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Operator
Good afternoon.
My name is April and I will be your conference facilitator today.
At this time, I would like to welcome everyone to the American Axle & Manufacturing fourth-quarter conference call.
All lines have been placed on mute to prevent any background noise. [OPERATOR INSTRUCTIONS]
As a reminder, today's call is being recorded.
I would now like to turn the call over to Mr. Chris Son, Director of Investor Relations.
Please go ahead, Chris.
- Director, IR
Thank you, and good afternoon, everyone, thank you for joining today and for your interest in American Axle Manufacturing.
All of you should have had a chance to review our fourth-quarter and full-year 2004 earnings announcement that we released earlier this afternoon.
If you have not, you can access it on the www.aam.com website or through the PR Newswire services.
Replay of this call will also be available beginning at noon today through 5 p.m.
Eastern standard time by calling 1-800-642-1687, reservation number 3247207.
Before I turn the call over to our Co-Founder, Chairman, and CEO, Dick Dauch, let me take a few minutes to read a quick statement.
This call is intended to be in compliance with Reg FD and is open to institutional investors and security analysts, news media representatives, and other interested parties.
I would like to remind everyone that the matters discussed in this conference call may contain comments and forward-looking statements based on current plans, expectations, events, and financial and industry trends which may affect the Company's future operating results and financial positions.
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 predicted or quantified, and which may cause future activity or results of operations to differ materially from those discussed.
The historical results achieved are not necessarily indicative of the future prospects of the Company.
For additional information, we ask that you refer to the Company's filings within the Securities and Exchange Commission, and our investor presentation on the www.aam.com website under the investor links.
During the call we may refer to certain non-GAAP financial measures.
Information regarding these non-GAAP measures, as well as the reconciliation to these non-GAAP measures to get financial information, is also be available on the www.aam.com website.
We are also audio webcasting this call through our website, www.aam.com.
This call will be archived in the investor sections of the website, and it will be available there for one year for later listening.
During the quarter, we will -- we will be appearing at the following conferences, the Smith Barney Small cap/Mid cap conference on February 16 and 17.
The Planes, Trains and Automobiles conference sponsored by Prudential on February 24.
The Smith Barney Industrial conference on March 8 and 9, and the Morgan Stanley Global Automotive Conference on March 21 and 22.
We look forward to seeing many of you at those conferences.
In addition, we are always happy to host investors at our facility either here, in Detroit or at our other locations.
With that said let's get to the purpose of today's call.
Let me turn things over to Dick Dauch, AAM's Co-Founder, Chairman and CEO.
- Co-Founder, Chairman, CEO
Thank you, Chris, and good afternoon, everyone.
We thank you for joining us to discuss American Axle's financial results for the fourth-quarter and full-year 2004.
I am pleased to be joined today by Joel Robinson, our Vice-Chairman, Yogendra Rahangdale, our Executive Vice President of Operations, Tom Martin, our Vice President of Finance and CFO, and Mike Simonte, our Vice President and Treasurer.
After I provide a brief overview of our financial results for the quarter, I will give you some brief highlights of AAM's achievements for 2004 and then finish up with a brief update on our 2005 outlook.
I will turn things over to Tom and Mike to discuss the details of our financial performance.
After that we will open the call for any questions you ladies and gentlemen may have.
Let me start off by saying that 2004 was a good and solid year for AAM.
Despite very challenging industry conditions, AAM made significant progress on critical operating, product technology, customer diversity, and strategic objectives in 2004.
We are well-positioned for our future profitable global growth.
AAM sales in the quarter were approximately $876 million.
Net income was $31 million.
Dilutive earnings per share were $0.61 for the fourth quarter of 2004.
Included in these results is a $10 million charge, or $0.15 per share for the quarter related to a voluntary separation program in the fourth quarter of 2004. 186 hourly associates terminated their employment with AAM in that process.
If we exclude the impact of the $0.15 charge in the quarter, the earnings for the quarter would have been $0.76 per share.
For the full-year 2004, AAM's sales were $3.6 billion.
As we had previously said, our sales were lower than expected in the second half of 2004, due to the impact of lower production volumes scheduled by our customers.
For the year 2004, North American light vehicle production was down about 1 percent as compared to 2003.
GM light truck production was off nearly 5 percent in that same period of 2004.
AAM's non-GM sales increased again by more than $50 million to $728 million or 20 percent of total sales in 2004.
This compares to non-GM sales of 18 percent in 2003, and 14 percent in 2002.
Very good progress.
Strong demand for AAM products supporting Chrysler Group program including the Dodge Ram heavy-duty pickup trucks were the primary driver of the non-GM sales growth in 2004.
For the full-year 2004, AAM's net income was approximately $160 million.
Dilutive earnings per share was $2.98.
Excluding the impact of the debt refinancing charge we took in the first quarter of 2004 and the December [VSP], earnings for the year would have been approximately $3.40 per share.
As we reported, at the 2005 North American International Auto Show on January 13, we are very pleased to have achieved our $200 million net operating cash flow target in 2004.
AAM has generated $213 million of net operating cash flow in 2004.
And after deducting $23 million of dividends to our shareholders, we generated $190 million of positive free cash flow for the year 2004.
Our strong free cash flow generation also allowed us to repurchase 5 million shares of our common stock in 2004, which cost us $171 million.
We also improved our net debt-to-capital ratio slightly to 31.2 percent at year end.
AAM is a rock-solid investment grade company with a fine balance sheet.
We have the financial flexibility to support our capital growth plan as we go forward.
Let me now provide with you some highlights of AAM's accomplishments in 2004.
First, we secured new, long-term four-year collective bargaining agreements with both our unions, the [UAW and IAM ] In the U.S.
The structural cost improvements in these agreements were vital and secured for AAM's long-term competitors.
Second, we established new International business and technical offices in [Panay] India, Shanghai, China, and Seoul, South Korea to support our global growth initiatives and expand our global footprint.
Third, we completed the construction of our new world-class manufacturing facility in [Arakaria ] Brazil.
Also the expansion of our Three Rivers driveline facility, and the second major expansion of our Rochester Hills Michigan technical center, as well as a fourth expansion of our [Wanawako] Mexico industrial complex, which we refer to as [Wanawako] South.
Fourth, AAM improved its quality performance in 2004.
Quality is a key differentiator in a global auto market in which AAM is the benchmark in the industry.
As measured by our largest customer, AAM obtained a world-class 12-month rolling average of 6 discrepant parts per million.
We also achieved Six Sigma that's less than 3.5 parts per million, in the months of April, July and November, we now know we can get close to perfection.
These quality performance records provide us with a competitive advantage in our ability to win new business.
It reduces structural costs, and continues to enhance margins.
It also provides our customers with excellence warranty performance and customer satisfaction.
Fifth, AAM continues to increase its investment in R&D to expand our product portfolio and advance our product processing systems technology in balance.
In 2004, our R&D spending rose over 13 percent to nearly $69 million.
AAM's R&D efforts have resulted in expansion of its product portfolio to include the following: First, tort transfer capability, including transfer cases and PTUs, or power transfer units.
Second, rear wheel drive, four-wheel drive, and all-wheel drive systems for passenger cars, as well as [customer] vehicles.
These include both independent, Front drive axles, IFDAs, and rear drive modules called RDMs.
Third, our full driveline system modules, especially our I-ride rear suspension module, RSM, and fourth, our electronic product integration.
Two of AAM's newest product offerings are now available on the all-new 2005 Dodge Ram Power Wagon, which is in production and going to market.
It also earned Four Wheeler magazine 2005 Pickup of the Year.
This exciting off-road pickup includes AM SmartBar, an electronically actuated roll control system, that allows the driver the choice of whether to engage or disengage a stabilizer bar, depending upon on or off-road conditions.
These technologies with new electronically controlled TracRite, front and rear locking differentials, provides a powerful combination to improve off-road performance and on-road stability.
We are extremely pleased with these new product involvements have allowed us to turn our R&D efforts into new business awards.
In 2004, we secured agreements with our customers, locking in 80 percent of our book of business for the next 10 years.
As mentioned at the Detroit Auto Analyst Conference during the 2005 North American International Auto Show, AAM has increased its backlog of new business significantly, by $500 million more dollars, over the original half billion, to $1 billion in the future.
A significant portion of these new awards supports AAM's efforts to further diversify its customer base and product portfolio.
Let me provide highlights of this backlog.
First, approximately 30 percent of AAM's new business backlog incorporates our newest technology for [PACCAR] as well as crossover vehicles.
Second, nearly 100 million of AAM's new business backlog relates to product programs outside of North America.
Third, AAM is also winning contracts with a major global OEM to combine a complete a driveline system utilizing our new developed products, IFDAs, RDMs, as well as RSMs for a rear-wheel drive passenger car program, planned for at least two separate geographic markets.
This is a major win for AAM, as it represents our first high-volume, rear wheel drive passenger car module program.
And fourth, the most notable awards are two new contracts from Asian OEMs.
One of these awards represents AAM's first opportunity to provide front and rear axle modules to a foreign customer for a major North American product platform and transplant, the second award represents AAM's entry into the Asian market.
AAM will provide the IFDAs and RDMs to South Korean automaker [Sang Yung] Motor Corporation for multiple new vehicle programs, beginning in the 2006 model year, that will launch in June of 2005.
AAM will launch approximately two-thirds of this new business backlog that I have been describing in the years 2005, '06, and '07 calendar years.
The rest will be done in 2008, '09 and '10.
We are also working hard on several additional opportunities to secure new business from existing and prospective customers.
Currently, we are actively quoting a new Business now totaling approximately $800 million, with nearly 40 percent of the activity outside of General Motors, and 50 percent representing opportunities for passenger car and crossover applications.
The production launch timing of these programs ranges from year 2006 through 2010.
We have also identified several emerging opportunities in the marketplace and expect to submit quotes on these opportunities in the upcoming months.
Before I turn it over to Tom, let me make a few comments about our newest board member and what lies ahead for AAM.
Today we are very happy to announce the appointment of Larry Switzer to our Board of Directors.
He has an extensive background in finance and operations, having been a CFO and CEO.
As well as moving AAM in to our global expansion, he will be able to help us and our fellow governance, with the business experience and financial expertise he has picked up over 40 years.
It is very valuable.
He is an independent Board member, and an excellent addition to our Board of Directors, and our audit committee as a 'financial expert'.
I would like to publicly thank him for joining the AAM team.
Ladies and gentlemen, 2004 is in the books, it's complete.
Our first 11 operating years at AAM is history, and we have been profitable each and every one of those 11 years.
We are very happy with that, but we are looking ahead for future accomplishments.
We respect the past, but we are focused on the future. 2005 will be a challenging year for all in the auto industry, especially the domestic auto industry, and that includes AAM.
First increasing energy cost and higher vehicle inventory levels.
Our softening customer's production schedules, at least in the first quarter of 2005 and maybe somewhat in the second quarter.
This will have a direct impact on AAM in this particular quarter.
Second, AAM and the industry will continue to be effective in 2005 by increasing in steel and other metallics, as well as other commodity pricing.
Third, the GM 800 is nearing the end of its healthy successful product life cycle.
This business represents more than 50 percent of AAM's topline sales and revenue.
We will continue to work with GM as they launch the exciting GM 900 SUVs in 2006, followed quickly by the pickups in 2007.
We are already launching our processes and systems right now, well prepared for the prototypes and production to come quick.
AAM's challenge is to work through this transition year.
We intend to transform these challenges into opportunities with exceptional operating performance that has become the trademark of AAM.
We have a very strong backlog of business, bodes well for the continued profitable growth for AAM.
In other words, I see many great years ahead of AAM.
I would like to thank our stockholders for their support in 2004.
Our focus is on the future for both products, customers, and markets.
We will continue to press forward with our vision, our strategy to ensure its sustainable and profitable future for AAM and its shareholders.
We will continue to differentiate ourselves in the marketplace by offering outstanding values for our customers and stockholders in is who we are.
This is what we do.
This is AAM.
I thank you for your attention today, and your interest in AAM.
Let me now turn the call to our Vice President of Finance and CFO, Tom Martin.
Tom?
- CFO, VP, Finance
Thank you, Dick.
We have a lot to cover today so let's get right to it.
Today AAM recorded fourth-quarter 2004 earnings of $0.61 per share.
AAM's fourth-quarter results includes a charge of $10 million, or $0.15 per share in the quarter, related to the voluntary separation program.
We had 186 hourly associates take advantage of this program during the quarter.
That, with the [VSP] that AAM initiated in the second quarter of 2004 makes a total voluntary reduction of 423 hourly associates for the year.
Excluding the impact of this charge, AAM's earnings in the quarter would have been $0.76 per share.
AAM's full-year 2004 earnings were $2.98 per share.
Excluding the impact of the debt refinancing charges we took in the first quarter of 2004 and the fourth-quarter VISA charge I just mentioned, AAM's earnings would have been approximately $3.40 per share for the year.
That's in line with our guidance.
And compares to the $3.70 per share in 2003.
Lower production volumes scheduled by our customers, and higher costs for purchase market commodities were the primary reasons for the decrease.
Let me share some of the other financial highlights for the fourth quarter and full-year 2004.
We had fourth-quarter sales of $876 million, and full-year sales of approximately $3.6 billion.
Non-GM sales increased by more than $50 million to $728 million or 20 percent of our total sales in 2004.
That's up from 18 percent in 2003.
Net operating cash flow, which we defined as net cash provided by operating activity less capital expenditures, was a quarterly record of $143.7 million.
That's a 25 percent increase over the fourth-quarter 2003.
For the year as a whole, net operating cash flow was $213 million, comfortably ahead of our $200 million guidance target.
After deducting $23 million of dividends, our free cash flow was approximately $190 million in 2004.
And in the fourth quarter, we repurchased 1.4 million shares of AAM's common stock for $40 million.
That brings our total repurchase activity to 5 million shares totaling $171 million in 2004.
Our strong free cash flow generation made that possible.
At the same time, we also reduced our net debt balances to $433.6 million in 2004, and improved our net debt-to-capital ratio to 31.2 percent at year end.
Let me now review some of these items in full detail.
First, starting with sales, AAM's sales were $876 million for the quarter as compared to $926 million in the fourth quarter 2003.
For the year, AAM's sales were approximately $3.6 billion, as compared to $3.7 billion in 2003.
Total GM light truck production was down approximately 2 percent in the fourth quarter of 2004 on a year-over-year basis.
Production volume for the program we support were approximately 6 percent lower.
For the year, our production volumes were approximately 4 percent lower in 2004 than in 2003.
Non-GM sales represented 20 percent of AAM's total sales in the fourth quarter and also for the year.
That's up from 18 percent in 2003.
AAM's total year non-GM sales of $728 million were 8 percent higher than in 2003.
AAM continues to benefit from the increasing four-wheel drive all-wheel drive penetration rate on the programs we support.
For the fourth quarter of 2004, our four-wheel all-wheel drive penetration rate increased to 64 percent versus 63 percent one year ago.
For the full-year 2004, our four-wheel, all-wheel drive penetration rate increased to nearly 63 percent, from less than 62 percent in 2003.
AAM's sales content per vehicle was $1182 for the quarter, and $1173 for the year 2004 as a whole.
Coincidentally, each of these amounts is approximately the same as in corresponding period in 2003.
AAM's gross margin for the quarter was 11.1 percent versus 14.9 percent for the fourth-quarter 2003.
The [VSP] charge reduced our gross margin in the quarter by more than 100 basis points alone.
For the full-year 2004 gross margin was 13.2 percent as compared to 14.7 percent in 2003.
Lower production volumes scheduled by our customers, and higher costs to purchase metal market commodities were the primary reasons for the decrease in our gross margin in 2004.
Selling, general and administrative expenses for the fourth quarter were $49 million or 5.6 percent of sales.
This compares to $46.9 million or 5.1 percent of sales in last year's fourth quarter.
For the 2004 as a whole, SG&A costs were relatively flat on a year-over-year basis at 5.3 percent of sales.
Despite a 13 percent increase in R&D costs.
As Dick mentioned earlier, our R&D expenses were nearly $69 million in 2004 versus $61 million in 2003.
Cost savings in other areas helped to offset the earnings impact of this increased investment in our R&D.
Operating income was $47.8 million in the fourth quarter versus $91.5 million in the fourth quarter 2003.
For the full-year 2004, operating income was $284.8 million or 8 percent of sales , as compared to $346.3 million or 9.4 percent of sales in 2003.
The fourth quarter, AAM's EBITDA margin was 10.6 percent as compared to 14.6 percent in the fourth quarter of 2003.
For the full-year 2004, AAM's EBITDA margin was 12 percent as compared to last year's 14 percent.
Excluding the impact of debt refinancing charges we took in the first-quarter 2004 and the fourth quarter VSP charge, AAM's EBITDA margin for the full-year 2004 would have been approximately 13 percent.
While this is short of our prior year results, we had a good and solid EBITDA performance in 2004.
Further down the income statement, net interest expense for the quarter was less than half of the prior year run rate at $5.3 million versus $11.1 million in the fourth-quarter 2003.
For the full-year 2004, AAM's net interest expense was 25.5 million versus $46.8 million in 2003.
The weighted average interest rate on AAM's outstanding borrowings in the fourth quarter 2004 was less than 5 percent, at 4.9 percent.
For the fourth quarter on the stand-alone basis, AAM's effective tax rate was approximately 25 percent.
For the full-year 2004, AAM's effective tax rate was 32.4 percent, as compared to 35 percent in 2003.
AAM's full 2004 tax revision reflects the impact of a couple one-time rate adjustments.
The first of these items relates to an opportunity to accelerate inventory deductions in Mexico.
The statutory income tax rate in Mexico is being reduced to 30 percent in 2005, from the 33 percent in 2004.
Accelerating the purchase of inventory in Mexico allowed us to deduct the cost of such inventory at a higher rate in 2004.
The other one-time rate adjustment in 2004 relates to our recognition of a tax benefit for adapting Medicare prescription drug improvement and modernization act of 2003.
This Act introduces a prescription drug benefit under Medicare referred to as Medicare part D. As a result of these adjustments, we were able to reduce the 2004 full-year tax revision rate by more than 100 basis points.
Net income was 31.3 million in the fourth-quarter 2004, as compared to 53.4 million for the fourth-quarter 2003.
For the full-year 2004, net income was $159.5 million or 4.4 percent of sales as it compares to $197.1 million or 5.4 percent of sales in 2003.
Excluding the impact of debt refinancing charges, we took in the first quarter of 2004 and the fourth-quarter VSP charge, net income would be $182.2 million or 5.1 percent of sales.
Let me now address our credit statistics.
Net interest coverage at year-end 2004 was 10.3 times versus 7.5 times at the end of 2003.
EBITDA coverage was approximately 17 times on an unadjusted basis at year-end 2004, significantly higher than the year-end 2003 coverage of approximately 11 times.
Our net debt to traveling 12-months EBITDA leverage ratio at year-end 2004 was approximately 1.0 versus 0.9 at the end of 2003.
Let's go through some of the balance sheet items.
Our inventories were up $25 million to $196.8 million at year-end 2004, as compared to $171.8 million at year-end 2003.
In addition to the accelerated inventory purchases in Mexico I just mentioned, our inventories are also higher because of higher cost of steel and other metallic materials in 2004.
Inventory turns were nearly 18 times 2004, versus 19.4 times at year-end 2003.
Current liabilities are up approximately $31 million at year-end 2004 as compared to the prior year, primarily due to increased inventory levels in 2004, and higher CapEx spending levels in the fourth-quarter 2004 versus the fourth-quarter 2003.
For the year as a whole, CapEx was right in line with our guidance of $240 million; however, in the fourth quarter 2004, CapEx was $25 million higher than in the fourth quarter of 2003.
Post retirement benefits and other long-term liabilities are up $68 million at year-end 2004 as compared to year-end 2003.
This increase is primarily due to an increase in accrued post retirement health-care cost.
Our booked expense under FASB statement #106 was almost $70 million; however, we -- less than $5 million of such benefit obligations in 2004.
Stockholders equity at year-end 2004 was approximately the same as in the prior year of $955 million.
As I just mentioned, our net earnings increased equity by almost $160 million in 2004.
Employee stock option exercise and reversals of a portion of our additional pension liability, also increased equity by a little more than 30 million; however, these additions in equity were offset by our dividends and stock repurchases.
AAM's performance for the year resulted in an after-tax return of investment capital, known as ROIC, up 12.7 percent.
Excluding only the impact of debt refinancing charges we took in the first quarter of 2004, ROIC for the full-year 2004 would have been just short of 14 percent.
Now let's turn to our expectations for 2005.
On January 13, 2005, we released earnings guidance for the full-year 2005 of approximately $2.40 to $2.55 per share.
This includes the impact of adapting FASB 123-R on July 1, 2005 which we currently estimate to be approximately $0.20 per share.
AAM's 2005 earnings outlook is based on assumptions that our customers production volume for North American light truck programs it currently supports will be approximately 8 percent lower than in 2004.
AAM's 2005 earnings outlook also assumes that the cost of steel and other purchased metal market commodities will also continue to increase in 2005.
We believe the impact of the year-over-year production volume reductions and material cost increases will be weighted more heavily in the first half of 2005.
Based upon our current customer production schedules, we expect revenue to be down more than $125 million in the first-quarter 2005 versus the first-quarter of 2004.
These estimates assume that production volume for the major customer programs we currently support will be 13 percent to 14 percent lower in the first quarter of 2005 as compared to one year ago.
This estimate also assumes a substantial increase in the cost of steel, and other purchase middle market commodities.
Taking all these factors into account, we expect earnings for the first quarter of 2005 to be approximately $0.40 to $0.45 cents per share.
This earnings estimate is fully contemplated within our guidance for the full year of 2005 of $2.40 to $2.55 per share. 2005 is going to be a challenging year for the auto industry.
Obviously the same is true for AAM.
Our task is complete focus on our long-term strategic goals of further developing our product offerings, customer diversification, global manufacturing presence to prepare for significant future profitability growth.
From a Commercial standpoint, we are off to a great start with our $1 billion new business backlog.
We have a rock-solid financial profile, and that means we are ready with the financial flexibility to take advantage of further commercial, strategic opportunities in 2005 and beyond.
Thank you, everyone, for your time.
Let me stop here and turn the call back over to Chris, for the question and answer period.
- Director, IR
Thank you, Dave, and thank you, Tom.
We have now reserved some time to take some questions.
Operator
[OPERATOR INSTRUCTIONS] The first question comes from the line of Steve Girsky with Morgan Stanley.
- Analyst
Good morning -- good afternoon, everybody, can everybody hear me.
- Director, IR
Yes, good afternoon, Steve.
- Analyst
Just a couple of questions.
The variable margin on operating profit looks a little volatile from quarter to quarter, is that just mix issues or raw material impacts, that vary from quarter to quarter?
- VP, Treasurer
Yeah, Steve, this is Mike.
You are exactly right.
There is a number of factors that play this year with the VSP program we ran the second quarter and the fourth quarter.
There are some benefits that accrued us to after that takes place, so in the the third and fourth quarter, we enjoyed the benefit of reduced labor cost associated with that.
The metal market activity obviously as you know revved up in the second half of the year.
So that also had a major factor in our margin performance in the back half of the year.
- Analyst
And can I ask you about the -- -- the importance of the 900 -- I know the 800 is important to the existing business.
But when I think about the backlog, how important is the 900 to the incremental business?
- Co-Founder, Chairman, CEO
Well, obviously the 900 is very important.
We have everything on it that we have with the 800, and we have an incremental add to it so we will have higher content.
I don't know what else I can --
- Analyst
If we sit here two years from now, is the 900 going to be -- you said the 800 is 50 percent of your business, Dick, something like that?
- Co-Founder, Chairman, CEO
About 55 percent.
- Analyst
Two years from now, 900 going to be less the same, more, what are you thinking?
- Vice Chairman
It will be more.
- Analyst
It will be more.
- Vice Chairman
Yeah.
- Analyst
Okay, thank you.
- Vice Chairman
A couple hundred million dollars more.
- Analyst
Okay, great.
Thanks so much.
- Vice Chairman
Thank you, Steve.
Operator
Your next question comes from the line of Jon Rogers with Smith Barney.
- Analyst
Yes, good afternoon.
Is there -- just to follow up on Steve's question, is there a four-wheel drive, all-wheel drive mix assumption that you're using for the 900, or is it too early to tell?
- VP, Treasurer
Jon, this is Mike.
At this time we would expect that the four-wheel drive, all-wheel drive continues to increase a little bit over the next couple of years.
We were at 53 percent or so in 2004 and see that ramping up to 65 percent over the next couple of years.
- Analyst
Okay, just as you -- we look at the income statements through 2005.
Mike, can you just talk about where you think the leverage is -- is coming from?
I guess if you look at the topline of -- although comps get easier, I am not sure that there is much improvement there, because most of the new business comes on in the latter half of the year, but is it productivity?
Is it -- as you get these employees off -- off the payroll, or do you anticipate some breaks toward the end of the year in raw materials prices?
- VP, Treasurer
Jon, a couple of things.
You know from a materials cost standpoint, we don't see a lot of relief in 2005.
We would expect that the market circumstances we saw in the second half of '04 persist through '05, so on a year-over-year basis, we feel that the third and fourth quarter will be pretty comparable at this time.
You are right to point out the impact of the VSP programs providing some additional strength to our margins next year.
We should see about $7 million of benefit there, but, of course, that benefit is offset by the metal market cost increases we will see in the first half of the year, and also the volume reductions, remember 200,000 units less production in the programs that we support this year.
- Analyst
What is the tax rate assumption in the 2005 guidance?
- VP, Treasurer
A good question, Jon, between 33 percent and 34 percent next year.
We -- we expected it to be around that level this year, and in the fourth quarter, of course, we had to value our 106 liability, and this Medicare part [B] subsidy that Tom mentioned.
That subsidy was valued and FASB B 106-Q, we had to and appropriate to recognize a benefit associated with that.
That kicked into the fourth quarter and we had the inventory benefit, the accelerated inventory reduction in Mexico, those two items were nonrecurring activity that allowed us to enjoy a much lower rate in 2004.
But in 2005, we see it back up 33 percent to 34 percent.
- Analyst
Great, thank you.
- Co-Founder, Chairman, CEO
Thank you, Jon.
Operator
Your next question comes from the line of David Leiker with Robert W. Baird.
- Analyst
Good afternoon.
- Director, IR
Good afternoon, sir.
- Analyst
I don't think I heard you quantify the impact of steel in the quarter for Q4 or going ahead.
- VP, Treasurer
Mike again.
About $10 million in the quarter for metal market cost increases.
The fluctuation associated with the metal market triggers in our contract.
- Analyst
That's about in line with what you expected it to be, correct?
- VP, Treasurer
Very much so.
We saw it at about $10 million, in the third and fourth quarter, and it came in right around that level.
- Analyst
I would presume given you didn't get hit about the metal cost in Q1, Q2, that's a number we should see for the first half of the year, in both Q1 and Q2?
- VP, Treasurer
That's right David.
We had about $2.5 million of impact trailing in towards the end of first quarter last year, a little bit more than that, maybe 4.5 in the second quarter.
So we see the bulk of our 12, maybe $15 million cost increase hitting us in the first half of the year.
- Analyst
Okay, great.
And then on this voluntary separation, you know payment.
It seems that, you know, we've seen this several years in a row.
Is this something that we are going to see continue going forward on a regular basis?
- Co-Founder, Chairman, CEO
No, I do not feel like we will have a lot of that.
We may have sporadic, but it depends on when our sales come in, and other applications of how much volume was going to be assigned to us.
And, therefore, I would not be able to put that in to my model if I were you.
- Analyst
Are these the actions you are taking to encourage people to leave?
The announced programs or -- ?
- CFO, VP, Finance
Overhead walks in on two feet.
You have to utilize the workforce, you have got the work thing, the work force.
The size of business we have.
We know when the new business is coming on, we told you when it is and we will adjust our manpower accordingly.
- Analyst
Okay, great.
- VP, Treasurer
Just before you leave that.
One thing I want to point out about the metal market cost, the $10 million quarter run rate in the third and fourth quarter, I want to remind everybody that is the metal market cost fluctuations themselves.
There are some additional big price increases we will see in '05.
Our task is to find other material cost reductions to offset that.
When we talk about the metal market, we only talking about the volatilities that are really based on the market conditions.
- Analyst
Is that net of recoveries, or is that a gross number?
- VP, Treasurer
That's right, the $14 million or what will be next year about $12 million to $15 million incremental to about the $28 million we saw in 2004.
So compared to where we started in 2004 about $40 million higher in 2005, it is -- that is net of recoveries that we expect.
- Analyst
Okay.
Thank you.
- Director, IR
Thank you, David.
Operator
Your next question comes from the line of Chris Ceraso of CSFB.
- Analyst
Thanks.
Good afternoon, folks.
- Co-Founder, Chairman, CEO
Good afternoon, Chris.
- Analyst
First question, Dick, I think you mentioned the backlog two-thirds comes on '05 through '07.
How much just for 2005?
- VP, Treasurer
Chris, it is Mike.
About $100 million coming on-line in '05.
Of course the biggest two pieces of that would be the Dodge Ram Power Wagon and the Hummer H3.
- Analyst
Okay.
And in the fourth quarter, at least based versus our expectation the GM sales were pretty consistent with what we had expected, but it looked like the non-GM stuff was lower from a sales standpoint.
Was the Ram volume off a bit, or was the mix of the content lower, was there less four-wheel drive penetration?
- Co-Founder, Chairman, CEO
We didn't see that big of a fluctuation.
There may be something that you see that we didn't.
I will have Mike or Tom talk to you after this call.
But we did not see any of significance there.
- Analyst
Okay.
Thank you.
- VP, Treasurer
Okay, have a great day, Chris.
Operator
Your next question comes from the line of John Casesa from Merrill Lynch.
- Analyst
Thank you very much.
Dick, can you just talk about the acquisition environment.
What is it like for you?
Are you seeing enough stuff?
How are the opportunities.
- Co-Founder, Chairman, CEO
The opportunities are very, very frequently, and they are getting greater each week, because people are having difficulties throughout the world competing in the auto business, and we're being very vigilant, and very observant and very careful but we have nothing to announce today.
- Analyst
Okay, secondly, just briefly maybe Mike or Tom -- or maybe you actually.
GM just trimmed its production schedule for the first quarter again yesterday, was that a surprise to you in -- are you concerned that we just could see a lot of sort of death by a thousand cuts through this year.
- Co-Founder, Chairman, CEO
It wasn't a surprise us to at all.
As a matter of fact, we were expecting it, and were prepared for it.
And I can't predict much further than the 16-week -- you know the inventory -- has not been fully balanced and obviously we are in the toughest month there is to sell.
January is always the toughest month in the auto year, and I think we will have a solid, good year.
If the production is probably going to be in our judgment 16-3 SAR, or something like that.
Sales will be 16.8, 16.9, and GM will get their fair share, but we all know as it relates to GM, part of their products, and the majority for us, is in the later life of their cycle, and we are going to have to just roll with it, it will be a transitional year but I am excited about it.
- Analyst
Thanks very much.
- Co-Founder, Chairman, CEO
Okay, John.
Operator
Your next question comes from the line of Michael Bruynesteyn with Prudential.
- Analyst
Good afternoon, gentlemen.
- Director, IR
Good afternoon, Mike.
- Analyst
Free cash flow. $25 million for '05, does that mean buybacks and debt reductions are probably on hold for a while?
- VP, Treasurer
Well, Mike, a couple of things.
The buybacks -- we used up now about 5 million shares of our 5.5 million share authorization, with a much larger new business backlog, we are much more focused on deploying our cash flow and foreign capability to investing in that future growth.
A couple of things.
Free cash flow is about 25 in our guidance for 2005.
That is after funding about $23 million of dividends, and, you know, all things being equal with that -- with that estimate, we should be able to reduce our debt by another $25 million in 2005.
- Analyst
Great.
And then in terms of the free cash flow, one of the things that you mentioned I thought was $60 million year-over-year variance on deferred tax.
That gone for the foreseeable future or is that just a temporary 2005 effect?
- VP, Treasurer
That is a good question.
As we ramp up our CapEx spending, we will be able to, again, take advantage of more accelerated depreciation, and as we spend at elevated levels in 2005 and 2006, I do expect our deferred tax situation to get better. 2005 will be a slight year from deferred taxes so we just have to live through that.
- Analyst
Okay.
And -- and then finally, can you characterize how the contribution margin differs from when you are increasing versus decreasing revenue?
Is there -- is there a differential there that we can think about?
- VP, Treasurer
Yeah, well -- you know our history is that there is, Mike.
We target to control the margin variance to about 25 percent on the way up, and on the way down.
A lot of times what happens is when you are on your way down, you are not entirely sure, you know, what's going to happen, and so our experience has been typically more like 30 percent on the way down, and, for example, we received more in the last couple of weeks, and in fact every week we get new schedules.
We are not able to trim all of our fixed costs because the volumes come up 1 or 2 percent every month.
- Analyst
Sure.
- VP, Treasurer
So our history and, Mike, the way we guide, and really manage it is to get $0.25 or better on the way up and control it to $0.25 to $0.30 on the way down.
- Analyst
Great, thanks very much.
- VP, Treasurer
Thank you, Mike.
Operator
Your next question comes from the line of Himanshu Patel from JP Morgan.
- Analyst
Good afternoon.
- Director, IR
Good afternoon, sir.
- Analyst
I had a question of how we should think of the quarterly cadence of earnings this year.
Obviously Q1 to Q2 has typically been sort of flattish and we usually get about a 20 percent decline in the second half.
Obviously this year, it is going to be very different to get to the full-year numbers.
Should we kind of think of most of the recovery and earnings sort of Q3-Q4 focused, or do we start seeing a decent amount of sequential improvement as early as the second quarter?
- Co-Founder, Chairman, CEO
I think I would react this way.
There are hard times presently in the auto industry.
And some have it harder than others, and right now I would say GM's days are in the barrel, Ford's days are in the barrel, and probably toward the third and fourth quarter, things will stabilize and get much stronger and a little bit more breeze behind their back.
First quarter and second quarter will probably be difficult quarters for people related more to their content and their market penetration with GM, Ford and not so much Chrysler.
- Analyst
Okay, Dick, just maybe following up on that, do your comments have -- obviously there is something to do with production over there but when you think of launch cost for the T-900 over the course of the year.
How does that flow through, a fairly steady kind of stream or --
- Co-Founder, Chairman, CEO
actually it is starting to flow through right now because Joel and I are great believers in minimizing the mountains, when you are launching major vehicle programs.
We try to minimize the process and systems that goes jointly normally with that.
So we are actually pulling our process launch cross ahead, but that can also be a two-edged sword.
We can actually now with our new process run both the GM 800 and 900 on the same line, so it could be beneficial to us once we get the initial launch curve behind us, and that's going on right now.
- Analyst
Great, thank you.
- Co-Founder, Chairman, CEO
You are welcome, sir.
Operator
Your next question comes from the line of Ronald Tadross with Banc of America Securities.
- Analyst
Good afternoon.
- Director, IR
Hi, Ron.
- Analyst
You are assuming your GM platforms are down 8 percent for 2005.
I am wondering if you are -- are -- know whether or not that is -- is that a little sales-related?
Like are you anticipating GM sales of those products to be down?
Or are you assuming some inventory production as well?
- Co-Founder, Chairman, CEO
Ron, we didn't say that, we said our customer volume would be down 8 percent and GM maybe a slight bit more than than that, on a program like the GM 800.
We will have to see what occurs over a 12-month cycle.
AAM's revenue volume will be down about 8 percent is what we said.
- Analyst
Okay.
I guess I am trying to get into whether or not that means that the sales are going to be down or -- do you believe this is just inventory related?
- Co-Founder, Chairman, CEO
I think that's a balance that you should talk to General Motors about.
- Analyst
Okay.
And then just -- on the restructuring -- the $10 million.
Can you just give us an idea what you expect to be normal restructuring?
I was a little surprised you called this one out, and going forward, basically what can be normal cash restructuring and whether or not you will call it out?
- VP, Treasurer
Right, let me just make a quick comment about calling it out, the only reason we called it out is because when we provided guidance on December 9, we did not plan to have that events, and we guided without it.
So I think it was important in terms of understanding our second half of the year performance, particularly our fourth quarter performance to call it out.
That is the only reason.
The second-quarter charge that we have, we already have had payback -- substantial payback on that during the course of 2004.
And that is the reason why we don't call off the second-quarter charge, and why we did make mention of the fourth quarter.
- Analyst
So then are -- are you going forward -- you want to call these things out, is that fair to say?
Or unless it happens last minute.
- Co-Founder, Chairman, CEO
If we have an abnormal event, we will give you guidance and we will give you an [advo] on it.
- Analyst
How much of this stuff is going through the P&L a year, $20 million, $30 million.
- VP, Treasurer
This year it was $12.5 million in the second quarter and $10 million in the fourth quarter.
A smaller amount running through '03.
As Dick said earlier today, we are not sure whether or not those will recur in the future.
- Co-Founder, Chairman, CEO
You have to adjust to the market.
You have to adjust to the cycles.
And you have to adjust to manning.
And remember when do you a VSP, that is a volunteer program, has to be done directly between management as well as union.
It has to be done thoughtfully and humanely and we do as best we can, but we don't make individual people's decisions.
- Analyst
One last thing, on this backlog, the billion dollars, a percentage of that that might be passed through sales where you may get -- you get a good return on capital but a low margin?
- Co-Founder, Chairman, CEO
No.
These are all big business cases.
- Analyst
All reasonable -- kind of average to better --
- Co-Founder, Chairman, CEO
we didn't say average.
We said they are good business case
- Analyst
Okay.
All right, thanks.
- Co-Founder, Chairman, CEO
Okay, thank you, Ron.
Operator
Your next question comes from the lane of Rod Lache, Deutsche Bank.
- Analyst
Good afternoon, everybody.
- Director, IR
Hi, Rod.
- Analyst
A couple of questions.
First on the GMT-800.
Can you confirm that the AAM content is similar on the large SUV versus the large pickup, I know it is a bit higher in the heavy duty, but how does that kind of work as there is mix between the two?
- VP, Treasurer
You know, Rod, we don't disclose the content on -- on specific programs like when what we said consistently, is for the year we run about $1173 dollars of content per vehicle.
It is about a couple hundred band on the high end and low end of that average that defines most of our sales, and so obviously with the 800, we are north of that, and we can be depending on the specific type of configuration, four-wheel drive obviously contributes a lot to that.
So we will be north of that $1173.
- Analyst
Right.
So -- you about it would be fair to assume that the four-wheel drive content on the SUVs is higher than on the pickups?
- VP, Treasurer
Well, I didn't say that.
I said we don't disclose the details.
- Analyst
Okay.
And relative to this production guidance for your customers are down 8 percent.
Correct me if I am wrong, but did you or did you not say that you are assuming that down 10 percent for the T-800?
- CFO, VP, Finance
We said that we would be -- of our Company, approximately 8 percent on average.
And that there would be some slightly higher or lower, and I indicated just earlier to one of the questioners that the GM 800 might be a slight bit higher.
- Analyst
Okay.
Just last question.
You know as you mentioned that there are abundant opportunities for acquisition.
Can you just give us some of the parameters you would place on acquisitions?
- Co-Founder, Chairman, CEO
Five or six things.
Number one, we will continue to be investment grade.
Secondly, we will continue to be accretive.
Third, we will continue to look for technology adds.
Fourth, we will continue to look for market expansion.
And fifth, we will take our most sophisticated products we have got, and incorporate them into new outlets of customer base, and those kinds of issues where there might be an acquisition that would have to fall within the framework of that.
- Analyst
Great, thank you very much.
- Co-Founder, Chairman, CEO
You are welcome, sir.
Operator
Your next question comes from Darren Kimball with Lehman Brothers.
- Analyst
Hi, guys, how are you doing?
- Director, IR
Hi, Darren.
- Analyst
Just I was curious about the first-quarter cash flow outlook.
I imagine they will be sort of the typical seasonal swing back in terms of working capital.
- CFO, VP, Finance
Darren, before Mike answers that, let me simply say for all the listeners, so maybe it will help their process of doing their business roll up.
In the auto business, the way it is set up, fourth quarter is always powerful.
We had $144 million quarter that was a powerful fourth quarter.
The first quarter is always the bad boy.
So we have issues on quarters of when the cash comes in.
I will let Mike give you specifics that he feels comfortable with covering.
- VP, Treasurer
Yeah, Darren, you are exactly right, the first quarter seasonally is tough.
Last year we were out about $42 million.
Out about $26 million the year before.
The main driver on a year-over-year basis this year will be increased Cap Ex levels.
We will be up $25 million to $30 million this year on CapEx.
So obviously we are going to be larger than 42.
- Co-Founder, Chairman, CEO
Darren, this is Dick, I want to make sure you and the listeners understand that we are delighted with that.
Because what that means we have all new product coming, and a lot of other products other than GM products coming at the same time, and that is going to take some CapEx up front, and we will have some marvelous times shortly thereafter.
- Analyst
Okay.
Thank you for that.
My second question is on the -- is on the metals.
I thought -- I thought I understood it and I have to admit that I got a little confused during the call.
You were talking about the $10 million -- I guess the incremental $12 million to $15 million in '05 being a function of the pass-throughs.
- Co-Founder, Chairman, CEO
what we said whatever our metal market hit was in 2004, we will have an additional increase of about $12 million to $15 million this year, which means a little bit over a million a month on top of what it was last year.
- Analyst
Right, but there was a reference to that being -- having to do with the pass -- with the metal market pass throughs, which is I thought pertained mostly to your GM contracts.
- Co-Founder, Chairman, CEO
Well, let me help on that.
We have got metal market clauses on the majority of our contracts with GM, but each of those contract came a different times.
They are all pegged to different indices and, therefore, you have an impact as to how much passes through.
Ours presently somewhere with GM between 65 and 70 percent passing through.
- Analyst
Let me just ask it this way.
There was a reference to another piece of the equation that you were going to be trying to offset whether the cost actions.
I just want to make sure I didn't get surprised by that later on.
I mean, how big is that -- -- other category?
- VP, Treasurer
Yeah, Darren, a couple of things.
You know, the pass through comment was simply to say that the amount of additional costs we had is net of the pass through we have with GM.
So that was the only reference to that.
The other comment was that we -- we do experience some [base line] Increases in 2005.
The metal market price fluctuations that we consistently disclose are just the market triggers.
It is -- the part that is volatile based on market indices, the other type of cost increases you are familiar with the fact that everybody has paid more for steel.
We have got our base prices in '05, so we see some additional costs there is, but we have plans to offset those costs with other purchase costs efficiencies.
So we are not -- we are not whining and crying about that. -- crying about that.
- Analyst
Okay, fair enough, thank you.
- Co-Founder, Chairman, CEO
Thank you, Darren
Operator
Next question comes from the line of Rob Hinchliffe with UBS.
- Analyst
Hi,.
- VP, Treasurer
Everybody hi, Rob.
- Analyst
I want to ask a question for CapEx for the 900.
Obviously you guys are ramping up quite a bit.
Ford has taken off some, shifted the Explorer, and we've seen some capacity come out.
How do you protect yourself if GM needs or feels the need to do something similar.
How do you not overspend on this?
- Co-Founder, Chairman, CEO
Well, first of all, nobody knows exactly what is going to happen in the auto business, but we feel very confident.
We have got another strong year.
I just told you we feel that SAR will be 16.8 million to 17 million.
We feel that production will be 16.3 or 16.4.
We think GM will get their fair share of the market.
The 800 and the trucks just sold 2.8 million trucks last year.
No way in the history of mankind has ever sold that many other than GM.
The second biggest is 2.6 million.
We feel very strong to be with GM, especially on the 800 which has proven to be a powerful product and there are 13 trucks off that one platform.
The 900 coming out has even more derivatives off of it, and we can run as I just told you earlier most of our stuff, 800 or 900 through the same process envelope because of the way we have done our processing.
We are in extremely good shape with that, and about 40 percent to 50 percent of our CapEx for this year will be tied to the GM 900 and related products.
So we feel extremely good on placing our bets there, and we've been short of track record the last seven or eight years which shows our investments placed very smartly.
- Analyst
Fair enough.
And then, Dick you mentioned Q2 production.
You sort of hinted that might be down t0o.
What are you seeing out in your 16-week --
- Co-Founder, Chairman, CEO
it is going to be up dramatically from quarter one, but it will probably be down still slightly from quarter 2 of '04 to quarter 2 '05 is what I alluded to.
- Analyst
Okay.
Lastly, content per vehicle.
What do you see as the trajectory for '05 and when the 900 launches in '06?
- VP, Treasurer
Rob, in 2005, we don't see any material changes in our concept.
We should be up a little bit, maybe 1 percent, something like that.
And in '06 at this time, we -- you know we have sort of the same comment.
We got additional content on the 900.
We talked about that, we'll begin to see that come into play in 2006.
The [VISAs], the 100 percent VISAs, that GM is launching on full-size and mid-size SUVs will contribute a little bit.
All said and done 1 percent up in 2005, and maybe some slight further increases in 2006.
- Analyst
Okay, thanks.
- VP, Treasurer
Thank you, Rob.
- Director, IR
Thank you, Rob.
We have time for one last question.
Operator
Thank you, gentlemen.
Your last question comes from the line of Rich Kwas with Wachovia Securities.
- Analyst
Glad I got in under the buzzer.
I wanted to ask about alternative sources for materials, and your progress on that end and how you could substitute maybe less expensive materials for some of your products, or maybe steel or some other materials that have increased here recently.
- Co-Founder, Chairman, CEO
All right, Rich, I will start and pass it over to Joel on this.
We have been very aggressive the last several years on the issue you are bringing up, a very pertinent issue.
Number one for the seven, eight years of our life cycle, all of our steel was sourced here in North America.
Number two, we have over the last several years found sources throughout the world, five or six other countries that we have now validated, and we will be moving a significant piece of our sourcing this year offshore at very favorable economic rates.
That's point one.
Point two, we have all our steel already committed, therefore, we do not have any shortage of supply.
That is a very critical point.
Next point is we have been changing with our OEM's blessing several substrates from steel to aluminum or other alloys, and we have all those processed, sourced, and validated, and we have been changing process design dramatically.
For example, one [of Billet], we may be going into near net or even net shape forging, or we may be reducing 3, 4, 5 pounds of steel per billet to make a blank.
We have 7 or 8 different things going on in this, and looking encouraging and looking very doable.
Joel, I may have missed a couple of things.
If so, add add to it.
- Vice Chairman
I think Dick covered most of it, the other thing we are doing, especially in our metal form products division, is finding creative ways to make forgings closer to net shape with less machining and less manufacturing.
So we have had some great successes with that, saving a lot of problems for component.
- Analyst
And all the favorable impact from these changes.
Now you know, will this be realized '06, '07, '08?
How much of that will be realized this year?
- Co-Founder, Chairman, CEO
Over a 24-month period.
It will start kicking in favorably for us around July of this year for the next 24-month cycle.
The other thing that it does which is a hidden savings, is let's just theoretically say we have something assigned to 5 presses.
Then all of a sudden we can do that with 4 or 3, but we forget a press or two, and that picks up a new program without any CapEx exposure, and we can have a nice margin on whatever that content is.
We see some real good byproduct of financial returns for that.
- Analyst
Thanks so much.
- Co-Founder, Chairman, CEO
Thank you all very, very kindly.
I will turn it back to Chris Son.
- Director, IR
Thank you, April.
We thank you all for participating on the call and appreciate your interest in American Axle.
We certainly look forward to talking to you in the future.
Thank you.