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

Q2 2008 Earnings Call Transcript

July 25, 2008 10:00 am ET

Executives

Jamie Little – Director of IR

Richard Dauch – Co-Founder, Chairman, and CEO

Michael Simonte – Group VP, Finance & CFO

Yogen Rahangdale – Vice Chairman & Chief Technology Officer

Analysts

Himanshu Patel – JP Morgan

John Murphy – Merrill Lynch

Rod Lache – Deutsche Bank

Rich Kwas – Wachovia

Chris Ceraso – Credit Suisse

David Leiker – Baird

Etah McCauley [ph] – Citi

Brian Johnson – Lehman Brothers

Operator

Good morning. My name is Rebecca and I will be your conference operator today. At this time I would like to welcome everyone to the American Axle & Manufacturing second 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 will now turn the conference over to Mr. Jamie Little, Director of Investor Relations. You may begin.

Jamie Little

Thank you and good morning, everyone. Thank you for joining us today and for your ongoing interest in American Axle & Manufacturing. This morning we released our Second quarter2008 earnings announcement. We’ve not had an opportunity to review this announcement you can access it on the aam.com Web site or through PR Newswire services. A replay of this call will be available beginning at 5 P.M. today through 5 P.M. Eastern Time, August 1st 008 by dialing 1-800-642-1687, reservation number 524-585-57.

Before we begin I'd 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 subject to risks and uncertainties which cannot be predicted or quantified and which may cause future activities and results of operation 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 aam.com Web site.

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

During the quarter, AAM will be presenting at the following conferences; the 2008 JP Morgan Harbour Automotive Conference in Dearborn, Michigan on August 13, the 2008 Credit Suisse Global Automotive Conference in New York City on September 4 and the Banc of America Annual Investment Conference in San Francisco on September 16. In addition, we're always happy to host investors at any of our global facilities. 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.

Richard Dauch

Thank you, Jamie and good morning everyone. Thank you for joining us today to discuss AAM's financial results for the Second quarter of 2008.

Joining me on the call with you today are Yogen Rahangdale, our Vice Chairman and Chief Technology Officer, David Dauch, our President and Chief Operating Officer and Michael Simonte, our Group Vice President, Finance and Chief Financial Officer.

This morning’s call will detail the most challenging and difficult quarter in AAM's history. There was a quarter severely impacted by an 87-day strike called by the International UAW at AAM's original US locations. The toll of the strike was compounded by the brutal market reality of a weakening US economy and steep declines in the light truck and SUV production volume. This resulted from a deep US housing recession that started in 2005, rapidly escalating fuel prices from oil shop (inaudible), the credit crisis and consumer confidence that's as low as we've seen in this country since 1991. We're currently experiencing the lowest US automotive industry selling rate in more than a decade. The June 2008 US SAR of 13.6 million units was the lowest monthly selling rate since August of 1993. This trend will likely be extended when sales results for the month of July are reported next week.

Today I will provide a brief update on AAM's Second quarter2008 financial results, then I will shift focus to detailing the positive actions that we are taking to accelerate the impact of AAM's comprehensive restructuring, resizing, and recovery plan. After that, I will turn things over to Mike to discuss the details of our financial performance.

Following Mike's comments, we will open the call up for questions that you men and women may have.

Today, AAM has reported a net loss in the second quarter of 2008 of $644.3 million or $12.49 per share. This compares to a net income of $34.6 million or $0.66 per share in the second quarter of 2007. We have estimated that the International UAW strike resulted in loss sales of approximately $275 million in the second quarter of 2008. We estimate the negative impact on operating profitability associated with the unfortunate strike to be $87 million or $1.73 per share.

AAM's second quarter2008 results also reflect the adverse impact of special charges, asset impairments, and other non-recurring operating costs of $576 million. That is equivalent to $11.16 per share. Substantially, all these charges were non-cash in the period. The charges relate first to AAM's new labor agreement with the International UAW and a different union, the IAL. These agreements relate to the original US plant location.

Second, the need to reduce AAM's installed capacity in the United States to align with current and projected market requirements. Third, are the attrition programs for both hourly and salaried associates of AAM. And fourth, other actions to rationalize and redeploy underutilized capacity to support our company’s global expansion and the launch of AAM's growing 1.4 billion more new business backlog.

Since the beginning of 2008, US market conditions have become increasingly more difficult, especially in the light truck and SUV segment. This includes a structural and permanent shift in consumer preferences away from full size SUV and pick up truck. In response to this dynamic, rapidly changing market environment, our company has created [ph] a comprehensive restructuring plan to resize our business structure based on lower vehicle sales and a (inaudible) shift in product mix that the consumer is driving. We're also having the financial resources in our company to do this plan, the management expertise and absolute bull-dog determination to accomplish this.

The major objective of AAM's restructuring plan are first to expand and continue our product development focus to support AAM's long-term business diversification objectives and increase AAM's total global served market.

Second, to realign AAM's global manufacturing footprint and sourcing footprint to increase the exposure to automotive growth markets, support our customer global product development needs, and establish (inaudible) cost competitiveness. Third, to achieve annual structural labor cost reduction in excess of $350 million. Fourth, we continue to target customer and supplier relationship developments to enhance the diversification of AAM's customer base, product portfolio, and global footprint. Fifth, to return AAM to profitability in the year 2009. Sixth, rebuild our traditional balance sheet strength and finally, to provide an adequate return to our shareholders.

The basic planning assumption for AAM's restructuring plan is the need to resize our business, cost structure to operate in a market with an anticipated US SAR of between 13 and 14 million units. In the process, we will reduce AAM's installed US production capacity by over 70%.

AAM will close the previously idle drive line assembly facility in Buffalo, New York as well as the forging facilities in Tonawanda, New York and Detroit, Michigan. These actions will occur within the next six to 12 months. AAM will idle and consolidate portions of our Detroit manufacturing complex over the next 18 months.

Our company will refocus production capacity at the Three Rivers drive line assembly facility to support new products for the commercial vehicle segment, and this will be in addition to the light truck product lines it currently supports.

As we reduce the size of our US manufacturing operation, we will expand AAM's global installed capacity by approximately 150%. This includes the construction of two new facilities in the country of India, and one new facility in the country of Thailand. We will also continue to expand AAM's existing facilities in the countries of Brazil, China, Mexico, and Poland.

These new and expanded facilities increase AAM's participation in the fastest growing automotive markets throughout the world. Our company is planning to reduce its US workforce, both salaried and hourly by more than 40%. AAM will also fully implement the new labor agreements recently negotiated with the International UAW and the other union the IAM. The combination of these actions will result in annual structural cost reductions as I indicated in excess of $350 million.

AAM's new labor agreement will help AAM achieve a market competitive labor cost structure which is what we have needed. This will help us with our US locations. These new agreements will also help us restore profitability at the location that we will continue in the US, and also support the economic viability of sustainability for our company. In addition, AAM can now convert the formally fixed legacy labor cost structure of the continuing US location to a highly flexible, variable cost structure. This will allow AAM to manage the business through the ups and downs of a market cycle inherent to the auto industry and especially the globalization effect.

A key part of the new labor agreement is the voluntary special separation program which we refer to SSP and as of July 18th, one week ago, more than 2,000 UAW representative associates have elected to participate in this program. Associates who choose to remain with AAM will participate in the involuntary Buy Down Program referred to as BDP. Beginning Monday, July 28th, three days from now, that new and significantly lower hourly wage rates will be in effect for those associates on that involuntary Buy Down Program.

AAM's US salaried workforce will be reduced by approximately 350 associates. This action is also necessary due to the reduction in AAM's U.S. installed production capacity. This will facilitate the redeployment of AAM's human resources on a global basis. AAM has also canceled a 2008 bonus program for executives including all executive officers, and today, AAM is also announcing a change in our dividend policy beginning in the third quarter of 2008, AAM will reduce our quarterly cash dividend to $0.02 per share, this represents an 87% reduction in the dividend.

Before I turn it over to Mike let me wrap up by making a few closing comments. First, AAM has a comprehensive plan to accelerate the restructuring, resizing, and recovery of the plant of the company. Secondly, we have a financial resources necessary to implement this plan. Third, AAM's new labor agreements are historic, transformational, structural and allow us to transition to market (inaudible). These new agreements will allow AAM to establish that market (inaudible) labor structure that we have required for these continuing U.S. facilities with the operating flexibility that is so required these days. Fourth, our company has over a 1.4 billion new business backlog and growing.

Business in addition to the replacement business for substantially all of the major North American light truck programs we currently support and enjoy with General Motors and Chrysler LLC. This is a powerful foundation for AAM's future profitable growth and will be that way for many years to come. At this point is the expansion of AAM's product portfolio and global footprint is quickly enhancing AAM's business diversification and the OEMs are very anxious to have us work with them throughout the world. AAM is currently working on 12 different passenger car and crossover vehicle programs as I indicated on a global basis with five different major OEM world customers.

Our company is successfully developing new customer relationships with Volkswagen, (inaudible) and their major division Audi along with Renault, Nissan, Tata, Mahindra, Cherry, Veyron as well as others. All this will add more balance to our revenue stream and better global diversification. Sixth, AAM will continue to improve upon its outstanding track record on product development, quality, warranty, reliability, delivery, advanced technology, and launch performance as an overall value package.

Others talk about Six Sigma. We have been doing it for years. We deliver Six Sigma to our customers each and every day. We have never had a recall. We have no product litigation. We're simply the finest engineering people in the drive line system in the world. These are critical differentiators in the marketplace and the OEMs recognize that. AAM's most important competitive advantage is our people and our commitment to having excellence. Our entire management team is totally dedicated to revitalizing and restructuring the company and we're anxious to do it. Our objective is to return AAM to profitability in 2009. I thank each and every one of you ladies and gentlemen today for your attention and your interest in AAM. That is vital to us and we appreciate it.

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

Michael Simonte

Thank you, Dick, and good morning, everybody. My job today is to review AAM's financial results for the second quarter of 2008. There's a lot to cover here so I want to get right to it.

Sales in the quarter were $490 million, that's down from $917 million in the second quarter of 2007. The single largest driver of this reduction in our sales was the 87-day strike called by the International UAW at AAM's original U.S. locations. We estimate that the strike reduced sales by $275 million in the second quarter of 2008, reduced operating income by approximately $87 million, and resulted in approximately $1.73 per share of lost earnings. In total, customer production volumes for our major light truck product programs were down approximately 51% in the quarter versus the prior year. For the first six months of the year, production volumes in these same programs were down approximately 43%.

As Dick mentioned, the rapid shift in consumer preferences away from light truck as well as the impact of the strike, high fuel prices, tight credit, the housing recession, rising unemployment, and low consumer confidence is having a major sudden impact on our top line this year. Virtually, every economic factor needed to support strong light truck sales is a (inaudible) force headwind at this time. Much of this change is structural. A good amount of it appears to be permanent and I'm not complaining about this, just explaining that for these reasons, we need to resize the company and our cost structure and that's exactly what we're going to do, with due care, with great urgency.

One bright spot is that the product mix continues to be relatively strong. AAM's content per vehicle in the second quarter of 2008 was $1,312. That's approximately the same as the second quarter of 2007. For the first six months of the year, AAM's content per vehicle was approximately $1,320, up a very solid 3% versus the first half of 2007. And we suspected we might see some fall off in four wheel drive, all wheel drive orders due to fuel efficiency concerns, that has not been the case so far this year.

Four wheel drive, all wheel drive penetration, a key factor in content per vehicle trending, and of course a key factor in the vehicle performance and the users of these vehicles approximated 65% in the quarter as well as for the first half of the year in total. At that level we're running a little bit ahead of the prior year. Non-GM sales in the quarter were $143 million or 29% of our sales. Similar to the first quarter, the strike had the effect of increasing this percentage. On an apples and apples basis, excluding the impact of the strike, GM sales would have been higher percentage of the total, approximately 80% of our sales.

Moving on to the P&L, all of the key measures of profitability were significantly adversely impacted by the strike as well as the special charges, asset impairments, and other non-recurring operating costs that we recorded in the quarter. And just to be clear, when I use the term “special charges” this morning, I'm referring to all these one-time items, including the asset impairments.

In total, AAM booked $576 million of special charges in the second quarter of 2008. This equates to $11.16 per share. Approximately, 95% of these items were non-cash in the period. Almost 2/3rd of these items primarily the asset impairments and deferred tax asset valuation allowance are simply not going to be cash funded at any point of time in the future. We're providing this information only to help you understand the nature of these charges. We're not trying to dismiss the importance or magnitude of the charges.

In total, including the $86 million negative strike impact, and $576 million for the special charges, AAM incurred a net loss of $644.3 million, or $12.49 per share in the second quarter. I'm going to spend the next several minutes reviewing the special charges recorded in the second quarter of 2008.

The first item was the lump sum signing bonus in connection with the ratification of the new labor agreements. AAM paid a lump sum signing bonus of $5,000 to the 3,652 UAW representative associates covered under the agreement. We paid and expensed $19.1 million or $0.37 per share in the second quarter related to this one-time payment.

The second item was our accrual for Supplemental Unemployment Benefits or SUB. In the new labor agreements, AAM agreed to continue paying SUB to UAW representative associates on lay off subject to a cap of $18 million. Once the $18 million cap is paid out, the SUB program terminates. In the second quarter of 2008, AAM expensed a cost of this benefit and that was $18 million or $0.35 per share.

The third item are attrition programs and benefit reductions for hourly and salaried associates. The second quarter of 2008, AAM recorded approximately $150 million of expense for attrition programs and benefit reductions for hourly and salaried associates. Included in this total were charges associated with separate programs for AAM's – UAW with representative associates at the original U.S. location, IAM representative associates at the Tonawanda and Detroit forging facilities and our salaried associates in the U.S.

Almost 90% of these charges relate to the UAW representative associates.

As Dick already mentioned more than 2,000 UAW representative associates have signed up to participate in the SSP. In the Second Quarter, we expensed a cost of buy-out for associates who were released prior to the end of the quarter. We also recorded a liability for those associates working at the plant to be closed.

In total, we recognized close to half of the total expense we expect to see on the SSP. As it relates to the salaried workforce, we have plans to eliminate 350 positions in the U.S. In the second quarter of 2008, we recorded the estimated liability for benefits payable under Salaried Retirement Incentive Program or SRIP and other existing benefit plans including our Layout Severance Program or LSP. Of course, all this is to effect these reductions.

The fourth item that we booked in the second quarter were asset impairments, and this includes related charges for lease accruals and indirect inventory write-down. The second quarter 2008, AAM recorded an aggregate total of approximately $330 million for asset impairments, lease accruals, and indirect inventory write-down, these are the machine repair parts that are associated with the fixed asset. The timing of these charges coincide with the emergence of several impairment indicators as that term is defined under GAAP in the quarter.

This included first the resolution of the International UAW strike and the ratification of the new labor agreement at the original U.S. location. As we've had a chance to tell you these new labor agreements are substantially changed from previous agreements, both in terms of the economic impact and operating flexibility. This allows our company to finalize long-term plant loading decisions, capacity utilization decisions that form the underpinning of the restructuring actions that we are announcing today.

Secondly, there were several market dynamics that emerged or were notably exacerbated in the second quarter of 2008. These are now dominant forces underlying the structural and potentially permanent shifts in demand for major elements of our current product portfolio. This, of course, affects mainly our U.S. operation. This includes the items that we have already discussed, the spike in fuel prices, shifts in consumer preferences and the credit crisis, those items. As a result of these and other factors, the monthly SAR fell quickly during the quarter from greater to 15 million units in the first quarter to $13.6 million in June, the lowest monthly sales performance in 15 years.

Thirdly, our customers announced plans in the second quarter, in many cases which were updated again even in July to significantly cut production capacity or to accelerate previously announced cuts for several AAM's major light truck product program. Based on these new, lower expectations that emerge during the quarter for customer production requirements in AAM's major light truck product program, AAM significantly reduced its estimate for total calendar year 2008 sales to approximately $2.2 billion. Of course, this has an impact on our forward-looking view of our requirements in these programs as well.

For these reasons, it was appropriate for AAM to initiate a comprehensive review of asset impairment at the facility supporting our North American light truck business. The write-downs we recorded in the second quarter contemplate the impact of the plant closing decisions we made internally as well as other decisions to rationalize and redeploy assets at these facilities to meet our customers’ new requirements.

The fifth item on our list is special charges this quarter is the deferred tax asset valuation allowance. In the Second quarter2008, AAM recorded a special charge of $54.4 million, or $1.06 per share to establish a valuation allowance on AAM's US deferred tax assets as required by FASB Statement No. 109 accounting for income taxes. This GAAP standard requires AAM to assess whether the recoverability of our deferred tax assets is “More likely than not” based on forecast of taxable income on a quarterly basis or whenever events indicate that a review is required.

The impairment indicators that I've just described above cause us to make an updated analysis of this position and our deferred tax assets in the second quarter of 2008, and I'm speaking here of our U.S. deferred tax asset.

Based on this updated analysis and with emphasis on the past three years of operating result, as the primary evidence required under GAAP, AAM concluded that it was appropriate to write-off the net US deferred tax asset position. It's important to note that this valuation allowance is a non-cash charge and has no effect in our ability to utilize the underlying positive tax attributes in our future tax filing.

We believe that we will have many options available to us to monetize these assets in the future, and continue to view these tax attributes as an important asset for the company. However, it was necessary and appropriate to record the valuation allowance at this time.

Sixth, in a much smaller category, but the other category includes special charges recorded in the second quarter of 2008 related to plant closure accruals and asset redeployment costs. These charges and costs amounted to $7.4 million or $0.14 per share in the quarter. Included in this total are liabilities for environmental remediation, and utility cancellation fees.

To wrap up on this part of our discussion today, the total impact of special charges in the second quarter of 2008 was $575.6 million or $11.16 per share. And, of course, this drove significant portion of the losses we recorded in this quarter. Although (inaudible) a little bit in the details, there were some other bright spots.

We were very pleased with the performance from an operating perspective and the results of our operations in Mexico. This was a very positive force for our company for many reasons in the second quarter. We also had an effective restart of our operations at the original U.S. location. So, certainly was not all doom and gloom and we're often ready to have a good operating performance in the third quarter and fourth quarter this half of the year.

Let's turn our attention now to cash flow. GAAP cash used in operations was $84.2 million versus cash provided at $224.8 million in the second quarter of 2007. CapEx was approximately flat at $33.6 million in the second quarter of 2008 versus 2007. The second quarter 2008 CapEx was reduced by $2.3 million of proceeds received from the sale of equipment. Dividends were $8.2 million. We define free cash flow to be net cash provided by or used in operating activities less capital expenditures, and less dividends paid. In the second quarter of2008, free cash flow was a use of $123.7 million versus free cash provided of $183.8 million in the second quarter of 2007.

As we previously noted, the working capital impact of the strike was the primary driver of our negative free cash flow results in the second quarter of 2008. We have estimated the cost in the strike to be approximately $130 million. The signing bonus of $19 million was also another key or unique factor weighing in on our cash flow results in the quarter.

At the end of the second quarter 2008, cash on hand was $196 million. And that is reduced from approximately $350 million at the end of the first quarter and virtually all tied to the free cash flow results. The net debt to capitalization ratio was 68.1%, that's a significant change, the impact of course of the special charges had a material affect at this ratio on a book value basis.

Let me finish up this morning with a summary of our restructuring plan from a financial perspective and then we'll turn the call to the Q&A. AAM's restructuring plan is (inaudible) noted is based on resizing our U.S. operations to a U.S. assume SAR of 13 million to 14 million units. This fully contemplates our customers announced plant closing and then some.

As Dick mentioned we will reduce our U.S. production capacity by approximately 70% to align with these current and projected market requirements. A key aspect of our plan is the annual structural labor cost reduction of $350 million associated with reducing our U.S. workforce by almost 2,500 associates in the near-term. This is an unfortunate, but necessary action to resize our cost structure to adapt to the new market realities we're facing. The cost of this labor transition is significant. We've estimated the total cost of these actions to range from 400 million to $450 million. The financial assistance that we will receive from our customer General Motors approximately $215 million, of course, this is to support the transition of UAW represented legacy labor at the original facilities will cover approximately half of this total cost, the rest will have to be funded internally.

With this in mind, AAM is taking action to reduce costs and shore up liquidity. This includes a focus on first, immediate cost reductions. And as Dick noted this includes the cancellation of the 2008 bonus program. And Dick also mentioned, the most significant of these cost reductions from a dollars and cents perspective takes effect on Monday, July 28, 2008, with the implementation of the Buy Down Program or BDP at the original U.S. locations. This will significantly reduce the hourly wage rates paid to our UAW representative associates at those locations.

Second, we're taking aggressive actions to reduce our inventory. This will provide us much as $75 million of liquidity in the second half of 2008 as we adjust all aspects of our operating plans including inventory levels to this new lower level of operations and our new adjusted plant loading and capacity utilization plan.

Thirdly, CapEx reductions and deferrals, the opportunity we have here to reduce annual CapEx spending is 4 to 6% of our total sales over the next several years by redeploying existing assets is a significant positive change for our free cash flow profile over the next several years. We're also evaluating asset sales. The potential to raise cash and sharpen our focus by selling two or three businesses that are not a core part of our long-term plan. This includes our stabilizer bar business, and our linkage business. We also are reviewing the possibility of selling excess land, equipment and facilities to raise cash.

We're looking at also (inaudible) in an orderly fashion and as planned establishing new foreign credit facilities to fund our foreign growth on a local basis, much more of our growth in the next several years will be occurring outside the U.S. we want to match up where we borrow funds with where we're growing. Also, the change in our dividend policy. This change should reduce the end run rate of AAM's quarterly cash dividend payment by more than $25 million effective immediately.

Our conservative balance sheet posture over the past several years has served us well in recent months. Although the restructuring plan as well as the impact of the market dynamics we're talking about will weaken our balance sheet position considerably in the short run, we are committed to rebuilding this balance sheet strength as quickly as we can.

The financial objectives of our restructuring plan are as follows

We have a new business backlog of $1.4 billion as we discussed in the past. We have a very solid foundation, albeit a little bit smaller than it was, but still very solid of success our business to the current program we run today and we intend to grow our top line to $4 billion by the calendar year 2013. Very significant labor cost savings are flowing right through the operating margins of our business. We see our EBITDA margins growing to 12% or more in the near-term. And this is a long-term objective for our company to maintain at that level.

Thirdly, we've said this many times. We see our CapEx spending reduced to a range of 4 to 6%. This will help us increase fixed asset turns to more than two times and increase our total asset turns to more than one and a half times. We're an asset intensive business and we're taking steps to manage that more efficiently. Sixth, and this is a continuing part of our financial objectives, we're looking to generate after-tax returns and invested capital of 15%. The actions that we're taking should help us get there.

We recognize this is a tough challenge, a very significant challenge, but we are focused, determined and ready to do what it takes to move AAM down the path to a successful future. We are now just days, weeks, and months away from establishing a market cost competitive structure in all of our global manufacturing locations. We are already there in Mexico, Brazil and China as well as MSP, Colfor, (inaudible) here in the United States of America. Very soon we'll be able to say that about all of our locations in the U.S. We have a substantial backlog of new business, a substantial base of new business and over the next several years, we will transform our revenue stream to a more balanced, diverse, and strong stream.

Thank you for your time this morning. Let me now turn the call back to Jamie for the Q&A

Jamie Little

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

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from Himanshu from JP Morgan.

Himanshu Patel – JP Morgan

First, Mike, the contribution margin on the loss strike related revenues, looks like that was about 30%, and it looks like the contribution margin on the non-strike related revenue decline was about 20%. Are those normal number we should use going forward?

Michael Simonte

Himanshu, this was anything but a normal quarter. I think that the contribution margins or the strike business which is of course centered in our US business in line generally with our expectations around 30%. Recall that we were ramping up our production in our Mexican operation so what you have there is a combination of a reduction in the U.S. business and an increase in the Mexican business. In the volumes that we ran and the overall decline in our non-strike related business you do see the benefit of the lower fixed cost structure and lower operating cost structure that we have in Mexico. So as we told you before, our attention is to reduce this variable contribution margin on the downside, back down to about 25% and I think what you're seeing there is a little bit of a glimpse into the future at a company that's a little bit more weighted towards cost competitive locations such as our Mexican operation.

Himanshu Patel – JP Morgan

Okay. And then do you have a sense of what sort of ballpark proceeds you could generate from asset sales?

Michael Simonte

Himanshu, we're not talking about businesses that are very significant portion of our business. Maybe aggregate sales somewhere in the 5% of total top line, and it's a little bit too early to speculate, but we do think that with all these asset sales be the book of business and the stabilizer bar, linkage area, for example, (inaudible) land and facilities that we have, and some other situations we're looking at, we probably had the opportunity to raise between $25 and $50 million over the next year. We may be able to exceed that, but to be realistic, that's what we think.

Himanshu Patel – JP Morgan

Okay. And then my last question on the liquidity. By year-end, how much of your revolver do you think you will have drawn down?

Michael Simonte

Himanshu, we have the cash resources on the balance sheet that we talked about certainly at the end of the first quarter we had this discussion, just on most of the cash outflows that we anticipate in the calendar year 2008, and of course, this is in mind with the financial assistance we expect to receive from GM. So the amount of revolver products that we're going to have is going to be dependent on a number of factors including working capital movements and what we're doing with our overseas activities. You know, I'm not going to make any significant comments relative to how much revolver products we're going to have today, but what I will tell you is that we would expect our total borrowings under the long-term fixed structure to fund most of our requirements in this calendar year.

Himanshu Patel – JP Morgan

Okay. Great. Thank you.

Michael Simonte

Thank you, Himanshu

Operator

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

John Murphy – Merrill Lynch

Mike, I was just wondering if you could run through the big potential – I mean you know the big cash calls that you see in the restructuring (inaudible) indicating to them over the next few quarters. Just so we can understand along with your operating cash flow what the cadence of the restructuring cash calls are going to be?

Michael Simonte

Okay, John. It's a good question. The significant element of the cash to fund this transition on the labor side, of course, is the SSP and the BVP. On the BVP, let's handle that first a little bit easier to think about, after we settle on how many associates are elected to participate in the SSP, and as we told you today looks like it's going to be more than 2,000, the remaining associates will have their (inaudible) effective on Monday and within approximately two weeks we'll make our first buy down payment and we'll make succeeding annual buy down payments in August of 2009 and August of 2010. So once we know the exact numbers we can shake that free, but it looks like somewhere in the neighborhood of $50 million or so, maybe a little bit more in calendar year 2008, a little bit less in calendar year 2009 and '10, split among those (inaudible).

John Murphy – Merrill Lynch

Okay.

Michael Simonte

On the special separation program, we, of course, already during the month of July had some associates leave the business or elected early participation. That lines up with the associates that we accrued for in terms of expense in the second quarter and what we need to do now in the third and fourth quarters is really identify a detailed level of the operating plans that we're going to have to run our business, meet our customer schedule requirements and in effect is very significant, really massive change in turnover in our workforce. In 2006, it was a little bit easier for us to (inaudible) the associates who elected to participate in the program – through the program because we had so many people on lay off. Much different situation this time, so we would expect, John, over the next three quarters to see the total impact of those SSP payments to be made and I would say that's probably going to be centered around the fourth quarter and first quarter just from a practical standpoint because it's going to take some time for us to work through this on an operating basis.

John Murphy – Merrill Lynch

And the aggregate payment of those?

Michael Simonte

Well the aggregate cost of the SSP is estimated to be somewhere in the neighborhood of $250 to $275 million. But that includes a couple elements that are pension related, roughly 10% or so of the total program expense and this is still subject to some actual valuations that roughly 10% of the 400 to 450 I'm saying, so $45 million relates to pension adjustments that are not going to be funded in the near-term. So backing down off that, then we will be funding a portion of this from our pension trust and a portion from operating cash flow. Some of the buy-out incentives and retirement incentives were offered as part of our pension trust, that's the structure of the program.

John Murphy – Merrill Lynch

Got it.

Michael Simonte

So as we work through this, John, you know, we're probably talking somewhere in the neighborhood of $200 to $225 million of cash for this special separation program. We have an obligation to pay it by the first quarter of 2008 because all of our associates that are participating in this program will (inaudible) of the business by February 1, 2009.

John Murphy – Merrill Lynch

And then the timing of the GM payments that are coming in, cash payments or their subsidy?

Michael Simonte

Yeah, the GM payments will be received by our company on or before August 1st in the amount of $15 million, on or before October 1st in the amount of $100 million, and on or before April 1st of $60 million for a total of $175 million.

John Murphy – Merrill Lynch

Great. Thank you very much.

Michael Simonte

You got it.

Operator

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

Rod Lache – Deutsche Bank

Good morning.

Michael Simonte

Hi, Rod.

Rod Lache – Deutsche Bank

Can you just repeat please the cash debt and securitizations at the end of the quarter?

Mike Simonte

Cash debt and securitizations. Okay. On the balance sheet, Rod, we have cash of $196 million. Let me get the specific number on debt. The long-term debt balance was $869.2 million and I'm not sure what you meant by securitization.

Rod Lache – Deutsche Bank

Do you have any securitized receivables at the end of this period?

Michael Simonte

(inaudible)

Rod Lache – Deutsche Bank

Okay.0x01 graphic

And can you just talk about the leverage covenants and compliance with those covenants through the production schedules that you're looking at in the back half of this year?

Michael Simonte

Yeah, Rod, listen, we are in compliance with our debt covenants today and – I'm not in a position to speculate about all the different contentions that (inaudible) developed, but what I can say is that we intend to operate as we do in all of our agreements in compliance with those agreements including our bank covenants.

Rod Lache – Deutsche Bank

On the cost savings of $350 million that you're referring to, does that include the lower depreciation that you would experience from these asset impairments?

Mike Simonte

No, it does not, Rod. The $350 million relates specifically and exclusively to the structural cost reductions we see on the labor side. That includes the $300 million that we previously announced relating to the UAW representative associates at the original U.S. locations and now at 350 that contemplates the salary cost reductions here in the U.S. as well as the reductions associated with our IAM representative associates at the locations that we're closing. I'm speaking of the Tonawanda and Detroit forging facility. In addition to that, Rod, we will have other fixed cost reductions. You're right to point out the fact that there would be depreciation reduction associated with the asset impairments and we would see those in a range of $30 to $40 million annually.

Rod Lache – Deutsche Bank

Okay. And lastly, could you just talk a little bit about how you anticipate the timing of these hourly and salaried cost savings to kind of work out and you said you're resizing to be profitable in 2009. Can you just give us a sense of the level of production that the sort of underlying those assumptions?

Michael Simonte

Okay. First of all, in terms of these cost structure savings, they're dominated of course by the UAW labor agreements, and as we said, those agreements begin to take effect in terms of cost reductions on Monday, this coming Monday, July 28, and at that point in time, the hourly wage rate reductions that were a key part of these overall cost savings take effect of the associates who are going to continue working for our company. So that's the first element of these savings. Beginning on January 1st 2009, all of the benefit related adjustments in this contract relating to, for example, cost sharing on the active healthcare program, the freezing of our defined benefit pension associated with these associates as well as the elimination of OPEB at our Three Rivers facility and other related OPEB adjustments, these take effect on the first of next year. So, by the first quarter next year – particularly in the second quarter we should have a full run rate of the savings from the UAW representative associates. Remember that $300 million is a combination of bottom line savings we'll see on the associates that continue working for our company as well as the structural cost reductions necessary to adapt to a lower volume assumption.

Rod Lache – Deutsche Bank

Is the 2,000 people that took the attrition program, does that happen all at once or does that kind of trickle out over the course of the next three quarters?

Michael Simonte

Rod that's a great point. No, that does happen over time. The associates will be leaving our company over time. As I mention some folks have left the company in July, others will be leaving throughout the third quarter and fourth quarter and into the first quarter of next year. We will control the timing of those departures with respect to making sure that we are able to run our operation. And again, this is a pretty massive transition so really can't happen all (inaudible). So the savings associated with those associates are the third element, Rod, of achieving that total $300 million reduction and as I said that will be accomplished by the first quarter of 2009.

Rod Lache – Deutsche Bank

And the production level that you're sizing towards?

Michael Simonte

The production level that we're sizing to, the primary assumption is a US SAR environment of between 13 and 14 million units. We are taking counsel from our customer and their plans and their scheduled production volumes and maybe the higher end of that range is where our customer is right now, but we need to take a more broad view of what could happen here, and so we are making our plans and our restructuring around 13 to 14 million unit potential.

Rod Lache – Deutsche Bank

Okay. But would you comment on the specific production of your, I mean 13 to 14 million is one thing, but obviously it's dependent on what percentage of the market is pick ups and SUVs of course, so any color on the level of actual production or the level of demand that you're anticipating for like GMT 900?

Michael Simonte

I'll make two quick comments. One is I'm not providing guidance today on 2009 so I'm not trying to be so specific about detail assumptions. We're in the process of building our budgets and we'll give you more color on that as we get closer to 2009, but our planning objective is around 13 to 14 million units in total. We are in line and consistent with General Motors expectations with a total size of the U.S. pick up market and the total size of the – full size SUV market and that of course is the primary and most foundational element of our planning.

Rod Lache – Deutsche Bank

Okay. Thank you.

Operator

Your next question comes from the line of Rich Kwas with Wachovia.

Rich Kwas – Wachovia

Hi. Just had a question, Mike, on overseas profitability. Seems like given the taxes you recorded this quarter that the overseas business was pretty strong. Is that a fair assumption and fair conclusion to come to?

Michael Simonte

Rich, good morning, and yes, it is. As we've said many times here in recent months, we have already transitioned to a fully market competitive cost structure at our (inaudible) operations. We set them up right to begin with. We locate it in the right locations to be competitive close to our customers and our supply base, and this is a very solid and important part of our financial profile. So, this activity currently is dominated by our operations in Mexico, and that is a very positive force as I mentioned earlier today and our financial performance has been and will continue to be and now that we're making transitions in the U.S. and as we take additional actions to support the growth of our business in places like India, China, Brazil by locating right from the start of the right market cost competitive locations, these are all reasons why we feel very good about our future, Rich.

Rich Kwas – Wachovia

And when you – just as a follow-up to that, I think that you had provided slides where you talked about the pro forma changes reducing your U.S. sales to below 40% everything that's going on, I think the exact number was 37.7. Based on what's happened here over the last month or so, does that U.S. sales percentage decline even further?

Michael Simonte

Rich, it certainly could. I mean, some of that is speculative in terms of where we'll be in the future, but yes, just cranking down the numbers here today, that same slide based on our new lower expectations, and of course, this is in the aftermath of the announcements GM just made here in the last couple weeks. We probably would see that a little bit lower, probably somewhere 35% or maybe just a (inaudible) lower.

Rich Kwas – Wachovia

And then finally on the turnover that's expected over the next several months, how do you feel about backfilling with new employees I assume most of that is going to occur outside of the U.S. What's your situation down South to be able to back?

Richard Dauch

Rich, good morning, this is Dich Dauch. We're in excellent shape as to how to transition our folks out as was indicated earlier. Management will control that process. Secondly, we have built the reservoir of qualified talent as need be to replenish in the appropriate spots, and that's all suffice to other country locations for our company.

Rich Kwas – Wachovia

Okay. Thank you.

Richard Dauch

You're welcome. Have a great day.

Operator

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

Chris Ceraso – Credit Suisse

Thanks, good morning.

Richard Dauch

Good morning.

Michael Simonte

Good morning, Chris.

Chris Ceraso – Credit Suisse

A couple items. First, Mike, on the evaluation allowance, just a housekeeping question, that goes on the tax line in terms of sort of a pro forma P&L, correct?

Michael Simonte

I'm not certain exactly what you mean, but let me say this. The $54 million charge ran through tax expense and any adjustments that we make up or down through the evaluation allowance in the future will also run through tax expense. That's a key factor.

Chris Ceraso – Credit Suisse

And you went through this a little bit but just to reconfirm here, so, clearly there's some look back here, but the expectation is that profitability in the U.S. is expected to remain challenged in the near-term, right? That's part of what goes into the assumption when you make this kind of adjustment?

Michael Simonte

Chris, that's right, you need to look forward, but the most important of an instrument accounting perspective really is the look back to the most recent three years as evidence of whether or not the business can support those tax assets. So we do need to look forward. And clearly, our U.S. profitability as the business is currently constituted will be challenging. There's no question about that in terms of being able to make up for what has now been literally hundreds of millions of dollars of operating losses in the U.S. with these special charges. But, I want to say this. We have many different plans and potential plans in place to grow and improve our business in the US and these tax assets are not affected by that. They're going to be available to us and they really will not be expiring in any time frame that should give us cause that we won't be able to realize it and if we can follow through on these plans. So, we see these as a very important asset for the company still, but to follow all of the appropriate GAAP literature and based on the status of current plans, I'm not trying to be speculative about things that we want to do and feel that we need to do before we actually pull them off, it's appropriate for us to write those tax assets down.

Chris Ceraso – Credit Suisse

Understood. I know once you've taken an allowance like this it becomes very difficult to forecast your tax rate. Do you have any kind of guidance for us on how to think about taxes for the company for the rest of for the rest of this year and next year?

Michael Simonte

Yes, I do. Our company’s revenue and income profile still very much dominated by our operations in the U.S. and our Operations in Mexico. And as we've had talked in the past, our Mexico earnings are taxed at lower rates than the statutory rate of 35%, substantially lower due to the manner in which those assets are owned and operated by our company. So, I would see – effectively in the U.S. now, our tax provision will be 0% on an ongoing basis. There could be some adjustments to evaluation allowances for judgments in other cumulative other comprehensive income to make this a little bit messy so we may have some items there particularly as we revalue pension and OPEB benefits for curtailments as our associates leave on the SSP, but if you too aside those one-time items and focus on a run rate, (inaudible) just the purposes, the tax rates around zero in the U.S. right now and in Mexico, it's probably 10% to 15% or lower, and on the rest of our business around the world, it is such a size of magnitude in the next few quarters to affect this very much so it should be a relatively low effective tax rate.

Chris Ceraso – Credit Suisse

Last question, Mike. In your prepared comments you mentioned a target of 12% EBITDA margin. What's the timing on that and if I'm doing the math right it looks like that implies something that's pretty well below the current '09 consensus expectation?

Michael Simonte

I'm not (inaudible) sure what's all the consensus expectation, but what I'll tell you is that we see that transition occurring very quickly in 2009, the labor cost savings that we incurred here in the U.S. are a critical part of achieving that objective, and I would say that 12% – we mentioned 12% because that is our target and objective but we are striving for significantly higher EBITDA margins and feel that those are obtainable as we work through the next several years.

Chris Ceraso – Credit Suisse

Okay, so that’s more of a near-term hurdle than a long-term target?

Michael Simonte

Yeah, I mean, again, the magnitude of these structural labor cost reductions are very significant and I know by the question you're asking, you've looked at that and you understand that, so we're not trying to say we see it limited at 12%, we're simply saying that that's our near-term objective, that's where we're heading, and as soon as we can build a base around that, we're going to be (inaudible) forward towards higher level.

Chris Ceraso – Credit Suisse

Okay. Appreciate it, Mike.

Operator

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

David Leiker – Baird

Can you hear me? All right.

Michael Simonte

Good morning, David.

Richard Dauch

Good morning, David.

David Leiker – Baird

With where volumes are running, at your customer today, what's your current estimate of when you're going to hit that limit on the SUB payments?

Michael Simonte

David, that is going to be dependent on two or three different factors. One of course is the volume requirements. Second is the timing and pace of how we can make this transition in our facilities to hiring and transitioning literally thousands of associates. I think at this point, David, we see that expiring or meeting the cap in 2009.

David Leiker – Baird

So the weak volumes, that doesn't get pull forward at all there?

Michael Simonte

Well, it will be pulled forward certainly as compared to an environment where the volumes were higher. There's no question about that.

David Leiker – Baird

Okay. On the working capital numbers, can you walk me through a little bit, just receivable inventory and payable numbers? You've got a lot of distortions there without having generated revenue in a large part of your plant where the receivable number obviously came down meaningfully, but there wasn't a big opportunity to move inventory. It looks to me across those three items just on a net basis there's about $60 million of cash that's in there. Is that a fair number?

Michael Simonte

Yes. I mentioned in fact a higher number relative to inventory which is the really key element of $75 million, but you're exactly right. The working capital (inaudible) a little bit of screw this quarter, our receivables for example, in terms of cash flow are effected by the issue that our U.S. plants had sales really only in the month of June and we don't collect that until July.

David Leiker – Baird

I guess I'm thinking is that the offset of that inventory receivable number about that 60 million number?

Michael Simonte

You know, we're going to see over the next couple of quarters the $75 million of the inventory, I wouldn't see any material issues on payables outside of normal trending. And on the receivable side, yeah, we're going to see some additional cash come into the – we're going to see some cash flow there on a relative basis because the month of December and the seasonal activity at the end of the year is still less than what it is during the month of June.

David Leiker – Baird

Okay. And then if we – I don't know if there's a fair assumption or not, but if we use the assumption that the volumes you saw because of the strike of the volumes that would have been normal anyway because of end demand, that we don't add that back in, do you end up really what's like something around a $50 million loss at the operating line? And the process to walk through that would be to add a lock in your labor savings, add in your labor savings, add in your white collar labor savings from what you're going through to get to a pro forma number. Are there any adjustments you'd make to that exercise?

Michael Simonte

You know, David, this is an interesting question, but I got enough trouble trying to figure out what the actual numbers are in explaining those, then making up a bunch of different pro forma situations so if you want to talk about that more in detail we can take that offline, I'd be happy to chit chat with you about it.

David Leiker – Baird

Okay. And then just one last – that's fine, I'm all right. We'll talk to you later. Thanks.

Michael Simonte

Yeah, David.

Operator

Your next question comes from the line of Etah McCauley [ph] with Citi.

Etah McCauley – Citi

Most of my questions have been asked, but just quickly back to cash flow, Mike. So, is it fair to assume that in the second half of the year working capital should be all in a source of cash?

Michael Simonte

Etah, yeah, we see the inventory reductions being an important source of cash for us in the second half of the year.

Etah McCauley – Citi

Okay, great. And just on the CapEx, the 4% to 6% target, just how quickly do you think you can get there and where do you think you may end up roughly around in 2009?

Michael Simonte

You know, the 4% to 6% target range is a plan, a commitment really from our perspective over time. We already had some commitments outstanding and because this ratio is based not just on our spending, but also the impact on sales, with the volatility in the demand environment we can't say for sure whether we're going to achieve that here in 2009. We did operate here down level in the first half of 2008 and that wasn't by accident, we took very significant action to manage our spending. We got some significant product launches coming in the second half of 2009 as you know, so we're going to need to spend some money. We may be a little bit higher than that range in 2009, but we're going to be trending there as quickly as we can and I think by the time we get out to 2010 and '11, we feel that it's doable, achievable and necessary for us to get there.

Etah McCauley – Citi

Great. Thank you.

Michael Simonte

Thanks. We have time for one last question.

Operator

Your final question comes from the line of Brian Johnson of Lehman Brothers.

Brian Johnson – Lehman Brothers

Good morning.

Richard Dauch

Good morning, Brian.

Michael Simonte

Good morning, Brian.

Brian Johnson – Lehman Brothers

Can you give us a sense of just big chunks of revenue, if we think about your $4 billion target for 2013, we think about the 2 billion run rate with depressed levels we're seeing now and the 1.4 billion backlog, how we get from 2 to 4?

Michael Simonte

Okay. First of all I think you know, Brian, in our new business backlog, we have approximately half of that or $700 million lined up for 12 different passenger car crossover vehicle product programs. These are all wheel drive systems. These are products that include rear drive modules, power transfer units, multi-piece drive shafts, a very nice expansion of our product portfolio (inaudible) adding a lot of diversity and balance to our revenue stream so a good chunk of that is the 700 million. We also have some on the light truck side we have a significant concentration of global, not U.S. but global light truck program, these are end-user market outside North America, approximately half of that backlog of $700 million will launch outside the US.

That number is not mutually exclusive with the first one, but again about half of that backlog is going to be launched outside the U.S. In that light truck area we got not just rear axle and front axle, but also transfer cases that we see as a very important part of our future, as we deliver complete drive line systems to our customers. We also have some orders on the light commercial vehicle side and maybe moving up the food chain a little bit, one of our core competencies of course, rear beam axles, we see that rear beam axle demand requirement moving up the food chain a little bit in terms of commercial vehicle and so we'll be participating in that, the order with Mahindra (inaudible) joint venture in India, very important part of that and some other things that we see developing, including SUBs in our backlog. Those are very significant elements of it.

Brian, we do see some improvement in operating conditions as we get up to 2011, 12 and 13 we would not expect the market to be operating in roughly 14 million units SAR, so we probably attribute somewhere between 100 and 150 maybe as much as $200 million of add up lift associated with simply a stronger market, the return to the housing economy notably for pick up demand, these types of things, and we've left ourselves a little bit of work undone. We have probably somewhere between 3 to $500 million of work to do to get to that $4 billion number. It's not all booked at this point in time. We have $800 million currently under quote today. Typical that we do. We set a target of approximately $400 million of new business wins for our company this year, and we would see many opportunities to expand particularly in the areas of passenger car, crossover vehicles, light commercial vehicle and commercial vehicle segment and end use markets outside North America. That's how we see the growth map of $4 billion, Brian.

Brian Johnson – Lehman Brothers

And in terms of the (inaudible) business ting particularly in your principal platform, are you assuming in 2013 that that's continued in its current body auto frame or are you assuming a shift to unit body and if so, are you assuming you're participating?

Michael Simonte

Two things, very important to say there. First of all, the current product programs that we run today we would anticipate to run through all most of that time period, and of course that's body on frame. Secondly, as we said very recently, and you know, Brian, that we will be participating in these programs whether they're body on frame or move to a different type of architecture and we're in the early stages of engineering all the design requirements. Some of this, the answer the – ultimate answer to your question a little bit speculative, but as we look at the requirements – product requirements necessary to deliver the appropriate drive line performance for that type of vehicle we do not see a significant fall out in the amount of content that will be necessary to achieve that.

Yogen Rahangdale

This is Yogen. Couple things. The products required even body on frame on unit body we are ready for both of them and prepared totally, so we don't see any impact on us which way it goes.

Richard Dauch

And the other thing Brian is that first of all how are you today?

Brian Johnson – Lehman Brothers

Good morning, Dick. I'm fine.

Richard Dauch

We're not authorized to discuss if and when the design is going to change. As you've already heard from our customer GM, they have extended the life of the present GM 900 and delayed the next generation, so that is point one. Point two, we, AAM will continue playing a major role on that GM full size light truck program for many, many years to come as Yogen said, point three, whether it goes a design A or design B, we're going to be there. And finally, we just enjoy being the drive line supplier with exclusivity with General Motors on these full size trucks. They're still an extraordinary product. And if you look at that as it relates to full size pickup or SUV, and let's say you took the 14 million SAR, it's going to be a minimum of 10% still in the full size pick up. I'm talking a million 400,000 wherever and GM gets their 40 plus percent and the SUV piece which has gone more from let's say a 4% in the historic previous two, three years, that drops to 2.2% or 2.3% of the SAR, so you could put those two together and that's the way we're expecting it, whether it's design body on frame or whether it's unit body, we're ready either way as Yogen has indicated, and we have an extreme confidence that GM will do well and we have a total knowledge that we'll fully support them, or other customers, be it Chrysler with the Dodge division, et cetera.

Brian Johnson – Lehman Brothers

Okay. Thank you.

Richard Dauch

You're welcome.

Michael Simonte

Thank you, Brian 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 future.

Operator

This concludes today’s conference call. You may now disconnect.

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Source: American Axle & Manufacturing Holdings, Inc. Q2 2008 Earnings Call Transcript
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