NN Inc (NNBR) 2003 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the NN Inc., second quarter results conference call. At this time all participants are in a listen-only mode. Following today's presentation instructions will be given for the question and answer session. If anyone needs assistance at any time during today's conference, please press the star followed by the zero on your push button phone. As a reminder, this conference is being recorded today, Tuesday, July 29, 2003. At this time I would like to turn the conference over to Ms. Susan Garland with FRB Weber Shandwig.

Thank you. Good morning. Welcome to the NN Inc., 2003 second quarter conference calling. By now you should have received a copies of this morning's earnings release. If anyone still needs a copy please call my office at 212-445-8473 and we will send you a copy immediately following this call. Before we begin we ask that you take note of the cautionary language regarding forward-looking statements contained in the press release. The same language applies to comments made on today's conference call and live webcast available on www.companyboardroom.com. Please note this call is being recorded on July 29, 2003, contains time-sensitive information and is intended for replay through August 5, 2003 only.

With us this morning is Rod Baty, Chairman and Chief Executive Officer, and members of NN's management team. First management will give an update and overview of the second quarter results for 2003 and afterwards there will be an opportunity for Q&A.

Now I'd like to turn the call over to Rod. Rod, please go ahead.

Thank you, Susan, and thanks to the participants this morning on the call. With me today I have Steve [Ray], our corporate controller, Will Kelly, our chief administrative officer and manager of IR, and Dave Dyckman, our VP of Business Development and Chief Financial Officer. Today on the call Dave is going to discuss and review our second quarter results as well as our outlook for the third quarter and the remainder of the year, and then I'd like to conclude the call with some comments regarding not only the second quarter activities within the company but also an update regarding the strategy of the business. With that I'd like to start by turning it over to Dave.

Thanks, Rod. First I'd like to focus on second quarter results. Revenues in the quarter of 2003 were up 30% versus 2002 second quarter. Roughly two-thirds of this improvement was due to including new results of our recently acquired operation of Veenendaal in the Netherlands in 2003's results. Excluding the contribution of Veenendaal sales were up 12% versus second quarter 2000 with currency accounting for essentially all of the increase.

While this marked the fifth consecutive quarter of improved revenues versus the prior year, the underlying economic environment continues to be a concern. As mentioned in the press release EPS as reported 44 cents for the second quarter of 2003 significantly exceeded the second quarter of 2002's 15 cents per share. However, within this 44 cents was several atypical and non-cash items. First, as with the purchase of [inaudible] 23% ownership of Veenendaal in December of 2002, we experienced a one time 6.6 million non-cash, nontaxable gain associated with our purchase of SKF's Euroball ownership. The gain nearly reflect the difference between the cash paid versus the minority interest carried on our consolidated books. Second, the company's decision to consolidate the NN Arte business in Lubbock, Texas and close the operation in Mexico resulted in a one time tax restructuring charge of 2 million. With the exception of severance charges this was also a non-cash charge. Third, upon closing our new Euro and dollar base credit facility we wrote off the remaining unamortized costs associated with structuring our preexisted facilities, taking a $291,000 non-cash after-tax charge. And finally the fourth item reflects a 205,000 after tax non-cash charge associated with a portion of stock options requiring variable accounting.

Excluding these four items from the recent quarter, EPS in the second quarter of 2003 of 19 cents was 26% higher than the prior year's second quarter. Bridging this improvement and starting with 2002 second quarter EPS of 15 cents we had the a negative impact of certain operating inefficiencies in both our North American and European operations of negative 3 cents which was more than offset by the benefit of the accretion from our purchase of [inaudible] and SKF ownership adding 4 cents, accretion from the Veenendaal acquisition rounding to a penny and favorable currency with the Euro dollar rate moving from 93 to 1.14, which contributed 2 cents, building to 2003 second quarter EPS of 19 cents. Focusing on this performance by business, IMG Delta and Arte combined for 3 cents per share, the ball and roller and Euroball divisions contributed 4 cents and 11 cents respectively for the quarter and as previously mentioned Veenendaal contributed a penny for the quarter.

Now changing focus to debt. As of June our debt level was 84 million which was 31 million higher than at the end of March. The components of this change include the following. The Veenendaal and Euroball transactions added 35 million. 5 million of proceeds from the exercise of an over allotment provision during our secondary offering completed in May helped reduce debt, and cash flow from operations was used to fund term debt retirements, capital expenditures, dividend payments in both April and June and Veenendaal's initial cash requirements.

As for our third quarter outlook, our release indicated that we anticipate profits of approximately $63m, with corresponding EPS in the range of 18 to 20 cents per share. We also mentioned that this guidance as well as our forecast for the year take into consideration automotive softening in both North America and Europe of 5 to 6% versus the prior year. As well as a flat industrial environment.

With that I'd like to turn it back over to Rod.

Thanks, Dave. Let me conclude today's call by just commenting specifically on not only the second quarter activity that you've seen from us but as well as provide kind of a strategy execution update in terms of what you can expect over the next year or so. As Dave mentioned, it was busy quarter at NN. On May 1, we negotiated and obtained a new $90 million credit facility put in place to consummate the transactions on May 2 of the Veenendaal acquisition. As you know, we acquired the SKFs Veenendaal Netherlands operation. That operation broadly expanded our product offering in a big way to include rollers and metal [inaudible], we believe it will greatly enhance our ability to serve our global customers moving forward and we believe it can be profitable grown in the next three to five years. We are very excited about the Veenendaal transaction. On May 2 we also finalized the acquisition of SKF's 23% ownership stake in Euroball. We now own 100% of what was a joint venture company in 2000. I think importantly their willingness to sell their remaining 23% is a reflection of the overall confidence they have in us as a supply partner to them. It's been an incredibly successful venture to date and we are looking forward to serving our global customers out of the venture going forward.

The fourth largest transaction occurred as a result of selling 3.6 million shares of a secondary stock offering on May 16. Our founding shareholders sold those shares. The company did receive and sell 533,000 primary shares off our shelf. And that was the result of meeting an over allotment commitment from our underwriters. We did end up with 29 new institutional shareholders at NN as a result of the secondary offering. We believe that those new shareholders as well as the overhang that existed almost from the day we went public will greatly enhance the liquidity and trading characteristics of our stock.

On June 11, the governance committee recommended and the full board approved the naming of Bob Aikens to the Board of Directors. He replaced Dick Gannon. Dick did not seek reelection to the board in May. Bob was also named at that time chair of our audit committee. He brings to NN a wealth of not only general management, but financial management expertise and he has certainly hit the ground running, and is making a substantial contribution already.

The other significant transaction in terms of the overall activity in the quarter is the integration of the Veenendaal operation. As we mentioned publicly we did form a new structure called NN Europe and named Dario Galetti not only an officer of NN Inc., but the managing director of NN Europe. Dario along with his management team in NN Europe, will have principal responsibility of integrating the Veenendaal transaction, improving the overall cost structure and profitability of the operation, as well as, growing it from a sales and revenue perspective. We believe there are terrific opportunities to improve the operation and grow it and further serve our global customers moving forward.

Then, finally today, as Dave mentioned we announced the closing of the NN Arte facility in Guadalajara,Mexico and redistributing that capacity and the small amount of sales volume that existed into our INC operation in Lubbock, Texas. While our primary concern is for the impact on the 44 employees, we are providing assistance to them in the form of both severance and employment search assistance.

The business environment in Guadalajara deteriorated almost from the day that we formed the venture in mid-2000 to today. And the pure opportunities to grow the business and capture additional business never developed to the extent that we thought possible. And it's a prudent decision from our perspective to go ahead and close the facility and move on.

Finally, I'd like to just kind of provide an update if I could with respect to our overall execution of our business strategy. As we've mentioned before it involves three broad objectives. First, the continuing pursuit of product offer expansion not only in bearing components but other industrial components that are consistent with our knowledge of current end markets in the bearing business. Second is this issue of a continuing focus on the $1.7 billion captive market in terms of our customers internal bearing component manufacturing operations. And finally a geographic expansion, a further geographic expansion of our manufacturing facilities and base. While we continue to work on all three legs of the stool, so to speak, our immediate focus centers on the geographic expansion, particularly targeting eastern Europe and Asia. And there are two principal reasons for those targets. One is our customers to better serve them and they in many instances are headed to those parts of the world, and we are committed to following them in a close way from a supply chain partner point of view. And then second is most of the growth in finished bearings both in eastern Europe and Asia to capture the growth we need to be in those geographic regions. They are growing rapidly and we physically need to be there. And you can expect over the next six to nine months to a year to hear our plans regarding the geographic expansion of our manufacturing base with respect to those issues.

Finally, another important element of the strategy is the broad category or the broad issue of organizational development. As we continue to grow at NN we want to insure in every way that we have the management talent both existing and in the future years not only identified but where it's needed to both retain and recruit additional management talent to insure that we have the skill sets needed to execute the strategy on an ongoing basis. It's an integral part of our five-year strategy in terms of organizational development and there's a great deal of activity going on with respect to that organizational development as we speak.

With that I'd like to open up the call to any questions you may have.

Thank you, sir. Ladies and gentlemen at this time we will begin the question and answer session. If you have a question please press the star followed by the one on your push button phone. If you would like to decline from the polling process please press the star followed by the two. You will hear a three-tone prompt acknowledging your selection and your questions will be polled in the order they are received. If you are using speaker equipment you would need to lift the handset before pressing the numbers. Our first question comes from Larry Baker with Legg Mason. Please go ahead.

Good morning, Rod.

Good morning, Larry.

Can you just talk a little bit about the Guadalajara, what the losses were and what the revenue change would be as a result of closing that facility down?

The revenue change will be pretty miniscule. The actual revenue run rate for the year.

1.5 million.

$1.5. And, Larry, we are discussing with our customers, I wasn't real clear on this but we are discussing with our customer that 1.5 million, folding it into our operation in Lubbock, Texas. So to the extent that our customers in Mexico agree to that you would see no revenue fall off whatsoever. And we are presently serving out of industrial molding some customers in Mexico. So it's not geographically a situation that you would say can't be done. We are less than a day from Guadalajara from Lubbock, Texas, in terms of shipping. So it's our intention to salvage that business, the small amount of business we did down there by folding it into INC. But we don't know the outcome today.

Can you talk about the current margin level at Veenendaal and maybe how you see that progressing?

Yeah. I think that when we look at the margins of any of these captive operations that we've acquired, there is, there is an immediate dilutive effect on our margins in the company. Euroball was certainly that way versus, our corporate averages, and Veenendaal was no exception. Veenendaal's margins coming right out the chute are mid to high teens in terms of gross profit margins. And when we look at the synergy as well as the ability to improve the cost structure of the business, we believe that Veenendaal can contribute over the next two to three years up to and including the corporate averaging in terms of margins. It's not a situation that takes place overnight. But some of the cost savings ideas that we are implementing as we speak. Others are a 24 to 36 month process. But I think it's important to state that we over the long-term when we view these transactions, one of the criteria is that we have to foresee it being able to contribute close to the corporate average in terms of margins, or we aren't interested in doing the transaction.

Larry, this is Dave. I would just add that as Rod indicated the GP improvement, programs are already under way. But there are also as you'd guess SGA level synergies that exist that we'll take advantage of as well.

Okay. Just in looking at your first two quarters of last year and the first two quarters of this year, last year you boosted your GM by 200 basis points going into the first quarter to the second quarter, and this year it fell by 300 basis points. Is all of that decline due to Veenendaal or is there something else?

Yeah, most of it is Veenendaal although as we mentioned in the release from an operating perspective we had [so] many inefficiencies from our ball operations in our Euroball and U.S. ball operations, that we don't foresee moving forward as the third and fourth quarter will occur. There are a variety of factors but the margins in both Euroball and U.S. ball were not as good in the second quarter as we have traditionally done. There was nothing driving that in particular other than we had some new business that we were starting up that we were shipping to Asia out of our U.S. facilities that hit us particularly hard.

And there were also some material surcharges that are not repeating. There were some unusual things. There was also some impairment on the Arte inventory. And between that and Veenendall you have about two-thirds of the drop.

You mentioned material surcharges, Dave. Can you talk about what the effect of the currency has had on your bearing steel or the raw materials that you get and your ability to push that through?

It's gone up. Our materials are up about 8 to 10%. That is not the reason for the margin deterioration. We actually have that forecasted in our business plan this year, Larry. I'm talking about the U.S. now. In Europe, the material surcharges in Europe that Dave is referring to that we have the ability through Euroball contracts to pass along, it's just a timing issue. We don't have the ability to pass it along until 2004. But in the U.S., it's not an environment where we can pass along to our customers based upon what they are facing, a 10% increase in material. We have to figure out ways to overcome that and maintain margins in light of a 10% increase, on the basis of just the current environment.

Okay. Thank you.

You bet.

Thank you, our next question comes from Mark Parr with McDonald Investments. Please go ahead.

Hi, Rod, hi, Dave. I wanted to kind of follow on some of the discussion you were having with Larry. Before I did that, could you talk a little bit about the tax rate? It looked like excluding everything that I could figure out how to exclude, or at least I thought I could, that the tax rate was about 31%. Is that right?

No. Your tax rate should be almost dead on what it was last year when you adjust for everything. In other words, it should be right about 37%.

So that I am doing something wrong here. I guess I can tell you-- I guess, maybe it would be easier if you could just kind of go through the non-cash, non-recurring issues and talk about the tax rate associated with it. Because I guess we were trying to do that here prior to the call and this is as good as we could come up with. So if you could help us out there that would be great. I could tell you what I did, Dave.

It might be easier, Mark, if we could just kind of roll through.

Terrific.

The first was the gain on the SKF buy out of their Euroball ownership, 6.6 million.

No taxes there, right?

No tax, you got it.

The NN Arte payment, we used a 36% tax rate.

So what you have here, you have the 2.723 million of restructuring and impairment cost and then there are additional costs in costs of sales associated with that?

Yes, Mark, there are 325,000 in COGS in addition to that 2.7 million number you read.

I think that's the miss right there.

All at 36%, though, Mark. If you read the rest of the way down it was using a 36% rate you ought to get there.

Okay. All right. That's terrific. Another question I had, do you have the segment profit numbers that you can share with us on the call.

We did read out the EPS by segment. Is that what you wanted?

I think these profit numbers are pretax that you have disclosed in previous releases.

In our Qs the accounting will go on a pretaxes basis. On our press release I think we do after tax Mark.

In our conference call.

In our conference call. We have always can done the EPS contribution by segment which I'm happy to read again to you, Mark, if that's helpful.

That would be great.

IMG., Delta and Arte, collectively the plastics and plastics division by segment were 3 cents per quarter, ball and roller was 4 cents, Euroball was 11, and Veenendall was a penny.

All right. One other thing that I wanted to bring up. In the release you indicated an outlook for a 5% decline in European automotive. Is this a more recent development? I think the last time I had spoken with you guys we were talking more like a flat European outlook.

No, we've been saying really, Mark, since we did in the last conference call, we said 5 to 6%.

Okay.

It's no change, in other words.

Okay. So there's no change. Okay. Terrific. I'll let somebody else go. I will get back in queue. I have a couple other little fine-tune things.

Thank you. Ladies and gentlemen, if you have an additional question please press the star followed by the one and if you are using the speaker equipment you would need to lift the handset before pressing the numbers. Our first question comes from Greg [Ramsby] from [Deprance, Rand and Zollo]. Please go ahead.

Hi, guys. Good quarter. I was hoping you could just expand a little bit, dive down into Euroball a little bit and talk about sort of the current state of business there, what you see going forward. Obviously that and Veenendaal are a big chunk of your business now. I was hoping you could give an overview of what you are seeing in Europe. Thanks.

Greg, you pointed out that it's a big chunk of our business and it's true. With post Veenendaal almost 60% of our revenue is derived out of our European manufacturing operations now. And around 60 of our employment as well. Europe is very, at least from our perspective and we were just over there last week for an NN Europe operations review. But from our perspective it's very similar, there's a very similar outlook economically to what's happening in North America. And that is they anticipate this continuing flatness in the industrial sector and the automotive piece in terms of build projections, automotive build projections for the full year is about what's forecasting in the U.S. now, in North America. The difference and the disconnect potentially could be what happens with the contract expirations with the UAW in September of this year. We are still seeing that assuming that nothing major happens there the production rates will still be only 5 to 6% down.

And that's in your guidance for the year, right?

Yes, it is, Greg. But to the extent that there's a major strike against GM or Chrysler or Ford or whoever, and those production rates drop beyond the 5 to 6% forecasted that could impact us in North America. But in Europe, in our guidance we pretty much forecasted this continued flatness as well as the reduction of 5 to 6% of the total build rate. We don't see any real changes in that having just been over there and discussed it with our NN Europe management team.

Okay. Good. One other question. You mentioned I think in response to a question earlier that your raw materials costs were up 8 to 10%. Do you guys have the ability to buy that forward? Or have you, if you do?

We haven't. It's possible. Historically it's gone the other ways for us in the last five years and we didn't hedge it this year. It's something we've looked at. And, yes I think we do have the ability. It's just a matter of deciding that it makes economic sense to do it, Greg.

Right.

Up to this point we haven't.

Sure. Okay. Thanks, guys. Good quarter.

Thank you, sir. Ladies and gentlemen, if you have an additional question please press the star followed by the one on your push button phone.

Our next question is a follow-up question from Mark Parr. Please go ahead

Thank you very much. Do you have an outlook for debt reduction through the end of the year that you are you can share with us?

We do, Mark. We think that, obviously based on the forecast that we are currently working off of, we ought to with the help of working capital over the next six months generate 9 to 10 million of cash flow that we can use towards debt reduction. We have in the last conference call I think said 11 million was our target but given some financing or some funding that we had to put in place for the Veenendaal working capital requirements, we will fall a little bit short of that.

Along those lines, can you help us with an interest expense outlook for the third quarter?

Sure. Today we have two-thirds of our debt floating at LIBOR plus 175 basis points and a third floating at EURBOR plus the same credit spread on a weighted average basis. That puts us at about 3.1 today.

Today?

At today's rates.

That's clearly a distressed company cost of capital here. I have a call next week with a company that has some 18% money. It's bad.

Is there anything going on that would indicate that the in-demand environment is getting better or worse? How do you feeling about the second quarter going into the second half, are you feeling any better about the outlook from an in-demand perspective?

Actually, no but, having said that our demand by and large in all of our operations globally right now, Mark, is not something that is to a level that we aren't comfortable operating at from an efficiency perspective. And we've been able to capture some additional business, export business out of our U.S. ball and roller operations, principally into Asia, as a result of currency. It's nice business to have and in the short term here it really helps mitigate some of the reductions in demand in automotive and industrial. But it is helping in the U.S. ball and roller plants in particular. So we aren't optimistic, I mean we read our customers releases in many instances to see what they are saying and talk to our customers. And Timkin, for example, in their release said that they saw the industrial segment not doing much of anything until mid next year. But having said that, as I mentioned we are positioned structurally to ride it out from a profitability point of view we believe nicely without an uptick.

I think the case of Timkin may have something to do with some inventory overhang on Torrington after market prices.

We read all that, too, for sure, but -- and, again, but I mean our other customers are saying there's just really no real sign on the industrial side that it's ticking up yet either.

Okay. The 3 cents of manufacturing inefficiencies in the second quarter that you alluded to, could you go into some more detail there and add some more color?

This is Dave, Mark. About a third of that is the surcharges in Europe that we talked about, it's a timing issue. We have in the U.S. ball and roller business as Rod indicated, some of the Asian business that we are in the process of gearing up for, as well as bringing over some of the [lean] techniques techniques that you saw when you were in [inaudible] Italy, that caused the majority of the rest of that shortfall.

What's involved in gearing up for the Asian business?

Tooling. It tends to be different sizes that we would run in our U.S. operations. And, you know, in the second quarter we were running, we incurred overtime as a result, it was a pretty significant amount of business, getting it up and geared up to run. And it's essentially an operational tooling process-related inefficiency. Obviously your mix changes and your set-up increase. And that pretty much bridges it.

All right. So the mix change that you talked about in the release again was also all wrapped up in this 3 cents worth of manufacturing inefficiencies, or were there additional issues related to mix shifts?

Not really.

Okay. The manufacturing surcharges in Europe, what did that relate to? Is that like an alloy surcharge for nickel?

Scrap related.

All right. So your customers are imposing higher prices to you by passing through scrap, higher scrap costs?

Suppliers. Our steel suppliers are passing along surcharges based upon hiring scrap.

Which we ultimately, Mark, pass through contractually to our customers. But there's a timing difference. We don't pick that up until 2004.

All right. That's interesting. Scrap in Europe is in short supply, also. That's interesting. Because it certainly is in short supply here in the U.S. right now.

Right.

Is there a potential for scrap surcharges from your -- you don't have any domestic suppliers, though.

We don't have the same structure in terms of the commercial structure with our European and Japanese suppliers as we do in Euroball.

Okay. Congratulations. It's a great quarter and it's nice to see you maintain the outlook. You are definitely a minority in my companies this quarter.

Thank you, sir. Ladies and gentlemen, if you have an additional question please press the star followed by the one.

Our next question comes from Boyd [Poston] with A.G. Edwards. Please go ahead.

Good morning. Great quarter. Could you give your estimate for depreciation of CAPEX for the year?

Sure. CAPEX we think is going to be in the neighborhood of 10 million for the year. G&A we see in the neighborhood of about 14 million.

And your early guess as to '04 in the same two categories?

We really haven't gone forward with '04 guidance in any way so I would defer that question or hold off. Boyd Poston

Do you anticipate any one time charges going forward with Veenendaal?

No, we don't.

Okay. Thanks.

Sure.

Thank you, sir. Management, we have no further questions at this time.

That concludes the call and, again, thank you for joining us this morning.

Thank you. Ladies and gentlemen, this concludes the NN Inc. second quarter results conference call. If you would like to listen to the replay of today's call, please dial 1(800)405-2236 and you will need to enter the passcode of 546875 followed by the pound sign. Thank you and have a great day.