NN Inc (NNBR) 2004 Q3 法說會逐字稿

Good morning ladies and gentlemen and welcome to the NN, Inc. third 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. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded today Tuesday, November 2, 2004 and it contains time-sensitive information and is intended for replays for November 9, 2004 only.

I would now like to turn the conference over to Ms. Susan Garland from the Financial Relations Board. Please go ahead, ma'am.

Thank you. Good morning everyone. Welcome to NN, Inc.'s third quarter 2004 conference call. If anyone needs a copy of this morning's press release, please call my office at 212-445-8473 and we will send you a copy.

Before we began, we ask that you take note of the cautionary language regarding forward-looking statements contained in the press release. That same language applies to comments made on today's conference call and live webcast available on www.fulldisclosure.com. With us this morning is Rock Baty, Chairman and Chief Executive Officer and member of NN's management team. First management will give an update and an overview of the quarter and afterwards we will open the line for questions.

Now I would like to turn the call over to Rock. Rock, would you like to begin?

Susan, thank you. Good morning everyone. Thanks for joining the call. With me this morning I have the following members of our management team; Nicola Trombetti, Managing Director of NN Europe, recently promoted to his position in July of this year and he is providing excellent leadership in his new role of heading our European organization. Tom McKown, also is here. He is the managing director of NN Asia. He joined NN, Inc. in January of this year and suffice it to say that we have an excellent progress in China on the basis of Tom's extensive knowledge of the landscape there.

Also have the regulars this morning Dave Dyckman, our Chief Financial Officer, VP of Business Development; Will Kelly, our Chief Administrative Officer; and Steve Fray (ph), our Corporate Controller. Today, Dave will offer an analysis and commentary on the third quarter results and our outlook for the remainder of the year. I will conclude the call with comments regarding 2004 results and our current actions that support our 2005 business plan process.

With that, I would like to turn the call over to Dave.

Thanks Rock. Revenues in the third quarter of this year were up 13 percent or 8 million versus 2003's third quarter of which approximately 3 million was due to currency. 2 million resulted from new business and the remaining 3 million of increase resulted from generally stronger demand, particularly in Europe.

With regards to profitability, gross profit excluding the impact of depreciation which as we have stated previously is a non-GAAP measure, was 21.5 percent for the third quarter of 2004, versus 22.2 percent for the third quarter of 2003. Primary dynamics in the quarter versus the prior year was a negative impact from material inflation and to a lesser extent inventory reductions which were mostly offset by volume leveraging and cost reductions.

As mentioned in the release, SG&A expense for the quarter was 1.9 million higher than the same period of 2003 and resulted from expenses associated with Sarbanes-Oxley compliance, currency, product expenses in Slovakia, China, and our Level 3 initiative.

Diluted earnings per share of 13 cents in the third quarter of 2004 compared with the prior year's third quarter EPS of 18 cents. The primary items bridging this 5 cent difference include favorable volume and cost reductions which contributed 10 cents, but were more than offset by a material inflation, negative 5 cents; inventory reductions, minus 2 cents; and the SG&A expense as I mentioned earlier minus 7 cents.

Briefly shifting to debt, as mentioned in the press release, total debt minus cash or net debt was 69.5 million as of September 30, which reflects a 4 million reduction in the third quarter and a 10 million reductions since December 2003. This puts us on track to reduce total debt minus cash, or again, net debt, by 13 to 14 million by year end.

As for our outlook for the remainder of the year, we anticipate full year revenues of approximately 300 million. This compares with 253 million in the prior year, and reflects first a full year contribution from Veenendaal, adding 26 million; currency, averaging 1.22 versus 1.13, adding 10 million; and volume and new business combining for an additional 11 million.

With regards to earnings per share, as mentioned in the press release, we are adjusting our earnings to reflect first a 3 cent share impact from additional material inflation we anticipate experiencing in our European operations during the fourth quarter. As we have communicated throughout the year, our supply contracts with our European customers generally provide for material related pricing adjustments in January of the coming year. In light of the pace of surcharge increases, this arrangement has made for a very difficult 2004, including the 3 cent impact we anticipate in this fourth quarter.

As Rob will talk to you shortly, we are currently in discussion with our customers to address this contractual delay to prevent being in a similar position next year. Secondly, we're also address adjusting our earnings to reflect an estimated 8 cent per share charge we anticipate recording in the fourth quarter associated with transitioning production from our Altman Germany operation to our new facility in Slovakia. This anticipated charge reflects an expected one-time severance arrangement for roughly 40 percent of the workforce at our Germany operation.

In response to the collective 11 cent per share impact anticipated from these 2 items, we have reduced our full year 2004 earnings per share guidance range from 60 to 63 cents to 49 to 52 cents.

With that, I would like to turn it back over to Rock.

Thank you Dave. I would like to conclude today's call if I could by commenting just specifically on the 2004 results and I think more importantly our plans for 2005. As you know, and based upon some of the issues Dave just discussed, 2004 has been a really challenging year for us at NN. As our earnings recently indicates and David as well, we have reduced our guidance to 49 to 52 cents from 60 to 63. And there were 2 principal factors as Dave has mentioned. The issue associated with increasing material specifically in Europe for the fourth quarter; cumulatively for the year that now amounts to a $2.7 million after-tax hit to earnings or 15 cents a share.

The second issue, the Altman Germany facility transitioning to Kysucke Nove Mesto, Slovakia facility. While this has an unfortunate impact on our employees at Altman, but as we mentioned in the release we really believe as a management team it's a necessary action to maintain our competitiveness as we rationalize our global capacities. We anticipate this charge to be 1.4 million approximately or 8 cents a share in the fourth quarter.

These 2 costs, though defer the material inflation and the severance cost at Altman Germany coupled with what we have talked about previously and we've communicated this relative to the unfavorable cost factors for 2004, and they are namely inventory reductions, SOX 404 compliance, the start-up costs in both Slovakia in China and the private placement of a portion of our debt have combined to impact our full-year after-tax earnings by $8.6 million or 49 cents a share. We estimate approximately 7 million or 40 cents a share of these cost items will not carry over to 2005.

With respect to 2005 I would like to comment just briefly if I could on our business planning process. We are in the process right now as we speak of an ongoing development of 2005 business plan. We don't anticipate a full completion until the mid to late November. Consistent with last year we would like to provide 2005 revenue and earnings guidance to you when we release our full year 2004 results sometime in late February of 2005.

We look forward to 2005 on the basis of several factors. First, we expect a continuation of solid global demand for our products and our served-end markets, notably the automotive and in general industrial.

Second, there is a full year contribution of Slovakia after a start-up in 2004 and we will begin startup of production in our Chinese facility in 2005. We anticipate a continuing integration of Veenendaal with improving results for 2005. We believe we will see full year-over-year improvements in each of our 9 global manufacturing operations on the basis of our Level 3 program. As we have mentioned, combinations of improvements, activities and Lean Enterprise Six Sigma, and maintenance excellence will not combine for improvements in cost, quality and cash flow.

Our start-up and initial training costs for 2004 are behind us and as we will leave 2005 program will really contribute excellent results. We anticipate SG&A spending reductions and savings for 2005 beyond what we spent in 2004, and we believe our SG&A levels of spending will get back to the historical levels you have experienced from us prior to 2004.

We anticipate passing through as Dave mentioned, material inflation to our customers as it occurs with no annual delay in 2005. Having said that, steel inflation is a concern moving forward, but steel supply is also very tight and an ongoing concern for 2005.

Finally, the continuation of our long-term revenue and earnings growth strategy focused on the following 3 key initiatives which we have talked about before. Further geographic expansion with our products; product offering expansion; and the development of further captive market opportunities with our global bearing customers.

I would like to conclude my comments this morning by saying we're looking forward to putting 2004 behind us. We faced a variety of very difficult challenges and took meaningful actions to ensure our long-term competitiveness. Specifically, Slovakia and the Chinese start-ups, the Level 3 training and implementation, the private placement of a portion of our debt, inventory reductions and the rebalancing of our European capacity were all necessary actions to ensure our continuing competitiveness in 2005 and beyond. As a result, we look forward to improving results in the coming year and look forward to a continuing execution of our 2005 plan and our long-term strategic growth plan.

With that, I would like to open up the call for questions you might have.

Thank you sir. Ladies and gentlemen, at this time we will begin the question-and-answer session. (OPERATOR INSTRUCTIONS) Holden Lewis of BB&T.

Good morning. Thank you. Can you just talk a little bit -- you talked about inventory costing a couple of pennies in the quarter. It looks like inventories actually went up. Wouldn't that suggest that should be a net benefit? Can you kind of explain how that works?

Hold on just a sec.

That is a good question. I had someone whisper in my ear. I apologize. Raw materials actually you saw an increase, but it depends on what part of the process your inventory goes down obviously the laborer and burden portion is at the back-end and what you saw is a decrease at the back-end of the process where the labor and burden impacted the P&L comes from.

Okay. Inventories are down year-on-year but I guess I'm just referring sequentially -- that is what you're referring to as well?

Yes, right. You are talking quarter end to quarter end, you mean?

Yes.

Yes.

So it is just a stage of inventory issue plus some pricing in there or perhaps not?

Not so much a pricing -- layering of inventory you mean, no, it is more purely -- where in the process the inventory came out. More simply put, more finished goods came out but raw build.

I got it. Can you just give a little bit of detail about sort of your end markets talking about where the growth is coming from? Where the new volumes are coming from? Whether it be U.S. automotive, European automotive, general, industrial?

Holden, the actual automotive build year-over-year in North America and Europe has been essentially flat. Europe has been up this year versus last some but the U.S. light vehicle build rate is essentially flat. But the general industrial markets have been a pretty significantly. We have seen nice growth in the 5 to 6 percent range. That accounts for about 35 percent of our end market demand. The other 65 percent is driven by light vehicle. And looking on into 2005, there is a variety of work honestly. But essentially in Western Europe, the forecast is essentially for flat production in Western Europe and a small increase in North America of around 2 to 3 percent. We think that is probably optimistic. And our process is for automotive, specifically. In terms of end market demand, we are essentially forecasting flat.

In the quarter of the 3 million that you sort of attribute to better markets to the incremental growth, is that all general industrial or is there something in there from the automotive whether it be Europe or the U.S?

It's pretty much all general industrial with a little bit of automotive in Europe.

Okay. The new business, can you sort of comment a little bit? Is that something brand new or is that just continuation of business you've closed before but hasn't annualized?

That comes from a combination of the Slovakian business we acquired when we took on the facility or acquired the facility last year, ramp up there with a European customer. There is also some ongoing growth with programs we have domestically. One with Timken for example, and we also have year-over-year comparisons with the Asian business that are up a little bit.

Okay. Great, thank you.

Larry Baker with Legg Mason.

Good morning. Just a question on steel. When you passed through costs at the end of the year, is this going to be higher prices, experienced year-to-date? I guess that is my first question.

Larry, we apologize for the confusion. Based upon our comments we might be very confusing but essentially our current contractual language allows us to pass through the material that we -- the increases that we actually incurred on average for the entire year. But in a period of rising prices, rapidly rising prices what can essentially happen is that we could be paying a higher price in the fourth quarter of this year than what the average for the year is. So as you move into 2005, that same mechanism would create an additional delay that we are saying to our customers we can't live with that.

If the material stayed just as it is in the fourth quarter, it is much, much higher in the fourth than it has averaged in the first, second and third. So that issue essentially says that we would experience again in 2005 if we don't address this issue with our customers the same kind of delayed response or delayed reaction to be passthrough as we have in 2004. We can't live with that for 2005. We aren't going to live with it for 2005.

So you're negotiating to include the fourth quarter rise in your passthrough?

Yes.

Several people that I've talked in the business also see year-end announcements of higher steel prices going into '05, so there is a further leg that you haven't experienced yet but you're going to experience on January 2?

Yes. Now that under our current contractual language is -- we have a coverage on unit price that would occur January 1, that is not the issue. It's the variable part of it, specifically scrap surcharges that create the dilemma and the way they are handled in the current contract language.

So you can handle the expected --?

Any unit price increase that is effective January 1 would be reflected if the runaway inflation that occurred in the scrap surcharges left the issue.

What is your pricing mechanism in the U.S. as opposed to the European passthrough?

It is much cleaner from the perspective that we get unit price changes. It is cleaner but it is very inflationary. It has been up substantially as well. It is cleaner from the perspective that we don't have the variable part of the program. It is totally unit price based, and it changes every 6 months.

With sales coming in at 300 million next year, with no volume increase whatsoever, what is the effect of pricing -- what type of sales would you expect to look at if you are in the middle of your success range in passing these costs through? What are talking about in terms of --?

We'd really like to delay our response to that until we provide revenue -- I think when we provide the revenue guidance in February, Larry, we will definitely we are willing to provide the components based upon the economics we see, new program development and what we envision the net impact of material plus productivity improvements we might pass along to our customers are.

I missed one number that you gave out when you said I think all in excess costs over prime were around 49 cents for '04?

That's right.

That is 11 cents higher than what we just talked about in the second quarter release.

Then you said ex will not carry into '05.That was the number I missed.

That number is 7 million or 40 cents a share. There are certain Sarbanes-Oxley and start-up costs in China and little bit higher debt or interest costs associated with the private placement of our debt that comprised the difference there.

Can you talk about sort of just as a follow-on to the question that was asked earlier but the new business that you are seeing sort of what was that for the 9 months and what would you -- is that -- are there plans to expand that in '05? I assume you retained that but is there other new business that you would expect to kick in in '05? Can you quantify that in some way?

Let me try to answer that in a way that I don't provide guidance for '05, Larry, which we're trying not to do. We have seen new business in a couple different areas. In Europe principally what I was talking to was the Slovakian business that we have picked up. A contract with the former owner of the business as well as some other European interest in the plant, and yes that will continue to ramp at probably about the same pace of increase that we saw this year. And I think we gave an indication of the Slovakian shipments in the fourth quarter in the release. Somewhere around 2 million, but yes we anticipate that continuing to ramp up into next year.

The business here that we were talking to, 1 leg of it is in contention with our Delta business, and that program -- that has been ongoing for many years. We have seen some good growth in that business and so yes, I would anticipate hopefully continuing seeing that grow. I think for the year we said that volume and new business combined for about 11 million, and I would tell you that it's about a 50-50 split between the two. The other piece of new business of size really this year has come out of Asia and we talked a little bit about that -- a couple million dollars that way. I don't know that I anticipate that necessarily continuing to grow though.

Okay, thank you very much gentleman.

Gregg Ramsey (ph) with (indiscernible).

Good morning Rock. Good morning Dave. I was hoping you could talk a little bit about what you're seeing in your -- you talked a little bit about your industrial business being pretty good. Your other end markets particularly in Europe they seem to be holding up pretty well and your outlook there? Just generally?

Yes.

Nicola was answering that one too, Gregg. The answer is yes.

Thank you.

(OPERATOR INSTRUCTIONS) Holden Lewis.

Thank you. If the guidance that you're giving for how much these costs should come back to you, I guess you said 8.7 million in cost. Is that a year-to-date number?

That is a total annual forecast for the year.

You are sort of expecting to recapture 7 million of that. That is still about an 80 percent recapture rate which is kind of the same rate that you had been talking about in prior quarters. If you don't get some relief on sort of the Q4 raw materials issues, I assume that 80 percent number should actually be lower. How confident are you that you will get relief on the Q4? Is this largely a done deal or is in the works now?

We're confident, Holden, and I think we're confident on the basis of this year it took our customer -- the inflation took our customers by surprise as well. If you think about it from their perspective, they have had a year where they have been trying to deal with it with their customers. And they have had delays. They have incurred delays like we have, but I really believe that 2005 the entire supply chain is passing it along. We have lots of indications from our customers that they are raising their finished bearing prices in 2005 without a delay. That is the basis for us saying we're confident that it is fair to pass it along to them without delay on the basis of them doing what with their customers. So we're confident.

Certainly we hear a lot of talk about price increases going through on the general industrial side which is a third of your business, but most companies that deal with the big 3 in particular have been far more circumspect about the hard line that the big 3 are drawing in the stand. It sounds like it is more obvious that you're going to get the price increase than I guess most other auto suppliers that I deal with are.

I think first of all with all of our customers generally speaking we don't deal with them specifically on automotive and another customer specifically on the industrial. These are customers that serve both the industrial end markets and the automotive end markets, and frankly speaking, this has been very difficult and I can't say that it has not been without many, many customers expressing major, major concern and in some cases saying you can't do it. We have tried to manage our way through that, and we are at a point literally from our perspective beginning January 1, it is changing for us. We -- we're committed to changing it. We're dealing with our customers in a manner that we don't want to damage long-term relationships, but at the same time, you see the impact that it had us financially in '04.

That is why I'm trying to get a sense of whether or not you are -- whether or not you have actual assurances from your customers that you can do this or whether you're simply assuming that they are going to behave rationally to your plight.

We had ongoing conversations with them for more than 2 months now regarding D-Day which is January 1. Not just -- when we talk about contractually in Europe, we're talking about our 2 largest global customers. But there are other customers as well where January 1 is in our view the key date. We intend to assure that the impact relative to inflation is minimal got zero next year.

Okay and you just feel like you've got assurances from your customer base that that can happen?

I wouldn't say -- as I mentioned it has been difficult, and, but we believe that they are passing along the inflation beginning in '05 and as a result of that, we will be allowed to as well.

The flipside of the question is, if you have been assuming you're recapture rate of 80 percent up through certainly Q2, and if you now assume that you are going to be able to get pricing up to the Q4 level, wouldn't that -- if you are actually successful at that, shouldn't you be getting a recapture rate of more than 80 percent?

If the averaging is less of an issue?

It depends -- you're talking about effective January 1 on the material alone?

Yes, because I assume you were guessing that you would get 80 percent that because of the affective averaging, right, over the course of the year?

No. That is just -- that number is just an estimate of the things that we believe will carry over into next year, and I'm named those. There are SOX 404 compliance in SG&A. There is the start-up of China. We had Slovakian and Chinese start-up costs in '04. Some of the costs in '05 for China will carry forward.

Also maybe I misunderstand your question but the material hit from inflation this year is obviously not an average number. So obviously, when we talk about a 49 cent number -- 8.6 million and recapturing 7 million, we're talking about recapturing working with our customers, recapturing all of the material inflation. Not just an average.

In prior quarters you were talking about basically recapturing about 80 percent of that raw materials?

No, 80 percent of all of the equivalent. The 49 cent number a quarter ago was 38 cents. Okay? Excluding the one-time severance cost and this fourth quarter '03 cent hit, it was 38 cents and what we are saying is we were going to get 30 to 32 cents if the number comes off the top of my head right back which is about 80 percent of that number. That is where the 80 percent came. We have always assumed that our customers would work with us on these inflation issues.

All right, thank you.

Ryan Purdy (ph) with Wells Capital Management.

Good morning. Can you provide the cash flow from operations number as well as the CapEx for the quarter?

Yes, that will be available in the Q and I don't think we have disclosed that although we can give you some pieces. CapEx for the year is about 8 million year-to-date period. We spent upwards of about 5 million through June so that gives you about 2.5 to 3 million in the third quarter.

Okay and cash flow from operations in the Q?

It will be --

Would you say you generated positive free cash in the quarter or --?

Yes we did. As a testimony to that, is the 4 million in net debt reduction.

Yes. And to that, to the debt reduction, the target of 13 to 14 million for the full year, does that include then the sale of your South Carolina facility?

Yes, it does. Well the high-end does and the low-end doesn't is the right way to say that.

Okay, thanks.

Gentlemen, there are no further questions at this time. Please continue.

Thank you again for joining today's call.

Ladies and gentlemen, that concludes today's NN, Inc. third quarter results conference call. If you would like to listen to a replay of today's conference call, you may do so by dialing in at 1-800-405-2236 followed by the pass code 11012483. Once again if you would like to listen to a replay of today's conference call, please do so by dialing 1-800-405-2236 followed by the pass code 11012483. Thank you. You may now disconnect.