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American Axle & Manufacturing Holdings, Inc. (NYSE:AXL)

Q1 2008 Earnings Call

April 25, 2008 10:00 am ET

Executives

Jamie Little - Director of Investor Relations

Dick Dauch - Co-founder, Chairman and Chief Executive Officer

Yogen Rahangdale - Vice Chairman and Chief Technology Officer

David Dauch - Executive Vice President and Chief Operating Officer

Mike Simonte - Groups Vice President and Chief Financial Officer

Analysts

Rich Kwas - Wachovia

Brett Hoselton - Keybanc Capital Markets

Himanshu Patel of J.P. Morgan

John Murphy - Merrill Lynch

Chris Ceraso - Credit Suisse

David Leiker - Robert W. Baird

Rod Lache - Deutsche Bank

Jonathan Steinmetz - Morgan Stanley

Operator

Good morning. My name is Bovedal, and I'll be your conference operator today. At this time, I would like to welcome everyone to the American Axle & Manufacturing First Quarter 2008 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions). Thank you.

I would now like to turn the call over to Mr. Jamie Little, Director of Investor Relations. Sir, you may begin.

Jamie Little - Director of Investor Relations

Thank you and good morning, everyone. Thank you for joining us today and your interest in American Axle & Manufacturing. This morning, we released our first quarter 2008 earnings announcement. If you have not had an opportunity to review this announcement, you can access it on the aam.com website or through the PR Newswire Services. A replay of this call will also be available beginning at 5 pm today through 5 pm Eastern Time May 2, 2008 calling 1-800-642-1687, reservation number 39482270.

Before we begin, I would like to remind everyone that the matters discussed in this conference call may contain comments and forward-looking statements that are within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not guarantees of future results or conditions, but rather are subject to risks and uncertainties, which cannot be predicted or quantified and which may cause future activities and results of operations to differ materially from those discussed. For additional information, we ask that you refer to our filings with the Securities and Exchange Commission. This information is also available on the aam.com website.

During the call, we may refer to certain non-GAAP financial measures. Information regarding these non-GAAP measures as well as a reconciliation of these non-GAAP measures to GAAP financial information is available on the aam.com website. We are audio webcasting this call through our website, aam.com. This call will be archived in the Investors section of the website and will be available there for one year to later listening.

During the quarter, we are plan on attending 2008 KeyBanc Capital Markets Industrial, Automotive & Transportation Conference in Boston on June 5th and 2008 Wachovia Securities Nantucket Conference on June 23rd and 24th. In addition, we are always happy to host Investors Day at our facilities either here in Detroit or at other locations. Please feel free to contact me to schedule a visit.

With that, let me turn things over to AAM's Co-founder, Chairman and CEO, Dick Dauch.

Dick Dauch - Co-founder, Chairman and Chief Executive Officer

Thank you, Jamie, and good morning everyone. Thank you for joining us today to discuss AAM's financial results for the first quarter of 2008. Joining me on the call today are Yogen Rahangdale, our Vice Chairman and Chief Technology Officer, David Dauch, our Executive Vice President and Chief Operating Officer, and Mike Simonte, our Group's Vice President and Chief Financial Officer.

I would like to start the call this morning by providing an update on our ongoing contract negotiations with the International UAW. Then I will move on to our first quarter 2008 financial results, before turning things over to Mike to discuss the details of our financial performance. After that we will open the call for any questions you men and women may have.

Today, Friday April 25, 2008, marks the 60th day of the strike called by the International UAW, against our Company AAM. AAM's primary objective and these negotiations with the International UAW has been and continues to be to achieve a US market competitive labor cost structure for AAM's original location in the United States of America. We also require operating flexibility for efficiency and competitiveness.

AAM leads a US market competitive labor agreement with these facilities. It is necessary, because the International UAW previously negotiated in the past year market competitive labor agreement with many of AAM's US competitors both in the supply group, as well as within Chrysler LLC and Ford Motor Company. This includes the Dana Corporation, FormTech, Chinese-owned Neapco in the State of Michigan and Indian-based Bharat Forge in Lansing, Michigan. It also includes the in-house axle-making operations in the Ford Motor Company and Chrysler LLC.

The all in wage-and-benefit package granted by the International UAW to these companies have reduced approximately $30 an hour down to $20 an hour. Under our previous company bargaining agreement AAM's all-in labor cost was $73.48 per hour going up. These domestic locations are totally uncompetitive and cannot earn new work under the present conditions.

As compared to the benchmark of approximately 20 to $30 per hour all-in cost for the US automotive supply industry aims work labor cost structure at the original US locations was at least 245% higher than market rate of our competition in the US that has been done in joint with the UAW. It is simply not sustainable in the future for our company.

AAM has not and never has been an OEM. We are a supplier. We are a Tier-1 supplier and Tier-2 and Tier-3 supplier in the auto industry. Yet 14 years after the company was founded, our company has continued work under uncompetitive OEM-style labor agreement with the International UAW at the original US locations.

During formal and informal discussions over a period for more than two and half years AAM has consistently and repeatedly communicated with the International UAW that the original US locations much transition to a US market competitive labor cost structure and operating flexibility or consideration of closure. AAM has showed bituminous detail in numerous meeting with the International UAW and our UAW-represented associates to support this economic and market reality. Any suggestion to contrary is much leading and absolutely false.

As a group, AAM's original US locations are not profitable and has been not been profitable for a minimum of three years. They have been and they continue to hemorrhage red ink. Without the structural and prudent changes we are not sure to match the economic and operating flexibility of our competitors in the United States that have already received what we are requesting from International UAW, these original facilities are simply not viable. These facilities are not appropriate. AAM's ability to operate the facilities under these conditions is certainly not sustainable.

Let me be clear AAM has no desire to close any of the original US location that is why we've invested so heavily in them over the last 14 years and supplied our associates absolutely appropriately. AAM's preferred approach is to reach an agreement with the International UAW on a new US market-competitive labor cost structure for these workforce and we need to show-off literally to negotiate.

If such a market-competitive agreement is accomplished, these facilities will be able to bid competitively for new and/or replacement business. AAM will then be able to continue investing in these operations that support present workforce.

AAM is prepared to invest up to 250 to $300 million in this next quarter of period to support new and expanding program sourcing at these facilities if a US market-competitive labor cost structuring with operating flexibility is achieved and ratified.

The International UAW has established a benchmark for US labor cost in the US guidelines segment with AAMs direct competitors such as the Dana Corporation and the in-house axel making operations of the Ford Motor Company and Chrysler LLC.

The International UAW has also granted a market-competitive labor cost structure and operating flexibility to a new firm called Neapco that is based headquarters in China but located in Van Buren Township, Michigan as well Bharat Forge, a company based headquarters in India with its plant locations in Lansing, Michigan.

Today the International UAW has not been willing to consider a US market-competitive labor agreement with AAM which is a Michigan based company that has invested well over $3 billion in plant facilities, machinery, and equipment, process and systems technology and the training, skill-set enhancement and development of our workforce which we so proudly have.

All this is being done proactively to create safe, modern, environment friendly, efficient and productive work environment at AAMs original US location. It's time for labor to come to the pump. It's aim for AAM to compete successfully for new and replacement business and provide employment at the original US locations. The International UAW must offer AAM economic terms and conditions that are comparable for those that they have already granted to our direct competitors in United States of America.

While AAM and the International UAW have made considerable progress on a wide variety of economic and operating issues, a lot of work still must be done to achieve an agreement through the collective bargaining process. I personally and my entire team has all input available and continue to be available right now to do this collective bargain process.

The International UAW has made its economic proposal to AAM dated April 23, 2008 included an all-in wage benefits and package that is well over 80% higher than the market rate established by the International UAW with our direct competitors all within the last 12 months.

I do not understand why the International UAW is profiling our company in this way and therefore directly our workforce. The International UAW's refusal to address the inequality and competitive disadvantage is truly in our industry recklessly places the future of our employees, their membership, the families, their communities in harms way.

The International UAWs claim that our competitors were in bankruptcy conveyed a closed mindset that failure should be rewarded and success should be penalized. We do not want to lose Detroit, Michigan. We do not also want to have any overly competitively operations where we can preserve and grow the business and give profits to our local associates.

AAM has been and continues to be totally committed to ensure that all of AAMs manufacturing operations are viable, profitable, and sustainable. As we grow, the original US locations are severely in fair of making money. AAMs negotiating team has never left the bargaining table. Our negotiating team is sincerely working in good faith to achieve a market competitive labor agreement that will allow the original US locations to compete on a level playing field in this US market.

I sincerely hope that the International UAW will join us as a party in table to jointly achieve that outcome as early as this afternoon or this weekend. Let me now turn our attention to AAM's financial results for the first quarter 2008.

AAM's first quarter '08 results were severely impacted by the International UAWs strike against our company AAM. In addition, a macroeconomic headwind has contributed significant reduction in demand for light vehicles in the US as well as a dramatic change in vehicle mix. These headwinds include the ongoing credit and financial crunch, the housing downturn, record high fuel prices, and deteriorating consumer confidence. Today, AAM has reported a net loss in the first quarter of ’08 of $27 million or about $0.52 per share. This compares to a net income a year ago of 15.7 million or $0.30 per share in the first quarter of 2007.

Our company estimate that the International UAW strike resulted in lost sales of approximately $33 million in the first quarter of 2008. We estimate it mainly impact on operating profitability associated with International UAW strike to $46 million or $0.56 per share. Without that strike, we would have been a profitable company again. We need cooperation, not concentration, we need reality of marketplace economics.

AAM’s first quarter ’08 results also include $3.5 million or $0.04 per share of special charges and non-recurring operating costs. These costs are primarily related to the redeployment of machinery and equipment. These costs were continuation of actions we initiated in the calendar year 2007 to realign our production capacity and cost structure to current and projected operational and market requirement. We would foresee no of that in the future.

While the first quarter of 2008 was most difficult, AAM continued to make steady progress on several critical initiatives for our future, profitable growth and diversification objectives.

First, on April 11 of 2008, we announced the ratification of new labor agreement with professional unions representing our AAM hourly associates in the countries of Mexico, England, and Scotland. It didn’t work with open-minded competitive people. These agreements support a market competitive labor cost structure for the regions that these facilities are located and supply their customers to be market competitive. These agreements were done quietly, professionally, responsibly, and effectively with no production disruption.

Point two. In the past 90 days, we have successfully increased the daily axle production rate of AAM’s Guanajuato Mexico manufacturing facility primarily 100%. This is a bio development and a significant accomplishment for our company, our customers, and we thank the excellent cooperation of our workforce and our supply base.

Third point. AAM international expansion in the countries of Brazil, India, and Taiwan is moving ahead at a rapid speed. AAM do Brazil will launch full axle assembly operations in 2008 and convert the whole driveline and drivetrain assembly facility in 2009. With this expansion, AAM do Brazil revenue generation is expected to triple in the next five years. AAM do Brazil will also serve new customers such as Volkswagen AG along with their other nine customer base.

In the country of India and that market constructs is underway and our new joint venture facility in Pune Nagar, India. This joint venture AAM Sona Axle Private Limited will produce wide truck axles for Tata Motors. Production at this facility is on track for launch in the second half of 2008 and Tata is an important new customer for AAM’s portfolio.

Also in India, AAM is making final preparation to construct a new wholly-owned production site in Pune as the second pivotal location and their facility India Gear Axle Private Limited will produce driving heads for commercial vehicles to be produced by Mahindra International Limited, called MIL. AAM anticipate groundbreaking for this facility in July 2008 with the startup production schedule for the first half 2009. MIL is another important new customer for AAM's wheel portfolio.

In the country of Thailand, AAM is preparing for the groundbreaking of a new wholly-owned manufacturing facility in Rayong, Thailand. They will produce a full range of highly engineered driveline products for major new global product programs at this facility. The startup production staff facility is expected to be in the first half of the year 2010.

Before I turn it over to Mike, let me wrap by making a few closing comments. As expected, the year 2008 has proven to be most difficult, a demanding and tough year for the auto industry in general. It specifically hurt on AAM. I am referring to the entire domestic auto investors in this category including the OEMs, the auto suppliers, at RLTs and their dealer by. For AAM specifically, this is highlighted by our current labor negotiation and unfortunate strike caused by and called by the International UAW.

For the completion of the UAW negotiations and every other aspect of our global operations, we at AAM remain laser focused and concern to improve the following things: cost competitiveness, operating flexibility, workforce utilization, capacity utilization, business diversification, quality of working performance improvement, product portfolio expansion, financial returns and balance sheet strength. And the continued success of these initiatives will enhance our ability to embed in the continuing diversification and expansion of the product portfolio and the growth of our customer base and a continuous profitable growth of our global manufacturing enterprise. Each and every plant must be profitable. There will be no exceptions. I thank each and every one of you ladies and gentlemen for your attention today and your vital interest in our company AAM.

Let me now turn this call over to our Groups Vice President - Finance and Chief Financial Officer, Mike Simonte. Michael?

Mike Simonte - Groups Vice President and Chief Financial Officer

Thank you, Dick, and good morning everybody. My job today is to review AAM's financial performance for the first quarter of 2008; I'll get right to it.

Our sales in the first quarter of 2008 were $588 million that's down approximately $240 million from 802 million in the first quarter of 2007. As Dick noted, the single largest driver of this reduction in sales was the strike called by the International UAW against AAM's original US location.

This International UAW strike, which as Dick mentioned, is now at its 60th day has shown most production at [inaudible], Three Rivers, Tonawanda forge and Cheektowaga Machining operation. Based on the production schedule that are going to be effective with new International UAW called the strike against our company on February 25, 2008, we have estimated that the strike reduced sales by $143 million in the first quarter of 2008, reduced operating income by approximately $46 million, and has been approximately $0.56 per share of lost earnings in total.

The company did expect a year-over-year reduction in sales of approximately 15% in the first half of 2008. We discussed that on our most recent teleconference at the end of January. Excluding the impact of this strike, first quarter volumes were reasonably consistent with our expectations and our plans. Now let me expand on that a little bit.

Excluding the impact of the strike, our sales were down approximately 10% year-over-year. Obviously, the revised energy prices, weakening economic conditions, credit market instability, and market share favoring past cause and cross-over vehicles were negatively affecting sales in our light truck business in the United States.

There were few additional matters that exacerbated this comparison in the first quarter of 2007. In the first quarter of 2007, we were supporting the launch of the GMT900 pick-up. Inventory for that product line were lean at the time and production was strong.

The second of these issues was that the Easter holiday fell into the first quarter this year 2008. In 2007, Easter was a second quarter holiday. That cost us two production days in the first quarter of 2008, of course that will hit us in the second quarter.

Our Guanajuato Gear & Axle facility had a very strong quarter from a sales perspective, really from every perspective. I'll now communicate the impact of the International UAW strike. As Dick mentioned, the daily axle production rate of this facility has nearly doubled over the past 60 days. This facility will play an even bigger role in our company in the future.

Mix was favorable in the first quarter of 2008 and this helped to mitigate the impact of reduced sales. AAM's content-per-vehicle is up to $1,326 in the first quarter of 2008 and that's compared to $1,282 in the first quarter of 2007.

Content-per-vehicle continues to be a bright spot for us. Remember, our content-per-vehicle is up about 5% in 2007 for the full year. Our continuing and successful R&D program is the driver of these gains.

In terms of customer mix, our non-GM sales were $152 million in the first quarter of 2008 or 26% of our total sales. International UAW strike affected this percentage on an apple-to-apples basis. Excluding the impact of the strike, GM sales would have been higher something as little short 80% of our total sales.

Moving on to P&L. Cost of goods sold was $13 million less than our sales this quarter. That equates to a gross margin was just 2.3%. Again, the strike had a severe impact on this meric and every other metric of profitability in the quarter. Operating margin was a negative 6.2% in the quarter. In total, we incurred a net loss of $27 million or $0.52 per share. In first quarter 2008, we incurred approximately $3.5 million of special charges and non-recurring operating cost, these relate primarily to the redeployment of equipment. These cost trailed into the first quarter of 2008 and are related to and very similar to the restructuring activities that initiated in 2007 that we discussed with you all last year.

In the first quarter of 2007, we incurred approximately $3 million of similar costs. In 2007, these are more heavily weighted to attrition program activity. While there has been reasonable possibility we may incur significant additional special charges and non-recurring operating costs and for the balance of calendar year 2008 including the potential for assets impairments, we need to complete our negotiations with the International UAW before we can finalize their future business and operational restructuring plans that may occur. Based on the status of our negotiations and the nature of facts or proposals on the table, it is quite likely that we will incur significant expenses related to buyouts, retirement incentives and buydowns once we eventually bring this strike to resolution.

We may be also be forced to consider closing one or more of the original US locations if the International UAW is ultimately unwilling to consider a US market competitive wage agreement for these facilities. We must create the business conditions to facilitate a viable, profitable and sustainable business model at all of our facilities. If we cannot, we will exit. That's simple.

Before I move on to cash flow and the balance sheet, let me clearly state that we are unable to estimate the impact of any possible restructuring costs, special charges, non-recurring operating costs, one-time items, impairments et cetera that we may incur in the coming months and quarters. What I can say and what I want you to know is that the impact of these items could be material from accounting perspective. As soon we are able to estimate these items, we will make all perfect accounting adjustments, disclosures and public announcements.

Let me address now accounting housekeeping issues. In the first quarter of 2008, we changed our accounting policy for direct inventory costing in the original US locations from LIFO or the Last In First Out basis to FIFO or First In First Out. This is preferable for many reasons including that it allows us to have one consistent inventory costing policy on a worldwide basis.

AAM's use of LIFO for inventory costing dates back to the founding of the company in 1994, our circumstances are very much different today. Switching gears to a related topic that may anticipate some questions related to our tax provision.

In the first quarter of 2008, our tax provision was a benefit of $22 million. Our effective tax rate is effective of 44.8%. While I very much look forward to the time in the future when we can spend much time talking about [inaudible] 109 and just focus on more conventional business issues. I think it's important to spend a couple of minutes addressing this topic.

Our effective tax rate is the result of two very different circumstances in our global business. In the US, which is dominated by the original US location, they are currently being severely impacted by the International UAW strike. We lost money in the first quarter of 2008. Because we expect to turn that around in the future as a result of achieving a US market competitive labor cost structure in all of our US facilities and hopefully we can make that happen soon, we continue to recognize the benefit related to deferred tax asset. It's important to note that we are not in a cash NOL position or Net Operating Loss position in the US and never have been. As a result of that and many other factors pertinent to the accounting standards governing this issue, we are and we should be recognizing these deferred tax assets.

In our non-US operations, we have a much different situation. Outside the US in total, AAM's business is profitable. Not surprisingly, we have market competitive labor cost structures in all of these other businesses. Outside the US, the respective statutory cash rates are lower and in the case of Mexico much lower than the US tax rate. So when we combine the US tax - US loss I should say, subject to a 35% tax rate together with foreign profits subject to a much lower than 35% tax rate, we end up with net effective tax rate of 44.8% in the first quarter of 2008. It's just the math.

Now just a few complicated matters. In the first quarter of 2008, we have incurred $0.07 of unfavorable tax adjustment. The larger of these items is a technical matter relating to a tax law change in Mexico. As a result of this tax law change, we were required to write down certain deferred tax assets in Mexico. The assets need to valued at a lower basis. Also in the first quarter of 2008, we were able to close the field work in our current IRS audit cycle, this cycle relates to the US tax year 2004 and 2005 and the process we have agreed to certain adjustments proposed by the IRS. The combined impact of these two items and remember the bigger the two was the tax law change in Mexico with an additional expense of $3.5 million or $0.07 per share in the first quarter of 2008. Both of those items are one-time item and I point that out because it is not part of our ongoing run rate of tax expense.

Now let's turn our attention to cash flow and the balance sheet. GAAP cash from operations was approximately $8 million in the first quarter of 2008, down just a little bit from $10 million in the first quarter of 2007. CapEx was lower in the first quarter of 2008 is lower by 9 million to $33 million in total for the quarter. Dividends were $8 million in the quarter. We define our free cash flow to be net cash provided by operating activities less CapEx and dividends pay. For the first quarter of 2008, free cash flow was the use of $33 million versus a use of $41 million in the first quarter of 2007. At the end of the first quarter 2008, cash on hand was $315 million. The net debt to capitalization ratio for our company at that date was 38.5%. We continue to be in a strong and stable financial condition.

Let me be clear. The strike is not a positive development from a liquidity perspective. However, the impact of the strike will not really affect our liquidity position all that much until after the strike is over and we return to work. This is true primarily because we have collected our receivable, I am speaking about sales prior to the strike called by the International UAW, and we continue to write down receivables in all sales meet at that point of time, but we are not currently incurring all of our payables at our original US location.

When we start off, we will not be paid by GM for approximately 45 days after we begin shipping and so once we begin paying the payroll, again after we get started will be outcast during that period and then we will see a more significant liquidity impact as a result of the International UAW strike. Remember that the seasonality from our working capital movements are favorable in the second and also in the fourth quarter and those seasonality adjustments will help mitigate the issue because we have already weathered the negative working capital movements in the first quarter of this year. I am talking about seasonal working capital movements in the first quarter.

In additional, AAM's Mexican operations are having a record year in terms of financial performance including cash flow. Together with the typical reduction in CapEx that we have been talking about for many quarters now and the structural benefit we enjoys as a result of our previous restricting actions we expect to incur some more activity in 2008, which mean a pretty good shape from a free cash flow perspective this year of 2008 before the impact of any buyouts and buydowns that I just mentioned before. Let me first make a few comments about the International UAW strike from a financial perspective. In the morning newspaper these days, we read a lot of emotional gibber-jabber about one way streets of these negotiations, sometimes we also hear about [inaudible] and globalization of the automotive industry. Many of these comments are shockingly inaccurate and even misleading as it relates to AAM and our positions in these negotiations with the International UAW. In finance and accounting, we must deal with the cold hard reality of economics and the bottom line.

But here is the bottom line on the International UAW strike and AAM's labor cost structure. AAM's economic proposals in this negotiation have been fair, reasonable and yes even compassionate. Although substantially lower in this uncompetitive OEM styel wage and benefit packages that we have had in the past for our UAW-represented associates at the original US location. While we've offered to the legacy associates, it's still considerably higher and I have to say considerably higher than the market rate of our competitors.

We have no disagreements with the International UW on that fact. While we have detailed all-in costs per our calculations on different sides of the table, we did provide a few pennies even a couple of dollars in some circumstances. Nobody denies the basis facts and trends.

Our competitors in United States came in the range of 20 to $30 per hour all-in cost. The International UAW has confirmed that that is the highest level. Prior to February 25, 2008, AAM would get $73.48 per hour all-in cost at the original US location. That's approximately three times the market rate of 20 to $30 per hour. Most recently, the International UAW economic proposal suggested we should approximately twice the time of the market rate they have established with our competitors. Keep in mind that we talk about this market rate of greater cost structure in the US, the International UAW creates and reimports that rate in the 20 to $30 per hour all-in cost range for our motor suppliers in the US.

We did not create this market reality, but we must benefit. Many of our competitors have agreed to all-in wage benefit package with the International UAW in this range. This includes the in-house act for making obligations of bureaucracy as Dick mentioned. This improved our long-term competitive gear and as Dick mentioned even the Chinese Neapco and Bharat Forge of India. When I name these competitors, I am not talking about the agents in China and India, I am talking about Michigan base, UAW-represented manufacturing facility owned by company, in China and India, although I have to include the same for similar deals that they have already agreed to with the International UAW.

In addition to premium wage and benefit packages, our company is prepared to pay literally hundreds of millions of dollars to UAW-represented associates and work down this transition, the reality of our market competitor wage in benefit package. That’s a significant soft landing.

The buyouts we are talking about between Michigan proposed by the International UAW by the way will provide associates to choose not to work for competitive market wages and general severance package in many cases disbursed in two to three years of take-home pay. If an associate chooses to full pay and work their way to competitors in average up to 30% higher than the market competitive rate in certain circumstances, some of our associates would stay. The buyouts we are talking about would actually increase take-home pay for many of our associates in the first three years of the agreement.

While being out in the strike called by the International UAW may be negatively affecting the family financials of our associates. The buyout and buydown packages offered by AAM certainly will not. We deeply appreciate our associates and hope that we can quickly resolve the strike called by the International UAW. Anybody who has ever visited our manufacturing facilities understands the significant financial and institutional commitment AAM has made to be objective of preserving and growing jobs in the United States. This however did not excuse our managerial, institutional responsibility command of the business and make investments to return adequate financial returns to our stockholders. It is necessary to provide stable and secure appointment to our hourly and our established associates as well.

We have built up the balance sheet strength and financial flexibility to manage through this situation. We hope that these financial resources to help us to addition AAM's original US locations for market competitiveness. If International UAW will not deal with our re-joining phase and it's going to continue to steal a bunch of stunningly inaccurate hard watch about the regions who will be "excruciating" slow pay to negotiations, the re-strengthen of financial resources can be and must be used to restructure the business that AAM can successfully compete in the United States with new and replacement business.

I thank you for your time this morning. I'm going to stop here and turn the call back over to Jamie. So, we can start the Q&A.

Jamie Little - Director of Investor Relations

Thank you, Mike, and thank you, Dick. We have very reserved some time to take questions. I would ask that you please limit your questions to no more than two. So, at this time, please feel free to proceed with any questions you may have.

Question-and-Answer Session

Operator

Your first question comes from the line of Rich Kwas of Wachovia.

Rich Kwas

Good morning gentlemen.

Dick Dauch

Good morning Rich.

Mike Simonte

Good morning Rich.

Rich Kwas

Mike, could you go into a little bit about the contribution margin that you have realized in the first quarter, it was a little big higher than I would have expected given that you are paying as much in labor cost and if you could just walk us through that would be helpful?

Mike Simonte

Okay, no problem, Rich. A couple of things going out. First one is truly we are not paying as much to our hourly associates in the original US locations, but we were also not generating sales with those locations. So now the analysis is the profit margins of the plants that we are running and moving our operations. We see our large contribution margin in this quarter whether you can get it sequentially through the fourth quarter or year-over-year in the first quarter, about 33 to 34% loss margin on sales. Now that’s a little bit higher than the 30% range than normal we expect, but in the time period we have been managing extraordinary events.

I would say a couple of things. First of all, at the plants that we are running and particularly to shift these manufacturing from some of our original US locations other locations, we had some logistical issues we have to overcome, we have some supply issues with raw materials to a different location and incurred some [inaudible] to do that. We did pay some overtime. We had to increase security and maintenance expenses. These is a host of things we had to do about the plant running and not running to manage through this situation. The other thing I would mention, I would say though that what I have already said is the primary reason for that 3 to 4% higher loss margin rate in this quarter, to begin with I would say is that excluding the impact of the strike our volumes were down about 15% or so in the quarter. Our volume for heavy duty program were down more than that, probably 50% more than that and so that also had an impact on this margin comparison in the quarter.

Rich Kwas

That’s helpful, thank you. And then as we think about this for the current quarter, with that contribution margin, the negative contribution margin actually come in a little bit relative to 34 in the first quarter or should be about the same?

Mike Simonte

I don’t think it's going to be significantly different. We are seeing a ramp up in our activity in our Guanajuato Mexico facility that happens to be of an impact of the International UAW strike, but we still have the same additions at our original US locations and we will sort of continue to face the same headwinds until the strike is resolved.

Rich Kwas

Okay. And then a last quick one on CapEx. As we think about it with a lot of your business launching in '09 and '10 as part of the five-year backlog, when does the CapEx get spent on that? Is that going to be more of an '09 phenomenon, are you going to start ramping that up later this year?

Mike Simonte

We have previously stated about 300 million of CapEx this year and a little north of that in '09.

Rich Kwas

Okay. So it shouldn’t be a big ramp up in this business sales. Okay, thank you.

Mike Simonte

Rich, CapEx in this quarter at $33 million is 1 million lower than the rate we just outlined, but we will see CapEx pick up a little bit according to run rate as we work through the rest of this year.

Rich Kwas

Thanks.

Mike Simonte

Thank you, Rich.

Operator

Your next question comes from the line of Brett Hoselton of Keybanc Capital Markets.

Brett Hoselton

Good morning gentlemen.

Mike Simonte

Good morning Brett.

Dick Dauch

Good morning Brett.

Brett Hoselton

Can you gentlemen be a little bit more specific in terms of what are the primary differences between yourself and American Axle and the UAW in terms of the all-in labor cost what they are proposing versus what you are requesting?

David Dauch

Let me start with this that our primary objective here are to continue negotiations with International UAW and to accomplish a labor market competitive structure in the original locations in the US and to cheer operating flexibility that's pretty clear that’s what the objectives are, that’s what the needs are. We need this because we got to be able to compete with all competition, most of which are now in the US, be they domestic or be they foreign home. We also think that International UAW as I said earlier has accomplished negotiations with our direct competitors here again Dana, FormTech, Neapco, Bharat Forge, et cetera which leaves us non-competitive on labor cost and therefore inability to favorably get in the Q new work and orientation work.

Our company is absolutely committed to correcting these losses that we have sustained financially in these locations over the last three years. We need a structure and permanent change. That's been communicated well over 30 months informally and formally including us and their party and it's not these particular locations where they are not viable, they are not profitable, they are not sustainable, that's generically where we are at.

Brett Hoselton

Okay. Let me ask you this question maybe a little bit more specifically. You have kind of thrown out a 20 to $30 number for your competitors, you are suggesting you are above that which kind of suggest that you are maybe in that 30 or 30 above range or something along those lines that the UAW is maybe two times at this point in time at around $60 that's a pretty significant different kind of a $30 differential and obviously those are my numbers. But what I am wondering is what makes up that $30 difference, maybe specifically what are you talking about with UAW with regards to future retirement benefits, healthcare benefits and pension benefits?

David Dauch

Well, let's start. We collectively negotiate with UAW, not you.

Brett Hoselton

Okay, fair enough. With regards to options there has been some discussion about replacement worker, there has also been some discussion about the possibility of closing your US facilities, where do you see as some of the logical options. Is it possible for you to get replacement workers and is it possible for you to close the US facilities and move them south or where does needs them to, what would the alternatives be?

David Dauch

First of all, management has the right and the responsibility, nobody else runs business except their selves, we will work at all stages and quarters softer, collectively and we are confined with contracts. When contracts expire, they have expired. What we are looking forward to is an appropriate compliance with legality and appropriate process and appropriate way to get ourselves where we can be competitive and operational flexible and that’s where we are at. Thank you.

Brett Hoselton

Well, thank you very much gentlemen.

Operator

Your next question comes from the line of Himanshu Patel of J.P. Morgan.

Himanshu Patel

Hi. Dick, I just had a question on General Motors involvement here. It seems like GM has been on the sidelines in most of these negotiations. What have you exactly been doing or talking to GM to get them comfortable with the current situation? And how long would you expect GM sort of benign stands on this at the last?

Dick Dauch

Well, first of all, good morning Himanshu. And secondly, as it relates to General Motors, they are our largest and most critical customer, and they have obviously been very open, forthright with them that our contract was going to expire in February 25 of '08 and how they handle their own operations and flexibility was certainly up to them, but we won't comment on GM other than to say we are working very softly, effectively with them, because they are our customer and that’s the first part we have to do is take care of our customer and we want to minimize disruptions that result from our AAM called by International UAW strike and secondly support GM however we can and obviously there are issues and we are working that out with GM and GM has been most professional, most helpful and we are most supportive of them as best as we can on this very difficult chapter of our life.

Himanshu Patel

And I am just wondering would you care to comment on GM's own labor dispute they are having at some of their facilities right now. Do you think this is completely independent or do you think this is the UAW trying to get GM involved in your dispute?

Dick Dauch

I think that’s a better question for you to ask GM.

Himanshu Patel

Okay, very good. That’s all I have. Thank you.

Dick Dauch

Thank you sir.

Operator

Your next question comes from the line of John Murphy of Merrill Lynch.

John Murphy

First question on the cost of the UAW plants, you have already stated to get them to agree to what you want to first is your Mexican plants and what would be the cost differential if you got this contract win by the Mexican plants?

Dick Dauch

We would still -- first of all good morning John.

John Murphy

Good morning.

Dick Dauch

As we said, we have been obligated to pay an all-in labor cost per hour as if we were OEM, we never had been and we must have receipts. Therefore they are way too high, that was 245% of their level of the present 20 to $30 range where we as a supplier should be. We are negotiating and try to get that down somewhere close to that, early in the spring, and that has to be done as you know, collectively between the two institutions AAM and International UAW and we will report on that when we have something to report on that.

John Murphy

Okay. You're Mexican plants and US plants at that time once you reach resolution, as you would like to welcome the similar cost structure?

Dick Dauch

They are selling in different markets, different demographics and we are talking about US, we are talking about contracts in USA, we are not talking about Mexico, we are talking about UAW contracts that compete with AAM and USA so to start with primary as AAM that will go to the direct competitors of getting to USA Dana or Chrysler or Ford or Neapco or FormTech or many elements so lets not try to change what the direction is what the focus is.

John Murphy

Okay. And then secondly, if you can just elaborate on how many axles you are shipping out of Guanajuato and its sounds like you have done a great job of doubling the output there in short order and they are potential to increase value even more in the near-term at Guanajuato?

Dick Dauch

Well first of all we have been focusing to be an international company back in the middle of 90 and 12 years ago and one of our top priorities was the country of Mexico and we have an extraordinary operations there, outstanding record and workforce to work with and our OEM Guanajuato, Mexican manufacturing complex as the capacity and the capability to produce 96,000 axles a day 6 days a week, so you consider that out. The location has served multiple customers, several plans and prior programs shipping to multi regions of the world and multi locations of the world customer, our two largest customers by far has served over that complex are General Motors and the Chrysler Corporation. And the sales generated as Mike just said will probably approach $1 billion in 2008 there and we have extraordinary performance extra ordinary quality and total operating flexibility and highly impressed that’s just for the Mexican operation. All the rest of other international operations are becoming very similar either in Brazil or India or China or Thailand or Scotland or England, we just have to fix little fashion USA.

John Murphy

Okay. Thank you very much.

Dick Dauch

You are welcome.

Operator

Your next question comes from the line Chris Ceraso of Credit Suisse.

Chris Ceraso

Thanks. Good morning.

Dick Dauch

Good morning Chris.

Chris Ceraso

The comment that you just made that brings up the questions about, if you can bring out that kind of capacity for Mexico and generate $1 billion of sales, once all this is resolved will you dial that back down in favor of doing more stuff in the US, would you don’t have to scale down your US ops and keep running as much as you can at the Mexico?

Dick Dauch

Well, the great thing about the auto industry Chris is its so dynamic and you know, all the data and variables as well as I do, energy is driving the world therefore gas, diesel whatever fuel it maybe is changing the mix demographic of the car, you also note that 90 to 95% of the auto growth in the next five or so years in the future is not in the US, it's outside the US. You got to be aware and I am sure right now if I was running General Motors, Ford, Chrysler, Toyota or whatever certainly this market outside the review, part of the product line. Once they get that done and we have a supplier understand how that’s impacts us, we have to evaluate our sourcing credit and our plant loading pattern. Where that comes that, we have Mexico, US, or something else, but that’s where we competitors investor, our shareholders responsibility and make money.

Chris Ceraso

Mike I know you brought up the issue of tax I do have one question on that. You mentioned in the opening remarks that the us facilities have been on profitable for at least three years that would seem to suggest you know, the way that just look back functions in terms of taking evaluation allowance that you might have had to do that. Can you just explain for me again why given chronic un-profitability of the US ops that you haven’t had the write-down your US deferred tax asset?

Mike Simonte

Yeah, a couple of things I would say you know, primary comment we made about the un-profitability of our US operations with the original US location. I think we had two US operations that are un-profitable. So always not boss there. We do have certain royalties and other situations coming back to the US. Chris I think that was important comment I think on the call today is you need to know that we have never been at tax and odd position in the US. As a result of the profits and other planning strategy that we aim to that we will continue to have us over, we have never been in a while. So while it's true that in the short-term time period, we have an issue with profitability that has not been a long-term pattern and we are confident that with the additional restructuring actions that we implemented in 2007 that we expect to initiate yet in 2008 that have broken the road and these are going to be with market competitiveness of the original US locations or along another path to achieve the same objectives. We want to have a future profitable competitive business and we will revise the forecast in the US. There is a dynamic continuing monitoring process and every quarter we undertake the appropriate accounting norms as to assure ourselves that that continues to be provide answer. As of March 31, 2008, that continues to be the right answer.

Chris Ceraso

You got a lot of groundbreakings coming up, new plants going up in different countries. Is there a risk that you may have to pull back on some of this if the strike endures and you continue to burn cash or perhaps, as you suggested you may have to close US facilities and relocate to Mexico or somewhere else, which would certainly take a lot of cash. Is there any risk to these expansion plans?

Mike Simonte

If there was anything, we may accelerate them.

Chris Ceraso

Okay, thanks guys.

Mike Simonte

Chris, everything I would say is that there is no default assumption that we would move all of the work outside the United States. We want to be competitive in the United States. We have plants and facility today that are competitive in the United States. We are in the process of launching Oxford Forge Inc. here in the metropolitan Detroit area with a very competitive cost structure and there are many ways for us to achieve a competitive business model in the US. So please don’t assume -- we are not saying and I don’t want you to assume let's say that we have to leave US to be competitive. That is not true.

Chris Ceraso

Alright. But I guess the point Mike is if even -- whether you are talking about Mexico or even within United States, if it comes to the point where you have to close your original facilities and open new facilities or expand existing facilities either in the US or Mexico that's going to require tremendous amount of cash. So the question was, those that jeopardize your expansion plan elsewhere because I would think that…

Dick Dauch

You asked the question. I answered. What's your next question?

Chris Ceraso

That's it, Dick.

Dick Dauch

Thank you.

Operator

Your next question comes from the line of David Leiker of Robert W. Baird.

David Leiker

Can you hear me alright?

Dick Dauch

Good morning, David.

Mike Simonte

Good morning, David.

David Leiker

Dick, you talk about your competitors who have got wage cost and what you have being an these handful of other folks. Have you seen any business of worry to them that with the different wage structure you think American acts a little bit ordered?

Mike Simonte

Obviously, if you take a look at the fact of economics, you are more learned in that area than I am, you got somebody who has an advantage per unit at $70, $80, to $100 a unit. You either are going to not get business or you are going to have a loss. We have no interest in having loss leaders. So I won't get into specificity as to an individual account that went somewhere. We've had a great business for the last 14 years. We are going to have a great business in the future.

David Leiker

I am not trying to dig anything specific, I just say in generally whether there has been…?

Mike Simonte

I understand, but I am answering you question, okay. You have the question, let me answer.

David Leiker

Okay.

Mike Simonte

We must be all incompetitive and at each and all of location, nobody gets a break.

David Leiker

No, I understand that. I agree with you on that. Is there are a way you can give us any sense of how much of your lost volume in the US from these plants that are under strike you have been able to replace in Mexico?

Dick Dauch

We have simply met the priority of our customer and I think we answered a little bit early to a different person, maybe you weren't listening. General Motors is our key customer. They have absolutely prioritize where they need and we try to get them the greatest what we could and Mexico has certainly had a powerful influence in doing that and we are continuing to have a great relationship with GM and support from them. And anything else from GM, you would have to ask them theirselves.

David Leiker

Is it fair to assume that's volume increase that you've seen in your Mexico plant is all replacing volume that would have come out of the US plants?

Dick Dauch

Yeah, certainly.

David Leiker

Okay, great.

Jamie Little

Thank you sir.

Operator

Your next question comes from the line of Rod Lache of Deutsche Bank.

Rod Lache

I was wondering you had a view on the longer term capacity that you need for axle production for the traditional buying for instructing a trend year. In the next few years are you pointing for a cyclical recovery or kind of structural decline as well, that’s what I am asking?

Dick Dauch

Well, we are certainly looking at structural decline in that segment and that’s why back in year 2000 and I have reported that to you before Rod, that we changed our priorities of direction of product portfolio and technology application into more of how we will drive applications, petro car, cross over utility and rather put half of our new business growing portfolio of 1.3 billion in those petro car applications and it also diversified not just in the North American region but throughout the world. So we saw this coming couple of years ago and have secured first of all the entire portfolio in these vehicles package able, separate the order to support it and again 2008, '09 and '10, we will be launching those, particularly unit. As it relates to the full side earnings conventional architecture there will still be very significant volume, but it will be descending. And therefore we have to make some adjustments as we [inaudible] on capacity rationalization, operating flexibility must go along with that and then we redeploy, how we do our plant loading where we have most compelling economic structure to support our shareholders need and judiciary responsibility.

Rod Lache

Could you tell us what your daily capacity is at the UAW represented plants?

Dick Dauch

I quote they are one.

Rod Lache

Okay. Can you maybe Mike you could just refresh us on sources of liquidity aside from the cash?

Mike Simonte

Yeah, we get, you referred to the $350 million cash in the first quarter, our revolver of 1200 units is $800 million credit facility, we have some money market lines of credit available to us here in the US and we have credit facilities available to help us fund our international expansions and some other money market mines in place like Mexico, Brazil. We are working through the Tata's facility in India and will have that online sometime later this year and of course China we had a line in place -- a significant line to help us in that market. So we have multiple sources of liquidity and when you read our 10-Q that will -- later we will file at the SEC today, you will see it worth of $1.6 billion of total credit availability into these facilities about $548 million or so of net debt, at this point in time communicating more than $1 billion of availability in those facilities.

Rod Lache

Any significant constraint covenants you know, receivable levels or things like that to back that up or is that available?

Mike Simonte

No. We had significant issues there that’s a lever I would point out that there is really no impact relative to receivables perspective, these facilities are generally unsecured, all the US facilities and so there are no restrictions [inaudible].

Rod Lache

Okay. My last question is just on any comments on steel and there has just been a lot of talk in the market about surcharges that kind of thing, I know you have quite a bit that pass-through, can you just refresh us on the exposure there.

David Dauch

This is Dave Dauch. As you know, we have got middle market agreements in place with our customers, we have the ability to pass-though some, but not all of any middle market increase. At the same time you know, most importantly we have got the long-term contracts in place with the majority of our steel purchases that we think we are in good shape there. There is some exposure in regard to some of the other metal products and with respect to what are the net savings when it comes mature for the year, what we have communicate earlier has just been obviously greatest what we had originally communicated due to some of the changes in the market place.

Rod Lache

Great. Thank you.

David Dauch

Yeah.

Jamie Little

I think we have time for one last question.

Operator

Your last question comes from the line of Jonathan Steinmetz of Morgan Stanley.

Jonathan Steinmetz

Can you hear me?

Dick Dauch

Yes. Good morning Jonathan.

Mike Simonte

Good morning Jonathan.

Jonathan Steinmetz

Okay. I guess my question was around the timing and specifically when you might begin to get a bit more concerned about the collateral impact here both on customers and some other suppliers, and when that factors into your cost benefit analysis. It seems as if a lot of the inventory that’s come out already is stuff that would have come out at some point in a year, but a lot of supplier weren’t going to get as much cash on May 2nd or June 2nd as they otherwise would have. Maybe you could just talk about it to a point in time Dick when you begin to get more concerned about collateral impact?

Dick Dauch

That will be months and months away.

Jonathan Steinmetz

Meaning, like end of summer?

Dick Dauch

Month to month, you can count.

Jonathan Steinmetz

Okay. Alright. Thank you.

Dick Dauch

Welcome.

Jamie Little

Thank you, Jonathan. And we thank all of you, who have participated on this call and appreciate your interest in American Axle & Manufacturing. We certainly look forward to talking with you in the near future.

Operator

This does conclude today's conference call. You may now disconnect.

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Source: American Axle & Manufacturing Holdings, Inc. Q1 2008 Earnings Call Transcript
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