UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

 

 

Commission file number: 1-11311

 

LEAR CORPORATION

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code:

(248) 447-1500

 

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

 

 

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

None

 

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

 

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

 

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

 

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

 

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

Large accelerated filer þ     Accelerated filer o     Non-accelerated filer o

 

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

 

As of July 2, 2005, the aggregate market value of the registrant’s Common Stock, par value $0.01 per share, held by non-affiliates of the registrant was $2,435,696,527. The closing price of the Common Stock on July 2, 2005, as reported on the New York Stock Exchange, was $36.40 per share.

 

As of February 28, 2006, the number of shares outstanding of the registrant’s Common Stock was 67,189,314 shares.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Certain sections of the registrant’s Notice of Annual Meeting of Stockholders and Proxy Statement for its Annual Meeting of Stockholders to be held on May  11, 2006, as described in the Cross-Reference Sheet and Table of Contents included herewith, are incorporated by reference into Part III of this Report.

 

LEAR CORPORATION AND SUBSIDIARIES

 

CROSS REFERENCE SHEET AND TABLE OF CONTENTS

 

 

 

 

In this Report, when we use the terms the “Company,” “Lear,” “we,” “us” and “our,” unless otherwise indicated or the context otherwise requires, we are referring to Lear Corporation and its consolidated subsidiaries. A substantial portion of the Company’s operations are conducted through subsidiaries controlled by Lear Corporation. The Company is also a party to various joint venture arrangements. Certain disclosures included in this Report constitute forward-looking statements that are subject to risks and uncertainties. See Item 1A, “Risk Factors,” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Forward-Looking Statements.”

 

BUSINESS OF THE COMPANY

 

General

 

We were incorporated in Delaware in 1987 and are one of the world’s largest automotive interior systems suppliers based on net sales. Our net sales have grown from $14.1 billion for the year ended December 31, 2000, to $17.1 billion for the year ended December 31, 2005. We supply every major automotive manufacturer in the world, including General Motors, Ford, DaimlerChrysler, BMW, PSA, Volkswagen, Fiat, Renault-Nissan, Hyundai, Mazda, Subaru and Toyota.

 

We supply automotive manufacturers with complete automotive seat systems, electrical distribution systems and various electronic products. We also supply automotive interior components and systems, including instrument panels and cockpit systems, headliners and overhead systems, door panels and flooring and acoustic systems. As a result of these capabilities, we can offer our customers a full range of automotive interior products, with any level of integration required. In light of recent customer and market trends, we have been evaluating strategic alternatives with respect to our interior segment.

 

We are focused on delivering high-quality automotive interior systems and components to our customers on a global basis. In order to realize substantial cost savings and improved product quality and consistency, automotive manufacturers are requiring their suppliers to manufacture products in multiple geographic markets. In recent years, we have expanded our operations significantly in Europe, Central America, South Africa and Asia. As a result of our efforts to expand our worldwide operations, our net sales outside of North America have grown from $4.6 billion in 2000 to $7.9 billion in 2005. See Note 11, “Segment Reporting,” to the consolidated financial statements included in this Report.

 

Strategy

 

Our principal objective is to strengthen and expand our position as a leading automotive supplier to the global automotive industry by focusing on the needs of our customers. Our customers face continuing competitive pressures to improve quality and functionality at a lower cost and to reduce time to market and capital needs. These trends have resulted in automotive manufacturers seeking fewer independent suppliers to provide automotive interior systems and components. We believe that the criteria for selection of automotive interior systems suppliers are cost, quality, technology, delivery and service. A worldwide presence is necessary to satisfy these criteria.

 

Specific elements of our strategy include:

 

 

 

 

 

 

With respect to our interior segment, we are actively implementing restructuring actions to improve our cost structure and capacity utilization while simultaneously evaluating strategic alternatives. In this regard, we entered into a framework agreement relating to a proposed joint venture relationship with WL Ross & Co. LLC and Franklin Mutual Advisers, LLC on October 17, 2005. We would hold a non-controlling interest in the new joint venture that would explore acquisition opportunities in the automotive interior components sector, including a possible acquisition of all or a portion of Collins & Aikman Corporation. The proposed joint venture would involve all or a portion of our interior segment, but not our seating or electronic and electrical segments. Establishment of the proposed joint venture is subject to the negotiation and execution of definitive agreements and other conditions. In the event that we fail to achieve resolution on various matters in such negotiations, we will continue to explore other strategic alternatives with respect to this segment. No assurances can be given that the proposed joint venture will be completed on the terms contemplated or at all.

 

Products

 

We conduct our business in three product operating segments: seating; interior; and electronic and electrical. The seating segment includes seat systems and the components thereof. The interior segment includes instrument panels and cockpit systems, headliners and overhead systems, door panels, flooring and acoustic systems and other interior products. The electronic and electrical segment includes electronic products and electrical distribution

systems, primarily wire harnesses and junction boxes; interior control and entertainment systems; and wireless systems. Net sales by product segment as a percentage of total net sales is shown below:

 

 

For further information related to our reportable operating segments, see Note  11, “Segment Reporting,” to the consolidated financial statements included in this Report.

 

 

As a result of our strong product design and product technology, we are a leader in designing seats with enhanced safety and convenience features. For example, our ProTec^tm Plus Self-Aligning Head Restraint is an advancement in seat passive safety features. By integrating the head restraint with the lumbar support, the occupant’s head is provided support earlier and for a longer period of time in a rear-impact collision, potentially reducing the risk of injury. In addition, we have developed OccuSense^®, a seat technology which detects the size and weight of an occupant to control airbag deployment. We also supply a patented integrated restraint seat system that uses an ultra high-strength steel tower and a split-frame design to improve occupant comfort and convenience, as well as a high-performance climate system for seat cooling and moisture removal. To address the increasing focus on craftsmanship, we have developed concave seat contours that eliminate wrinkles and provide improved styling. We are also satisfying the growing customer demand for reconfigurable seats with our thin profile rear seat and our stadium slide seat system. For example, General Motors full-size sport utility vehicles and light trucks, as well as the Ford Freestyle, Cadillac SRX, and Dodge Durango, use our reconfigurable seating technology, and General Motors full-size sport utility vehicles, as well as the Ford Explorer and Dodge Durango, use our thin profile seating technology for their third row seats.

 

 

 

 

 

Our electronic and electrical products can be grouped into three categories:

 

 

 

Manufacturing

 

A description of the manufacturing processes for each of our operating segments is set forth below.

 

 

Some of the principal components attached to the wire harness assemblies that we manufacture include junction boxes and electronic control modules. Junction boxes are manufactured in both North America and Europe with a proprietary, capital-intensive assembly process, using printed circuit boards, a portion of which are purchased from third-party suppliers. Proprietary processes have been developed to improve the function of these junction boxes in harsh environments, including high temperatures and humidity. Electronic control modules are assembled using high-speed surface mount placement equipment in both North America and Europe.

 

While we internally manufacture many of the components that are described above, a substantial portion of these components are furnished by independent, tier II automotive suppliers and other vendors throughout the world. In certain instances, it would be difficult and expensive for us to change suppliers of products and services that are critical to our business. With the recent decline in the automotive production of our key customers and substantial and continuing pressures to reduce costs, certain of our suppliers have experienced, or may experience, financial difficulties. We seek to carefully manage our supplier relationships to minimize any significant disruptions of our operations. However, adverse developments affecting one or more of our major suppliers, including certain sole-source suppliers, could negatively impact our operating results. See Item 1A, “Risk Factors — Adverse developments affecting one or more of our major suppliers could harm our profitability.”

 

Customers

 

We serve the worldwide automotive and light truck market, which produced over 63 million vehicles in 2005. We have automotive interior content on over 300 vehicle nameplates worldwide, and our major automotive manufacturing customers (including customers of our non-consolidated joint ventures) currently include:

 

 

During the year ended December 31, 2005, General Motors and Ford, two of the largest automotive and light truck manufacturers in the world, together accounted for approximately 44% of our net sales, excluding net sales to Saab, Volvo, Jaguar and Land Rover, which are affiliates of General Motors or Ford. Inclusive of their respective affiliates, General Motors and Ford accounted for approximately 28% and 25%, respectively, of our net sales in 2005. In addition, DaimlerChrysler accounted for approximately 11% of our net sales in 2005. For further information related to our customers and domestic and foreign sales and operations, see Note 11, “Segment Reporting,” to the consolidated financial statements included in this Report.

 

We receive blanket purchase orders from our customers. These purchase orders generally provide for the supply of a customer’s annual requirements for a particular vehicle model, rather than for the purchase of a specified quantity of products. Although purchase orders may be terminated at any time by our customers, such terminations have been minimal and have not had a material impact on our operating results. Our primary risks are that an automotive manufacturer will produce fewer units of a vehicle model than anticipated or that an automotive manufacturer will not award us a replacement program following the life of a vehicle model. In order to reduce our reliance on any one vehicle model, we produce automotive interior systems and components for a broad cross-section of both new and established models. However, larger passenger cars and light trucks typically have more interior content and therefore, tend to have a more significant impact on our operating performance. Our net sales for the year ended December 31, 2005, were comprised of the following vehicle categories: 54% cars, including 23% mid-size, 15% compact, 14% luxury/sport and 2% full-size, and 46% light truck, including 25% sport utility and 21% pickup and other light truck.

Our agreements with our major customers generally provide for an annual productivity cost reduction. Historically, cost reductions through product design changes, increased productivity and similar programs with our suppliers have generally offset these customer-imposed productivity cost reduction requirements. However, in the latter part of 2004 and in 2005, unprecedented increases in certain raw material and commodity costs (principally steel, resins and other oil-based commodities), as well as increases in energy costs had a material adverse impact on our operating results. While we were able to offset a portion of the adverse impact through aggressive cost reduction actions, relatively high raw material, energy and commodity costs are expected to continue, and no assurances can be given that we will be able to achieve such customer cost reduction targets in the future.

 

Technology

 

We have the ability to integrate the engineering, research, design, development and validation testing of all automotive interior systems. Advanced technology development is conducted at our six advanced technology centers and at our product engineering centers worldwide. At these centers, we engineer our products to comply with applicable safety standards, meet quality and durability standards, respond to environmental conditions and conform to customer and consumer requirements. Our research and design studio located in Southfield, Michigan, develops and integrates new concepts and is our central location for consumer research, benchmarking, craftsmanship and industrial design activity.

 

We also have state-of-the-art acoustic testing and instrumentation and data analysis capabilities. We own an industry-leading validation test center featuring acoustic and sound quality testing, including a dual-surface, four-wheel chassis dynamometer acoustical chamber and reverberant sound room, capable of precision acoustic testing of front, rear and four-wheel drive vehicles. Together with computer-controlled data acquisition and analysis capabilities, the reverberant sound room provides precisely controlled laboratory conditions for sophisticated interior and exterior noise, vibration and harshness testing of parts, materials and systems, including powertrain, exhaust and suspension components. We also maintain electromagnetic compatibility labs at several of our electronic and electrical facilities, where we develop and test electronic products for compliance with governmental requirements and customer specifications.

 

We have developed a number of designs for innovative interior features focused on increasing value to our customers. Our umbrella technology, Intertronics^®, reflects our ability to integrate electronic products with automotive interior systems. Intertronics products and technologies are grouped into three categories: integrated electronic control units; interior control and entertainment systems, which include sound systems and family entertainment systems, as well as switches; and wireless systems, which include remote keyless entry. In addition, we incorporate many convenience, comfort and safety features into our interior designs, including advanced whiplash concepts, lifestyle vehicle interior storage systems, overhead integrated modules, integrated restraint seat systems (3-point and 4-point belt systems integrated into seats), side impact airbags, integrated child restraint seats and integrated instrument panel airbag systems. We also invest in our computer-aided engineering design and computer-aided manufacturing systems. Recent enhancements to these systems include advanced acoustic modeling and analysis capabilities and the enhancement of our research and design website. Our research and design website is a tool used for global customer telecommunications, technology communications, collaboration and direct exchange of digital assets.

 

We have created certain brand identities, which identify products for our customers. The ProTec^tm brand products are optimized for interior safety; the SonoTec^® brand products are optimized for interior acoustics; and the EnviroTec^tm brand products are environmentally friendly.

 

We hold many patents and patent applications pending worldwide. While we believe that our patent portfolio is a valuable asset, no individual patent or group of patents is critical to the success of our business. We also license selected technologies to automotive manufacturers and to other automotive suppliers. We continually strive to identify and implement new technologies for use in the design and development of our products.

 

We have numerous registered trademarks in the United States and in many foreign countries. The most important of these marks include “LEAR CORPORATION” (including a stylized version thereof) and “LEAR.” These marks are widely used in connection with our product lines and services. The trademarks and service marks

“ADVANCE RELENTLESSLY,” “CAR2U,” “INTELLITIRE,” “PROTEC,” “PROTEC PLUS” and others are used in connection with certain of our product lines and services.

 

We have dedicated, and will continue to dedicate, resources to research and development. Research and development costs incurred in connection with the development of new products and manufacturing methods, to the extent not recoverable from our customers, are charged to selling, general and administrative expenses as incurred. These costs amounted to approximately $174 million, $198 million and $171 million for the years ended December 31, 2005, 2004 and 2003, respectively.

 

Joint Ventures and Minority Interests

 

We form joint ventures in order to gain entry into new markets, facilitate the exchange of technical information, expand our product offerings and broaden our customer base. In particular, we believe that certain joint ventures have provided us, and will continue to provide us, with the opportunity to expand our business relationships with Asian automotive manufacturers. In 2005, our joint ventures continued to be awarded new business with Asian automotive manufacturers both in Asia (including seating business with Chang’an Ford, Beijing Hyundai Motor Co. and BMW Brilliance Automotive Co. in China, seating business with General Motors/Daewoo in Korea and seating business with Nissan in China, India and Thailand) and elsewhere (including seating and flooring business with Nissan in the United States and interior business with Toyota in the United States). In addition, our joint ventures continue to produce flooring and carpet products for Honda in the United States. We currently have thirty-three strategic joint ventures located in twelve countries. Of these joint ventures, eighteen are consolidated and fifteen are accounted for using the equity method of accounting; sixteen operate in Asia, fourteen operate in North America (including eight that are dedicated to serving Asian automotive manufacturers) and three operate in Europe and Africa. Net sales of our consolidated joint ventures accounted for less than 5% of our consolidated net sales for the year ended December 31, 2005. As of December 31, 2005, our investments in non-consolidated joint ventures totaled $29 million and support nineteen customers. For further information related to our joint ventures, see Note 5, “Investments in Affiliates and Other Related Party Transactions,” to the consolidated financial statements included in this Report.

 

Competition

 

Within each of our operating segments, we compete with a variety of independent suppliers and automotive manufacturer in-house operations, primarily on the basis of cost, quality, technology, delivery and service. A summary of our primary independent competitors is set forth below.

 

 

As the automotive supply industry becomes increasingly global, certain of our European and Asian competitors have begun to establish a stronger presence in North America, which is likely to increase competition in this region.

 

Seasonality

 

Our principal operations are directly related to the automotive industry. Consequently, we may experience seasonal fluctuations to the extent automotive vehicle production slows, such as in the summer months when plants close for model year changeovers and vacations or during periods of high vehicle inventory. Historically, our sales and operating profit have been the strongest in the second and fourth calendar quarters. See Note 13, “Quarterly Financial Data,” to the consolidated financial statements included in this Report.

 

Employees

 

As of December 31, 2005, Lear employed approximately 115,000 people worldwide, including approximately 29,000 people in the United States and Canada, approximately 40,000 in Mexico and Central America, approximately 33,000 in Europe and approximately 13,000 in other regions of the world. A substantial number of our employees are members of unions. We have collective bargaining agreements with several unions, including: the United Auto Workers; the Canadian Auto Workers; UNITE; the International Brotherhood of Teamsters, Chauffeurs, Warehousemen and Helpers of America; and the International Association of Machinists and Aerospace Workers. Virtually all of our unionized facilities in the United States and Canada have a separate agreement with the union that represents the workers at such facilities, with each such agreement having an expiration date that is independent of other collective bargaining agreements. The majority of our European and Mexican employees are members of industrial trade union organizations and confederations within their respective countries. Many of these organizations and confederations operate under national contracts, which are not specific to any one employer. We have occasionally experienced labor disputes at our plants. We have been able to resolve all such labor disputes and believe our relations with our employees are generally good.

 

See Item 1A, “Risk Factors — A significant labor dispute involving us or one or more of our customers or suppliers or that could otherwise affect our operations could reduce our sales and harm our profitability,” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Forward-Looking Statements.”

 

Available Information on our Website

 

Our website address is http://www.lear.com. We make available on our website, free of charge, the periodic reports that we file with or furnish to the Securities and Exchange Commission (the “SEC”), as well as all amendments to these reports, as soon as reasonably practicable after such reports are filed with or furnished to the SEC. We also make available on our website, or in printed form upon request, free of charge, our Corporate Governance Guidelines, Code of Business Conduct and Ethics (which includes specific provisions for our executive officers), charters for the committees of our Board of Directors and other information related to the Company.

 

The public may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington D.C. 20549. The public may obtain information about the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site (http://www.sec.gov) that contains reports, proxy and information statements and other information related to issuers that file electronically with the SEC.

 

Our business, financial condition, operating results and cash flows may be impacted by a number of factors. In addition to the factors affecting specific business operations identified in connection with the description of these operations and the financial results of these operations elsewhere in this Report, the most significant factors affecting our operations include the following:

 

Demand for our products is directly related to the automotive vehicle production by our major customers. Automotive sales and production can be affected by general economic or industry conditions, 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 industry is characterized by significant overcapacity, fierce competition and significant pension and healthcare liabilities for the domestic automakers. In Europe, the market structure is more fragmented with significant overcapacity, and several of our key platforms have experienced production declines.

 

General Motors and Ford, our two largest customers, together accounted for approximately 44% of our net sales in 2005, excluding net sales to Saab, Volvo, Jaguar and Land Rover, which are affiliates of General Motors and Ford. Inclusive of their respective affiliates, General Motors and Ford accounted for approximately 28% and 25%, respectively, of our net sales in 2005. North American automotive production by General Motors and Ford has declined between 2000 and 2005, and these two customers have recently announced facility closures and other restructuring actions that will negatively impact future production levels for several of our key platforms. While we have been aggressively seeking to expand our business with Asian automotive manufacturers to offset these declines, no assurances can be given as to how successful we will be in doing so. As a result, any decline in the automotive production levels of our major customers, particularly with respect to models for which we are a significant supplier, could materially reduce our sales and harm our profitability, thereby making it more difficult for us to make payments under our indebtedness or resulting in a decline in the value of our common stock.

 

 

During 2005, General Motors and Ford lowered production levels on several of our key platforms in an effort to reduce inventory levels. In addition, these customers have experienced declining market shares in North America and have recently announced significant restructuring actions in an effort to improve profitability. The domestic automotive manufacturers are also burdened with substantial structural costs, such as pension and healthcare costs, that have impacted their profitability and labor relations. Several other global automotive manufacturers are also experiencing operating and profitability issues, as well as labor concerns. In this environment, it is difficult to forecast or assess future customer production schedules, the potential for labor disputes or the success or sustainability of any strategies undertaken by any of our major customers in response to the current industry environment. In addition, cuts in production schedules are also sometimes announced by our customers with little advance notice, making it difficult to respond with corresponding cost reductions.

 

Our supply base has also been adversely affected by industry conditions. Lower production levels for our key customers and increases in certain raw material, commodity and energy costs have resulted in severe financial distress among many companies within the automotive supply base. Several large suppliers have filed for bankruptcy protection or ceased operations. The continuation of financial distress within the supply base may lead to increased commercial disputes and possible supply chain interruptions. In addition, the adverse industry environment has required us to provide financial support to distressed suppliers or take other measures to ensure uninterrupted production. While we have taken certain actions to mitigate these factors, we have offset only a portion of their overall impact on our operating results.

 

The continuation or worsening of these industry conditions would harm our profitability.

 

 

Although we have purchase orders from many of our customers, these purchase orders generally provide for the supply of a customer’s annual requirements for a particular model and assembly plant, renewable on a year-to-year basis, rather than for the purchase of a specific quantity of products. Therefore, the discontinuation of, the loss of business with respect to or a lack of commercial success of a particular vehicle model for which we are a

significant supplier could reduce our sales and harm our profitability, thereby making it more difficult for us to make payments under our indebtedness or resulting in a decline in the value of our common stock.

 

 

As a result of our global presence, a significant portion of our revenues and expenses are denominated in currencies other than U.S. dollars. In addition, we have manufacturing and distribution facilities in many foreign countries, including countries in Asia, Eastern and Western Europe and Central and South America. International operations are subject to certain risks inherent in doing business abroad, including:

 

 

Expanding our business in Asian markets and our business relationships with Asian automotive manufacturers are important elements of our strategy. In addition, our strategy includes expanding our European market share and expanding our manufacturing operations in lower-cost regions. As a result, our exposure to the risks described above may be greater in the future. The likelihood of such occurrences and their potential effect on us vary from country to country and are unpredictable. However, any such occurrences could be harmful to our business and our profitability, thereby making it more difficult for us to make payments under our indebtedness or resulting in a decline in the value of our common stock.

 

 

Higher costs for certain raw materials and commodities, principally steel, resins and other oil-based commodities, as well as higher energy costs, had a material adverse impact on our operating results in 2005 and will continue to negatively impact our profitability in 2006. While we have developed strategies to mitigate or partially offset the impact of higher raw material, energy and commodity costs, we cannot assure you that such measures will be successful. In addition, no assurances can be given that the magnitude and duration of these cost increases or any future cost increases will not have a larger adverse impact on our profitability and consolidated financial position than currently anticipated.

 

 

Most of our employees and a substantial number of the employees of our largest customers and suppliers are members of industrial trade unions and are employed under the terms of collective bargaining agreements. Virtually all of our unionized facilities in the United States and Canada have a separate agreement with the union that represents the workers at such facilities, with each such agreement having an expiration date that is independent of other collective bargaining agreements. Collective bargaining agreements covering approximately 57% of our unionized workforce of approximately 92,000 employees, including approximately 16% of our unionized workforce in the United States and Canada, are scheduled to expire during 2006. The current collective bargaining agreements of our three largest customers in the United States expire in 2007. A labor dispute involving us or any of our customers or suppliers or that could otherwise affect our operations could reduce our sales and harm our profitability, thereby making it more difficult for us to make payments under our indebtedness or resulting in a decline in the value of our common stock. A labor dispute involving another supplier to our customers that results in a slowdown or closure of our customers’ assembly plants where our products are included in assembled vehicles

could also have a material adverse effect on our business. In addition, the inability by us or any of our suppliers, our customers or our customers’ other suppliers to negotiate an extension of a collective bargaining agreement covering a large number of employees upon its expiration could reduce our sales and harm our profitability. Significant increases in labor costs as a result of the renegotiation of collective bargaining agreements could also be harmful to our business and our profitability.

 

 

We obtain components and other products and services from numerous tier II automotive suppliers and other vendors throughout the world. In certain instances, it would be difficult and expensive for us to change suppliers of products and services that are critical to our business. In addition, in some cases, our customers designate our tier II suppliers and as a result, we do not always have the flexibility or authority to change suppliers. Certain of our suppliers are financially distressed or may become financially distressed. In addition, an increasing number of our suppliers are located outside of North America or Western Europe. Any significant disruption in our supplier relationships, including certain relationships with sole-source suppliers, could harm our profitability, thereby making it more difficult for us to make payments under our indebtedness or resulting in a decline in the value of our common stock.

 

 

In the event that our products fail to perform as expected and such failure results in, or is alleged to result in, bodily injury and/or property damage or other losses, we may be subject to product liability lawsuits and other claims. In addition, we are a party to warranty-sharing and other agreements with our customers related to our products. These customers may seek contribution or indemnification from us for all or a portion of the costs associated with product liability and warranty claims, recalls or other corrective actions involving our products. These types of claims could significantly harm our profitability, thereby making it more difficult for us to make payments under our indebtedness or resulting in a decline in the value of our common stock.

 

 

We are 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 our suppliers, intellectual property matters, personal injury claims and employment matters. No assurances can be given that such proceedings and claims will not have a material adverse effect on our profitability and consolidated financial position.

 

 

A substantial portion of our revenue and operating income is generated by our wholly-owned subsidiaries. Accordingly, we are dependent on the earnings and cash flows of, and dividends and distributions or advances from, our subsidiaries to provide the funds necessary to meet our debt service obligations. We utilize certain cash flows of our foreign subsidiaries to satisfy obligations locally. Our obligations under our primary credit facility and senior notes are currently guaranteed by certain of our subsidiaries, but such guarantees may be released under certain circumstances.

 

 

Our consolidated financial statements for the year ended December 31, 2001, were audited by Arthur Andersen LLP, independent public accountants. On June  15, 2002, Arthur Andersen LLP was convicted of federal obstruction of justice charges. On August 31, 2002, Arthur Andersen LLP ceased practicing before the SEC.

Holders of our securities may have no effective remedy against Arthur Andersen LLP in connection with a material misstatement or omission in any of our financial statements audited by Arthur Andersen LLP.

 

Arthur Andersen LLP did not participate in the preparation of this Report and did not reissue its audit report with respect to the financial information included in this Report. As a result, holders of our securities may have no effective remedy against Arthur Andersen LLP in connection with a material misstatement or omission in the financial information audited by Arthur Andersen LLP. In addition, even if such holders were able to assert such a claim, as a result of its conviction on federal obstruction of justice charges and other lawsuits, Arthur Andersen LLP may fail or otherwise have insufficient assets to satisfy claims made by investors that might arise under federal securities laws or otherwise with respect to the financial information it has audited.

 

None.

 

As of December 31, 2005, our operations were conducted through 282 facilities, some of which are used for multiple purposes, including 174 production/manufacturing facilities, 51 administrative/technical support facilities, 47 assembly sites, six advanced technology centers and four distribution centers, in 34 countries. We also have warehouse facilities in the regions in which we operate. Our corporate headquarters is located in Southfield, Michigan. Our facilities range in size up to 1,148,000 square feet.

 

Of our 282 total facilities, which include facilities owned or leased by our consolidated subsidiaries, 128 are owned and 154 are leased with expiration dates ranging from 2006 through 2053. We believe that substantially all of our property and equipment is in good condition and that we have sufficient capacity to meet our current and expected manufacturing and distribution needs. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Financial Condition.”

 

The following table presents the locations of our operating facilities and the operating segments(1) that use such facilities:

 

Argentina

Escobar, BA(S)

Pacheco, BA(E)

 

Austria

Graz(S)

Koeflach(S)

 

Belgium

Genk(S)

 

Brazil

Betim(S)

Cacapava(S)

Camacari(S)

Gravatai(S)

Sao Paulo(S)

 

Canada

Ajax, ON(S)

Concord, ON(I)

Kitchener, ON(S)

Mississauga, ON(I)

St. Thomas, ON(S)

Whitby, ON(S)

Windsor, ON(S)

 

China

Beijing(A/T)

Changchun(S)

Chongqing(S)

Liuzhou(S)

North Point(A/T)

Shanghai(I)

Shenyang(I)

Wuhan(E)

 

Czech Republic

Kolin(S)

Prestice(I)

Vyskov(E)

 

England

Coventry, CV(S)

Coventry, WM(S)

Liverpool, ME(S)

Nottingham, NG(S)

 

France

Cergy(S)

Feignies(S)

Garches(E)

Guipry(S)

Lagny-Le-Sec(S)

Offranville(I)

Rueil-Malmaison(A/T)

 

Germany

Allershausen-

 Leonhardsbuch(S)

Bersenbruck(E)

Besigheim(S)

Boeblingen(S)

Bremen(S)

Ebersberg(I)

Eisenach(S)

Garching-Hochbruck(S)

Ginsheim-Gustavsburg(M)

Koln(E)

Kranzberg(A/T)

Kronach(E)

Munich(S)

Plattling(I)

Quakenbruck(S)

Remscheid(E)

Rietberg(S)

Saarlouis(E)

Wackersdorf(S)

Wismar(E)

Wuppertal(E)

Zwiesel(I)

 

Honduras

Naco, SB(E)

San Pedro Sula, CA(E)

 

Hungary

Godollo(E)

Gyongyos(E)

Gyor(S)

Mor(S)

 

India

Halol(S)

Mumbai(S)

Nasik(S)

New Delhi(S)

Thane(A/T)

Italy

Caivano, NA(S)

Cassino, FR(M)

Grugliasco, TO(S)

Melfi, PZ(M)

Montelabate, PS(I)

Pianfei, CN(I)

Pozzo d’Adda, MI(S)

Termini Imerese, PA(S)

 

Japan

Atsugi-shi(A/T)

Hiroshima(A/T)

Tokyo(E)

Toyota City(A/T)

Utsunomiya(A/T)

 

Mexico

Chihuahua, CH(E)

Hermosillo, SO(S)

Juarez, CH(M)

Mexico City, DF(I)

Puebla, PU(S)

Ramos Arizpe, CO(S)

Saltillo, CO(S)

Santa Catarina, NL(I)

Silao, GO(S)

Tlahuac, DF(I)

Toluca, MX(I)

 

Morocco

Tangier(E)

 

Netherlands

Weesp(A/T)

 

Philippines

LapuLapu City, CE(E)

 

Poland

Mielec(E)

Jaroslaw(S)

Teresin(I)

Tychy(S)

 

Portugal

Palmela, SL(S)

Valongo, PO(E)

 

Romania

Pitesti(E)

 

Russia

Nizhny Novgorod(S)

 

Singapore

Wisma Atria(S)

 

Slovakia

Lozorno(I)

 

South Africa

East London(S)

Port Elizabeth(S)

Rosslyn(S)

 

South Korea

Cheonan(S)

Gyeongju(S)

Seoul(A/T)

 

Spain

Almussafes(E)

Avila(E)

Epila(S)

Logrono(S)

Roquetes(E)

Valdemoro(S)

Valls(E)

 

Sweden

Fargelanda(I)

Gothenburg(M)

Tanumshede(I)

Tidaholm(I)

Trollhattan(S)

 

Thailand

Bangkok(S)

Muang

Nakornratchasima(S)

Rayong(S)

 

Tunisia

Bir El Bey(E)

 

Turkey

Bostanci-Istanbul(E)

Bursa(S)

 

United States

Alma, MI(I)

Arlington, TX(S)

Atlanta, GA(S)

Berne, IN(S)

Bridgeton, MO(S)

Brownstown, MI(S)

Canton, MS(I)

Carlisle, PA(I)

Chicago, IL(I)

Columbus, OH(E)

Covington, VA(I)

Dayton, TN(I)

Dearborn, MI(M)

Detroit, MI(M)

Duncan, SC(S)

Edinburgh, IN(I)

El Paso, TX(E)

Elsie, MI(S)

Farwell, MI(S)

Fenton, MI(S)

Frankfort, IN(S)

Fremont, OH(I)

Greencastle, IN(I)

Hammond, IN(S)

Hazelwood, MO(S)

Hebron, OH(S)

Highland Park, MI(I)

Holt, MI(I)

Huron, OH(I)

Iowa City, IA(I)

Janesville, WI(S)

Lebanon, OH(I)

Lebanon, VA(I)

Liberty, MO(S)

Louisville, KY(S)

Madison Heights, MI(S)

Madisonville, KY(I)

Manteca, CA(I)

Marshall, MI(I)

Mason, MI(S)

Mendon, MI(I)

Monroe, MI(S)

Montgomery, AL(S)

Morristown, TN(S)

Newark, DE(M)

Northwood, OH(I)

Plymouth, IN(E)

Plymouth, MI(S)

Pontiac, MI(A/T)

Port Huron, MI(I)

Rochester Hills, MI(S)

Romulus, MI(S)

Roscommon, MI(S)

Saline, MI(S)

Selma, AL(S)

Sheboygan, WI(I)

Sidney, OH(I)

Southfield, MI(A/T)

Strasburg, VA(I)

Tampa, FL(E)

Taylor, MI(E)

Traverse City, MI(E)

Troy, MI(A/T)

Walker, MI(S)

Warren, MI(M)

Warren, OH(S)

Wauseon, OH(I)

Wentzville, MO(S)

Zanesville, OH(E)

 

Venezuela

Valencia(S)

 

(1) Legend

S — Seating

I — Interior

M — Multiple segments

 

Certain administrative/

technical facilities are

included within the

operating segments.

 

 

Commercial Disputes

 

We are involved from time to time in legal proceedings and claims, including, without limitation, commercial or contractual disputes with our suppliers and competitors. Largely as a result of generally unfavorable industry conditions and financial distress within the automotive supply base, we experienced an increase in commercial and contractual disputes, particularly with our suppliers. These disputes vary in nature and are usually resolved by negotiations between the parties.

On January 29, 2002, Seton Company (“Seton”), one of our leather suppliers, filed a suit alleging that we had breached a purported agreement to purchase leather from Seton for seats for the life of the General Motors GMT 800 program. Seton filed the lawsuit in the U.S. District Court for the Eastern District of Michigan seeking compensatory and exemplary damages totaling approximately $97 million, plus interest, on breach of contract and promissory estoppel claims. In May 2005, this case proceeded to trial, and the jury returned a $30 million verdict against us. On September 27, 2005, the Court denied our post-trial motions challenging the judgment and granted Seton’s motion to award prejudgment interest in the amount of approximately $5 million. We are appealing the judgment and the interest award.

 

On January 26, 2004, we filed a patent infringement lawsuit against Johnson Controls Inc. and Johnson Controls Interiors LLC (together, “JCI”) in the U.S. District Court for the Eastern District of Michigan alleging that JCI’s garage door opener products infringed certain of our radio frequency transmitter patents. JCI counterclaimed seeking a declaratory judgment that the subject patents are invalid and unenforceable, and that JCI is not infringing these patents. JCI also has filed motions for summary judgment asserting that its garage door opener products do not infringe our patents. We are vigorously pursuing our claims against JCI and discovery is on-going. A trial in the case is currently scheduled for the second quarter of 2006.

 

After we filed our patent infringement action against JCI, affiliates of JCI sued one of our vendors and certain of the vendor’s employees in Ottawa Circuit Court, Michigan, on July 8, 2004, alleging misappropriation of trade secrets. The suit alleges that the defendants misappropriated and shared with us trade secrets involving JCI’s universal garage door opener product. JCI seeks to enjoin the defendants from selling or attempting to sell a competing product. We are not a defendant in this lawsuit; however, the agreements between us and the defendants contain customary indemnification provisions. We do not believe that our garage door opener product benefited from any allegedly misappropriated trade secrets or technology. However, JCI has sought discovery of certain information which we believe is confidential and proprietary, and we have intervened in the case for the limited purpose of protecting our rights with respect to JCI’s discovery efforts. Discovery has been extended to July 2006. A trial date has not yet been scheduled.

 

On June 13, 2005, The Chamberlain Group (“Chamberlain”) filed a lawsuit against us and Ford Motor Company (“Ford”) in the Northern District of Illinois alleging patent infringement. Two counts were asserted against us and Ford based upon Chamberlain’s rolling code security system patent and a related product which operates transmitters to actuate garage door openers. Two additional counts were asserted against Ford only (not us) based upon different Chamberlain patents. The Chamberlain lawsuit was filed in connection with the marketing of our universal garage door opener system, which competes with a product offered by JCI. JCI obtained technology from Chamberlain to operate its product. In October 2005, JCI joined the lawsuit as a plaintiff along with Chamberlain, and Chamberlain dismissed its infringement claims against Ford based upon its rolling security system patent. JCI and Chamberlain have filed a motion for a preliminary injunction, which we are contesting. We are vigorously defending the claims asserted in this lawsuit. A trial date has not yet been scheduled.

 

Product Liability Matters

 

In the event that use of our products results in, or is alleged to result in, bodily injury and/or property damage or other losses, we may be subject to product liability lawsuits and other claims. In addition, we are a party to warranty-sharing and other agreements with our customers relating to our products. These customers may pursue claims against us for contribution of all or a portion of the amounts sought in connection with product liability and warranty claims. We can provide no assurances that we will not experience material claims in the future or that we will not incur significant costs to defend such claims. In addition, if any of our products are, or are alleged to be, defective, we may be required or requested by our customers to participate in a recall or other corrective action involving such products. Certain of our customers have asserted claims against us for costs related to recalls or other corrective actions involving our products. In certain instances, the allegedly defective products were supplied by tier II suppliers against whom we have sought or will seek contribution. We carry insurance for certain legal matters, including product liability claims, but such coverage may be limited. We do not maintain insurance for product warranty or recall matters.

Environmental Matters

 

We are subject to local, state, federal and foreign laws, regulations and ordinances which govern activities or operations that may have adverse environmental effects and which impose liability for clean-up costs resulting from past spills, disposals or other releases of hazardous wastes and environmental compliance. Our policy is to comply with all applicable environmental laws and to maintain an environmental management program based on ISO 14001 to ensure compliance. However, we currently are, have been and in the future may become the subject of formal or informal enforcement actions or procedures.

 

We have been named as a potentially responsible party at several third-party landfill sites and are engaged in the cleanup of hazardous waste at certain sites owned, leased or operated by us, including several properties acquired in our 1999 acquisition of UT Automotive, Inc. (“UT Automotive”). Certain present and former properties of UT Automotive are subject to environmental liabilities which may be significant. We obtained agreements and indemnities with respect to certain environmental liabilities from United Technologies Corporation (“UTC”) in connection with our acquisition of UT Automotive. UTC manages and directly funds these environmental liabilities pursuant to its agreements and indemnities with us.

 

While we do not believe that the environmental liabilities associated with our current and former properties will have a material adverse effect on our business, consolidated financial position or results of operations, no assurances can be given in this regard.

 

One of our subsidiaries and certain predecessor companies were named as defendants in an action filed by three plaintiffs in August 2001 in the Circuit Court of Lowndes County, Mississippi, asserting claims stemming from alleged environmental contamination caused by an automobile parts manufacturing plant located in Columbus, Mississippi. The plant was acquired by us as part of our acquisition of UT Automotive in May 1999 and sold almost immediately thereafter, in June 1999, to Johnson Electric Holdings Limited (“Johnson Electric”). In December 2002, 61 additional cases were filed by approximately 1,000 plaintiffs in the same court against us and other defendants relating to similar claims. In September 2003, we were dismissed as a party to these cases. In the first half of 2004, we were named again as a defendant in these same 61 additional cases and were also named in five new actions filed by approximately 150 individual plaintiffs related to alleged environmental contamination from the same facility. The plaintiffs in these actions are persons who allegedly were either residents and/or owned property near the facility or worked at the facility. In November 2004, two additional lawsuits were filed by 28 plaintiffs (individuals and organizations), alleging property damage as a result of the alleged contamination. Each of these complaints seeks compensatory and punitive damages.

 

All of the plaintiffs have dismissed their claims for health effects and personal injury damages without prejudice. There is the potential that these plaintiffs could seek separate counsel to re-file their personal injury claims. Currently, there are approximately 270 plaintiffs remaining in the lawsuits who are proceeding with property damage claims only. In March 2005, the venue for these lawsuits was transferred from Lowndes County, Mississippi, to Lafayette County, Mississippi. In April 2005, certain plaintiffs filed an amended complaint alleging negligence, nuisance, intentional tort and conspiracy claims and seeking compensatory and punitive damages. In April 2005, the court scheduled the first trial date for the first group of plaintiffs to commence March 2006. The March 2006 trial date has since been continued until a date to be set by the court, and discovery has extended into the first quarter of 2006.

 

UTC, the former owner of UT Automotive, and Johnson Electric have each sought indemnification for losses associated with the Mississippi claims from us under the respective acquisition agreements, and we have claimed indemnification from them under the same agreements. To date, no company admits to, or has been found to have, an obligation to fully defend and indemnify any other. We intend to vigorously defend against these claims and believe that we will eventually be indemnified by either UTC or Johnson Electric for a substantial portion of the resulting losses, if any. However, the ultimate outcome of these matters is unknown.

 

Other Matters

 

In January 2004, the Securities and Exchange Commission (the “SEC”) commenced an informal inquiry into our September 2002 amendment of our 2001 Form 10-K. The amendment was filed to report our employment of

relatives of certain of our directors and officers and certain related party transactions. The SEC’s inquiry does not relate to our consolidated financial statements. In February 2005, the staff of the SEC informed us that it proposed to recommend to the SEC that it issue an administrative “cease and desist” order as a result of our failure to disclose the related party transactions in question prior to the amendment of our 2001 Form 10-K. We expect to consent to the entry of the order as part of a settlement of this matter.

 

In February 2006, we received a subpoena from the SEC in connection with an ongoing investigation of General Motors Corporation by the SEC. This investigation has been previously reported by General Motors as involving, among other things, General Motors’ accounting for payments and credits by suppliers. The SEC subpoena seeks the production of documents relating to payments or credits by us to General Motors from 2001 to the present. We are cooperating with the SEC in connection with this matter.

 

Prior to our acquisition of UT Automotive from UTC in May 1999, one of our subsidiaries purchased the stock of a UT Automotive subsidiary. In connection with the acquisition, we agreed to indemnify UTC for certain tax consequences if the Internal Revenue Service (the “IRS”) overturned UTC’s tax treatment of the transaction. The IRS proposed an adjustment to UTC’s tax treatment of the transaction seeking an increase in tax of approximately $88 million, excluding interest. In April 2005, a protest objecting to the proposed adjustment was filed with the IRS. The case was then referred to the Appeals Office of the IRS for an independent review. There have been several meetings and discussions with the IRS Appeals personnel in an attempt to resolve the case. Although we believe that valid support exists for UTC’s tax positions, we and UTC are currently in settlement negotiations with the IRS. An indemnity payment by us to UTC for the ultimate amount due to the IRS would constitute an adjustment to the purchase price and resulting goodwill of the UT Automotive acquisition, if and when made, and would not be expected to have a material effect on our reported earnings.

 

Although we record reserves for legal, product warranty and environmental matters in accordance with Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies,” the outcomes of these matters are inherently uncertain. Actual results may differ significantly from current estimates. See Item 1A, “Risk Factors.”

 

We are involved in certain other legal actions and claims arising in the ordinary course of business, including, without limitation, commercial disputes, intellectual property matters, personal injury claims, tax claims and employment matters. Although the outcome of any legal matter cannot be predicted with certainty, we do not believe that any of these other legal proceedings or matters in which we are currently involved, either individually or in the aggregate, will have a material adverse effect on our business, consolidated financial position or results of operations. See Item 1A, “Risk Factors — We are involved from time to time in legal proceedings and commercial or contractual disputes, which could have an adverse impact on our profitability and consolidated financial position,” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Other Matters.”

 

No matters were submitted to a vote of security holders during the fourth quarter of 2005.

 

The following table sets forth the names, ages and positions of our executive officers. Executive officers are elected annually by our Board of Directors and serve at the pleasure of our Board.

 

 

Set forth below is a description of the business experience of each of our executive officers.

 

 

Lear’s common stock is listed on the New York Stock Exchange under the symbol “LEA.” The Transfer Agent and Registrar for Lear’s common stock is The Bank of New York, located in New York, New York. On February 28, 2006, there were 1,387 holders of record of Lear’s common stock.

 

The high and low sales prices per share of our common stock, as reported on the New York Stock Exchange, and the amount of our dividend declarations for 2005 and 2004 are shown below:

 

 

 

We did not pay cash dividends prior to January 9, 2004.

 

On February 9, 2006, our Board of Directors declared a cash dividend of $0.25 per share of common stock, payable on March 13, 2006, to shareholders of record at the close of business on February 24, 2006. The payment of cash dividends in the future is dependent upon our financial condition, results of operations, capital requirements, alternative uses of capital and other factors. Also, we are subject to the restrictions on the payment of dividends contained in our amended and restated primary credit facility and in certain other contractual obligations. Under our amended and restated primary credit facility, payment of a quarterly dividend is permitted if at the time our Board of Directors declares such dividend, no default under our primary credit facility has occurred, is occurring or would occur as a result of such dividend.

 

As discussed in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Capitalization — Common Stock Repurchase Program,” in November 2004, our Board of Directors approved a new common stock repurchase program which replaced the prior program. The current program permits the discretionary repurchase of up to 5,000,000 shares of our common stock through November 15, 2006. As of December 31, 2005, we had repurchased 490,900 shares of our outstanding common stock under this program. There were no shares repurchased under this program during the quarter ended December 31, 2005.

 

The following statement of operations, balance sheet and cash flow statement data were derived from our consolidated financial statements. Our consolidated financial statements for the years ended December 31, 2005, 2004, 2003 and 2002, have been audited by Ernst & Young LLP. Our consolidated financial statements for the year ended December 31, 2001, have been audited by Arthur Andersen LLP. The selected financial data below should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our consolidated financial statements and the notes thereto included in this Report. For a discussion of the risks related to Arthur Andersen LLP’s audit of our financial statements, see Item 1A, “Risk Factors — Risks related to Arthur Andersen LLP.”

 

 

 

 

Executive Overview

 

We were incorporated in Delaware in 1987 and are one of the world’s largest automotive interior systems suppliers based on net sales. Our net sales have grown from $14.1 billion for the year ended December 31, 2000, to $17.1 billion for the year ended December 31, 2005. We supply every major automotive manufacturer in the world, including General Motors, Ford, DaimlerChrysler, BMW, PSA, Volkswagen, Fiat, Renault-Nissan, Hyundai, Mazda, Subaru and Toyota.

 

We supply automotive manufacturers with complete automotive seat systems, electrical distribution systems and various electronic products. We also supply automotive interior components and systems, including instrument panels and cockpit systems, headliners and overhead systems, door panels and flooring and acoustic systems.

 

In light of recent customer and market trends, we have been evaluating strategic alternatives with respect to our interior segment. On October 17, 2005, we entered into a framework agreement relating to a proposed joint venture relationship with WL Ross & Co. LLC and Franklin Mutual Advisers, LLC. We would hold a non-controlling interest in the new joint venture that would explore acquisition opportunities in the automotive interior components sector, including a possible acquisition of all or a portion of Collins & Aikman Corporation. The proposed joint venture would involve all or a portion of our interior segment, but not our seating or electronic and electrical segments. Establishment of the proposed joint venture is subject to the negotiation and execution of definitive agreements and other conditions. In the event that we fail to achieve resolution on various matters in such negotiations, we will continue to explore other strategic alternatives with respect to this segment. No assurances can be given that the proposed joint venture will be completed on the terms contemplated or at all.

 

Demand for our products is directly related to automotive vehicle production. Automotive sales and production can be affected by general economic or industry conditions, labor relations issues, regulatory requirements, trade agreements and other factors. Our operating results are also significantly impacted by what is referred to in this section as “vehicle platform mix”; that is, the overall commercial success of the vehicle platforms for which we supply particular products, as well as our relative profitability on these platforms. A significant loss of business with respect to any vehicle model for which we are a significant supplier, or a decrease in the production levels of any such models, could have a material adverse impact on our future operating results. In addition, our two largest customers, General Motors and Ford, accounted for approximately 44% of our net sales in 2005, excluding net sales to Saab, Volvo, Jaguar and Land Rover, which are affiliates of General Motors or Ford. The automotive operations of both General Motors and Ford experienced significant operating losses in 2005 and recently announced restructuring actions, which could have a material impact on our future operating results.

 

Automotive industry conditions in North America and Europe continue to be challenging. In North America, the industry is characterized by significant overcapacity, fierce competition and significant pension and healthcare liabilities for the domestic automakers. In Europe, the market structure is more fragmented with significant overcapacity. We expect these challenging industry conditions to continue in the foreseeable future. During 2005, the domestic automakers lowered production levels on several of our key platforms, particularly within the traditional sport utility vehicle market segment. In addition, many of our key platforms in North America and Europe underwent model changeovers or refreshenings in 2005. As a result, our vehicle platform mix had a material adverse impact on our operating results in 2005, and we experienced a significant increase in launch costs. Launch costs are expected to moderate in 2006.

 

In 2005, the market share of certain of our key customers in both North America and Europe declined. There remains considerable uncertainty regarding our customers’ production schedules in 2006. Historically, the majority of our sales have been derived from the U.S.-based automotive manufacturers in North America and, to a lesser extent, automotive manufacturers in Western Europe. As discussed below, our ability to increase sales in the future will depend, in part, on our ability to increase our penetration of Asian automotive manufacturers worldwide and leverage our existing North American and European customer base across all product lines. See Item 1A, “Risk Factors.”

Our customers require us to reduce costs and, at the same time, assume significant responsibility for the design, development and engineering of our products. Our profitability is largely dependent on our ability to achieve product cost reductions through manufacturing efficiencies, product design enhancement and supply chain management. We also seek to enhance our profitability by investing in technology, design capabilities and new product initiatives that respond to the needs of our customers and consumers. We continually evaluate alternatives to align our business with the changing needs of our customers and to lower the operating costs of our Company.

 

In the second quarter of 2005, we began to implement consolidation and census actions in order to address unfavorable industry conditions. These actions continued in the third and fourth quarters of 2005 and are part of a comprehensive restructuring strategy intended to (i) better align our manufacturing capacity with the changing needs of our customers, (ii) eliminate excess capacity and lower our operating costs and (iii) streamline our organizational structure and reposition our business for improved long-term profitability. In connection with the restructuring actions, we expect to incur pretax costs of approximately $250 million, although all aspects of the restructuring actions have not been finalized. The restructuring actions recently announced by General Motors and Ford may require certain restructuring actions on our part that could increase the overall cost of our restructuring.

 

Our material cost as a percentage of net sales increased to 68.3% in 2005 from 65.5% in 2004. A substantial portion of this increase was the result of less favorable vehicle platform mix and increases in certain raw material, energy and commodity costs, as well as net selling price reductions. Increases in certain raw material, energy and commodity costs (principally steel, resins and other oil-based commodities) had a material adverse impact on our operating results in 2005. These conditions worsened as a result of the Gulf Coast storms in the third quarter of 2005. Unfavorable industry conditions have also resulted in financial distress within our supply base and an increase in commercial disputes and the risk of supply disruption. We have developed and implemented strategies to mitigate or partially offset the impact of higher raw material, energy and commodity costs, which include aggressive cost reduction actions, the utilization of our cost technology optimization process, the selective in-sourcing of components where we have available capacity, the continued consolidation of our supply base and the acceleration of low-cost country sourcing and engineering. However, due to the magnitude and duration of the increased raw material, energy and commodity costs, these strategies, together with commercial negotiations with our customers and suppliers, offset only a portion of the adverse impact. We expect that high raw material, energy and commodity costs will continue to have a material adverse impact on our operating results in the foreseeable future. See Item 1A, “Risk Factors — High raw material costs may continue to have a significant adverse impact on our profitability.”

 

In evaluating our financial condition and operating performance, we focus primarily on profitable sales growth and cash flows, as well as return on investment on a consolidated basis. In addition to maintaining and expanding our business with our existing customers in our more established markets, we have increased our emphasis on expanding our business in the Asian market (including sourcing activity in Asia) and with Asian automotive manufacturers worldwide. The Asian market presents growth opportunities, as automotive manufacturers expand production in this market to meet increasing demand. We currently have twelve joint ventures in China and several other joint ventures dedicated to serving Asian automotive manufacturers. We will continue to seek ways to expand our business in the Asian market and with Asian automotive manufacturers worldwide. In addition, we have improved our low-cost country manufacturing capabilities through expansion in Asia, Eastern Europe and Central America.

 

Our success in generating cash flow will depend, in part, on our ability to efficiently manage working capital. Working capital can be significantly impacted by the timing of cash flows from sales and purchases. In this regard, changes in certain customer payment terms had a one-time material adverse impact on our reported cash flows in 2005, but these changes are not expected to impact reported cash flows for full year 2006. Historically, we have been generally successful in aligning our vendor payment terms with our customer payment terms. However, our ability to continue to do so may be adversely impacted by the recent decline in our financial results and adverse industry conditions. In addition, our cash flow is also dependent on our ability to efficiently manage our capital spending. Capital spending, as well as expenditures for recoverable customer engineering and tooling, increased in 2005 as compared to prior years, primarily as a result of spending to support new program awards and investments in common seat architecture. Capital spending is expected to moderate in 2006.

We utilize return on investment as a measure of the efficiency with which assets are deployed to increase earnings. Improvements in our return on investment will depend on our ability to maintain an appropriate asset base for our business and to increase productivity and operating efficiency. The level of profitability and the return on investment of our interior segment is below that of our seating and electronic and electrical segments. Our interior segment continues to experience unfavorable operating results, primarily as a result of higher raw material costs, lower production volumes on key platforms, industry overcapacity, insufficient customer pricing and changes in certain customers’ sourcing strategies. In 2005, we evaluated the carrying value of goodwill within our interior segment for potential impairment and recorded goodwill impairment charges of approximately $1.0 billion. We also concluded that certain fixed assets within our interior segment were materially impaired and recorded fixed asset impairment charges of $82 million.

 

In 2005, we incurred costs of $104 million related to the restructuring actions described above, including $89 million of restructuring charges and $15 million of manufacturing inefficiencies. In addition, we recognized aggregate charges of $47 million related to the divestiture of an equity investment in a non-core business and the capital restructuring of two previously unconsolidated affiliates. In 2004, we incurred estimated costs of $48 million related to facility closures and other similar actions. For further information regarding to these items, see “— Restructuring” and Note 3, “Restructuring,” and Note 5, “Investments in Affiliates and Other Related Party Transactions,” to the consolidated financial statements included in this Report.

 

During 2005, operating losses generated in the United States resulted in an increase in the carrying value of our deferred tax assets. In light of our recent operating performance in the United States and current industry conditions, we assessed, based upon all available evidence, whether it was more likely than not that we would realize our U.S. deferred tax assets. We concluded that it was no longer more likely than not that we would realize our U.S. deferred tax assets. As a result, in the fourth quarter of 2005, we recorded a tax charge of $300 million comprised of (i) a full valuation allowance of $255 million and (ii) an increase in related tax reserves of $45 million. Although the tax charge did not result in current cash expenditures, it did negatively impact net income, assets and stockholders’ equity as of and for the year ended December 31, 2005. In the first quarter of 2005, we recorded a tax benefit of $18 million resulting from a tax law change in Poland. For further information related to income taxes, see Note 8, “Income Taxes,” to the consolidated financial statements included in this Report.

 

This section includes forward-looking statements that are subject to risks and uncertainties. For further information related to other factors that have had, or may in the future have, a significant impact on our business, consolidated financial position or results of operations, see Item 1A, “Risk Factors,” and “— Forward-Looking Statements.”

 

Results of Operations

 

A summary of our operating results in millions of dollars and as a percentage of net sales is shown below:

 

Year Ended December 31, 2005, Compared With Year Ended December 31, 2004

 

Net sales for the year ended December 31, 2005, were $17.1 billion as compared to $17.0 billion for the year ended December 31, 2004, an increase of 0.8%. The impact of new business, net foreign exchange rate fluctuations and the acquisition of Grote & Hartmann favorably impacted net sales by $1.6 billion, $151 million and $120 million, respectively. These increases were largely offset by less favorable vehicle platform mix, particularly in North America, which reduced net sales by $1.8 billion.

 

Gross profit and gross margin were $736 million and 4.3% in 2005, as compared to $1.4 billion and 8.3% in 2004. The declines in gross profit and gross margin were largely due to less favorable vehicle platform mix and net selling price reductions, which collectively reduced gross profit by $578 million. Gross profit also declined by $134 million as a result of fixed asset impairment charges and costs related to restructuring actions. The benefit from new business and our productivity initiatives and other efficiencies was largely offset by the net impact of higher raw material and commodity costs and inefficiencies associated with increased program launch activity.

 

Selling, general and administrative expenses, including research and development, were $631 million for the year ended December 31, 2005, as compared to $634 million for the year ended December 31, 2004. As a percentage of net sales, selling, general and administrative expenses were 3.7% in 2005 and 2004. The decrease in selling, general and administrative expenses during the period was primarily due to a decline in compensation-related expenses and our overall cost control initiatives, as well as a decrease in research and development expenses. These decreases were largely offset by increases in litigation-related charges.

 

Research and development costs incurred in connection with the development of new products and manufacturing methods, to the extent not recoverable from the customer, are charged to selling, general and administrative expenses as incurred. Such costs totaled $174 million in 2005 and $198 million in 2004. In certain situations, the reimbursement of pre-production engineering, research and design costs is contractually guaranteed by, and fully recoverable from, our customers and is therefore capitalized. For the years ended December 31, 2005 and 2004, we capitalized $227 million and $245 million, respectively, of such costs.

 

Interest expense was $183 million in 2005 as compared to $166 million in 2004, primarily due to an increase in short-term interest rates and the interest component of litigation-related charges, partially offset by the refinancing of our primary credit facility and a portion of our senior notes at lower interest rates and a decrease in interest expense related to our use of factoring and asset-backed securitization facilities.

 

Other expense, which includes state and local non-income related taxes, foreign exchange gains and losses, gains and losses on the sales of fixed assets and other miscellaneous income and expense, was $38 million in 2005 as compared to $39 million in 2004.

 

Equity in net loss of affiliates was $51 million for the year ended December 31, 2005, as compared to equity in net income of affiliates of $3 million for the year ended December 31, 2004. In 2005, we divested an equity investment in a non-core business, recognizing a charge of $17 million. In December 2005, we also recognized a loss of $30 million related to two previously unconsolidated affiliates as a result of capital restructurings, changes in the investors and amendments to the related operating agreements.

 

The provision for income taxes was $194 million, representing an effective tax rate of negative 16.4%, for the year ended December 31, 2005, as compared to $128 million, representing an effective tax rate of 23.3%, for the year ended December 31, 2004. The decrease in the effective tax rate is primarily the result of the impact of the goodwill impairment charges for which no tax benefit was provided as this goodwill is nondeductible for tax purposes, as well as the tax charge related to our decision to provide a full valuation allowance with respect to our net U.S. deferred tax assets in the fourth quarter of 2005. No tax benefit was provided on the portion of the restructuring and litigation-related charges that were incurred in certain countries for which no tax benefit is likely to be realized due to a history of operating losses in those countries. These items were partially offset by a one-time benefit of $18 million in the first quarter of 2005 resulting from a tax law change in Poland.

 

Net loss in 2005 was $1.4 billion, or $20.57 per diluted share, as compared to net income of $422 million, or $5.77 per diluted share, in 2004, reflecting the goodwill impairment charges of $1.0 billion and the other factors

described above. For further information related to our goodwill impairment charges, see Note 2, “Summary of Significant Account Policies,” to the consolidated financial statements included in this Report.

 

Reportable Operating Segments

 

The financial information presented below is for our three reportable operating segments for the periods presented. These segments are: seating, which includes seat systems and the components thereof; interior, which includes instrument panels and cockpit systems, headliners and overhead systems, door panels, flooring and acoustic systems and other interior products; and electronic and electrical, which includes electronic products and electrical distribution systems, primarily wire harnesses and junction boxes; interior control and entertainment systems; and wireless systems. Financial measures regarding each segment’s income (loss) before goodwill impairment charges, interest, other expense, provision for income taxes, minority interests in consolidated subsidiaries and equity in net (income) loss of affiliates (“segment earnings”) and segment earnings divided by net sales (“margin”) are not measures of performance under accounting principles generally accepted in the United States (“GAAP”). Such measures are presented because we evaluate the performance of our reportable operating segments, in part, based on income (loss) before goodwill impairment charges, interest, other expense and income taxes and the related margin. Segment earnings should not be considered in isolation or as a substitute for net income (loss), net cash provided by operating activities or other income statement or cash flow statement data prepared in accordance with GAAP or as measures of profitability or liquidity. In addition, segment earnings, as we determine it, may not be comparable to related or similarly titled measures reported by other companies. For a reconciliation of consolidated income before goodwill impairment charges, interest, other expense, provision for income taxes, minority interests in consolidated subsidiaries and equity in net (income) loss of affiliates to income (loss) before provision for income taxes, minority interests in consolidated subsidiaries and equity in net (income) loss of affiliates, see Note 11, “Segment Reporting,” to the consolidated financial statements included in this Report.

 

Seating —

 

A summary of the financial measures for our seating segment is shown below (dollar amounts in millions):

 

 

 

 

Seating net sales were $11.0 billion for the year ended December 31, 2005, as compared to $11.3 billion for the year ended December 31, 2004, a decrease of $280 million or 2.5%. Less favorable vehicle platform mix and changes in production volumes, particularly in North America, reduced net sales by $1.4 billion. This decrease was partially offset by the impact of new business and net foreign exchange rate fluctuations, which improved net sales by $927 million and $145 million, respectively. Segment earnings and the related margin on net sales were $323 million and 2.9% in 2005 as compared to $682 million and 6.0% in 2004. The declines in segment earnings and the related margin were largely due to less favorable vehicle platform mix and changes in production volumes, which, collectively with the favorable impact of new business, negatively impacted segment earnings by $246 million. Segment earnings and the related margin were also negatively affected by the gross impact of higher raw material and commodity costs. The benefit from our productivity initiatives and other efficiencies was partially offset by the effect of net selling price reductions, inefficiencies associated with increased program launch activity and increases in litigation-related charges. In 2005, we also incurred costs related to our restructuring actions of $33 million. In 2004, we incurred estimated costs related to facility closures and other similar actions in the seating segment of $32 million.

Interior —

 

A summary of the financial measures for our interior segment is shown below (dollar amounts in millions):

 

 

 

 

Interior net sales were $3.1 billion for the year ended December 31, 2005, as compared to $3.0 billion for the year ended December 31, 2004, an increase of $133 million or 4.5%. The impact of new business improved net sales by $448 million. This increase was partially offset by less favorable vehicle platform mix and changes in production volumes, particularly in North America, which reduced net sales by $292 million. Segment earnings and the related margin on net sales were ($191) million and (6.2)% in 2005 as compared to $85 million and 2.9% in 2004. The declines in segment earnings and the related margin were largely due to the gross impact of higher raw material and commodity costs of approximately $110 million, which was partially offset by the benefit of productivity and cost reduction initiatives. Less favorable vehicle platform mix and changes in production volumes, collectively with the favorable impact of new business, reduced segment earnings by $107 million. Segment earnings and the related margin were also negatively affected by inefficiencies associated with program launch activity. In 2005, we also incurred fixed asset impairment charges and costs related to our restructuring actions of $114 million. In 2004, we incurred estimated costs related to facility closures and other similar actions in the interior segment of $4 million.

 

Electronic and Electrical —

 

A summary of the financial measures for our electronic and electrical segment is shown below (dollar amounts in millions):

 

 

 

 

Electronic and electrical net sales were $3.0 billion for the year ended December 31, 2005, as compared to $2.7 billion for the year ended December 31, 2004, an increase of $276 million or 10.3%. The impact of new business, net of selling price reductions, and the acquisition of Grote & Hartmann improved net sales by $139 million and $120 million, respectively. Segment earnings and the related margin on net sales were $180 million and 6.1% in 2005 as compared to $211 million and 7.9% in 2004. In 2005, we incurred costs related to our restructuring actions of $39 million. In 2004, we incurred estimated costs related to facility closures and other similar actions in the electronic and electrical segment of $12 million. The effect of net selling price reductions and inefficiencies associated with increased program launch activity was largely offset by the benefit from our productivity initiatives and other efficiencies. The acquisition of Grote & Hartmann favorably impacted segment earnings by $8 million.

 

Year Ended December 31, 2004, Compared With Year Ended December 31, 2003

 

Net sales for the year ended December 31, 2004, were $17.0 billion as compared to $15.7 billion for the year ended December 31, 2003, an increase of 7.7%. New business, net of selling price reductions, and net foreign exchange rate fluctuations increased net sales by $1,010 million and $748 million, respectively. Net sales also benefited from the net impact of our acquisitions and divestitures, which contributed $173 million to the increase. These increases were partially offset by changes in vehicle production volume and platform mix, which negatively impacted net sales by $718 million.

Gross profit and gross margin were $1,402 million and 8.3% in 2004, as compared to $1,346 million and 8.6% in 2003. The benefit from our productivity initiatives and other efficiencies and the impact of new business contributed $421 million and $90 million, respectively, to the increase in gross profit. Gross profit also benefited from the impact of net foreign exchange rate fluctuations and our acquisition of Grote & Hartmann. Gross profit was negatively affected by the net impact of customer and supplier commercial settlements, including selling price reductions, which, collectively with the impact of vehicle platform mix, reduced gross profit by $444 million. Gross profit was also negatively impacted by higher raw material and commodity costs, including increased steel and resin prices.

 

Selling, general and administrative expenses, including research and development, were $634 million for the year ended December 31, 2004, as compared to $574 million for the year ended December 31, 2003. As a percentage of net sales, selling, general and administrative expenses were 3.7% in 2004 and 3.6% in 2003. Our incremental investment in Asian infrastructure and new programs, net foreign exchange rate fluctuations and the impact of our acquisition of Grote & Hartmann contributed $24 million, $22 million and $20 million, respectively, to the increase in selling, general and administrative expenses.

 

Research and development costs incurred in connection with the development of new products and manufacturing methods, to the extent not recoverable from the customer, are charged to selling, general and administrative expenses as incurred. Such costs totaled $198 million in 2004 and $171 million in 2003. In certain situations, the reimbursement of pre-production engineering, research and design costs is contractually guaranteed by, and fully recoverable from, our customers and is therefore capitalized. For the years ended December 31, 2004 and 2003, we capitalized $245 million and $181 million, respectively, of such costs.

 

Interest expense was $166 million in 2004 as compared to $187 million in 2003. Lower interest rates, after giving effect to our hedging activities, favorably impacted interest expense by $22 million.

 

Other expense, which includes state and local non-income related taxes, foreign exchange gains and losses, gains and losses on the sales of fixed assets and other miscellaneous income and expense, was $39 million in 2004 as compared to $52 million in 2003. The primary reasons for the decrease were a reduction in losses on the sales of fixed assets and other miscellaneous expenses, which were partially offset by an increase in state and local non-income related taxes.

 

The provision for income taxes was $128 million, representing an effective tax rate of 23.3%, for the year ended December 31, 2004, as compared to $154 million, representing an effective tax rate of 28.8%, for the year ended December 31, 2003. Our overall tax planning strategy, as well as the mix of our earnings by country, has contributed to the decrease in the effective tax rate. The effective tax rates for 2004 and 2003 approximated the United States federal statutory income tax rate of 35%, adjusted for income taxes on foreign earnings, losses and remittances, valuation adjustments, research and development credits and other items, including the benefit from the settlement of prior years’ tax matters. For further information related to income taxes, see Note 8, “Income Taxes,” to the consolidated financial statements included in this Report.

 

Net income increased to $422 million, or $5.77 per diluted share, for the year ended December 31, 2004, as compared to $381 million, or $5.31 per diluted share, for the year ended December 31, 2003, for the reasons described above.

 

Reportable Operating Segments

 

The financial information presented below is for our three reportable operating segments for the periods presented. These segments are: seating, which includes seat systems and the components thereof; interior, which includes instrument panels and cockpit systems, headliners and overhead systems, door panels, flooring and acoustic systems and other interior products; and electronic and electrical, which includes electronic products and electrical distribution systems, primarily wire harnesses and junction boxes; interior control and entertainment systems; and wireless systems. Financial measures regarding each segment’s income before interest, other expense, provision for income taxes, minority interests in consolidated subsidiaries and equity in net (income) loss of affiliates (“segment earnings”) and segment earnings divided by net sales (“margin”) are not measures of performance under accounting principles generally accepted in the United States (“GAAP”). Such measures

are presented because we evaluate the performance of our reportable operating segments, in part, based on income before interest, other expense and income taxes and the related margin. Segment earnings should not be considered in isolation or as a substitute for net income, net cash provided by operating activities or other income statement or cash flow statement data prepared in accordance with GAAP or as measures of profitability or liquidity. In addition, segment earnings, as we determine it, may not be comparable to related or similarly titled measures reported by other companies. For a reconciliation of consolidated income before interest, other expense, provision for income taxes, minority interests in consolidated subsidiaries and equity in net (income) loss of affiliates to income before provision for income taxes, minority interests in consolidated subsidiaries and equity in net (income) loss of affiliates, see Note 11, “Segment Reporting,” to the consolidated financial statements included in this Report.

 

Seating —

 

A summary of the financial measures for our seating segment is shown below (dollar amounts in millions):

 

 

 

 

Net sales were $11.3 billion for the year ended December 31, 2004, as compared to $10.7 billion for the year ended December 31, 2003, an increase of $571 million or 5.3%. New business, net of selling price reductions, net foreign exchange rate fluctuations and the impact of a seating acquisition in Korea favorably impacted net sales by $504 million, $528 million and $66 million, respectively. These increases were partially offset by the impact of vehicle production volume and platform mix, which reduced net sales by $527 million. Segment earnings and the related margin on net sales were $682 million and 6.0% in 2004 as compared to $697 million and 6.5% in 2003. Segment earnings and the related margin benefited from the impact of our productivity initiatives and other efficiencies, net of higher raw material and commodity costs, which contributed $161 million. This increase was more than offset by the impact of selling price reductions and changes in vehicle production volume and platform mix.

 

Interior —

 

A summary of the financial measures for our interior segment is shown below (dollar amounts in millions):

 

 

 

 

Net sales were $3.0 billion for the year ended December 31, 2004, as compared to $2.8 billion for the year ended December 31, 2003, an increase of $148 million or 5.3%. New business, net of selling price reductions, and net foreign exchange rate fluctuations favorably impacted net sales by $206 million and $93 million, respectively. These increases were partially offset by the impact of vehicle production volume and platform mix, as well as our divestitures, which decreased net sales by $108 million and $42 million, respectively. Segment earnings and the related margin on net sales were $85 million and 2.9% in 2004 as compared to $104 million and 3.7% in 2003. Segment earnings and the related margin benefited from our productivity initiatives and other efficiencies, net of higher raw material and commodity costs, which contributed $106 million. This increase was more than offset by the impact of selling price reductions and changes in vehicle production volume and platform mix.

Electronic and Electrical —

 

A summary of the financial measures for our electronic and electrical segment is shown below (dollar amounts in millions):

 

 

 

 

Net sales were $2.7 billion for the year ended December 31, 2004, as compared to $2.2 billion for the year ended December 31, 2003, an increase of $495 million or 22.6%. New business, net of selling price reductions, the impact of our acquisition of Grote & Hartmann and net foreign exchange rate fluctuations favorably impacted net sales by $300 million, $130 million and $134 million, respectively. These increases were partially offset by the impact of vehicle production volume and platform mix, which decreased net sales by $88 million. Segment earnings and the related margin on net sales were $211 million and 7.9% in 2004 as compared to $200 million and 9.2% in 2003. Segment earnings benefited from our productivity initiatives and other efficiencies, which contributed $21 million. The increase was largely offset by the impact of selling price reductions, net of the impact of new business. The decline in the related margin on net sales was primarily due to the impact of selling price reductions and the integration of our acquisition of Grote & Hartmann, partially offset by the benefit of our productivity initiatives and other efficiencies.

 

Restructuring

 

2005

 

In order to address unfavorable industry conditions, we began to implement consolidation and census actions in the second quarter of 2005. These actions are part of a comprehensive restructuring strategy intended to (i) better align our manufacturing capacity with the changing needs of our customers, (ii) eliminate excess capacity and lower our operating costs and (iii) streamline our organizational structure and reposition our business for improved long-term profitability.

 

In connection with the restructuring actions, we expect to incur pre-tax costs of approximately $250 million, although all aspects of the restructuring actions have not been finalized. Such costs will include employee termination benefits, asset impairment charges and contract termination costs, as well as other incremental costs resulting from the restructuring actions. These incremental restructuring costs will principally include equipment and personnel relocation costs. We also expect to incur incremental manufacturing inefficiency costs at the operating locations impacted by the restructuring actions during the related restructuring implementation period. Restructuring costs will be recognized in our consolidated financial statements in accordance with accounting principles generally accepted in the United States. Generally, charges will be recorded as elements of the restructuring strategy are finalized. Actual costs recorded in our consolidated financial statements may vary from current estimates.

 

In connection with our restructuring actions, we recorded restructuring and related manufacturing inefficiency charges of $104 million in 2005, including $100 million recorded as cost of sales and $6 million recorded as selling, general and administrative expenses. The remaining amounts include a gain on the sale of a facility, which is recorded as other expense, net. These charges resulted in cash expenditures of $67 million in 2005. The 2005 charges consist of employee termination benefits of $57 million for 643 salaried and 3,720 hourly employees, asset impairment charges of $15 million and contract termination costs of $13 million, as well as other costs of $4 million. We also estimate that we incurred approximately $15 million in manufacturing inefficiency costs during this period as a result of the restructuring. Employee termination benefits were recorded based on existing union and employee contracts, statutory requirements and completed negotiations. Asset impairment charges relate to the disposal of buildings, leasehold improvements and machinery and equipment with carrying values of $15 million in excess of related estimated fair values. Contract termination costs include lease cancellation costs of $3 million, which are

expected to be paid through 2006, the repayment of various government-sponsored grants of $5 million, the termination of joint venture, subcontractor and other relationships of $3 million and pension and other postretirement benefit plan curtailments of $2 million.

 

2004 and 2003

 

In December 2003, we initiated actions affecting two of our U.S. seating facilities. As a result of these actions, we recorded charges of $26 million and $8 million in 2003 and 2004, respectively, for employee termination benefits and asset impairments. These actions were completed in the second quarter of 2004. In 2004, we also incurred $40 million in estimated costs related to additional facility consolidations and closures and census reductions.

 

Acquisition

 

On July 5, 2004, we completed the acquisition of the parent of GHW Grote & Hartmann GmbH (“Grote & Hartmann”) for consideration of $160 million, including assumed debt of $86 million, subject to adjustment. This amount excludes the cost of integration, as well as other internal costs related to the transaction which were expensed as incurred. Grote & Hartmann was based in Wuppertal, Germany, and manufactured terminals and connectors, as well as junction boxes, primarily for the automotive industry.

 

The Grote & Hartmann acquisition was accounted for as a purchase, and accordingly, the assets purchased and liabilities assumed are included in the consolidated balance sheets as of December 31, 2005 and 2004. The operating results of Grote & Hartmann are included in the consolidated financial statements since the date of acquisition.

 

Liquidity and Financial Condition

 

Our primary liquidity needs are to fund capital expenditures, service indebtedness and support working capital requirements. In addition, approximately 90% of the costs associated with our current restructuring strategy are expected to require cash expenditures. Our principal sources of liquidity are cash flows from operating activities and borrowings under available credit facilities. A substantial portion of our operating income is generated by our subsidiaries. As a result, we are dependent on the earnings and cash flows of and the combination of dividends, distributions and advances from our subsidiaries to provide the funds necessary to meet our obligations. There are no significant restrictions on the ability of our subsidiaries to pay dividends or make other distributions to Lear. For further information regarding potential dividends from our non-U.S. subsidiaries, see Note 8, “Income Taxes,” to the consolidated financial statements included in this Report.

 

Cash Flows

 

Net cash provided by operating activities was $561 million in 2005 as compared to $676 million in 2004. Net income (loss), excluding impairment charges, deferred tax provision (benefit) and equity in net (income) loss of affiliates, declined by $607 million between years. This decrease was largely offset by the net change in sold accounts receivable, which resulted in a $482 million increase in operating cash flows between the periods. Increases in accounts receivable and accounts payable were a use of $250 million and a source of $298 million of cash, respectively, in 2005, reflecting the timing of payments received from our customers and made to our suppliers.

 

Net cash used in investing activities was $531 million in 2005 as compared to $473 million in 2004. Capital spending was $568 million in 2005 as compared to $429 million in 2004. This increase was primarily a result of spending to support new program awards and investments in common seat architecture. The increase in net cash used in investing activities was partially offset by cash paid related to the acquisition of Grote & Hartmann in 2004. In 2006, capital spending is forecasted to be approximately $400 million.

 

Our financing activities were a use of $347 million of cash in 2005 as compared to a source of $166 million of cash in 2004, primarily as a result of the repayment of $600 million aggregate principal amount of 7.96% senior notes in 2005.

Capitalization

 

In addition to cash provided by operating activities, we utilize a combination of our amended and restated primary credit facility and long-term notes to fund our capital expenditures and working capital requirements. For the years ended December 31, 2005 and 2004, our average outstanding long-term debt balance, as of the end of each fiscal quarter, was $2.3 billion and $2.2 billion, respectively. The weighted average long-term interest rate, including rates under our committed credit facility and the effect of hedging activities, was 6.5% and 6.3% for the respective periods.

 

We utilize uncommitted lines of credit as needed for our short-term working capital fluctuations. For the years ended December 31, 2005 and 2004, our average outstanding unsecured short-term debt balance, as of the end of each fiscal quarter, was $38 million and $19 million, respectively. The weighted average interest rate was 3.7% and 2.8% for the respective periods. The availability of uncommitted lines of credit may be affected by our financial performance, credit ratings and other factors. Uncommitted lines of credit available from banks decreased by approximately $105 million from December 31, 2004, to December 31, 2005. See also “— Off-Balance Sheet Arrangements” and “— Accounts Receivable Factoring.”

 

Amended and Restated Primary Credit Facility

 

On March 23, 2005, we entered into a $1.7 billion credit and guarantee agreement (the “primary credit facility”), which provides for maximum revolving borrowing commitments of $1.7 billion and matures on March 23, 2010. The primary credit facility replaced our existing $1.7 billion amended and restated credit facility, which was due to mature on March 26, 2006. On August 3, 2005, the primary credit facility was amended to (i) revise the leverage ratio covenant for the third quarter of 2005 through the first quarter of 2006, (ii) obtain the consent of the lenders to permit us to enter into a new 18-month term loan facility (the “term loan facility”) with a principal amount of up to $400 million and (iii) provide for the pledge of the capital stock of certain of our material subsidiaries to secure our obligations under the primary credit facility and the term loan facility. On August 11, 2005, we entered into an amended and restated credit and guarantee agreement (the “amended and restated primary credit facility”). The amended and restated primary credit facility effectively combined our existing primary credit facility, as amended, with the new $400 million term loan facility with a maturity date of February 11, 2007. The amended and restated primary credit facility provides for multicurrency revolving borrowings in a maximum aggregate amount of $750 million, Canadian revolving borrowings in a maximum aggregate amount of $200 million and swing-line revolving borrowings in a maximum aggregate amount of $300 million, the commitments for which are part of the aggregate revolving credit facility commitment. As of December 31, 2005, we had $400 million in borrowings outstanding under the amended and restated primary credit facility, all of which were outstanding under our term loan facility, as well as $97 million committed under outstanding letters of credit.

 

Revolving borrowings under the amended and restated primary credit facility bear interest, payable no less frequently than quarterly, at (a) (1) applicable interbank rates, on Eurodollar and Eurocurrency loans, (2) the greater of the U.S. prime rate and the federal funds rate plus 0.50%, on base rate loans, (3) the greater of the rate publicly announced by the Canadian administrative agent and the federal funds rate plus 0.50%, on U.S. dollar denominated Canadian loans, (4) the greater of the prime rate announced by the Canadian administrative agent and the average Canadian interbank bid rate (CDOR) plus 1.0%, on Canadian dollar denominated Canadian loans, and (5) various published or quoted rates, on swing line and other loans, plus (b) a percentage spread ranging from 0% to 1.0%, depending on the type of loan and/or currency and our credit rating or leverage ratio. Borrowings under the term loan facility bear interest at a percentage spread ranging from 0.50% to 0.75% for alternate base rate loans and 1.50% to 1.75% for Eurodollar loans depending on our credit rating or leverage ratio. Under the amended and restated primary credit facility, we agree to pay a facility fee, payable quarterly, at rates ranging from 0.10% to 0.35%, depending on our credit rating or leverage ratio, and when applicable, a utilization fee.

 

Subsidiary Guarantees —

 

Our obligations under the amended and restated primary credit facility are guaranteed, on a joint and several basis, by certain of our subsidiaries, which are primarily domestic subsidiaries and all of which are directly or

indirectly 100% owned by us. In addition, our obligations under the amended and restated primary credit facility are secured by the pledge of all or a portion of the capital stock of certain of our significant subsidiaries.

 

Covenants —

 

The amended and restated primary credit facility contains operating and financial covenants that, among other things, could limit our ability to obtain additional sources of capital. The principal financial covenants require that we maintain a leverage ratio of not more than 3.75 to 1 as of December 31, 2005, 3.50 to 1 as of April 1, 2006 and 3.25 to 1 as of the end of each quarter thereafter and an interest coverage ratio of not less than 3.5 to 1 as of the end of each quarter. These ratios are calculated on a trailing four quarter basis. The leverage and interest coverage ratios, as well as the related components of their computation, are defined in the amended and restated primary credit facility. The leverage ratio is calculated as the ratio of consolidated indebtedness (which is net of cash and excludes transactions related to our asset-backed securitization and factoring facilities) to consolidated operating profit (which excludes, among other things, certain impairments and certain restructurings, as discussed more fully in the amended and restated primary credit facility). The interest coverage ratio is calculated as the ratio of consolidated operating profit to consolidated interest expense. As of December 31, 2005, we were in compliance with all covenants and other requirements set forth in our amended and restated primary credit facility. Our leverage and interest coverage ratios were 2.7 to 1 and 4.2 to 1, respectively. The amended and restated primary credit facility does not require accelerated repayment in the event of a decline in our credit ratings (see “— Credit Ratings”).

 

For further information related to our amended and restated primary credit facility described above, including the operating and financial covenants to which we are subject and related definitions, see Note 7, “Long-Term Debt,” to the consolidated financial statements included in this Report and the agreement governing our amended and restated primary credit facility, which has been incorporated by reference as an exhibit to this Report.

 

Senior Notes

 

As of December 31, 2005, we had $1.8 billion of senior notes outstanding, consisting primarily of $399 million aggregate principal amount of senior notes due 2014, $300 million accreted value of zero-coupon convertible senior notes due 2022, Euro 250 million (approximately $296 million based on the exchange rate in effect as of December 31, 2005) aggregate principal amount of senior notes due 2008 and $800 million aggregate principal amount of senior notes due 2009. We repaid the $600 million senior notes due May 2005 at maturity with excess cash and borrowings under the primary credit facility.

 

In August 2004, we issued $400 million aggregate principal amount of unsecured 5.75% senior notes, which mature in 2014, yielding gross proceeds of $399 million. The notes are unsecured and rank equally with our other unsecured senior indebtedness, including our other senior notes. The proceeds from these notes were ultimately utilized to refinance a portion of the $600 million senior notes due May 2005. In April 2005, we completed an exchange offer of the 2014 Notes for substantially identical notes registered under the Securities Act of 1933, as amended.

 

Zero-Coupon Convertible Senior Notes —

 

In February 2002, we issued $640 million aggregate principal amount at maturity of zero-coupon convertible senior notes due 2022, yielding gross proceeds of $250 million. The notes are unsecured and rank equally with our other unsecured senior indebtedness, including our other senior notes. Each note of $1,000 principal amount at maturity was issued at a price of $391.06, representing a yield to maturity of 4.75%. Holders of the notes may convert their notes at any time on or before the maturity date at a conversion rate, subject to adjustment, of 7.5204 shares of our common stock per note, provided that the average per share price of our common stock for the 20 trading days immediately prior to the conversion date is at least a specified percentage, beginning at 120% upon issuance and declining 1/2% each year thereafter to 110% at maturity, of the accreted value of the note, divided by the conversion rate (the “Contingent Conversion Trigger”). The average per share price of our common stock for the 20 trading days immediately prior to December 31, 2005, was $28.01. As of December 31, 2005, the Contingent Conversion Trigger was $73.87. The notes are also convertible (1) if the long-term credit rating assigned to the notes by either Moody’s Investors Service or Standard & Poor’s Ratings Services is reduced below Ba3 or BB−,

respectively, or either ratings agency withdraws its long-term credit rating assigned to the notes, (2) if we call the notes for redemption or (3) upon the occurrence of specified other events.

 

We have an option to redeem all or a portion of the notes for cash at their accreted value at any time on or after February 20, 2007. Should we exercise this option, holders of the notes could exercise their option to convert the notes into our common stock at the conversion rate, subject to adjustment, of 7.5204 shares per note. Holders may require us to purchase their notes on each of February 20, 2007, 2012 and 2017, as well as upon the occurrence of a fundamental change (as defined in the indenture governing the notes), at their accreted value on such dates. On August 26, 2004, we amended our outstanding zero-coupon convertible senior notes to require the settlement of any repurchase obligation with respect to the notes for cash only.

 

Subsidiary Guarantees —

 

Our obligations under the senior notes are guaranteed by the same subsidiaries that guarantee our obligations under the amended and restated primary credit facility. In the event that any such subsidiary ceases to be a guarantor under the amended and restated primary credit facility, such subsidiary will be released as a guarantor of the senior notes. Our obligations under the senior notes are not secured by the pledge of the capital stock of any of our subsidiaries.

 

Covenants —

 

Our senior notes contain covenants limiting our ability to incur liens and to enter into sale and leaseback transactions and limiting our ability to consolidate with, to merge with or into or to sell or otherwise dispose of all or substantially all of our assets to any person. As of December 31, 2005, we were in compliance with all covenants and other requirements set forth in our senior notes.

 

For further information related to our senior notes described above, see Note 7, “Long-Term Debt,” to the consolidated financial statements included in this Report and the indentures governing our senior notes, which have been incorporated by reference as exhibits to this Report.

 

Contractual Obligations

 

Our scheduled maturities of long-term debt, including capital lease obligations, our scheduled interest payments on our outstanding debt and our lease commitments under non-cancelable operating leases as of December 31, 2005, are shown below (in millions):

 

 

 

 

Borrowings under our amended and restated primary credit facility bear interest at variable rates, and we utilize interest rate swap agreements to convert certain fixed rate obligations to variable rate. Therefore, an increase in interest rates would reduce our profitability. See “— Market Risk Sensitivity.”

 

In addition to the obligations set forth above, we have capital requirements with respect to new programs. We enter into agreements with our customers to produce products at the beginning of a vehicle’s life. Although such agreements do not provide for minimum quantities, once we enter into such agreements, we are generally required to fulfill our customers’ purchasing requirements for the entire production life of the vehicle. Prior to being formally awarded a program, we typically work closely with our customers in the early stages of designing and engineering a

vehicle’s interior systems. Failure to complete the design and engineering work related to a vehicle’s interior systems, or to fulfill a customer’s contract, could adversely affect our business.

 

We also enter into agreements with suppliers to assist us in meeting our customers’ production needs. These agreements vary as to duration and quantity commitments. Historically, most have been short-term agreements not providing for minimum purchases or are requirements-based contracts.

 

We also have minimum funding requirements with respect to our pension obligations. We expect to contribute approximately $65 million to our domestic and foreign pension plans in 2006 as compared to $49 million in 2005. Our minimum funding requirements after 2006 will depend on several factors, including the investment performance of our retirement plans and prevailing interest rates. Our funding obligations may also be affected by changes in applicable legal requirements. We also have payments due with respect to our postretirement benefit obligations. We do not fund our postretirement benefit obligations. Rather, payments are made as costs are incurred by covered retirees. We expect benefit payments to be approximately $9 million in 2006 as compared to $8 million in 2005. For further information related to our pension and other postretirement benefit plans, see “— Other Matters — Pension and Other Postretirement Benefit Plans” and Note 9, “Pension and Other Postretirement Benefit Plans,” to the consolidated financial statements included in this Report.

 

Off-Balance Sheet Arrangements

 

Asset-Backed Securitization Facility — We have in place an asset-backed securitization facility (the “ABS facility”), which provides for maximum purchases of adjusted accounts receivable of $150 million as of December 31, 2005. As of December 31, 2005, accounts receivable in an aggregate amount of $150 million were sold under this facility. Although we utilized the ABS facility throughout 2004, as of December 31, 2004, there were no accounts receivable sold under this facility. The level of funding utilized under this facility is based on the credit ratings of our major customers, the level of aggregate accounts receivable in a specific month and our funding requirements. Should our major customers experience further reductions in their credit ratings, we may be unable to utilize the ABS facility in the future. Should this occur, we would intend to utilize our amended and restated primary credit facility to replace the funding currently provided by the ABS facility. In October 2005, the ABS facility was amended to extend the termination date from November 2005 to October 2006. No assurances can be given that the ABS facility will be extended upon its maturity. For further information related to the ABS facility, see Note 12, “Financial Instruments,” to the consolidated financial statements included in this Report.

 

Guarantees and Commitments — We guarantee the residual value of certain of our leased assets. As of December 31, 2005, these guarantees totaled $27 million. In addition, we guarantee 39% of certain of the debt of Total Interior Systems — America, LLC, 40% of certain of the debt of Beijing Lear Dymos Automotive Seating and Interior Co., Ltd. and 60% of certain of the debt of Honduras Electrical Distribution Systems S. de R.L. de C.V. The percentages of debt guaranteed of these entities are based on our ownership percentages. As of December 31, 2005, the aggregate amount of debt guaranteed was approximately $29 million.

 

Accounts Receivable Factoring

 

Certain of our European and Asian subsidiaries periodically factor their accounts receivable with financial institutions. Such receivables are factored without recourse to us and are excluded from accounts receivable in our consolidated balance sheets. As of December 31, 2005, the amount of factored receivables was $256 million. As of December 31, 2004, there were no factored accounts receivable. We cannot provide any assurances that these factoring facilities will be available or utilized in the future.

 

Credit Ratings

 

The credit ratings below are not recommendations to buy, sell or hold our securities and are subject to revision or withdrawal at any time by the assigning rating organization. Each rating should be evaluated independently of any other rating.

The credit ratings of our senior unsecured debt as of the date of this Report are shown below. The ratings of Standard & Poor’s Rating Services and Fitch Ratings are one level below investment grade. The rating of Moody’s Investors Service is two levels below investment grade.

 

 

Dividends

 

See Item 5, “Market for the Company’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.”

 

Common Stock Repurchase Program

 

In May 2002, our Board of Directors approved a common stock repurchase program which permitted the discretionary repurchase of up to 3.3 million shares of our outstanding common stock over an initial period of 24 months, as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2003. In May 2004, the program was extended until May 2006, as disclosed in our Quarterly Report on Form 10-Q for the quarter ended April 3, 2004. In 2004, we repurchased 1,834,300 shares of our outstanding common stock at an average purchase price of $53.26 per share, excluding commissions of $0.03 to $0.04 per share, under this program. In 2003, we repurchased 31,800 shares of our outstanding common stock at an average purchase price of $34.03 per share, excluding commissions of $0.04 per share, under this program.

 

In November 2004, our Board of Directors approved a new common stock repurchase program which permits the discretionary repurchase of up to 5,000,000 shares of our common stock through November 15, 2006, as disclosed in our Current Report on Form 8-K dated November 11, 2004. This stock repurchase program replaced the program described above. In 2005, we repurchased 490,900 shares of our outstanding common stock at an average purchase price of $51.72 per share, excluding commissions of $0.03 per share, under this program. In 2004, there were no shares of our common stock repurchased under this program. As of December 31, 2005, 4,509,100 shares of common stock were available for repurchase under the common stock repurchase program. The extent to which we will repurchase our common stock and the timing of such repurchases will depend upon prevailing market conditions, alternative uses of capital and other factors. See “— Forward-Looking Statements.”

 

Adequacy of Liquidity Sources

 

We believe that cash flows from operations and available credit facilities will be sufficient to meet our liquidity needs, including capital expenditures and anticipated working capital requirements, for the foreseeable future. Certain of our debt will mature in the first quarter of 2007, and we are currently exploring refinancing alternatives. Our cash flows from operations, borrowing availability and overall liquidity are subject to risks and uncertainties. See Item 1A, “Risk Factors,” “— Executive Overview” and “— Forward-Looking Statements.”

 

Market Risk Sensitivity

 

In the normal course of business, we are exposed to market risk associated with fluctuations in foreign exchange rates and interest rates. We manage these risks through the use of derivative financial instruments in accordance with management’s guidelines. We enter into all hedging transactions for periods consistent with the underlying exposures. We do not enter into derivative instruments for trading purposes.

 

Foreign Exchange

 

Operating results may be impacted by our buying, selling and financing in currencies other than the functional currency of our operating companies (“transactional exposure”). We mitigate this risk by entering into forward foreign exchange, futures and option contracts. The foreign exchange contracts are executed with banks that we believe are creditworthy. Gains and losses related to foreign exchange contracts are deferred and included in the

measurement of the foreign currency transaction subject to the hedge. Gains and losses incurred related to foreign exchange contracts are generally offset by the direct effects of currency movements on the underlying transactions.

 

Our most significant foreign currency transactional exposures relate to the Mexican peso, the Canadian dollar and the Euro. We have performed a quantitative analysis of our overall currency rate exposure as of December 31, 2005. The potential earnings benefit related to net transactional exposures from a hypothetical 10% strengthening of the U.S. dollar relative to all other currencies for 2006 is approximately $16 million. The potential earnings benefit related to net transactional exposures from a similar strengthening of the Euro relative to all other currencies for 2006 is approximately $2 million.

 

As of December 31, 2005, foreign exchange contracts representing $2.0 billion of notional amount were outstanding with maturities of less than twelve months. As of December 31, 2005, the fair market value of these contracts was approximately $0 million. A 10% change in the value of the U.S. dollar relative to all other currencies would result in a $34 million change in the aggregate fair market value of these contracts. A 10% change in the value of the Euro relative to all other currencies would result in a $44 million change in the aggregate fair market value of these contracts.

 

There are certain shortcomings inherent in the sensitivity analysis presented. The analysis assumes that all currencies would uniformly strengthen or weaken relative to the U.S. dollar or Euro. In reality, some currencies may strengthen while others may weaken, causing the earnings impact to increase or decrease depending on the currency and the direction of the rate movement.

 

In addition to the transactional exposure described above, our operating results are impacted by the translation of our foreign operating income into U.S. dollars (“translation exposure”). In 2005, net sales outside of the United States accounted for 63% of our consolidated net sales. We do not enter into foreign exchange contracts to mitigate this exposure.

 

Interest Rates

 

We use a combination of fixed and variable rate debt and interest rate swap contracts to manage our exposure to interest rate movements. Our exposure to variable interest rates on outstanding variable rate debt instruments indexed to United States or European Monetary Union short-term money market rates is partially managed by the use of interest rate swap contracts to convert certain variable rate debt obligations to fixed rate, matching effective and maturity dates to specific debt instruments. We also utilize interest rate swap contracts to convert certain fixed rate debt obligations to variable rate, matching effective and maturity dates to specific debt instruments. All of our interest rate swap contracts are executed with banks that we believe are creditworthy and are denominated in currencies that match the underlying debt instrument. Net interest payments or receipts from interest rate swap contracts are included as adjustments to interest expense in our consolidated statements of operations on an accrual basis.

 

We have performed a quantitative analysis of our overall interest rate exposure as of December 31, 2005. This analysis assumes an instantaneous 100 basis point parallel shift in interest rates at all points of the yield curve. The potential adverse earnings impact from this hypothetical increase for 2006 is approximately $12 million.

 

As of December 31, 2005, interest rate swap contracts representing $600 million of notional amount were outstanding with maturity dates of September 2007 through May 2009. Of these outstanding contracts, $300 million are designated as fair value hedges and modify the fixed rate characteristics of our outstanding 8.11% senior notes due May 2009. The remaining $300 million are designated as cash flow hedges and modify the variable rate characteristics of our variable rate debt instruments. The fair market value of all outstanding interest rate swap contracts is subject to changes in value due to changes in interest rates. As of December 31, 2005, the fair market value of these contracts was approximately negative $10 million. A 100 basis point parallel shift in interest rates would result in a $6 million change in the aggregate fair market value of these contracts.

 

Commodity Prices

 

We have commodity price risk with respect to purchases of certain raw materials, including steel, leather, resins, chemicals and diesel fuel. In limited circumstances, we have used financial instruments to mitigate this risk.

Increases in certain raw material, energy and commodity costs (principally steel, resins and other oil-based commodities) had a material adverse impact on our operating results in 2005. These conditions worsened as a result of the Gulf Coast storms in the third quarter of 2005. Unfavorable industry conditions have also resulted in financial distress within our supply base and an increase in commercial disputes and the risk of supply disruption. We have developed and implemented strategies to mitigate or partially offset the impact of higher raw material, energy and commodity costs, which include aggressive cost reduction actions, the utilization of our cost technology optimization process, the selective in-sourcing of components where we have available capacity, the continued consolidation of our supply base and the acceleration of low-cost country sourcing and engineering. However, due to the magnitude and duration of the increased raw material, energy and commodity costs, these strategies, together with commercial negotiations with our customers and suppliers, offset only a portion of the adverse impact. We expect that high raw material, energy and commodity costs will continue to have a material adverse impact on our operating results in the foreseeable future. See Item 1A, “Risk Factors — High raw material costs may continue to have a significant adverse impact on our profitability,” and “— Forward-Looking Statements.”

 

For further information related to the financial instruments described above, see Note 7, “Long-Term Debt,” and Note 12, “Financial Instruments,” to the consolidated financial statements included in this Report.

 

Other Matters

 

Legal and Environmental Matters

 

We are involved from time to time in legal proceedings and claims, including, without limitation, commercial or contractual disputes with our suppliers and competitors. Largely as a result of generally unfavorable industry conditions and financial distress within the automotive supply base, we experienced an increase in commercial and contractual disputes, particularly with our suppliers. These disputes vary in nature and are usually resolved by negotiations between the parties.

 

On January 29, 2002, Seton Company (“Seton”), one of our leather suppliers, filed a suit alleging that we had breached a purported agreement to purchase leather from Seton for seats for the life of the General Motors GMT 800 program. Seton filed the lawsuit in the U.S. District Court for the Eastern District of Michigan seeking compensatory and exemplary damages totaling approximately $97 million, plus interest, on breach of contract and promissory estoppel claims. In May 2005, this case proceeded to trial, and the jury returned a $30 million verdict against us. On September 27, 2005, the Court denied our post-trial motions challenging the judgment and granted Seton’s motion to award prejudgment interest in the amount of approximately $5 million. We are appealing the judgment and the interest award.

 

On January 26, 2004, we filed a patent infringement lawsuit against Johnson Controls Inc. and Johnson Controls Interiors LLC (together, “JCI”) in the U.S. District Court for the Eastern District of Michigan alleging that JCI’s garage door opener products infringed certain of our radio frequency transmitter patents. JCI counterclaimed seeking a declaratory judgment that the subject patents are invalid and unenforceable, and that JCI is not infringing these patents. JCI also has filed motions for summary judgment asserting that its garage door opener products do not infringe our patents. We are vigorously pursuing our claims against JCI and discovery is on-going. A trial in the case is currently scheduled for the second quarter of 2006.

 

After we filed our patent infringement action against JCI, affiliates of JCI sued one of our vendors and certain of the vendor’s employees in Ottawa Circuit Court, Michigan, on July 8, 2004, alleging misappropriation of trade secrets. The suit alleges that the defendants misappropriated and shared with us trade secrets involving JCI’s universal garage door opener product. JCI seeks to enjoin the defendants from selling or attempting to sell a competing product. We are not a defendant in this lawsuit; however, the agreements between us and the defendants contain customary indemnification provisions. We do not believe that our garage door opener product benefited from any allegedly misappropriated trade secrets or technology. However, JCI has sought discovery of certain information which we believe is confidential and proprietary, and we have intervened in the case for the limited purpose of protecting our rights with respect to JCI’s discovery efforts. Discovery has been extended to July 2006. A trial date has not yet been scheduled.

On June 13, 2005, The Chamberlain Group (“Chamberlain”) filed a lawsuit against us and Ford Motor Company (“Ford”) in the Northern District of Illinois alleging patent infringement. Two counts were asserted against us and Ford based upon Chamberlain’s rolling code security system patent and a related product which operates transmitters to actuate garage door openers. Two additional counts were asserted against Ford only (not us) based upon different Chamberlain patents. The Chamberlain lawsuit was filed in connection with the marketing of our universal garage door opener system, which competes with a product offered by JCI. JCI obtained technology from Chamberlain to operate its product. In October 2005, JCI joined the lawsuit as a plaintiff along with Chamberlain, and Chamberlain dismissed its infringement claims against Ford based upon its rolling security system patent. JCI and Chamberlain have filed a motion for a preliminary injunction, which we are contesting. We are vigorously defending the claims asserted in this lawsuit. A trial date has not yet been scheduled.

 

We are subject to local, state, federal and foreign laws, regulations and ordinances which govern activities or operations that may have adverse environmental effects and which impose liability for clean-up costs resulting from past spills, disposals or other releases of hazardous wastes and environmental compliance. Our policy is to comply with all applicable environmental laws and to maintain an environmental management program based on ISO 14001 to ensure compliance. However, we currently are, have been and in the future may become the subject of formal or informal enforcement actions or procedures.

 

We have been named as a potentially responsible party at several third-party landfill sites and are engaged in the cleanup of hazardous waste at certain sites owned, leased or operated by us, including several properties acquired in our 1999 acquisition of UT Automotive, Inc. (“UT Automotive”). Certain present and former properties of UT Automotive are subject to environmental liabilities which may be significant. We obtained agreements and indemnities with respect to certain environmental liabilities from United Technologies Corporation (“UTC”) in connection with our acquisition of UT Automotive. UTC manages and directly funds these environmental liabilities pursuant to its agreements and indemnities with us.

 

While we do not believe that the environmental liabilities associated with our current and former properties will have a material adverse effect on our business, consolidated financial position or results of operations, no assurances can be given in this regard.

 

One of our subsidiaries and certain predecessor companies were named as defendants in an action filed by three plaintiffs in August 2001 in the Circuit Court of Lowndes County, Mississippi, asserting claims stemming from alleged environmental contamination caused by an automobile parts manufacturing plant located in Columbus, Mississippi. The plant was acquired by us as part of our acquisition of UT Automotive in May 1999 and sold almost immediately thereafter, in June 1999, to Johnson Electric Holdings Limited (“Johnson Electric”). In December 2002, 61 additional cases were filed by approximately 1,000 plaintiffs in the same court against us and other defendants relating to similar claims. In September 2003, we were dismissed as a party to these cases. In the first half of 2004, we were named again as a defendant in these same 61 additional cases and were also named in five new actions filed by approximately 150 individual plaintiffs related to alleged environmental contamination from the same facility. The plaintiffs in these actions are persons who allegedly were either residents and/or owned property near the facility or worked at the facility. In November 2004, two additional lawsuits were filed by 28 plaintiffs (individuals and organizations), alleging property damage as a result of the alleged contamination. Each of these complaints seeks compensatory and punitive damages.

 

All of the plaintiffs have dismissed their claims for health effects and personal injury damages without prejudice. There is the potential that these plaintiffs could seek separate counsel to re-file their personal injury claims. Currently, there are approximately 270 plaintiffs remaining in the lawsuits who are proceeding with property damage claims only. In March 2005, the venue for these lawsuits was transferred from Lowndes County, Mississippi, to Lafayette County, Mississippi. In April 2005, certain plaintiffs filed an amended complaint alleging negligence, nuisance, intentional tort and conspiracy claims and seeking compensatory and punitive damages. In April 2005, the court scheduled the first trial date for the first group of plaintiffs to commence March 2006. The March 2006 trial date has since been continued until a date to be set by the court, and discovery has extended into the first quarter of 2006.

 

UTC, the former owner of UT Automotive, and Johnson Electric have each sought indemnification for losses associated with the Mississippi claims from us under the respective acquisition agreements, and we have claimed

indemnification from them under the same agreements. To date, no company admits to, or has been found to have, an obligation to fully defend and indemnify any other. We intend to vigorously defend against these claims and believe that we will eventually be indemnified by either UTC or Johnson Electric for a substantial portion of the resulting losses, if any. However, the ultimate outcome of these matters is unknown.

 

In January 2004, the Securities and Exchange Commission (the “SEC”) commenced an informal inquiry into our September 2002 amendment of our 2001 Form 10-K. The amendment was filed to report our employment of relatives of certain of our directors and officers and certain related party transactions. The SEC’s inquiry does not relate to our consolidated financial statements. In February 2005, the staff of the SEC informed us that it proposed to recommend to the SEC that it issue an administrative “cease and desist” order as a result of our failure to disclose the related party transactions in question prior to the amendment of our 2001 Form 10-K. We expect to consent to the entry of the order as part of a settlement of this matter.

 

In February 2006, we received a subpoena from the SEC in connection with an ongoing investigation of General Motors Corporation by the SEC. This investigation has been previously reported by General Motors as involving, among other things, General Motors’ accounting for payments and credits by suppliers. The SEC subpoena seeks the production of documents relating to payments or credits by us to General Motors from 2001 to the present. We are cooperating with the SEC in connection with this matter.

 

Although we record reserves for legal, product warranty and environmental matters in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 5, “Accounting for Contingencies,” the outcomes of these matters are inherently uncertain. Actual results may differ significantly from current estimates. See Item 1A, “Risk Factors.” For further information regarding legal and environmental matters, see Item 3, “Legal Proceedings.”

 

Certain Tax Matters

 

UT Automotive

 

Prior to our acquisition of UT Automotive from UTC in May 1999, one of our subsidiaries purchased the stock of a UT Automotive subsidiary. In connection with the acquisition, we agreed to indemnify UTC for certain tax consequences if the Internal Revenue Service (the “IRS”) overturned UTC’s tax treatment of the transaction. The IRS proposed an adjustment to UTC’s tax treatment of the transaction seeking an increase in tax of approximately $88 million, excluding interest. In April 2005, a protest objecting to the proposed adjustment was filed with the IRS. The case was then referred to the Appeals Office of the IRS for an independent review. There have been several meetings and discussions with the IRS Appeals personnel in an attempt to resolve the case. Although we believe that valid support exists for UTC’s tax positions, we and UTC are currently in settlement negotiations with the IRS. An indemnity payment by us to UTC for the ultimate amount due to the IRS would constitute an adjustment to the purchase price and resulting goodwill of the UT Automotive acquisition, if and when made, and would not be expected to have a material effect on our reported earnings.

 

American Jobs Creation Act of 2004

 

In October 2004, the American Jobs Creation Act of 2004 (“the Act”) was signed into law. The Act created a temporary incentive for U.S. corporations to repatriate earnings from foreign subsidiaries by providing an 85% dividends received deduction for certain dividends from controlled foreign corporations to the extent the dividends exceed a base amount and are invested in the United States pursuant to a domestic reinvestment plan. The temporary incentive was available to us until December 31, 2005. The amount of our dividends potentially eligible for the deduction was limited to $500 million.

 

After completing our evaluation, we decided not to pursue dividends under the repatriation provision of the Act due to numerous tax and treasury considerations. This decision had no effect on our provision for income taxes for the year ended December 31, 2005.

 

Significant Accounting Policies and Critical Accounting Estimates

 

Our significant accounting policies are more fully described in Note 2, “Summary of Significant Accounting Policies,” to the consolidated financial statements included in this Report. Certain of our accounting policies require

management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. These estimates and assumptions are based on our historical experience, the terms of existing contracts, our evaluation of trends in the industry, information provided by our customers and suppliers and information available from other outside sources, as appropriate. However, they are subject to an inherent degree of uncertainty. As a result, actual results in these areas may differ significantly from our estimates.

 

We consider an accounting estimate to be critical if it requires us to make assumptions about matters that were uncertain at the time the estimate was made and changes in the estimate would have had a significant impact on our consolidated financial position or results of operations.

 

Pre-Production Costs Related to Long-Term Supply Arrangements

 

We incur pre-production engineering, research and development (“ER&D”) and tooling costs related to the products produced for our customers under long-term supply agreements. We expense all pre-production ER&D costs for which reimbursement is not contractually guaranteed by the customer. In addition, we expense all pre-production tooling costs related to customer-owned tools for which reimbursement is not contractually guaranteed by the customer or for which the customer has not provided a non-cancelable right to use the tooling. During 2005 and 2004, we capitalized $227 million and $245 million, respectively, of pre-production ER&D costs for which reimbursement is contractually guaranteed by the customer. During 2005 and 2004, we also capitalized $639 million and $396 million, respectively, of pre-production tooling costs related to customer-owned tools for which reimbursement is contractually guaranteed by the customer or for which the customer has provided a non-cancelable right to use the tooling. During 2005 and 2004, we collected $716 million and $646 million, respectively, of cash related to ER&D and tooling costs.

 

Gains and losses related to ER&D and tooling projects are reviewed on an aggregate program basis. Net gains on projects are deferred and recognized over the life of the related long-term supply agreement. Net losses on projects are recognized as costs are incurred.

 

A change in the commercial arrangements affecting any of our significant programs that would require us to expense ER&D or tooling costs that we currently capitalize could have a material adverse impact on our operating results.

 

Goodwill

 

As of December 31, 2005 and 2004, we had recorded goodwill of approximately $1.9 billion and $3.0 billion, respectively. Goodwill is not amortized but is tested for impairment on at least an annual basis. Impairment testing is required more often than annually if an event or circumstance indicates that an impairment, or decline in value, may have occurred. In conducting our impairment testing, we compare the fair value of each of our reporting units to the related net book value. If the fair value of a reporting unit exceeds its net book value, goodwill is considered not to be impaired. If the net book value of a reporting unit exceeds its fair value, an impairment loss is measured and recognized. We conduct our annual impairment testing on the first day of the fourth quarter each year.

 

We utilize an income approach to estimate the fair value of each of our reporting units. The income approach is based on projected debt-free cash flow which is discounted to the present value using discount factors that consider the timing and risk of cash flows. We believe that this approach is appropriate because it provides a fair value estimate based upon the reporting unit’s expected long-term operating cash flow performance. This approach also mitigates the impact of cyclical downturns that occur in the industry. Fair value is estimated using recent automotive industry and specific platform production volume projections, which are based on both third-party and internally-developed forecasts, as well as commercial, wage and benefit, inflation and discount rate assumptions. Other significant assumptions include terminal value growth rates, terminal value margin rates, future capital expenditures and changes in future working capital requirements. While there are inherent uncertainties related to the assumptions used and to management’s application of these assumptions to this analysis, we believe that the income approach provides a reasonable estimate of the fair value of our reporting units.

During the third quarter of 2005, events occurred which indicated a significant decline in the fair value of our interior segment, as well as an impairment of the related goodwill. These events included unfavorable operating results, primarily as a result of higher raw material costs, lower production volumes on key platforms, industry overcapacity, insufficient customer pricing and changes in certain customers’ sourcing strategies, as well as our decision to evaluate strategic alternatives with respect to this segment. As of the end of the third quarter of 2005, we evaluated the net book value of goodwill within our interior segment by comparing the fair value of the reporting unit to the related net book value. As a result, we recorded an estimated goodwill impairment charge of $670 million in the third quarter of 2005.

 

During the fourth quarter of 2005, additional events occurred which indicated a further decline in the fair value of our interior segment. These events included a further deterioration of the commercial outlook for this segment, as well as an updated assessment of our ability to recover the increase in the costs associated with resin-based raw materials in North America. We updated the fair value estimate for this segment and finalized the implied fair value of goodwill pursuant to asset valuation and allocation procedures. As a result, we recorded an additional goodwill impairment charge of $343 million in the fourth quarter of 2005.

 

The annual impairment testing for our remaining segments was completed as of October 2, 2005, and there was no additional impairment.

 

Long-Lived Assets

 

We monitor our long-lived assets for impairment indicators on an ongoing basis in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” If impairment indicators exist, we perform the required analysis and record impairment charges in accordance with SFAS No. 144. In conducting our analysis, we compare the undiscounted cash flows expected to be generated from the long-lived assets to the related net book values. If the undiscounted cash flows exceed the net book value, the long-lived assets are considered not to be impaired. If the net book value exceeds the undiscounted cash flows, an impairment loss is measured and recognized. An impairment loss is measured as the difference between the net book value and the fair value of the long-lived assets. Fair value is estimated based upon either discounted cash flow analyses or estimated salvage values. Cash flows are estimated using internal budgets based on recent sales data, independent automotive production volume estimates and customer commitments, as well as assumptions related to discount rates. Changes in economic or operating conditions impacting these estimates and assumptions could result in the impairment of long-lived assets.

 

During the third and fourth quarters of 2005, we evaluated the net book value of the fixed assets of certain operating locations within our interior segment. As a result, we recorded impairment charges of $82 million. Consistent with the goodwill impairment charges, the fixed asset impairment charges are due to the unfavorable operating results of our interior segment, as well as the deterioration of the commercial outlook for this segment. Also in 2005, we recorded fixed asset impairment charges of $15 million in conjunction with our restructuring actions. We have certain other facilities that have generated operating losses in recent years. The results of the related impairment analyses indicated that impairment of the fixed assets was not required. However, we will continue to monitor the operating plans of these facilities for potential impairment.

 

In 2004, we recorded impairment charges of $3 million related to certain facility consolidations. In 2003, we recorded impairment charges of $5 million related to certain facility consolidations and impairment charges of $6 million related to other facility closures, an early program termination and ongoing losses at certain of our facilities.

 

These fixed asset impairment charges are recorded in cost of sales in the consolidated statements of operations for the years ended December 31, 2005, 2004 and 2003.

 

Restructuring

 

Accruals have been recorded in conjunction with our restructuring actions, as well as the integration of acquired businesses. These accruals include estimates primarily related to facility consolidations and closures, census reductions and contract termination costs. Actual costs may vary from these estimates. Restructuring-related

accruals are reviewed on a quarterly basis, and changes to the restructuring actions are appropriately recognized when identified.

 

Legal and Other Contingencies

 

We are subject to legal proceedings and claims, including product liability claims, commercial or contractual disputes, environmental enforcement actions and other claims that arise in the normal course of business. We routinely assess the likelihood of any adverse judgments or outcomes to these matters, as well as ranges of probable losses, by consulting with internal personnel principally involved with such matters and with our outside legal counsel handling such matters. We have accrued for estimated losses in accordance with accounting principles generally accepted in the United States for those matters where we believe that the likelihood that a loss has occurred is probable and the amount of loss is reasonably estimable. The determination of the amount of such reserves is based on knowledge and experience with regard to past and current matters and consultation with internal personnel principally involved with such matters and with our outside legal counsel handling such matters. The reserves may change in the future due to new developments or changes in circumstances. The inherent uncertainty related to the outcome of these matters can result in amounts materially different from any provisions made with respect to their resolution.

 

Pension and Other Postretirement Benefit Plans

 

Approximately 20% of our active workforce is covered by defined benefit pension plans. Approximately 10% of our active workforce is covered by other postretirement benefit plans. Pension plans provide benefits based on plan-specific benefit formulas as defined by the applicable plan documents. Postretirement benefit plans generally provide for the continuation of medical benefits for all eligible employees. We also have contractual arrangements with certain employees which provide for supplemental retirement benefits. In general, our policy is to fund our pension benefit obligation based on legal requirements, tax considerations and local practices. We do not fund our postretirement benefit obligation.

 

As of December 31, 2005 (based on a September 30, 2005 measurement date), our projected benefit obligations related to our pension and other postretirement benefit plans were $788 million and $266 million, respectively, and our unfunded pension and other postretirement benefit obligations were $314 million and $266 million, respectively. These benefit obligations were valued using a weighted average discount rate of 5.75% and 5.70% for domestic pension and other postretirement benefit plans, respectively, and 5.00% and 5.30% for foreign pension and other postretirement benefit plans, respectively. The determination of the discount rate is based on the construction of a hypothetical bond portfolio consisting of high-quality fixed income securities with durations that match the timing of expected benefit payments. Changes in the selected discount rate could have a material impact on our projected benefit obligations and the underfunded status of our pension and other postretirment benefit plans. Decreasing the discount rate by 1% would have increased the projected benefit obligations and underfunded status of our pension and other postretirement benefit plans by approximately $155 million and $50 million, respectively.

 

For the year ended December 31, 2005, pension and other postretirement net periodic benefit cost was $58 million and $29 million, respectively, and was determined using a variety of actuarial assumptions. Pension net periodic benefit cost in 2005 was calculated using a weighted average discount rate of 6.00% for both domestic and foreign plans and an expected return on plan assets of 7.75% and 7.00% for domestic and foreign plans, respectively. The expected return on plan assets is determined based on several factors, including adjusted historical returns, historical risk premiums for various asset classes and target asset allocations within the portfolio. Adjustments made to the historical returns are based on recent return experience in the equity and fixed income markets and the belief that deviations from historical returns are likely over the relevant investment horizon. Other postretirement net periodic benefit cost was calculated in 2005 using a discount rate of 6.00% and 6.50% for domestic and foreign plans, respectively. Adjustments to our actuarial assumptions could have a material adverse impact on our operating results. Decreasing the discount rate by 1% would have increased pension and other postretirement periodic net benefit cost by approximately $14 million and approximately $5 million, respectively, for the year ended December 31, 2005. Decreasing the expected return on plan assets by 1% would have increased pension net periodic benefit cost by approximately $4 million for the year ended December 31, 2005.

Aggregate pension and other postretirement net periodic benefit cost is forecasted to be approximately $97 million in 2006. This estimate is based on a weighted average discount rate of 5.75% and 5.00% for domestic and foreign pension plans, respectively, and 5.70% and 5.30% for domestic and foreign other postretirement benefit plans, respectively. Actual cost is also dependent on various other factors related to the employees covered by these plans.

 

We expect to contribute approximately $65 million to our domestic and foreign pension plans in 2006. Contributions to our pension plans are consistent with minimum funding requirements of the relevant governmental authorities. We may make contributions in excess of these minimums when we believe it is financially advantageous to do so and based on our other capital requirements.

 

For further information related to our pension and other postretirement benefit plans, see Note 9, “Pension and Other Postretirement Benefit Plans,” to the consolidated financial statements included in this Report.

 

Revenue Recognition and Sales Commitments

 

We enter into agreements with our customers to produce products at the beginning of a vehicle’s life. Although such agreements do not provide for minimum quantities, once we enter into such agreements, we are generally required to fulfill our customers’ purchasing requirements for the entire production life of the vehicle. These agreements generally may be terminated by our customer at any time. Historically, terminations of these agreements have been minimal. In certain limited instances, we may be committed under existing agreements to supply products to our customers at selling prices which are not sufficient to cover the direct cost to produce such products. In such situations, we recognize losses as they are incurred.

 

We receive blanket purchase orders from our customers on an annual basis. Generally, each purchase order provides the annual terms, including pricing, related to a particular vehicle model. Purchase orders do not specify quantities. We recognize revenue based on the pricing terms included in our annual purchase orders as our products are shipped to our customers. We are asked to provide our customers with annual cost reductions as part of certain agreements. We accrue for such amounts as a reduction of revenue as our products are shipped to our customers. In addition, we have ongoing adjustments to our pricing arrangements with our customers based on the related content, the cost of our products and other commercial factors. Such pricing accruals are adjusted as they are settled with our customers.

 

Amounts billed to customers related to shipping and handling are included in net sales in our consolidated statements of operations. Shipping and handling costs are included in cost of sales in our consolidated statements of operations.

 

Income Taxes

 

In determining the provision for income taxes for financial statement purposes, we make certain estimates and judgments, which affect our evaluation of the carrying value of our deferred tax assets, as well as our calculation of certain tax liabilities. In accordance with SFAS No. 109, “Accounting for Income Taxes,” we evaluate the carrying value of our deferred tax assets on a quarterly basis. In completing this evaluation, we consider all available evidence. Such evidence includes historical results, expectations for future pretax operating income, the time period over which our temporary differences will reverse and the implementation of feasible and prudent tax planning strategies.

 

During 2005, operating losses generated in the United States resulted in an increase in the carrying value of our deferred tax assets. In light of our recent operating performance in the United States and current industry conditions, we assessed, based upon all available evidence, whether it was more likely than not that we would realize our U.S. deferred tax assets. We concluded that it was no longer more likely than not that we would realize our U.S. deferred tax assets. As a result, in the fourth quarter of 2005, we recorded a tax charge of $300 million comprised of (i) a full valuation allowance of $255 million and (ii) an increase in related tax reserves of $45 million. Although the tax charge did not result in current cash expenditures, it did negatively impact net income, assets and stockholders’ equity as of and for the year ended December 31, 2005. As of December 31, 2005, we recorded a U.S. valuation allowance of $255 million and a valuation allowance for certain foreign tax jurisdictions of

$223 million. We intend to maintain these allowances until it is more likely than not that the deferred tax assets will be realized. Our future income tax expense will be reduced to the extent of decreases in our valuation allowances.

 

In addition, the calculation of our tax benefits and liabilities includes uncertainties in the application of complex tax regulations in a multitude of jurisdictions across our global operations. We recognize tax benefits and liabilities based on our estimate of whether, and the extent to which, additional taxes will be due. We adjust these liabilities based on changing facts and circumstances; however, due to the complexity of some of these uncertainties and the impact of any tax audits, the ultimate resolutions may be materially different from our estimated liabilities. For further information related to income taxes, see Note 8, “Income Taxes,” to the consolidated financial statements included in this Report.

 

Use of Estimates

 

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. During 2005, there were no material changes in the methods or policies used to establish estimates and assumptions. Generally, matters subject to estimation and judgment include amounts related to accounts receivable realization, inventory obsolescence, asset impairments, unsettled pricing discussions with customers and suppliers, restructuring accruals, deferred tax asset valuation allowances and income taxes, pension and other postretirement benefit plan assumptions, accruals related to litigation, warranty and environmental remediation costs and self-insurance accruals. Actual results may differ from estimates provided.

 

Recently Issued Accounting Pronouncements

 

Inventory Costs

 

The Financial Accounting Standards Board (“FASB”) issued SFAS No. 151, “Inventory Costs — an amendment of ARB No. 43, Chapter 4.” This statement clarifies the requirement that abnormal inventory-related costs be recognized as current-period charges and requires that the allocation of fixed production overheads to inventory conversion costs be based on the normal capacity of the production facilities. The provisions of this statement are to be applied prospectively to inventory costs incurred during fiscal years beginning after June 15, 2005. We do not expect the effects of adoption to be significant.

 

Nonmonetary Assets

 

The FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets — an amendment of APB Opinion No. 29.” APB Opinion No. 29, in general, requires the use of fair value as the measurement basis for exchanges of nonmonetary assets. This statement eliminates the exception to the fair value measurement principle for nonmonetary exchanges of similar productive assets and replaces it with a general exception for nonmonetary asset exchanges that lack commercial substance. The provisions of this statement are to be applied prospectively to nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. We do not expect the effects of adoption to be significant.

 

Stock-Based Compensation

 

The FASB issued a revised SFAS No. 123, “Share-Based Payment.” This statement requires that all share-based payments to employees be recognized in the financial statements based on their grant-date fair value. Under previous guidance, companies had the option of recognizing the fair value of stock-based compensation in the consolidated financial statements or disclosing the proforma impact of stock-based compensation on the

consolidated statement of operations in the notes to the consolidated financial statements. As described in Note 2, “Summary of Significant Accounting Policies,” to the consolidated financial statements included in this Report, we adopted the fair value recognition provisions of SFAS No. 123 for all employee awards issued after January 1, 2003. The revised statement is effective at the beginning of the first annual period beginning after June 15, 2005, and provides two methods of adoption, the modified-prospective method and the modified-retrospective method. We anticipate adopting the revised statement using the modified-prospective method. We are currently evaluating the provisions of the revised statement but do not expect the impact of adoption to be significant.

 

Conditional Asset Retirement Obligations

 

The FASB issued Interpretation (“FIN”) No. 47, “Accounting for Conditional Asset Retirement Obligations.” FIN 47 requires the accrual of costs related to legal obligations to perform certain activities in connection with the retirement, disposal or abandonment of assets. The effects of adoption were not significant.

 

Financial Instruments

 

The FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments — an amendment of FASB Statements No. 133 and 140.” This statement resolves issues related to the application of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” to beneficial interests in securitized assets. The provisions of this statement are to be applied prospectively to all financial instruments acquired or issued during fiscal years beginning after September 15, 2006. We are currently evaluating the provisions of this statement but do not expect the effects of adoption to be significant.

 

Forward-Looking Statements

 

The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements made by us or on our behalf. The words “will,” “may,” “designed to,” “outlook,” “believes,” “should,” “anticipates,” “plans,” “expects,” “intends,” “estimates” and similar expressions identify these forward-looking statements. All statements contained or incorporated in this Report which address operating performance, events or developments that we expect or anticipate may occur in the future, including statements related to business opportunities, awarded sales contracts, sales backlog and net income per share growth or statements expressing views about future operating results, are forward-looking statements. Important factors, risks and uncertainties that may cause actual results to differ from those expressed in our forward-looking statements include, but are not limited to:

 

 

 

Finally, the proposed joint venture between us and WL Ross & Co. LLC with respect to our interior segment is subject to the negotiation and execution of definitive agreements and other conditions. No assurances can be given that the proposed joint venture will be completed on the terms contemplated or at all.

 

The forward-looking statements in this Report are made as of the date hereof, and we do not assume any obligation to update, amend or clarify them to reflect events, new information or circumstances occurring after the date hereof.

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

To the Board of Directors and Shareholders of

Lear Corporation

 

We have audited the accompanying consolidated balance sheets of Lear Corporation and Subsidiaries (the Company) as of December 31, 2005 and 2004, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2005. Our audits also included the financial statement schedule for the three years in the period ended December 31, 2005, included in Item 8. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2005 and 2004, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule for the three years in the period ended December 31, 2005, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

 

As discussed in Note 2 to the consolidated financial statements, the Company changed its method of calculating diluted net income per share in accordance with Emerging Issues Task Force Issue No. 04-8, “The Effect of Contingently Convertible Instruments on Diluted Earnings per Share,” effective December 15, 2004.

 

We have also audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 6, 2006, expressed an unqualified opinion thereon.

 

/s/  Ernst & Young LLP

 

Troy, Michigan

March 6, 2006

Report of Independent Registered Public Accounting Firm on
Internal Controls over Financial Reporting

 

To the Board of Directors and Shareholders of

Lear Corporation

 

We have audited management’s assessment, included in Management’s Annual Report on Internal Control Over Financial Reporting included in Item 9A(b), that Lear Corporation and Subsidiaries (the Company) maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the COSO criteria.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Company as of December 31, 2005 and 2004, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2005, and the related financial statement schedule for the three years in the period ended December 31, 2005, and our report dated March 6, 2006, expressed an unqualified opinion thereon.

 

/s/  Ernst & Young LLP

Troy, Michigan

March 6, 2006

LEAR CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

LEAR CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

LEAR CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY