Maximizing Long-Term Cash Flow

Our value-creating process focuses on long-term cash flow to provide funds for competitive compensation to shareholders, in addition to funds for an adequate financial position and maintaining earnings momentum. We therefore focus on growing earnings per share, while minimizing the capital required to take full advantage of Autoliv's growth potential.

Topline growth

One of Autoliv's targets is to outperform the global occupant restraint market and to grow topline revenues faster than costs.

  As with all companies, Autoliv's revenues are determined by the size of the market and the company's share of that market. In Autoliv's case, the growth of our market has added just over 4% annually to sales since the new Autoliv company was launched in 1997. During the same period, market share gains (including acquisitions) have added nearly 5% per year, on average, to Autoliv's sales.

The Market

Our market, the automotive safety systems market, exceeded $14 billion in 2003. It primarily consists of frontal airbags (36%), side airbags (14%), seat belts (29%) and related electronics (21%).
  Adjusted for currency effects, the market grew by $0.5 billion in 2003. The size of the market also depends on global vehicle production and the safety content per vehicle. Since 1997, these drivers have caused the market to rise at annual average rates of 1.5% and nearly 3%, respectively.
  Vehicle production is driven by GNP growth, and fluctuates with the business cycles in individual markets. The age of the vehicle fleet influences demand less than GNP growth.
  The safety content per vehicle is driven by introduction and higher penetration rates of new airbags and other new technologies. Equally important are new regulations and crash test programs. The average supply value per vehicle exceeded $245 in 2003. However, the gap between the low-end cars and the best safety-equipped vehicles was more than ten times - providing great potential for improvements among less well-equipped vehicles while the best equipped ones strive to defend their superiority. As a result, the safety content per vehicle is expected to continue to rise.
  In the regulatory field, 2003 was a particularly eventful year. Vehicle manufacturers in the United States announced a self commitment for enhanced side-impact protection to be phased in by September 2009. In Europe, the EU commission signed a new directive that will phase in stricter pedestrian protection requirements on new vehicles in 2005 and in 2010. Japan is considering following Europe's move.

Market Share Growth

Since 1997, Autoliv has grown its sales at an average rate of nearly 9% per year. In 1998, we became the industry sales leader. Currently, we have approximately one-third of the global market, followed by the Japanese family- owned company Takata and the American public company TRW Automotive. Both have nearly one-quarter of the global occupant restraint market.
  Organic growth - based on technical leadership and geographical expansion - has, as an average, contributed over 5 percentage points annually to Autoliv's sales growth since 1997. Acquisitions have contributed just over 3 points.
  It is our goal to continue to outgrow the total market. Autoliv is better positioned than our competitors in the market's growth areas (such as side airbags), and we have developed a more significant global presence. This is a tremendous asset as Asian vehicle manufacturers continue to increase their share of global vehicle production. With Autoliv's system capabilities we are also helped by the fact that many vehicle manufacturers prefer to purchase airbags, seat belts and other safety products as one combined system.

Cost control

Approximately 50% of Autoliv's revenues are spent on components and other direct materials from external suppliers. Almost 30% of revenues are used for salaries and other costs for employees; most of this (nearly 20%) is in manufacturing.
  R,D&E (Research, Development and Engineering) takes currently almost 6%, and S,G&A (Sales, General and Administration) about 5% of sales. Both R,D&E and S,G&A expenditures are mainly for salaries.

Direct Material

Our target is to annually reduce direct material costs by at least 3% - i.e. faster than the decline in market prices for our safety systems.
  The most efficient cost-reduction method is redesigning and replacing existing designs and components with new, more cost-efficient ones.
   We have reduced, for instance, the material content in our traditional seat belt pretensioner by more than 70% since the introduction of the first product generation 15 years ago. Having to use fewer components also speeds up the manufacturing process, thereby reducing costs even more.
  Another cost-reduction method is the current supplier consolidation program, which should reduce our global supplier base from over 2,000 suppliers to less than 500 in a few years.

Labor Costs

Our target is to improve labor productivity by at least 5% per year to offset higher labor costs. For this we rely on Kaizen, Six-Sigma, Autoliv's own production system (APS) and many other manufacturing principles and methods.
  In addition, we have set a target to move at least 1,000 jobs per year to low-labor-cost countries, and to establish at least 35% of total headcount in these countries. This target is based on the current cost and product mix. Today, we have 31% of headcount in these countries.

Short-term cash flow

Since roughly one-third of Autoliv's costs are relatively fixed, short-term earnings are highly dependent on capacity utilization in our plants and are therefore sales dependent. Cash-flow also depends short-term on the timing of payments from customers (primarily the ten largest vehicle manufacturers.) Short-term cash flow could therefore swing substantially from month to month.
  Total production levels in our major markets are good overall indicators of Autoliv's capacity utilization, but the production levels of individual vehicle models are most critical, since many under-utilized production lines cannot be used to supply another car model.

Cash requirements

During the next few years, cash needed for working capital is targeted to remain at 10% of sales (although it may fluctuate somewhat between quarters).
  It is also Autoliv's policy to maintain net debt significantly below three times EBITDA (Earnings before Interest, Taxes, Depreciation and Amortization) and an interest coverage ratio significantly above 2.75 times. Since these ratios were 1.2 and 10.2, respectively, at the end of 2003, there is substantial borrowing capacity.
  We believe that foreseeable capital expenditures during the next few years will not significantly exceed depreciation (including amortization.)
  The need for additional manufacturing capacity could, however, be affected by the new self commitment for enhancing side-impact protection in the United States.

Capital Employed

We have a number of initiatives for better utilization of capital employed, such as plant consolidations, outsourcing and moving to low-labor-cost countries (where less capital-intensive manufacturing processes can be used.)
  Currently, 54% of Autoliv's capital employed consists of goodwill and other intangible assets (mainly from the acquisition of Morton ASP in 1997). Since this fixed amount does not increase as long as growth in revenues is generated organically, we could grow our sales and earnings at a higher rate than capital employed.
  Furthermore, we do not presently foresee any major acquisitions.

Returning Funds

In summary, Autoliv has the potential to generate strong free cash flow for its shareholders. At the end of 2003, we had bought back 8.1 million shares for $176 million (at an average cost of $21.66). In addition, we have raised the quarterly dividend by 82% in three steps during the last 14 months.
  We are continously evaluating the best ways to compensate shareholders. For this evaluation, the Board uses internal forecasts, external advice from an investment banker as well as analysts' target prices for the Autoliv stock. In addition, the Board takes tax effects into account to make sure that funds are returned to shareholders in the most efficient way, thereby creating the highest possible shareholder value out of all available market and business conditions.

	Market By Product Since 1993, the global safety systems market has grown by 9% per year, on average, to over $14 billion. In 2003, the growth was almost 12% when the strong Euro and Yen boosted growth by 8%. The market was primarily driven by side airbags and smart frontal airbags, which mainly drove the electronics segment. The stagnation in 2000 and 2001 reflects the weaker Euro and lower vehicle production.
	Market Growth Drivers Since 1993, new airbags and other new technologies have increased the safety- system supply value at an annual average rate of 6%. Currently, the value exceeds $245 per vehicle. The safety content in high-end vehicles is often twice as high as this average. The other growth driver for Autoliv's market - global light vehicle production - has increased at an average rate of less than 3% during the same period.
	Market By Company Autoliv accounts for one-third of the global automotive safety market. Takata and TRW account for nearly one-quarter each, and Key Automotive for less than 10% of the market. Autoliv's competitive edge is technological leadership, superior global presence and system capabilities with in-house expertise in all key competence areas. Takata is a Japanese family-owned company. TRW Automotive is an American company that was acquired in 2003 by the Blackstone equity fund. In 2004, TRW made a public offering and its shares were re-listed. Key Automotive entered the safety market in 2002 by acquiring the American company Breed. The owner of Key Automotive is the Carlyle equity fund.