in the costs of certain commodities used in the manufacture of the Company’s products. The Company records such price reductions when specific facts and circumstances indicate that a price reduction is probable and the amounts are reasonably estimable.

 

Other Customers

 

The Company sells products to various customers in the worldwide aftermarket as replacement or enhancement parts, such as body appearance packages and in-car entertainment systems, for current production and older vehicles. The Company’s service revenues relate to the supply of leased personnel and transition services to ACH in connection with various agreements pursuant to the ACH Transactions.

 

The Company’s Competition

 

The Company conducts its business in a complex and highly competitive industry. The global automotive parts industry principally involves the supply of systems, modules and components to vehicle manufacturers for the manufacture of new vehicles. Additionally, suppliers provide components to other suppliers for use in their product offerings and to the aftermarket for use as replacement or enhancement parts. As the supplier industry consolidates, the number of competitors decreases fostering extremely competitive conditions. Vehicle manufacturers rigorously evaluate suppliers on the basis of product quality, price competitiveness, technical expertise and development capability, new product innovation, reliability and timeliness of delivery, product design and manufacturing capability and flexibility, customer service and overall management.

 

A summary of the Company’s primary independent competitors is provided below.

 

Electronics — The Company’s principal competitors in the Electronics segment included the following: Robert Bosch GmbH; Delphi Corporation; Denso Corporation; Hella KGaA; Koito Manufacturing Co., Ltd (North American Lighting); Matsushita Electric Industrial Co., Ltd. (Panasonic); and Siemens VDO Automotive AG.

 

Climate — The Company’s principal competitors in the Climate segment included the following: Behr GmbH & Co. KG; Delphi Corporation; Denso Corporation; and Valéo S.A.

 

Interiors — The Company’s principal competitors in the Interiors segment included the following: Faurecia Group; Johnson Controls, Inc.; Lear Corporation; Magna International Inc.; International Automotive Components Group; and Delphi Corporation.

 

Other — The Company’s principal competitors in the Other segment included the following: American Axle & Manufacturing Holdings, Inc; Robert Bosch GmbH; Dana Corporation; Delphi Corporation; Denso Corporation; Magna International Inc.; Siemens VDO Automotive AG; TRW Automotive Holdings Corp.; Valéo S.A.; GKN Plc.; JTEKT Corporation; ZF Friedrichshafen AG; NTN Corporation; Kautex Textron GmbH&Co KG; Inergy Automotive Systems; and TI Automotive.

 

The Company’s Product Sales Backlog

 

Anticipated net product sales for 2007 through 2009 from new and replacement programs, less net sales from phased-out and canceled programs are approximately $1 billion. The Company’s estimate of anticipated net sales may be impacted by various assumptions, including vehicle production levels on new and replacement programs, customer price reductions, foreign exchange rates and the timing of program launches. In addition, the Company typically enters into agreements with its customers at the beginning of a vehicle’s life for the fulfillment of a customers’ purchasing requirements for the entire production life of the vehicle. Although instances of early termination have historically been rare, these agreements generally may be terminated by customers at any time. Therefore, this anticipated net sales information does not represent firm orders or firm commitments.

 

The Company’s International Operations

 

Financial information about sales and net property by major geographic region can be found in Note 20, “Segment Information,” to the Company’s consolidated financial statements included in Item 8 of this Annual Report on Form 10-K. The attendant risks of the Company’s international operations are primarily related to currency fluctuations, changes in local economic and political conditions, and changes in laws and regulations. The following table sets forth the Company’s net sales and net property and equipment by geographic region as a percentage of total consolidated net sales and total consolidated net property and equipment, respectively:

 

 

Seasonality of the Company’s Business

 

The Company’s business is moderately seasonal because its largest North American customers typically halt operations for approximately two weeks in July for model year changeovers and approximately one week in December during the winter holidays. Customers in Europe historically shut down vehicle production during a portion of August and one week in December. In addition, third quarter automotive production traditionally is lower as new vehicle models enter production. Accordingly, the Company’s third and fourth quarter results may reflect these trends. Refer to Note 21, “Summary Quarterly Financial Data” to the Company’s consolidated financial statements included in Item 8 of this Annual Report on Form 10-K.

 

The Company’s Workforce and Employee Relations

 

The Company’s workforce as of December 31, 2006 included approximately 45,000 persons, of which approximately 16,000 were salaried employees and 29,000 were hourly workers. As of December 31, 2006, the Company leased approximately 2,800 employees to ACH under the terms of the Salaried Employee Lease Agreement.

 

A substantial number of the Company’s hourly workforce in the U.S. are represented by unions and operate under collective bargaining agreements. In connection with the ACH Transactions, the Company terminated its lease from Ford of its UAW Master Agreement hourly workforce. Many of the Company’s European and Mexican employees are members of industrial trade unions and confederations within their respective countries. Many of these organizations operate under collectively bargained contracts that are not specific to any one employer. The Company constantly works to establish and maintain positive, cooperative relations with its unions around the world and believes that its relationships with unionized employees are satisfactory. There have been no significant work stoppages in the past five years, except for a brief work stoppage by employees represented by the IUE-CWA Local 907 at a manufacturing facility located in Bedford, Indiana during June 2004.

 

The Company’s Product Research and Development

 

The Company’s research and development efforts are intended to maintain leadership positions in core product lines and provide the Company with a competitive edge as it seeks additional business with new and existing customers. Total research and development expenditures were approximately $594 million in 2006, decreasing from $804 million in 2005 and $896 million in 2004 due to the ACH Transactions. The Company also works with technology development partners, including customers, to develop technological capabilities and new products and applications.

 

The Company’s Intellectual Property

 

The Company owns significant intellectual property, including a large number of patents, copyrights, proprietary tools and technologies and trade secrets and is involved in numerous licensing arrangements. Although the Company’s intellectual property plays an important role in maintaining its competitive position, no single patent, copyright, proprietary tool or technology, trade secret or license, or group of related patents, copyrights, proprietary tools or technologies, trade secrets or licenses is, in the opinion of management, of such value to the Company that its business would be materially affected by the expiration or termination thereof. The Company’s general policy is to apply for patents on an ongoing basis, in appropriate countries, on its patentable developments which are considered to have commercial significance.

 

The Company also views its name and mark as significant to its business as a whole. In addition, the Company holds rights in a number of other trade names and marks applicable to certain of its businesses and products that it views as important to such businesses and products.

 

The Company’s Raw Materials and Suppliers

 

Raw materials used by the Company in the manufacture of its products primarily include steel, aluminum, resins, precious metals, urethane chemicals and electronics components. All of the materials used are generally available from numerous sources. However, the automotive supply industry has experienced significant inflationary pressures, which have placed significant operational and financial burdens on suppliers at all levels and has adversely impacted their financial condition.

 

Although the Company does not anticipate significant interruption in the supply of raw materials, the cost of ensuring the continued supply of certain raw materials, in particular steel, aluminum and resins, has increased significantly. This increase has had an adverse impact on the Company’s results of operations and will continue to adversely affect results of operations unless the Company’s customers share in these increased costs. To date, the Company has not been able to fully recover increased raw material costs from all of its customers, and the Company cannot provide assurance that it will be able to recover those costs in the future.

 

Impact of Environmental Regulations on the Company

 

The Company is subject to the requirements of federal, state, local and foreign environmental and occupational safety and health laws and regulations. These include laws regulating air emissions, water discharge and waste management. The Company is also subject to environmental laws requiring the investigation and cleanup of environmental contamination at properties it presently owns or operates and at third-party disposal or treatment facilities to which these sites send or arranged to send hazardous waste.

 

At the time of spin-off, the Company and Ford agreed on a division of liability for, and responsibility for management and remediation of environmental claims existing at that time and, further, that the Company would assume all liabilities for existing and future claims relating to sites that were transferred to it and its operation of those sites, including off-site disposal, except as otherwise specifically retained by Ford in the Master Transfer Agreement. In connection with the ACH Transactions, Ford agreed to re-assume these liabilities to the extent they arise from the ownership or operation prior to the spin-off of the locations transferred to ACH (excluding any increase in costs attributable to the exacerbation of such liability by the Company or its affiliates).

 

The Company is aware of contamination at some of its properties and relating to various third-party Superfund sites at which the Company or its predecessor has been named as a potentially responsible party. It is in various stages of investigation and cleanup at these sites. At December 31, 2006, the Company had recorded a reserve of approximately $9 million for this environmental investigation and cleanup. However, estimating liabilities for environmental investigation and cleanup is complex and dependent upon a number of factors beyond the Company’s control and which may change dramatically. Accordingly, although the Company believes its reserve is adequate based on current information, the Company cannot provide any assurance that its ultimate environmental investigation and cleanup costs and liabilities will not exceed the amount of its current reserve.

 

During 2006, the Company did not make any material capital expenditures relating to environmental compliance.

 

The Company’s Website and Access to Available Information

 

The Company’s current and periodic reports filed with the Securities and Exchange Commission, including amendments to those reports, may be obtained through its internet website at www.visteon.com free of charge as soon as reasonably practicable after the Company files these reports with the SEC. A copy of the Company’s code of business conduct and ethics for directors, officers and employees of Visteon and its subsidiaries, entitled “Ethics and Integrity Policy,” the Corporate Governance Guidelines adopted by the Company’s Board of Directors and the charters of each committee of the Board of Directors are also available on the Company’s website. A printed copy of the foregoing documents may be requested by contacting the Company’s Shareholder Relations department in writing at One Village Center Drive, Van Buren Township, MI 48111; by phone (877) 367-6092; or via email at vcstock@visteon.com.

 

The risks and uncertainties described below are not the only ones facing the Company. Additional risks and uncertainties, including those not presently known or that the Company believes to be immaterial, also may adversely affect the Company’s results of operations and financial condition. Should any such risks and uncertainties develop into actual events, these developments could have material adverse effects on the Company’s business and financial results.

 

A decline in automotive sales could reduce the Company’s sales and harm its operations.

 

Demand for the Company’s products is directly related to automotive vehicle production. Automotive sales and production can be affected by general economic conditions, such as employment levels and trends, fuel prices and interest rates, labor relations issues, regulatory requirements, trade agreements and other factors. Automotive industry conditions in North America and Europe continue to be challenging. In North America, the domestic automotive industry is characterized by significant overcapacity, fierce competition, high fixed cost structures and significant employee pension and health care obligations for the domestic automakers. Domestic automakers continue to report market share loss to other vehicle manufacturers resulting in lower annual production volumes and the need to further address their production capacity and cost structure. Any decline in automotive production levels of its current and future customers could reduce the Company’s sales and harm its results of operations and financial condition.

 

Further, certain automakers, particularly in North America and Europe, report significant financial challenges due to the factors described above. These automakers continue to implement actions to further reduce capacity and streamline their cost structure while at the same time investing in new technologies and vehicle platforms. In the United States, DaimlerChrysler Corporation, Ford Motor Company, and General Motors Corporation have announced restructuring plans aimed at realigning their cost structure in light of current and projected market share and production volumes for the North American market. A significant element of these cost reduction actions includes closing factories, reducing the number of production shifts at open factories and the negotiation with and participation of the respective unionized workforces in addressing legacy costs related to health care, pensions, wages and other employee benefits. The results and effects of these actions and related negotiations are uncertain and, accordingly, could have a material adverse affect on the Company’s results of operations and financial condition.

 

The Company is highly dependent on Ford. Ford is currently undergoing a restructuring plan and further decreases in Ford’s vehicle production volume would adversely affect the Company’s results.

 

Ford is the Company’s largest customer and accounted for approximately 45% of total product sales in 2006, 62% of total product sales in 2005 and 70% of total product sales in 2004. The Company has made significant progress in diversifying its customer base with other automakers and reducing its sales concentration with Ford as a result of the completion of the ACH Transactions in 2005. Ford will continue to be the Company’s largest customer for the foreseeable future. Further, Ford has recently announced a restructuring plan and may ultimately restructure its operations in a way that could be adverse to the Company’s interests. As in the past, any change in Ford’s vehicle production volume will have a significant impact on the Company’s sales volume and restructuring efforts.

 

The Company currently leases approximately 2,800 salaried employees to ACH, a company controlled by Ford, and has an agreement with Ford to reimburse the Company for up to $150 million of the costs related to separating any of the leased employees should they be returned to the Company for any reason. In the event that Ford is unable or unwilling to fulfill its obligations under this agreement, the Company could be adversely affected.

 

The discontinuation of, the loss of business with respect to, or a lack of commercial success of a particular vehicle model for which the Company is a significant supplier could affect our estimates of anticipated net sales.

 

Although the Company has purchase orders from many of its customers, these purchase orders generally provide for the supply of a customer’s annual requirements for a particular model and assembly plant and are renewable on a year-to-year basis, rather than for the purchase of a specific quantity of products. Therefore, the discontinuation, loss of business with respect to, or a lack of commercial success, of a particular vehicle model for which the Company is a significant supplier could reduce the Company’s sales and affect its estimates of anticipated net sales.

 

Escalating pricing pressures from the Company’s customers may adversely affect the Company’s business.

 

Downward pricing pressures by automotive manufacturers has been a characteristic of the automotive industry in recent years. Virtually all automakers have aggressive price reduction initiatives and objectives each year with their suppliers, and such actions are expected to continue in the future. Accordingly, suppliers must be able to reduce their operating costs in order to maintain profitability. The Company has taken steps to reduce its operating costs to offset customer price reductions, in addition to other actions designed to resist such reductions; however, price reductions have impacted the Company’s sales and profit margins and are expected to do so in the future. If the Company is unable to offset customer price reductions in the future through improved operating efficiencies, new manufacturing processes, sourcing alternatives and other cost reduction initiatives, the Company’s results of operations and financial condition would be adversely affected.

 

The automotive supplier environment in which the Company operates continues to evolve and be uncertain.

 

In recent years, the competitive environment among suppliers to the global automotive manufacturers has changed significantly as these manufacturers have sought to outsource more vehicular components, modules and systems. In addition, the number of suppliers worldwide has been declining due to continued consolidation. In the United States, declining sales volumes of certain domestic automakers combined with high raw material and labor costs has adversely impacted the financial condition of several domestic automotive suppliers, including resulting in several significant supplier bankruptcies. The Company expects to respond to these developments by continuing to diversify its customer base through the continued development of innovative products at competitive prices as well as through strategic alliances, joint ventures, acquisitions and divestitures. However, there is no assurance that the Company’s efforts will be successful or that competitors with lower cost structures and better access to liquidity sources will not significantly impact the Company’s business, results of operations and financial condition.

 

Severe inflationary pressures impacting ferrous and non-ferrous metals and petroleum-based commodities may adversely affect the Company’s profitability and the profitability of the Company’s Tier 2 and Tier 3 supply base.

 

The automotive supply industry has experienced significant inflationary pressures, primarily in ferrous and non-ferrous metals and petroleum-based commodities, such as resins. These inflationary pressures have placed significant operational and financial burdens on automotive suppliers at all levels, and are expected to continue for the foreseeable future. Generally, it has been difficult to pass on, in total, the increased costs of raw materials and components used in the manufacture of the Company’s products to its customers. In addition, the Company’s need to maintain a continued supply of raw materials and/or components has made it difficult to resist price increases and surcharges imposed by its suppliers.

 

Further, this inflationary pressure, combined with other factors, has adversely impacted the financial condition of several domestic automotive suppliers, including resulting in several significant supplier bankruptcies. Because the Company purchases various types of equipment, raw materials and component parts from suppliers, it may be materially and adversely affected by the failure of those suppliers to perform as expected. This non-performance may consist of delivery delays, failures caused by production issues or delivery of non-conforming products, or supplier insolvency or bankruptcy. Consequently, the Company’s efforts to continue to mitigate the effects of these inflationary pressures may be insufficient if conditions were to worsen, resulting in a negative impact on the Company’s financial results.

 

The Company could be adversely affected by shortages of components from suppliers.

 

In an effort to manage and reduce the costs of purchased goods and services, the Company, like many suppliers and automakers, has been consolidating its supply base. As a result, the Company is dependent on single or limited sources of supply for certain components used in the manufacture of its products. The Company selects its suppliers based on total value (including price, delivery and quality), taking into consideration their production capacities and financial condition. However, there can be no assurance that strong demand, capacity limitations or other problems experienced by the Company’s suppliers will not result in occasional shortages or delays in their supply of components. If the Company was to experience a significant or prolonged shortage of critical components from any of its suppliers, particularly those who are sole sources, and could not procure the components from other sources, the Company would be unable to meet its production schedules for some of its key products and to ship such products to its customers in timely fashion, which would adversely affect sales, margins and customer relations.

 

Work stoppages or similar difficulties could significantly disrupt the Company’s operations.

 

A work stoppage at one or more of the Company’s manufacturing and assembly facilities could have material adverse effects on the business. Also, if one or more of the Company’s customers were to experience a work stoppage, that customer would likely halt or limit purchases of the Company’s products which could result in the shut down of the related manufacturing facilities. Further, because the automotive industry relies heavily on just-in-time delivery of components during the assembly and manufacture of vehicles, a significant disruption in the supply of a key component due to a work stoppage at one of the Company’s suppliers or any other supplier could have the same consequences, and accordingly, have a material adverse effect on the Company’s financial results.

 

The Company has a history of significant losses; the Company is in the process of implementing a multi-year improvement plan but may be unable to successfully improve its performance or attain profitability.

 

The Company incurred net losses of $163 million, $270 million and $1,536 million for 2006, 2005 and 2004, respectively. The Company’s ability to improve its financial performance and return to profitability is dependent on its ability to implement its multi-year improvement plan, and realize the benefits of such plan. The Company expects to fund the majority of the cash restructuring costs contemplated by its multi-year plan with reimbursements from the $400 million escrow account established by Ford upon the completion of the ACH Transactions. However, it is possible that actual cash restructuring costs could vary significantly from the Company’s initial projections as the plan progresses, which could result in unexpected costs in future periods that may be in excess of amounts available from the escrow account resulting in an adverse impact on the Company’s financial results. Further, the Company cannot provide assurances that it will realize the expected benefits in the time periods projected, or at all, from its restructuring actions, or that such actions will improve its financial performance or return the Company to profitability in the near term or at all. In addition, a majority of the Company’s hourly workforce is unionized. Labor contracts with these unions can significantly restrict the Company’s ability to restructure or close plants and divest unprofitable, noncompetitive businesses as well as limit its ability to change local work rules and practices at a number of the Company’s facilities, constraining the implementation of cost-saving measures. These restrictions and limitations could have adverse effects on the Company’s results of operations and competitive position and could slow or alter the Company’s improvement plans.

 

Moreover, the Company recorded asset impairment charges of $22 million, $1,511 million and $314 million in 2006, 2005 and 2004, respectively, to adjust the carrying value of certain assets to their estimated fair value. Additional asset impairment charges in the future may result in the event that the Company does not achieve its internal financial plans, and such charges could materially affect the Company’s results of operations and financial condition in the period(s) recognized. In addition, the Company cannot provide assurance that it will be able to recover its remaining net deferred tax assets which is dependent upon achieving future taxable income in certain foreign jurisdictions. Failure to achieve its taxable income targets may change the Company’s assessment of the recoverability of its remaining net deferred tax assets and would likely result in an increase in the valuation allowance in the applicable period. Any increase in the valuation allowance would result in additional income tax expense, would reduce stockholders’ equity and could have a significant impact on the Company’s earnings going forward.

 

Sources of financing may not be available to the Company in the amount or terms required.

 

The Company’s business is highly dependent upon the ability to access the credit and capital markets. Access to, and the costs of borrowing in, these markets depend in part on the Company’s credit ratings, which are currently below investment grade. There can be no assurance that the Company’s credit ratings will not decline further in the future. Further downgrades of these ratings would increase the Company’s costs of borrowing and could imperil its liquidity.

 

The Company’s working capital requirements and cash provided by operating activities can vary greatly from quarter to quarter and from year to year, depending in part on the level, variability and timing of its customers’ worldwide vehicle production and the payment terms with the Company’s customers and suppliers. The Company cannot provide assurance that it will be able to satisfy its capital expenditure requirements during 2007 or subsequent years, or during any particular quarter, from cash provided by operating activities. If the Company’s working capital needs and capital expenditure requirements exceed its cash flows from operations, the Company would look to its cash balances and availability for borrowings to satisfy those needs, as well as the need to raise additional capital, which may not be available on satisfactory terms and in adequate amounts. For a discussion of these and other factors affecting the Company’s liquidity, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.”

 

The Company’s pension and other postretirement employee benefits expense and underfunding levels of pension plans could materially increase.

 

Substantially all of the Company’s employees participate in defined benefit pension plans or retirement/termination indemnity plans. The Company has previously experienced declines in interest rates and pension asset values. Future declines in interest rates or the market values of the securities held by the plans, or certain other changes, could materially increase the underfunded status of the Company’s plans and affect the level and timing of required contributions in 2007 and beyond. Additionally, a material increase in the underfunded status of the plans could significantly increase pension expenses and reduce the Company’s profitability.

 

The Company also sponsors other postretirement employee benefit (“OPEB”) plans in the United States. The Company funds its OPEB obligations on a pay-as-you-go basis; accordingly, the related plans have no assets. The Company is subject to increased OPEB cash outlays and costs due to, among other factors, rising health care costs. Increases in the expected cost of health care in excess of current assumptions could increase actuarially determined liabilities and related OPEB expenses along with future cash outlays.

 

The Company’s expected annual effective tax rate could be volatile and materially change as a result of changes in mix of earnings and other factors.

 

Changes in the Company’s debt and capital structure, among other items, may impact its effective tax rate. The Company’s overall effective tax rate is equal to consolidated tax expense as a percentage of consolidated earnings before tax. However, tax expense and benefits are not recognized on a global basis but rather on a jurisdictional basis. Further, the Company is in a position whereby losses incurred in certain tax jurisdictions generally provide no current financial statement benefit. In addition, certain jurisdictions have statutory rates greater than or less than the United States statutory rate. As such, changes in the mix and source of earnings between jurisdictions could have a significant impact on the Company’s overall effective tax rate in future periods. Changes in tax law and rates, changes in rules related to accounting for income taxes, or adverse outcomes from tax audits that regularly are in process in any of the jurisdictions in which the Company operates could also have a significant impact on the Company’s overall effective rate in future periods.

 

The Company’s ability to effectively operate could be hindered if it fails to attract and retain key personnel.

 

The Company’s ability to operate its business and implement its strategies effectively depends, in part, on the efforts of its executive officers and other key employees. In addition, the Company’s future success will depend on, among other factors, the ability to attract and retain qualified personnel, particularly engineers and other employees with critical expertise and skills that support key customers and products. The loss of the services of any key employees or the failure to attract or retain other qualified personnel could have a material adverse effect on the Company’s business.

 

The Company’s international operations, including Asian joint ventures, are subject to various risks that could adversely affect the Company’s business, results of operations and financial condition.

 

The Company has operating facilities, and conducts a significant portion of its business, outside the United States. The Company has invested significantly in joint ventures with other parties to conduct business in South Korea, China and elsewhere in Asia. The Company’s ability to repatriate funds from these joint ventures depends not only upon their uncertain cash flows and profits, but also upon the terms of particular agreements with the Company’s joint venture partners and maintenance of the legal and political status quo. The Company risks expropriation in China and the instability that would accompany civil unrest or armed conflict within the Asian region. More generally, the Company’s Asian joint ventures and other foreign investments could be adversely affected by changes in the political, economic and financial environments in host countries, including fluctuations in exchange rates, political instability, changes in foreign laws and regulations (or new interpretations of existing laws and regulations) and changes in trade policies, import and export restrictions and tariffs, taxes and exchange controls. Any one of these factors could have an adverse effect on the Company’s business, results of operations and financial condition. In addition, the Company’s consolidated financial statements are denominated in U.S. dollars and require translation adjustments, which can be significant, for purposes of reporting results from, and the financial condition of, its foreign investments.

 

Warranty claims, product liability claims and product recalls could harm the Company’s business, results of operations and financial condition.

 

The Company faces inherent business risk of exposure to warranty and product liability claims in the event that its products fail to perform as expected or such failure results, or is alleged to result, in bodily injury or property damage (or both). In addition, if any of the Company’s designed products are defective or are alleged to be defective, the Company may be required to participate in a recall campaign. As suppliers become more integrally involved in the vehicle design process and assume more of the vehicle assembly functions, automakers are increasingly expecting them to warrant their products and are increasingly looking to them for contributions when faced with product liability claims or recalls. A successful warranty or product liability claim against the Company in excess of its available insurance coverage and established reserves, or a requirement that the Company participate in a product recall campaign, would have adverse effects that could be material on the Company’s business, results of operations and financial condition.

 

The Company is involved from time to time in legal proceedings and commercial or contractual disputes, which could have an adverse effect on its business, results of operations and financial position.

 

The Company is involved in legal proceedings and commercial or contractual disputes that, from time to time, are significant. These are typically claims that arise in the normal course of business including, without limitation, commercial or contractual disputes (including disputes with suppliers), intellectual property matters, personal injury claims and employment matters. In addition, the Company, certain directors, officers and employees have been named in lawsuits alleging violations of the federal securities laws, ERISA and fiduciary obligations. No assurances can be given that such proceedings and claims will not have a material adverse impact on the Company’s profitability and financial position.

 

The Company could be adversely impacted by environmental laws and regulations.

 

The Company’s operations are subject to U.S. and non-U.S. environmental laws and regulations governing emissions to air; discharges to water; the generation, handling, storage, transportation, treatment and disposal of waste materials; and the cleanup of contaminated properties. Currently, environmental costs with respect to former, existing or subsequently acquired operations are not material, but there is no assurance that the Company will not be adversely impacted by such costs, liabilities or claims in the future either under present laws and regulations or those that may be adopted or imposed in the future.

 

Developments or assertions by or against the Company relating to intellectual property rights could materially impact its business.

 

The Company owns significant intellectual property, including a large number of patents, trademarks, copyrights and trade secrets, and is involved in numerous licensing arrangements. The Company’s intellectual property plays an important role in maintaining its competitive position in a number of the markets served. Developments or assertions by or against the Company relating to intellectual property rights could materially impact the business. Significant technological developments by others also could materially and adversely affect the Company’s business and results of operations and financial condition.

 

The Company’s business and results of operations could be affected adversely by terrorism.

 

Terrorist-sponsored attacks, both foreign and domestic, could have adverse effects on the Company’s business and results of operations. These attacks could accelerate or exacerbate other automotive industry risks such as those described above and also have the potential to interfere with the Company’s business by disrupting supply chains and the delivery of products to customers.

 

A failure of the Company’s internal controls could adversely affect the Company’s ability to report its financial condition and results of operations accurately and on a timely basis. As a result, the Company’s business, operating results and liquidity could be harmed.

 

Because of the inherent limitations of any system of internal control, including the possibility of human error, the circumvention or overriding of controls or fraud, even an effective system of internal control may not prevent or detect all misstatements. In the event of an internal control failure, the Company’s ability to report its financial results on a timely and accurate basis could be adversely impacted, which could result in a loss of investor confidence in its financial reports or have a material adverse affect on the Company’s ability to operate its business or access sources of liquidity.

 

None.

 

The Company’s principal executive offices are located in Van Buren Township, Michigan. The Company also maintains regional headquarters in Kerpen, Germany and Shanghai, China. Set forth below is a listing of the Company’s most significant manufacturing and/or assembly facilities that are owned or leased by the Company and its consolidated subsidiaries as of December 31, 2006.

 

 

 

 

(O) indicates owned facilities; (L) indicates leased facilities

 

As of December 31, 2006, the Company also owned or leased 37 corporate and sales offices, technical and engineering centers and customer service centers in fifteen countries around the world, 30 of which were leased and 7 were owned. Although the Company believes that its facilities are suitable and adequate, and have sufficient productive capacity to meet its present needs, additional facilities may be needed to meet future needs. The majority of the Company’s facilities are operating at normal levels based on respective capacities, with the exception of facilities that are in the process of being closed or restructured.

 

In addition, the Company’s non-consolidated affiliates operate over 40 manufacturing and/or assembly locations, primarily in the Asia-Pacific region.

 

Securities and Related Matters

 

In February 2005, a shareholder lawsuit was filed in the U.S. District Court for the Eastern District of Michigan against the Company and certain current and former officers of the Company. In July 2005, the Public Employees’ Retirement System of Mississippi was appointed as lead plaintiff in this matter. In September 2005, the lead plaintiff filed an amended complaint, which alleges, among other things, that the Company and its independent registered public accounting firm, PricewaterhouseCoopers LLP, made misleading statements of material fact or omitted to state material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading. The named plaintiff seeks to represent a class consisting of purchasers of the Company’s securities during the period between June 28, 2000 and January 31, 2005. Class action status has not yet been certified in this litigation. On August 31, 2006, the defendants motion to dismiss the amended complaint for failure to state a claim was granted. The plaintiffs have appealed this decision.

 

In March 2005, a number of current and former directors and officers were named as defendants in two shareholder derivative suits pending in the State of Michigan Circuit Court for the County of Wayne. As is customary in derivative suits, the Company has been named as a defendant in these actions. As a nominal defendant, the Company is not liable for any damages in these suits nor is any specific relief sought against the Company. The complaints allege that, among other things, the individual defendants breached their fiduciary duties of good faith and loyalty and aided and abetted such breaches during the period between January 23, 2004 and January 31, 2005 in connection with the Company’s conduct concerning, among other things, the matters alleged in the securities class action discussed immediately above. The derivative matters have been stayed pending resolution of defendants motion to dismiss the securities matter pending in the Eastern District of Michigan and any related appeal.

 

In March and April 2005, the Company and a number of current and former employees, officers and directors were named as defendants in three class action lawsuits brought under the Employee Retirement Income Security Act (“ERISA”) in the U.S. District Court for the Eastern District of Michigan. In September 2005, the plaintiffs filed an amended and consolidated complaint, which generally alleges that the defendants breached their fiduciary duties under ERISA during the class period by, among other things, continuing to offer the Company stock as an investment alternative under the Visteon Investment Plan (and the Visteon Savings Plan for Hourly Employees, together the “Plans”), failing to disclose complete and accurate information regarding the prudence of investing in the Visteon stock, failing to monitor the actions of certain of the defendants, and failing to avoid conflicts of interest or promptly resolve them. These ERISA claims are predicated upon factual allegations similar to those raised in the derivative and securities class actions described immediately above. The consolidated complaint was brought on behalf of a named plaintiff and a putative class consisting of all participants or beneficiaries of the Plans whose accounts included Visteon stock at any time from July 20, 2001 through May 25, 2005. Class action status has not yet been certified in this litigation. In November 2005, the defendants moved to dismiss the consolidated amended complaint on various grounds. Prior to resolution of the defendants’ motion, the parties tentatively agreed to a settlement, which has been preliminarily approved by the judge assigned to this proceeding. The settlement is subject to final approval by the court.

 

In June 2006, the Company and Ford Motor Company were named as defendants in a purported class action lawsuit brought under ERISA in the United States District Court for the Eastern District of Michigan on behalf of certain former salaried employees of the Company associated with two plants located in Michigan. The complaint alleges that the Company and Ford violated their fiduciary duties under ERISA when they established and spun off the Company and allocated certain pension liabilities between them, and later when they transferred the subject employees to Ford as new hires in 2006 after Ford acquired the plants. In August 2006, the Company and Ford moved to dismiss the complaint for failure to state a claim, which is currently pending.

 

The Company and its current and former directors and officers intend to contest the foregoing lawsuits vigorously. However, at this time the Company is not able to predict with certainty the final outcome of each of the foregoing lawsuits or its potential exposure with respect to each such lawsuit. In the event of an unfavorable resolution of any of these matters, the Company’s financial results and cash flows in one or more periods could be materially affected to the extent any such loss is not covered by insurance or applicable reserves.

 

Other Matters

 

Various other legal actions, governmental investigations and proceedings and claims are pending or may be instituted or asserted in the future against the Company, including those arising out of alleged defects in the Company’s products; governmental regulations relating to safety; employment-related matters; customer, supplier and other contractual relationships; intellectual property rights; product warranties; product recalls; and environmental matters. Some of the foregoing matters may involve compensatory, punitive or antitrust or other treble damage claims in very large amounts, or demands for recall campaigns, environmental remediation programs, sanctions, or other relief which, if granted, would require very large expenditures.

 

Litigation is subject to many uncertainties, and the outcome of individual litigated matters is not predictable with assurance. Reserves have been established by the Company for matters discussed in the immediately foregoing paragraph where losses are deemed probable and reasonably estimable. It is possible, however, that some of the matters discussed in the foregoing paragraph could be decided unfavorably to the Company and could require the Company to pay damages or make other expenditures in amounts, or a range of amounts, that cannot be estimated at December 31, 2006 and that are in excess of established reserves. The Company does not reasonably expect, except as otherwise described herein, based on its analysis, that any adverse outcome from such matters would have a material effect on the Company’s financial condition, results of operations or cash flows, although such an outcome is possible.

 

None.

 

The following table shows information about the executive officers of the Company. All ages are as of February 1, 2007:

 

ITEM 4A. EXECUTIVE OFFICERS OF VISTEON — (Continued)

 

Michael F. Johnston has been Visteon’s Chairman of the Board and Chief Executive Officer since June 2005, and a member of the Board of Directors since May 2002. Prior to that, he was Chief Executive Officer and President since July 2004, and President and Chief Operating Officer since joining the Company in September 2000. Before joining Visteon, Mr. Johnston served as President, e-business for Johnson Controls, Inc., and previously as President-North America and Asia of Johnson Control’s Automotive Systems Group, and as President of its automotive interior systems and battery operations. Mr. Johnston is also a director of Flowserve Corporation and Whirlpool Corporation.

 

Donald J. Stebbins has been Visteon’s President and Chief Operating Officer since joining the Company in May 2005, and a member of the Board of Directors since December 2006. Before joining Visteon, Mr. Stebbins served as President and Chief Operating Officer of operations in Europe, Asia and Africa for Lear Corporation since August 2004 and prior to that he was President and Chief Operating Officer of Lear’s operations in the Americas since September 2001.

 

James F. Palmer has been Visteon’s Executive Vice President and Chief Financial Officer since joining the Company in June 2004. Until February 2004, he was Senior Vice President of The Boeing Company, where he also served as President of Boeing Capital Corporation from November 2000 to November 2003, and President of the Boeing Shared Services Group prior thereto. Mr. Palmer has notified the Company that he will resign as Visteon’s Executive Vice President and Chief Financial Officer effective as of March 9, 2007.

 

John Donofrio has been Visteon’s Senior Vice President and General Counsel since joining the Company in June 2005. Before joining Visteon, he was Vice President and General Counsel, Honeywell Aerospace of Honeywell International since 2000, where he also served as Vice President and Deputy General Counsel of Honeywell International from 1996 — 2005. Prior to that he was a Partner at Kirkland & Ellis LLP.

 

John F. Kill has been Visteon’s Senior Vice President and President, North America Customer Group and Global Advanced Product Development since August 2005. Prior to that, he served as Senior Vice President of Product Development since July 2004, and Vice President of Product Development since January 2001. Mr. Kill has also served as Operations Director of the Climate Control Division since 1999, and served as the European Operations Director from 1997 to 1999. Mr. Kill began his career with Ford Motor Company in 1971, and has held various engineering and management positions.

 

Robert C. Pallash has been Visteon’s Senior Vice President and President, Asia Customer Group since August 2005. Prior to that, he was Vice President and President, Asia-Pacific since July 2004, and Vice President, Asia Pacific since joining the Company in September 2001. Before joining Visteon, Mr. Pallash served as president of TRW Automotive Japan since 1999, and president of Lucas Varity Japan prior thereto.

 

Dorothy L. Stephenson has been Visteon’s Senior Vice President, Human Resources since joining the Company in May 2006. Prior to that, she was a human resources consultant since May 2003, and Vice President, Human Resources for Bethlehem Steel prior thereto.

 

Joel Coque has been Visteon’s Vice President, Interiors Product Group since August 2005. Prior to that, he was Vice President and General Manager of Visteon’s PSA Peugeot-Citroën and Renault/Nissan customer business groups since 2001. Mr. Coque joined Visteon in July 1999 as Managing Director of Interior Systems for Europe and South America. Prior to that, he served as the Managing Director of Plastic Omnium’s Automotive Interiors Division.

 

Joy M. Greenway has been Visteon’s Vice President, Climate Product Group since August 2005. Prior to that, she was Director, Powertrain since March 2002, and Director of Visteon’s Ford truck customer business group since April 2001. She joined Visteon in 2000 as Director of Fuel Storage and Delivery Strategic Business Unit.

ITEM 4A. EXECUTIVE OFFICERS OF VISTEON — (Continued)

 

Jonathan K. Maples has been Vice President, Global Purchasing and Visteon Services since January 2006. Prior to that, he has served as Vice President and General Manager of Ford North American Customer Group, and Vice President of Quality and Materials Management since joining the Company in November 2001. Before joining Visteon, he was Executive Vice President of Business Services for MSX International since May 2000. Mr. Maples was Vice President of Operations and Vice President of Supplier Management for DaimlerChrysler Corporation prior thereto.

 

Steve Meszaros has been Visteon’s Vice President, Electronics Product Group since August 2005. Prior to that, he was Managing Director, China Operations and General Manager, Yanfeng Visteon since February 2001. Prior to that, he was based in Europe, where he was responsible for Visteon’s interior systems business in the United Kingdom and Germany since 1999.

 

William G. Quigley III has been Visteon’s Senior Vice President, Corporate Controller and Chief Accounting Officer since February 26, 2007 and was Vice President, Corporate Controller, and Chief Accounting Officer since joining the Company in December 2004. On March 9, 2007, Mr. Quigley will also serve as Visteon’s Chief Financial Officer. Before joining Visteon, he was the Vice President and Controller — Chief Accounting Officer of Federal-Mogul Corporation since June 2001. Mr. Quigley was previously Finance Director — Americas and Asia Pacific of Federal-Mogul since July 2000, and Finance Director — Aftermarket Business Operations of Federal-Mogul prior thereto.

 

The Company’s common stock is listed on the New York Stock Exchange in the United States under the symbol “VC.” As of February 23, 2007, the Company had 129,013,936 shares of its common stock $1.00 par value outstanding, which were owned by 102,146 shareholders of record. The table below shows the high and low sales prices for the Company’s common stock as reported by the New York Stock Exchange for each quarterly period for the last two years.

 

 

 

On February 9, 2005, the Company’s Board of Directors suspended the Company’s quarterly cash dividend on its common stock. Accordingly, no dividends were paid by the Company during the years ended December 31, 2006 or 2005. The Board evaluates the Company’s dividend policy based on all relevant factors. The Company’s credit agreements limit the amount of cash payments for dividends that may be made. Additionally, the ability of the Company’s subsidiaries to transfer assets is subject to various restrictions, including regulatory requirements and governmental restraints. Refer to Note 10, “Non-Consolidated Affiliates,” to the Company’s consolidated financial statements included in Item 8 of this Annual Report on Form 10-K.

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES — (Continued)

 

The following table summarizes information relating to purchases made by or on behalf of the Company, or an affiliated purchaser, of shares of Visteon common stock during the fourth quarter of 2006.

 

Issuer Purchases of Equity Securities

 

 

 

 

The following table presents information from the Company’s consolidated financial statements for each of the five years ended December 31, 2006. This information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Financial Statements and Supplementary Data” included under Items 7 and 8, respectively, of this Annual Report on Form 10K.

 

 

This section summarizes significant factors affecting the Company’s consolidated operating results, financial condition and liquidity for the three-year period ended December 31, 2006. This section should be read in conjunction with the Company’s consolidated financial statements and related notes appearing in Item 8 of this Annual Report on Form 10-K.

 

Description of the Business

 

Visteon Corporation (“Visteon” or the “Company”) is a leading global supplier of climate, interiors, electronics and other automotive systems, modules and components to vehicle manufacturers as well as the automotive aftermarket. The Company sells to the world’s largest vehicle manufacturers including BMW, DaimlerChrysler, Ford, General Motors, Honda, Hyundai/Kia, Nissan, Peugeot, Renault-Nissan, Toyota and Volkswagen. The Company has a broad network of manufacturing, technical engineering and joint venture operations throughout the world, supported by approximately 45,000 employees dedicated to the design, development, manufacture and support of its product offering and its global customers.

 

Visteon was incorporated in Delaware in January 2000 as a wholly-owned subsidiary of Ford Motor Company (“Ford” or “ Ford Motor Company ”). Subsequently, Ford transferred the assets and liabilities comprising its automotive components and systems business to Visteon. The Company separated from Ford on June 28, 2000 when all of the Company’s common stock was distributed by Ford to its shareholders.

 

On May 24, 2005, the Company and Ford entered into a non-binding Memorandum of Understanding (“MOU”), setting forth a framework for the transfer of 23 North American facilities and related assets and liabilities (the “Business”) to a Ford-controlled entity. In September 2005, the Company and Ford entered into several definitive agreements, and the Company completed the transfer of the Business to Automotive Components Holdings, LLC (“ACH”), an indirect, wholly-owned subsidiary of the Company.

 

On June 30, 2005, following the signing of the MOU, the Company classified the manufacturing facilities and associated assets, including inventory, machinery, equipment and tooling, to be sold as “held for sale.” The liabilities to be assumed or forgiven by Ford pursuant to the ACH Transactions, including employee liabilities and postemployment benefits payable to Ford, were classified as “Liabilities associated with assets held for sale” in the Company’s consolidated balance sheet following the signing of the MOU. Statement of Financial Accounting Standards No. 144 (“SFAS 144”), “Accounting for the Impairment or Disposal of Long-Lived Assets,” requires long-lived assets that are considered “held for sale” to be measured at the lower of their carrying value or fair value less cost to sell and future depreciation of such assets is ceased. During the second quarter of 2005, the Company recorded a non-cash impairment charge of $920 million to write-down those assets considered “held for sale” to their aggregate estimated fair value less cost to sell. Fair values were determined primarily based on prices for similar groups of assets determined by third-party valuation firms and management estimates.

 

On October 1, 2005, Ford acquired from Visteon all of the issued and outstanding shares of common stock of the parent of ACH in exchange for Ford’s payment to the Company of approximately $300 million, forgiveness of certain other postretirement employee benefit (“OPEB”) liabilities and other obligations relating to hourly employees associated with the Business, and the assumption of certain other liabilities with respect to the Business (together, the “ACH Transactions”). Additionally, on October 1, 2005, Ford acquired from the Company warrants to acquire 25 million shares of the Company’s common stock and agreed to provide funds to be used in the Company’s further restructuring.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (Continued)

 

The Business accounted for approximately $6.1 billion of the Company’s total 2005 product sales, the majority being products sold to Ford. Also, the transferred facilities included all of the Company’s plants that leased hourly workers covered by Ford’s Master Agreement with the UAW. The ACH Transactions addressed certain strategic and structural challenges of the business, although the Company expects additional restructuring activities and business improvement actions will be needed in the foreseeable future for the Company to achieve sustainable success in an increasingly challenging environment.

 

Business Strategy

 

By leveraging the Company’s extensive experience, innovative technology and geographic strengths, the Company aims to grow leading positions in its key climate, interiors and electronics product groups and to improve overall margins, long-term operating profitability and cash flows. To achieve these goals and respond to industry factors and trends, the Company is working to improve its operations, restructure its business, and achieve profitable growth.

 

Visteon has embarked upon a multi-phase, multi-year plan to implement this strategy. A significant milestone in this long-term plan was the successful completion of the ACH Transactions with Ford on October 1, 2005. Although the ACH Transactions resulted in a significant reduction in the Company’s total sales (the business constituted approximately $6 billion in 2005 sales through the date of the transaction), this business was loss making and the Company’s ability to improve profitability was significantly restricted given the inflexible operating arrangements. Further, pursuant to this transaction, the Company transferred all master Ford-UAW employees to ACH including full relief of approximately $2.2 billion of related postretirement employee obligations and received cash funding for future restructuring actions with the establishment of a $400 million escrow account funded by Ford under the terms of the Escrow Agreement.

 

Organizational Structure

 

The Company views its organizational structure as an important enabler of its business strategy. Accordingly, and in late 2005, the Company announced a new operating structure to manage the business following the ACH Transactions. The new organizational structure was designed to achieve a global product focus and a regional customer focus. The global product focus is achieved through a product group structure, which provides for financial and operating responsibility over the design, development and manufacture of the Company’s product portfolio. The regional customer focus is achieved through a customer group structure, which provides for the marketing, sales and service of the Company’s product portfolio to its customer base. Additionally, certain functions such as procurement, information technology and other administrative activities are managed on a global basis with regional deployment.

 

In 2006 the Company completed the process of realigning systems and reporting structures to facilitate financial reporting under the revised organizational structure. The Company’s global product groups as of December 31, 2006 are as follows:

 

Climate — The Company’s Climate product group includes facilities that primarily manufacture climate products including air handling modules, powertrain cooling modules, heat exchangers, compressors, fluid transport, and engine induction systems. Climate accounted for approximately 25%, 24%, and 27% of the Company’s total net sales, excluding ACH and intra-product group eliminations, in 2006, 2005 and 2004, respectively.

 

Electronics — The Company’s Electronics product group includes facilities that primarily manufacture electronics products including audio systems and components, infotainment, driver information, climate control electronics, powertrain controls and lighting. Electronics accounted for approximately 25%, 27% and 32% of the Company’s total net sales, excluding ACH and intra-product group eliminations, in 2006, 2005 and 2004, respectively.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (Continued)

 

Interiors — The Company’s Interior product group includes facilities that primarily manufacture interior products including instrument panels, cockpit modules, door trim and floor consoles. Interiors accounted for approximately 24%, 25% and 18% of the Company’s total net sales, excluding ACH and intra-product group eliminations, in 2006, 2005 and 2004, respectively.

 

Other — The Company’s Other product group includes facilities that primarily manufacture fuel products, chassis products, powertrain products, alternators and starters, as well as parts sold and distributed to the automotive aftermarket. Other accounted for approximately 21%, 22% and 23% of the Company’s total net sales, excluding ACH and intra-product group eliminations, in 2006, 2005 and 2004, respectively.

 

Services — The Company’s Services Operations supply leased personnel and transition services as required by certain agreements entered into by the Company with ACH as a part of the ACH Transactions. Pursuant to the Master Services Agreement and the Salaried Employee Lease Agreement, the Company agreed to provide ACH with certain information technology, personnel and other services to enable ACH to conduct its business. Services to ACH are provided at a rate approximately equal to the Company’s cost until such time the services are no longer required by ACH or the expiration of the related agreement. Services accounted for approximately 5% and 1% of the Company’s total net sales, excluding ACH and intra-product group eliminations in 2006 and 2005, respectively.

 

2006 Overview and Financial Results

 

The automotive industry remains challenging in North America and Europe, with continued market share pressures concentrated with U.S. vehicle manufacturers. While the ACH Transactions significantly reduced the Company’s exposure to Ford’s North America vehicle production, Ford remains an important customer, accounting for 45% of the Company’s 2006 product sales. However, Ford North America production volumes decreased by approximately 300,000 units or 10% during 2006, which was partially offset by an increase in Ford Europe production volume. Further, the Company has significant content on certain key Nissan vehicles produced for the North American market and PSA Peugeot Citroen and Renault-Nissan vehicles produced for the European market, all of which posted year-over-year production declines. The Company’s net product sales and gross margin for the year ended December 31, 2006 were pressured by these vehicle production declines, unfavorable vehicle mix, a weakening aftermarket business in North America and deteriorating performance of certain Western European manufacturing facilities. These pressures were partially offset by net sales increases associated with new business launches and continued growth in the Company’s Asia Pacific operations.

 

Net Sales

 

During the year ended December 31, 2006, the Company recorded total net sales of $11.4 billion, including product sales of $10.9 billion and services sales of $547 million, representing a decrease of $5.6 billion or 33% when compared to the same period of 2005. The ACH Transactions resulted in a decrease in product sales of $6.1 billion, which was partially offset by an increase in revenues of $383 million for services provided to ACH.

 

Following the ACH Transactions, the Company’s regional sales mix has become more balanced, with a greater percentage of product sales outside of North America. The Company believes that it is well positioned globally, with a diversifying customer base. Although Ford remains the Company’s largest customer, the Company has been steadily diversifying its sales with growing OEMs. Product sales to Ford were $4.9 billion, or 45% of total product sales and $10.4 billion, or 62% of total product sales for the years ended December 31, 2006 and 2005, respectively.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (Continued)

 

In late 2006, Ford announced further reductions in North America vehicle production for the remainder of 2006 and into 2007. Continued declines in Ford’s vehicle production could materially affect the Company’s operating results, and the Company continues to work with other vehicle manufacturers to further its sales growth and diversification. During 2006, the Company was awarded new forward year programs across all of its product groups by other vehicle manufacturers as well as Ford. These new programs will further diversify the Company’s sales base in future years.

 

Gross Margin

 

The Company’s gross margin was $734 million in 2006, compared with $534 million in 2005, representing an increase of $200 million or 37%. The increase in gross margin was attributable to efficiencies achieved through manufacturing, purchasing and ongoing restructuring efforts and certain one-time cost benefits, including postretirement benefit relief resulting from the assumption of such obligation by Ford related to Company employees transferred to Ford in connection with two ACH manufacturing facilities. These favorable items were partially offset by the unfavorable impact of lower Ford North America vehicle production, unfavorable product mix, and lower vehicle production volume of other customers.

 

The Company continues to take actions to lower its manufacturing costs by increasing its focus on production utilization and related investment, closure and consolidation of facilities and relocation of production to lower cost environments to take further advantage of its global manufacturing footprint. The Company has consolidated its regional purchasing activities into a global commodity driven organization to provide increased spending leverage and to further standardize its production and related material purchases. The Company has increased its focus and financial discipline in the evaluation of and bidding on new customer programs to improve operating margins and continues to take actions to address lower margin customer programs.

 

Restructuring Activities

 

In January 2006, the Company announced a multi-year improvement plan designed to further restructure the business and improve profitability. This improvement plan identified certain underperforming and non-strategic facilities that require significant restructuring or potential sale or exit, as well as other infrastructure and cost reduction initiatives. This improvement plan is expected to have a cumulative cash cost of approximately $430 million, of which $340 million is expected to be reimbursed from the escrow account. Additionally, the Company anticipates that the multi-year improvement plan will generate up to approximately $400 million of per annum savings when completed.

 

As part of this multi-year improvement plan, the Company originally identified 23 facilities that were targeted for closure, divestiture or actions to improve profitability. During 2006, the Company identified an additional 7 facilities, bringing the total number of facilities targeted for closure, divestiture or actions to improve profitability under the multi-year improvement plan to 30. The Company substantially completed actions related to 11 operations during the year-ended December 31, 2006. The Company continues to evaluate alternative courses of action related to the remaining 19 facilities, including the possibility of divestiture, closure or renegotiated commercial and/or labor arrangements. However, there is no assurance that a transaction or other arrangement will occur in the near term or at all. The Company’s ultimate course of action for these facilities will be dependent upon that which provides the greatest long term return to shareholders. Generally, expenses related to the multi-year improvement plan are recorded as elements of the plan are finalized and the timing of activities and the amount of related costs are not likely to change.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (Continued)

 

In light of current and expected near-term vehicle production levels by the Company’s key customers, on October 31, 2006 the Company announced a plan to reduce its salaried workforce by 900 people. As of December 31, 2006 the Company had taken action on approximately 800 salaried positions at a cost of approximately $19 million. The Company expects to complete the salaried workforce reduction during 2007 as additional elements of the plan are finalized and related actions become probable of occurrence.

 

Throughout 2006, the Company continued to perform organizational restructuring activities to build its engineering capability in more competitive cost locations, and re-examine its current third-party supplier arrangements for purchased services to further reduce the Company’s administrative and engineering costs.

 

While the Company continues its efforts to improve its operations, restructure its business, and achieve profitable growth, there can be no assurances that the results of these efforts alone will be sufficient to address the impact of current industry and market trends. The Company will continue to monitor such industry and market trends taking action as necessary, including, but not limited to, additional restructuring activities and global capacity rationalization.

 

Debt and Capital Structure

 

The Company monitors and evaluates its debt and capital structure on an ongoing basis and in consideration of liquidity needs and capital market conditions enters into transactions designed to enhance liquidity, improve financial flexibility and reduce associated costs of capital. Accordingly, the Company entered into the following transactions during 2006.

 

On January 9, 2006, the Company closed on an 18-month secured term loan (the “18-Month Term Loan”) in the amount of $350 million to replace the Company’s $300 million secured short-term revolving credit agreement that expired on December 15, 2005. The 18-Month Term Loan was made a part of the Company’s existing Five-Year Revolving Credit Facility agreement, which was to expire in June 2007.

 

On June 13, 2006, the Company entered into a credit agreement with a syndicate of third-party lenders to provide for an $800 million seven-year secured term loan. The proceeds from that loan were used to repay borrowings and interest under the $350 million 18-Month Term Loan, the $241 million five-year term loan, and amounts outstanding under the Five-Year Revolving Credit Facility. Subsequent to closing on the new term loan, the Company initiated open market purchases of its 8.25% notes due 2010. The Company purchased $150 million of the 8.25% notes at an all-in weighted cost of 94.16% of par, resulting in a gain on early extinguishment of approximately $8 million. On November 27, 2006 the Company increased the seven-year term loan by $200 million, for a total of $1 billion outstanding as of December 31, 2006.

 

Effective August 14, 2006, the Company entered into a European accounts receivable securitization facility that extends until August 2011 and provides up to $325 million in funding from the sale of certain customer trade account receivables originating from Company subsidiaries located in Germany, Portugal, Spain, France and the U.K. Availability of funding depends primarily upon the amount of trade accounts receivable, reduced by outstanding borrowings on the facility and other characteristics of those receivables that affect their eligibility (such as bankruptcy or the grade of the obligor, delinquency and excessive concentration). As of December 31, 2006, approximately $207 million of the Company’s transferred receivables were considered eligible for borrowing under this facility, of which $76 million was outstanding and $131 million was available for funding.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (Continued)

 

On August 14, 2006, the Company entered into a revolving credit agreement (“Revolving Credit Agreement”) with a syndicate of financial institutions to provide for up to $350 million in secured revolving loans. The Revolving Credit Agreement replaced the Company’s Five-Year Revolving Credit Facility agreement that was to expire in June 2007. The Revolving Credit Agreement, which expires on August 14, 2011, allows for available borrowings of up to $350 million. The amount of availability at any time is dependent upon various factors, including outstanding letters of credit, the amount of eligible receivables, inventory and property and equipment. Borrowings under the Revolving Credit Agreement bear interest based on a variable rate interest option selected at the time of borrowing.

 

Future maturities of the Company’s debt, including capital lease obligations, are as follows: 2007 — $100 million; 2008 — $42 million; 2009 — $22 million; 2010 — $553 million; 2011 — $19 million; thereafter — $1,492 million. In addition to debt service, the Company’s cash and liquidity needs will be affected by its efforts to improve operations, restructure the business and achieve profitable growth. Accordingly, the Company continues to explore opportunities to enhance liquidity, improve financial flexibility and reduce the long term costs of capital.

 

Critical Accounting Estimates

 

The accompanying consolidated financial statements in Item 8 of this Annual Report on Form 10-K have been prepared in conformity with accounting principles generally accepted in the United States and, accordingly, the Company’s accounting policies have been disclosed in Note 2 to the consolidated financial statements. The Company considers an estimate to be a critical accounting estimate when:

 

 

When more than one accounting principle, or the method of its application, is generally accepted, management selects the principle or method that it considers to be the most appropriate given the specific circumstances. Application of these accounting principles requires the Company’s management to make estimates about the future resolution of existing uncertainties. Estimates are typically based upon historical experience, current trends, contractual documentation, and other information, as appropriate. Due to the inherent uncertainty involving estimates, actual results reported in the future may differ from those estimates. In preparing these financial statements, management has made its best estimates and judgments of the amounts and disclosures included in the financial statements.

 

Pension Plans and Other Postretirement Employee Benefit Plans

 

Using appropriate actuarial methods and assumptions, the Company’s defined benefit pension and non-pension postretirement employee benefit plans are accounted for in accordance with Statement of Financial Accounting Standards No. 87 (“SFAS 87”), “Employers’ Accounting for Pensions,” and Statement of Financial Accounting Standards No. 106 (“SFAS 106”), “Employers’ Accounting for Postretirement Benefits Other Than Pensions,” respectively, and as amended by Statement of Financial Accounting Standards No. 158 (“SFAS 158”), “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans”. Disability, early retirement and other postretirement employee benefits are accounted for in accordance with Statement of Financial Accounting Standards No. 112 (“SFAS 112”), “Employer Accounting for Postemployment Benefits.”

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (Continued)

 

The determination of the Company’s obligation and expense for its pension and other postretirement employee benefits, such as retiree health care and life insurance, is dependent on the Company’s selection of certain assumptions used by actuaries in calculating such amounts. Selected assumptions are described in Note 14 “Employee Retirement Benefits” to the Company’s consolidated financial statements, which are incorporated herein by reference, including the discount rate, expected long-term rate of return on plan assets and rates of increase in compensation and health care costs.

 

In accordance with accounting principles generally accepted in the United States, actual results that differ from assumptions used are accumulated and amortized over future periods and, accordingly, generally affect recognized expense and the recorded obligation in future periods. Therefore, assumptions used to calculate benefit obligations as of the annual measurement date directly impact the expense to be recognized in future periods. The primary assumptions affecting the Company’s accounting for employee benefits under SFAS Nos. 87, 106, 112 and 158 as of December 31, 2006 are as follows:

 

 

 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (Continued)

 

 

While the Company believes that these assumptions are appropriate, significant differences in actual experience or significant changes in these assumptions may materially affect the Company’s pension and other postretirement employee benefit obligations and its future expense. The following table illustrates the sensitivity to a change in certain assumptions for Company sponsored U.S. and non-U.S. pension plans on its 2006 funded status and 2007 pre-tax pension expense (excludes certain salaried employees that are covered by a Ford sponsored plan):

 

 

 

 

The following table illustrates the sensitivity to a change in the discount rate assumption related to Visteon sponsored postretirement employee health care and life insurance plans expense (excludes certain salaried that employees are covered by a Ford sponsored plan):

 

 

 

 

The following table illustrates the sensitivity to a change in the assumed health care trend rate related to Visteon sponsored postretirement employee health expense (excludes certain salaried employees that are covered by a Ford sponsored plan):

 

 

 

 

Effective October 1, 2005 and in connection with the ACH Transactions, Ford relieved the Company of all liabilities associated with postretirement employee health care and life insurance related obligations for Visteon-assigned Ford-UAW employees and retirees and for salaried retirees who retired prior to
May 24, 2005. The amount of benefit relief pursuant to the ACH transactions totaled $2.2 billion.

 

The Company continues to have a financial obligation to Ford for the cost of providing selected health care and life insurance benefits to certain Visteon salaried employees who retire after May 24, 2005. The health care and life insurance costs for these employees are calculated using Ford’s assumptions.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (Continued)

 

Impairment of Long-Lived Assets and Certain Identifiable Intangibles

 

Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”) requires that long-lived assets and intangible assets subject to amortization are reviewed for impairment when certain indicators of impairment are present. Impairment exists if estimated future undiscounted cash flows associated with long-lived assets are not sufficient to recover the carrying value of such assets. Generally, when impairment exists the long-lived assets are adjusted to their respective fair values.

 

In assessing long-lived assets for an impairment loss, assets are grouped with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Asset grouping requires a significant amount of judgment. Accordingly, facts and circumstances will influence how asset groups are determined for impairment testing. In assessing long-lived assets for impairment, management considered the Company’s product line portfolio, customers and related commercial agreements, labor agreements and other factors in grouping assets and liabilities at the lowest level for which identifiable cash flows are largely independent. Additionally, in determining fair value of long-lived assets, management uses appraisals, management estimates or discounted cash flow calculations.

 

Product Warranty and Recall

 

The Company accrues for warranty obligations for products sold based on management estimates, with support from the Company’s sales, engineering, quality and legal functions, of the amount that eventually will be required to settle such obligations. This accrual is based on several factors, including contractual arrangements, past experience, current claims, production changes, industry developments and various other considerations.

 

The Company accrues for product recall claims related to potential financial participation in customers’ actions to provide remedies related primarily to safety concerns as a result of actual or threatened regulatory or court actions or the Company’s determination of the potential for such actions. The Company accrues for recall claims for products sold based on management estimates, with support from the Company’s engineering, quality and legal functions. Amounts accrued are based upon management’s best estimate of the amount that will ultimately be required to settle such claims.

 

Environmental Matters

 

The Company is subject to the requirements of federal, state, local and international environmental and occupational safety and health laws and regulations. These include laws regulating air emissions, water discharge and waste management. The Company is also subject to environmental laws requiring the investigation and cleanup of environmental contamination at properties it presently owns or operates and at third-party disposal or treatment facilities to which these sites send or arranged to send hazardous waste.

 

At the time of spin-off, the Company and Ford agreed on a division of liability for, and responsibility for management and remediation of, environmental claims existing at that time, and, further, that the Company would assume all liabilities for existing and future claims relating to sites that were transferred to it and its operation of those sites, including off-site disposal, except as otherwise specifically retained by Ford in the Master Transfer Agreement. In connection with the ACH Transactions, Ford agreed to re-assume these liabilities to the extent they arise from the ownership or operation prior to the spin-off of the locations transferred to ACH (excluding any increase in costs attributable to the exacerbation of such liability by the Company or its affiliates).

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (Continued)

 

The Company is aware of contamination at some of its properties and relating to various third-party superfund sites at which the Company or its predecessor has been named as a potentially responsible party. The Company is in various stages of investigation and cleanup at these sites. At December 31, 2006 , the Company had recorded a reserve of approximately $9 million for this environmental investigation and cleanup. However, estimating liabilities for environmental investigation and cleanup is complex and dependent upon a number of factors beyond the Company’s control and which may change dramatically. Accordingly, although the Company believes its reserve is adequate based on current information, the Company cannot provide any assurance that its ultimate environmental investigation and cleanup costs and liabilities will not exceed the amount of its current reserve.

 

Income Taxes

 

The Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes”. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The Company records a valuation allowance on deferred tax assets by tax jurisdiction when it is more likely than not that such assets will not be realized. Management judgment is required in determining the Company’s valuation allowance on deferred tax assets. Deferred taxes have been provided for the net effect of repatriating earnings from certain consolidated foreign subsidiaries.

 

Results of Operations

 

2006 Compared with 2005

 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (Continued)

 

Net Sales

 

The Company’s consolidated net sales decreased by approximately $5.6 billion or 33% during the year ended December 31, 2006 when compared to the same period of 2005. The ACH Transactions resulted in a decrease of $6.1 billion, which was partially offset by an increase in services revenues of $383 million. Excluding the ACH Transactions and related eliminations and revenue from services provided to ACH, product sales decreased by $182 million. The decrease included favorable currency of $91 million year-over-year. Sales were significantly lower in North America reflecting decreased Ford vehicle production volume and unfavorable product mix, lower non-Ford vehicle production, principally Nissan products, and lower aftermarket sales. This decrease was partially offset by a significant sales increase in Asia Pacific. Higher Asia Pacific sales are partially attributable to new business launched in 2006.

 

Net sales for Climate were $3.0 billion in 2006, compared with $2.9 billion in 2005, representing an increase of $186 million or 7%. Continued growth in the Company’s Asia Pacific consolidated subsidiaries increased net sales by $307 million. This growth was primarily driven by new business, and included favorable currency of $70 million partially offset by customer price reductions. Net sales in North America were $117 million lower year-over-year. This decrease reflects lower Ford North America vehicle production volumes and unfavorable product mix, partially offset by the launch of a new manufacturing facility in Alabama. Net sales in Europe increased $47 million reflecting higher Ford European vehicle production volumes partially offset by lower production volumes by other customers.

 

Net sales for Electronics were $3.0 billion in 2006, compared with $3.2 billion in 2005, representing a decrease of $179 million or 6%. Vehicle production volume and mix decreased net sales by $164 million, primarily attributable to lower Ford and Nissan vehicle production volume and unfavorable product mix in North America and lower sales in Asia Pacific. This reduction was partially offset by higher Ford Europe vehicle production volume. Net customer price reductions and unfavorable currency of $9 million, primarily in Europe, decreased sales year-over-year.

 

Net sales for Interiors were $2.8 billion in 2006, compared with $3.0 billion in 2005, representing a decrease of $169 million or 6%. Vehicle production volume and product mix decreased net sales by $189 million. The decrease was attributable to lower Ford and Nissan vehicle production volume and unfavorable product mix in North America of $257 million and lower vehicle production by certain Europe OEM’s of $94 million, partially offset by increased sales in the Asia Pacific region of $163 million. The increase in Asia Pacific sales reflected increased pass-through sales at a consolidated joint venture. Net customer price reductions were more than offset by price increases resulting from favorable customer settlements, raw material cost recoveries, and product design actions. Favorable currency increased year-over-year sales by $2 million.

 

Net sales for Other was $2.5 billion in 2006, compared with $2.6 billion in 2005. Vehicle production volume and product mix decreased net sales by $72 million. Lower Ford vehicle production volume in North America, lower non-Ford vehicle production in Europe, and lower aftermarket sales decreased net sales by $125 million. This decrease was partially offset by higher vehicle production volume in Asia Pacific and South America. Customer price reductions were more than offset by price increases resulting from favorable customer settlements, raw material cost recoveries, and product design actions. Favorable currency of $30 million, primarily in South America, increased sales year-over-year.

 

Services related to information technology, engineering, administrative and other business support services provided by the Company to ACH, pursuant to agreements associated with the October 1, 2005 ACH Transactions, were $547 million in 2006, compared with $164 million in 2005, representing the full-year impact of the arrangement.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (Continued)

 

Gross Margin

 

The Company’s gross margin was $734 million in 2006, compared with $534 million in 2005, representing an increase of $200 million or 37%. The increase in gross margin is primarily attributable to OPEB and pension relief of $72 million related to the transfer of certain Visteon salaried employees supporting two ACH manufacturing facilities that were transferred to Ford in January 2006, lower depreciation and amortization expense of $73 million (primarily reflecting the impact of the 2005 asset impairments), the benefit of eliminating loss making operations transferred to ACH of $42 million, improved operating performance, and lower non-income based taxes (primarily reflecting a reserve adjustment of $23 million for the completion of regulatory tax audits and the lapse of certain statutory limitation periods). These increases were partially offset by unfavorable vehicle production volumes of $135 million, net customer price reductions, unfavorable currency of $17 million, and a one-time arbitration settlement of $9 million in excess of previously provided reserves.

 

Gross margin for Climate was $166 million in 2006, compared with $167 million in 2005, representing a decrease of $1 million or 1%. Although net sales increased during the year, unfavorable North America customer and product mix partially offset by continued growth of the Company’s Asia Pacific consolidated subsidiaries resulted in a net decrease in gross margin of $7 million. Material and manufacturing cost reduction activities, lower depreciation and amortization expense reflecting the impact of the 2005 asset impairments, and lower OPEB expenses increased gross margin by $101 million. This performance was partially offset by net customer price reductions and increases in raw material costs (principally aluminum) of $89 million. Unfavorable currency reduced gross margin by $6 million.

 

Gross margin for Electronics was $338 million in 2006, compared with $309 million in 2005, representing an increase of $29 million or 9%. Lower vehicle production volumes and unfavorable product mix reduced gross margin by $104 million, primarily attributable to lower volumes in North America. Material and manufacturing cost reduction activities, lower depreciation and amortization expense reflecting the impact of the 2005 asset impairments, and lower OPEB expenses increased gross margin by $176 million. This performance was partially offset by net customer price reductions and increases in raw material costs of $31 million. Unfavorable currency reduced gross margin by $12 million.

 

Gross margin for Interiors was $43 million in 2006, compared with $17 million in 2005, representing an increase of $26 million or 153%. Lower vehicle production volume and unfavorable product mix reduced gross margin by $27 million, primarily attributable to lower PSA production in Europe. Material and manufacturing cost reduction activities, lower depreciation and amortization expense reflecting the impact of the 2005 asset impairments, and lower OPEB expenses increased gross margin by $53 million. Additionally, favorable customer agreements, raw material cost recoveries, and product design actions more than offset customer price reductions and raw material cost increases, increasing gross margin by $2 million. Unfavorable currency reduced gross margin by $2 million.

 

Gross margin for Other was $110 million in 2006, compared with $82 million in 2005, representing an increase of $28 million or 34%. Vehicle production volumes and product mix was favorable by $3 million. Material and manufacturing cost reduction activities, lower depreciation and amortization expense reflecting the impact of the 2005 asset impairments, and lower OPEB expenses increased gross margin by $25 million, despite unfavorable operating performance at certain Western Europe manufacturing facilities engaged in ongoing restructuring initiatives. This performance was partially offset by net customer price reductions and increases in raw material costs of $5 million. Favorable currency increased gross margin $5 million.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (Continued)

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses were $716 million in 2006, compared with $946 million in 2005, representing a decrease of $230 million or 24%. Under the terms of various agreements between the Company and ACH, expenses previously classified as selling, general and administrative expenses incurred to support the business of ACH are now classified as “Cost of sales” in the consolidated statements of operations, comprising $175 million of the decrease. Bad debt expense improved year-over-year primarily reflecting the non-recurrence of a charge of approximately $41 million related to the bankruptcy of a customer in the second quarter of 2005. Furthermore, selling, general and administrative expenses decreased by $39 million reflecting lower OPEB and pension expenses, net cost efficiencies, and favorable currency. Increases to selling, general and administrative expenses during the year included fees associated with the implementation of the Company’s European securitization facility of $10 million and increased expenses related to the Company’s stock-based incentive compensation plans of $15 million.

 

Interest

 

Net interest expense increased by $27 million from $132 million in 2005 to $159 million in 2006. The increase resulted from higher average interest rates of $31 million on outstanding debt and a write-off of unamortized deferred charges of $7 million, partially offset partially by higher global investment rates of $11 million. In addition, the Company recognized a gain on early extinguishment of approximately $8 million related to the repurchase of $150 million of its 8.25% bonds due in 2010.

 

2005 Compared with 2004

 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (Continued)

 

Sales

 

The Company’s consolidated net sales decreased by approximately $1.7 billion or 9% during the year ended December 31, 2005 when compared to 2004. The ACH Transactions resulted in a decrease in product sales of $2.9 billion, which was partially offset by services revenues of $164 million. Excluding the ACH Transactions and revenue from services provided to ACH, product sales increased by $1.1 billion. Sales increased reflecting the launch of new factories in Illinois, Tennessee, Alabama, Germany and Spain. These factories are just-in-time assembly facilities where third party supplier content is integrated into the Company’s products and shipped to its customers. The sales increase also reflects favorable currency partially offset by lower sales in North America reflecting decreased Ford North America vehicle production volume and unfavorable product mix.

 

Net sales for Climate were $2.9 billion in 2005, essentially flat to 2004. Continued growth in the Company’s Asia Pacific consolidated subsidiaries increased net sales by $277 million. This growth was primarily driven by new business, partially offset by customer price reductions. Net sales in North America decreased $202 million reflecting lower Ford North America vehicle production volume, unfavorable product mix, and customer price reductions partially offset by the launch of a new factory in Alabama.

 

Net sales for Electronics were $3.2 billion in 2005, compared with $3.4 billion in 2004, representing a decrease of $163 million or 5%. Net sales in North America were $165 million lower reflecting lower Ford North America vehicle production volume, unfavorable product mix and customer price reductions. Sales were slightly higher year-over-year in Europe offset by lower sales in Asia Pacific.

 

Net sales for Interiors were $3.0 billion in 2005, compared with $1.9 billion in 2004, representing an increase of $1.1 billion or 61%. Sales increased $871 million in North America primarily reflecting the launch of new factories in Illinois and Tennessee. Sales increased $235 million in Europe primarily reflecting the launch of a new factory in Spain. These factories are just-in-time assembly facilities where third party supplier content is integrated into the Company’s products and shipped to its customers.

 

Net sales for Other were $2.6 billion in 2005, compared with $2.5 billion in 2004, representing an increase of $90 million or 4%. Aftermarket sales in North America increased $55 million reflecting new business, and South America sales increased $30 million. Sales in Europe decreased $3 million despite the launch of new factories in Germany.

 

Services related to information technology, engineering, administrative and other business support services provided by the Company to ACH, pursuant to agreements associated with the October 1, 2005 ACH Transactions, were $164 million in 2005.

 

Gross Margin

 

The Company’s gross margin was $534 million in 2005, compared with $888 million in 2004, representing a decrease of $354 million or 40%. Gross margin at the ACH facilities decreased $69 million. The remainder of the decrease in gross margin is primarily explained by lower Ford North American vehicle production volume and unfavorable product mix. Cost reduction activities, net of raw material and employee wage and benefit cost increases, were partially offset by customer price reductions.

 

Gross margin for Climate was $167 million in 2005, compared with $356 million in 2004, representing a decrease of $189 million or 53%. In North America, lower Ford North American vehicle production volumes, unfavorable product mix and lost business decreased gross margin by $199 million. This decrease was partially offset by increased gross margin in Asia Pacific attributable to new business.

 

Gross margin for Electronics was $309 million in 2005, compared with $441 million in 2004, representing a decrease of $132 million or 30%. In North America, lower Ford North American production volume, unfavorable product mix and lost business decreased gross margin by $119 million. This was partially offset by increased gross margin in Asia Pacific reflecting new business.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (Continued)

 

Gross margin for Interiors was $17 million in 2005, compared with a loss of $28 million in 2004, representing an increase of $45 million. The increase primarily reflected the launch of new factories in Illinois, Tennessee, and Spain. These factories are just-in-time assembly facilities where third party supplier content is integrated into the Company’s products and shipped to its customers.

 

Gross margin for Other was $82 million in 2005, compared with $92 million in 2004, representing a decrease of $10 million or 11%. Gross margin in South America and in the European Aftermarket decreased year-over-year, partially offset by an increase in the North America Aftermarket business.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses for 2005 were $946 million, compared with $980 million in 2004, representing a decrease of $34 million or 3%. Under the terms of various agreements between the Company and ACH, expenses previously classified as selling, general and administrative expenses incurred to support the business of ACH are now classified as “Cost of sales” in the consolidated statements of operations. The decrease in selling, general, and administrative expenses reflects approximately $50 million of expenses incurred in support of ACH included in costs of sales in the fourth quarter of 2005. Further, net cost reduction activities of approximately $20 million were offset by approximately $30 million in bad debt expense related to the bankruptcy of a customer in the second quarter of 2005 and unfavorable currency of $10 million.

 

Interest

 

Net interest expense increased by $47 million from $85 million in 2004 to $132 million in 2005. The increase resulted from higher market interest rates on outstanding debt in 2005 as compared to 2004. Additionally, the Company recorded a loss on debt extinguishment of $11 million during 2004.

 

Restructuring Activities

 

The Company has undertaken various restructuring activities to achieve its strategic objectives, including the reduction of operating and overhead costs. Restructuring activities include, but are not limited to, plant closures, production relocation, administrative realignment and consolidation of available capacity and resources. Management expects to finance restructuring programs through cash reimbursement from an escrow account established pursuant to the ACH Transactions, from cash generated from its ongoing operations, or through cash available under its existing debt agreements, subject to the terms of applicable covenants. Management does not expect that the execution of these programs will have a significant adverse impact on its liquidity position.

 

Escrow Agreement

 

Pursuant to the October 1, 2005 Escrow Agreement between the Company, Ford and Deutsche Bank Trust Company Americas, Ford paid $400 million into an escrow account for use by the Company to restructure its businesses. The Escrow Agreement provides that the Company will be reimbursed from the escrow account for the first $250 million of reimbursable restructuring costs, as defined in the Escrow Agreement, and up to one half of the next $300 million of such costs. The Company recorded total reimbursements from the escrow account of $106 million and $51 million during the years ended December 31, 2006 and 2005, respectively. Amounts receivable from the escrow account were $55 million and $27 million as of December 31, 2006 and 2005, respectively and are included in the Company’s consolidated balance sheets under the caption “Other current assets”.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (Continued)

 

Restructuring Reserves

 

The following is a summary of the Company’s consolidated restructuring reserves and related activity for the years ended December 31, 2006, 2005 and 2004, respectively. Substantially all of the Company’s restructuring expenses are related to severance and other employee termination costs.