NN Inc (NNBR) 2004 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the NN Inc. fourth 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, Monday, February the 28th of 2005. I would now like to turn the conference over to Susan Garland with the Financial Relations Board. Please go ahead, ma'am.

Thank you, good morning, everyone. Welcome to NN Inc.'s fourth quarter 2004 conference call. If anyone still needs a copy of this morning's press release, please call my office at 212-827-3777 and we'll send you a copy. 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.fulldisclosure.com. With us this morning is Rock Baty, Chairman and Chief Executive Officer and members of NN's management team. First, management will give an update and an overview of the quarter and afterwards, they'll open the line for questions. Now I'd like to turn the call over to Rock. Rock, please begin.

Susan, thank you. Good morning, everyone. I have with me this morning Will Kelly, our Chief Administrative Officer; as well as Steve Fray [ph], our Corporate Controller. For those of you that have been accustomed to hearing from Dave Dyckman on the call, he's obviously not here this morning. If you missed our announcement, Dave resigned his position at NN in mid-January of '05 to join Thermadyne. As CFO and business development over the last 6 years in his position, he made real contributions to NN and he'll be missed. We have retained Spencer Stuart to conduct a search for us -- a search process for us to attain a new VP of Business Development and Chief Financial Officer. Included in that process is an evaluation of both internal and external candidates. I think it's important to say that the Board and I consider this position one of many internal positions vital to our formal succession planning here at NN. We anticipate a conclusion of the process and the hiring of an individual early in the second quarter.

Today, I want to comment and provide some specific detail analysis on our results, for not only the fourth quarter and full-year of 2004, but provide an overview on our earnings guidance for 2005. Let me begin by starting with the fourth quarter and full-year results. Based upon reporting $0.41 a share versus the $0.77 a share guidance at the beginning of the year, obviously it was a very disappointing year for us at NN. In particular, coming off a good 2003, we felt we had real momentum going into '04, and the real irony of the year is that our major business units performed well as expected. For the most part, the variety of the issues impacting our earnings, both in the fourth quarter and for 2004 full-year, had very little to do with our operating results within the Company. Both the fourth quarter full-year results -- and the full-year result were characterized by 3 -- what I'll call groupings of major charges to earnings. First, the restructuring and rationalization of our manufacturing facility, specifically in the fourth quarter. Second, the one-time expenses that were incurred throughout the year and, third, raw materials steel inflation not recovered in the form of higher prices to our customers. The first two issues, restructuring rationalization and one-time expenses, were unanticipated and certainly not considered in our original guidance of $0.77 a share. Steel material inflation, as we mentioned in our previous -- in our year -- our guidance for the year, although it was considered in the $0.77 a share guidance, it certainly impacted our 2004 margins and lowered overall available earnings.

I'd like to discuss all 3 of these categories groupings briefly if I could. First, the restructuring and rationalization actions and resulting charges in the fourth quarter by -- in order of impact. The severance charges in Eltmann, Germany facility were $0.08 a share, 1.4 million after tax. We've mentioned before that it impacts approximately 90 employees. Importantly, it shifts high-volume, lower-priced product to our lower-cost facility in Slovakia. The shift of product mix also accomplishes a more competitive long-term cost structure for us at NN, particularly within our European operations. The second issue in terms of restructuring was the Walterboro, South Carolina sale of our -- the building at $0.03 cents a share, 500,000 after tax. These charges include the loss on the sale of the building and land, and a small miscellaneous remaining equipment right off. As we've mentioned before, we closed that facility in September of '01, consolidating the operations into our 2 remaining Tennessee facilities.

The decision to sell in an auction was really made in the fourth quarter based upon the fact that we've had 3 years of real -- relatively no market activity in terms of potential selling of the actual facility. We eliminated 250 to $300,000 in annual carrying costs, netted $300,000 in cash in terms of the sale. Felt like it was the right decision to make long-term. Third and finally, in terms of restructuring issues and rationalization, we exited a lease early on office space in Veenendaal, the Netherlands, of $0.02 a share or approximately $200,000 after tax. The early exit of that lease was in the form of a large detached office complex. We consolidated the offices and space in closer proximity to our roller and cage manufacturing operations in Veenendaal. We believe it provides for more efficient use of space and management focus in terms of the manufacturing operations itself.

I would like to summarize just the fourth quarter briefly by saying that the operating businesses delivered $0.14 a share at 2.4 million in after-tax earnings. Good results, we believe, given the inflationary environment relative to steel. The total restructuring/rationalization charges of $0.13 a share, plus the unplanned audit fee increase from PriceWaterhouseCoopers of $0.02 a share, netted to the reported loss of $0.01 a share for the quarter.

I'd like to shift, if I could, to a discussion of full-year results in the second broad grouping of expenses negatively impacting earnings, that of 4 essentially one-time expense categories, again, by order of impact. First, Sarbanes-Oxley 404 compliance. The total year impact was $0.09 a share or $1.5 million after tax. This is essentially the third consecutive quarter that escalating fees and outside costs leading -- have led to an explanation of an earnings hit to you, and I'd like to just comment that if you're tired of hearing about it as shareholders, we are certainly tired about communicating it. It's an understatement to say the initial year of SOx 404 compliance, documentation, testing, remediation, retesting, and auditing of NN internal controls have been incredibly costly from both a financial and internal resources perspective.

Out-of-pocket expenses, namely third-party services provided by Ernst & Young for documentation and testing of internal controls and PWC for auditing of those controls, escalated throughout the year, and were off by a factor of almost 4 times versus originally-communicated costs-to-complete. It's important to state that this was the initial year. There was significant one-time effort and costs were expended in terms of not only focused management attention but expended in terms of outside providers to become fully compliant with the Section 404 Sarbanes-Oxley. Although PWC has not issued an opinion as of yet for the year, we believe at NN that the process yielded excellent results from an overall strengthening of our internal controls and ultimately in our financial reporting.

Moving into 2005, I think it's important to comment that our audit committee at NN is proactively planning to ensure not only ongoing compliance but doing it in a cost-effective manner. We have retained -- the audit committee has retained Jefferson Wells [ph] to assist us in creating in a required internal audit function beginning in 2005. We intend to leverage internal financial resources in terms of financial management at NN and Jefferson Wells to create what we believe will be an effective internal audit function within the Company. The audit committee also plans, in terms of linking with management execution, large reductions in overall expenses in excess of 50 percent versus 2004 moving into 2005 for compliance. The second big issue, inventory reduction of $0.05 a share in terms of one-time expenses, 900,000 after tax.

This is very consistent with our Lean Manufacturing and Level 3 initiatives. Inventories at the end of the year, netting out currency impact and the Slovakia increases in terms of startup were down essentially $3 million for the year. Positive impact on cash flow, which we mentioned in the earnings release, debt reduction results, asset utilization, and return on assets. Future inventory reductions in 2005, which will be ongoing as part of our Level 3 initiatives, it's important to note will be offset by Level 3 cost improvements moving forward.

The third issue, private placement of debt of $0.03 a share, 500,000 after tax. We mentioned as we completed it in May of 2004, $40 million in senior notes with an average seven-year life and a 4.89 percent interest rate. We did have to write off unamortized loan cost with previous debt and higher interest costs on floating interest rate debt associated with that retirement in 2004 impacted earnings. The decision was based on our belief that interest rates would rise, and we wanted to lock in more favorable long-term debt and rates in anticipation of those rising rates. Based upon rate history this year, that's proven to be a very good decision with both LIBOR and EURIBOR rates increasing throughout 2004. Our floating debt, which had been sub-4 percent at the beginning of the year, is now approaching the rate of the senior subordinated -- the senior note associated with the private placement. As a result, the earnings penalty of our floating debt interest versus the fixed long-term debt won't reoccur next year in -- this year in 2005. In 2005, interest expense as a result of interest rates increasing on our U.S. revolver and our European debt will increase, but will be offset by lower levels of debt because of debt reduction in 2005 and '4.

And our fourth and final one-time expense of the startup costs principally in Slovakia, $0.02 a share, 350,000 after tax. Although good progress was made in Slovakia in 2004 in terms of starting the facility and getting it up and going, delayed customer approvals impacted the transfer of the timing and therefore the revenue coming out of Slovakia. The China startup essentially was on plan. We began production and expect -- excuse me, began production of the actual construction of the facility and expect to have it completed in May of this year. Both startups, as I have mentioned before, are critical to our overall strategy of geographic expansion of our manufacturing base, following our customers where they go geographically, and improvements in our overall long-term cost structure.

Finally, in the overall review of 2004, the largest -- the last large category of major earnings impact, steel inflation not passed through to customers, $0.12 a share, 2.1 million after tax. Although it's important to state that it was in our planned $0.77 a share guidance at the beginning of the year, it definitely suppressed earnings for the year and impacted gross profit margins. The result in delays in terms of pass-through of surcharges, particularly in Europe, it was not as big an impact as I mentioned before in the U.S., where we passed through them to customers as it occurred in 2004. The 2004 impact and the delay associated with that -- with those delays was passed through to our customers in January -- January 1st of this year, 2005.

Summarizing my comments for full-year 2004 earnings, currency adjusted actual revenues of 304 million were essentially in line with 295 million in terms of beginning-of-the-year guidance for revenues. Our reported EPS of $0.41 a share versus $0.77 a share guidance considering the restructuring and the rationalization actions, as well as the one-time expenses totaling $0.32 a share account for the majority of the miss. Debt minus cash for the year was down a really excellent 15.6 million, good cash flow for the year, given the lower earnings results, lower inventories, and reductions of inventories certainly was a contributing factor.

I'd like to close today's call, if I could, by commenting specifically on our outlook for 2005. From a revenue perspective, we expect 11 percent or 33 percent -- or 33 million increase from 304 million this year to 337 million in 2005. The currency plus the pass-through pricing to our customers account for around 2/3 of that $33 million increase. The remaining third, or approximately $11 million, represents new business development and marketshare improvements. The economics outlook as by we mentioned in the release essentially flat, slightly down in automotive in both Europe and the U.S., offset by improving industrial demand in both Europe and the U.S. Current overall demand allows for good levels of utilization in our U.S. and European facilities, ranging from approximately 80 to 90 percent, depending on plant and location. Again, for 2005, the volatility of global steel markets and specifically the special product we buy, which is 52100 chrome wire rod, is a big issue for our suppliers and customers and us at NN. Again this year, the dynamics in the U.S. are quite different than in Europe, and so I'd like to discuss each of them briefly, if I could.

In the U.S., prices on a -- as a percent basis, have risen about 35 percent from the end of 2002. Most of that rate increase occurred in 2004. We have primarily 2 suppliers in the U.S., both in Japan or Japanese domestic demand, the weak dollar when we import, and escalating raw material costs, have led to not only these incredible amounts of inflation, but supply issues as well. Our commercial terms with our suppliers, mainly price and supply allocation, have dramatically changed as well. In 2002, we had essentially firm pricing and allocation commitments for one year, going out 12 months. n 2003 and 2004, that changed to 6 months, and beginning in July of 2005, our suppliers are only committing 3-month pricing and 3-month allocations.

In 2005, we anticipate another major mid-year price increase of 20-plus percent. Coupled with a 35 percent, that's 55 percent increase since the end of 2002. This results obviously in necessary pass-through to our customers again in 2005. And availability has also become a bigger issue in 2005. Where allocations from our principal supplier -- principal Japanese supplier have been reduced through the end of the year. However, through the end of the year, based upon our current situation, we look to have enough allocation. But as I mentioned in the release, the situation is extremely volatile. In Europe, 2 principal European suppliers. With one supplier, we have a 6-year supply agreement which has resulted in inflation in the form of scrap surcharges, not unit price increases. Total costs in Europe are up a little bit more moderate 17 percent since the beginning of 2003. Again, principally in the form of scrap surcharges. For now, availability in Europe, not as big an issue as in the U.S. Good news appears to be the scrap surcharges, having peaked in the fourth quarter of '04, have started coming down in January and February of '05. As of now, our current forecast for the year is for slow but steady decreases in the amount of scrap surcharges in terms of cost. Based upon scrap prices declining, it's not a big financial issue for us in 2005 in Europe.

With steel inflationary conditions on our products specifically, are associated with a couple of factors as I have mentioned, but essentially, there's only 4 approved suppliers globally, 2 in Europe and 2 to 3 in Japan. And in both U.S. and Europe, the pressure on our customers as we pass through the increases as they occur, and the resulting end-market pressure it creates with their customers is -- the best way to put it is it's created strains in our historically good relationships with our customers. Many of our customers continue to communicate their inability to pass through to their customers, and it is an issue for '05.

I'd like to provide, if I could, in terms of an overall comment on 2005, an update on our Level 3 program, namely Lean Manufacturing Initiatives, Six Sigma, and TPM. Through the first quarter of this year, 55 managers in Europe and U.S. have been through 6 months of extensive training. Specific Six Sigma training is also occurring, and we hope to have 15 black belts certified by the end of 2005 throughout NN. Both the 55 managers that have been through Level 3, as well as the 15 managers on Six Sigma training are taking those skill sets back to their home plants. They're training in-home -- their in-home plant individuals and associated production employees on the execution of improvement principles associated with Lean, Six Sigma, and TPM. It's a consistent approach to the improvement process globally where cultural transformation and consistency is important when you have 10 global operations operating in 7 countries in 7 different languages moving forward.

Our current 4 company-wide improvement measures as part of this prop -- project are specific in terms of improvement goals. They're consistently measured throughout all 9 -- or all 10 manufacturing operations, and we've communicated them to our employees over the -- for the next 3 years in terms of 2005 '06, and '07. They relate to productivity, inventory turns utilization, cost of goods sold, and internal TPM. I think, and I think our employees would tell you and our managers throughout the Company that it's an incredibly solid program, is really transforming our businesses as we speak, and we're really pleased with the result.

Finally, I'd like to comment specifically on the EPS outlook for 2005. Our guidance of $0.90 to $0.94 a share includes the following key earnings drivers -- revenue growth from new business up 3.6 percent for 2005 or $11 million. Prior recovery of material inflation that occurred in 2004, fully passed-through effective 1-1-05 in Europe and as incurred in the United States. Level 3 improvement in cost of goods sold and productivity, coupled with the pass-throughs I just mentioned, result in forecasted gross profit margins improving approximately 2 percent for 2005.

Reduction in SOx 404 compliance cost and other SG&A savings being forecasted, result in approximately a 1 percent improvement in SG&A as a percent of overall net sales, slightly below 9 percent for 2005 and more importantly, trending toward our historical NN levels, ranging from 8.5 percent to 8.9 percent over the last 3 or 4 years. Excluding the impact of any potential acquisitions in 2005, the increases in Cap Ex spending to 17 million for Slovakia and China and the earnings improvement and further inventory reduction should allow us to lower debt again next year -- or this year, excuse me, 2005, in the 12 to $13 million range. Our funded debt-to-EBITDA levels at the end of 2005 we forecast to be less than 1.5 times. A good number given the situation in terms of '04 in particular.

Let me close by saying that 2004 was obviously a disappointment, although we believe that the actions that taken were essentially necessary to ensure the long-term competitiveness of NN and the continuing long-term revenue and earnings momentum that we had going in to '04 in 2005 and beyond. We look forward to 2005 in terms of improved -- of improved earnings outlook of 2005 is not without risk based upon the steel raw material front, we anticipate a positive trend in gross profit margins, SG&A spending levels as a percent of overall revenue, and a continuing inventory and debt reduction -- debt reductions for the upcoming year that will help our overall quality of returns. With that, I'd like to mention that Will, Steve, and I would be glad to answer any questions you may have and open up the call for questions.

Thank you, sir. [Operator Instructions]. Michael Greenwold [ph], BB&T Capital Markets.

Thank you. Can you quantify the currency impact in revenue for the Q4?

Compared to Q4 '03?

Just a dollar value. What impact did currency have?

We, I think we, Michael, we quantified it, I think, for the full year.

Well, can you give me that number and i'll -- I can back it out.

Okay. We'll just use it as a 6 percent.

Yes, of the 20 percent increase in year-over-year. Full-year, 6 percent was associated with currency.

Okay. And what about the, in the Q4. What about the raw material impact? How big of a drag was it in Q4? Are you willing to quantify that?

We said $0.12 for the full-year beginning in the year -- at the beginning of the year we said $0.12 and that was -- it was really right on. So, I mean you, can you look at that and say around $0.03 to $0.04 for the fourth quarter, therefore.

Okay. And in your guidance for fiscal year '05 what -- how are you looking at raw materials? Are you -- are you looking at it as a net -- I mean as a -- are you looking at it as it being a drag? Are you expecting to get any gain out of it as far as price recovery or -- what is in the guidance, what is -- how are you guys modeling that?

We're modeling, sensually full pass-through in the United States.

Okay.

And slightly less than full pass-through in Europe, although not because of -- because the inflation as I mentioned in the call is in the form of scrap surcharges in Europe, and they are coming down and we have this timing issue.

We don't see nearly the impact in '05 that we did in '04. And I think the other -- the other thing in terms of modeling '05 and planning for '05, when you have this kind of inflation that's this significant and your suppliers are saying to you that essentially we'll give you -- especially in the U.S., we'll give you 3 months -- a 3-month look, while we don't want there to be a timing issue in terms of our ability to pass it along, there's -- there's occasions where it's a one- or two-month situation where maybe you can't get the prices changed.

And so given all of those factors, we've got a -- I don't want to say -- we didn't disclose it in terms of our earnings release, but it's a relatively small earnings hit in our $0.92 guidance for that kind of factor, but by and large, the '05 includes pass-through in both -- as I mentioned, effective January 1st of this year for Europe for what occurred in '04 and in the U.S. as it's incurred.

Okay. And lastly, sir. What incremental benefit are you modeling now for Slovakia? I mean, we're going to start seeing some of the savings there that we were anticipated and also, from the office space that was closed in the Netherlands and the Waterloo facility, are we going to see -- is there going to be a meaningful impact from that as well as far as cost savings year-over-year?

I think if you look at our $0.92 a share guidance, all those -- all the factors that you just mentioned are reflected --

Okay.

-- in the guidance.

Okay. Great. All right. Thank you.

You bet.

Michael Corelli, Barry Vogel & Associates.

Hi, good morning.

Morning, Michael.

Just a couple of questions. What is your -- the percent of your revenues that come from the U.S. automotive business?

It -- we, it's -- I'll give of a number, but I want to just qualify it a little bit. Globally, both in -- and when I'm talking globally, I'm talking North America and Europe -- we've said around 60 to 65 percent. Having said that, for us to get an absolute number on that as is a little difficult because as you know, we supply to original OEMs that supply OEM. The ultimate automotive company. So, we're second and sometimes third-tier removed, but essentially when we kind of look at it, it's around 60 to 65 percent and the remaining 30 to -- 40 to 35 percent is in the broad categories of industrial.

Okay. And as far as the automotive is concerned, is there -- is it a higher concentration in the U.S., is it similar to that?

It's actually a little bit higher concentration in Europe because of our new acquisition in Veenendaal, the Netherlands is essentially 100 percent automotive.

Okay. And you had mentioned that you're expecting a price -- or a steel price increase in mid-year for the steel you buy for the U.S. So you're under the assumption at this point that you'll be able to pass that on?

Yes, and I also mentioned that the scrap surcharges were declining in Europe.

Right. So in the U.S., I guess your experience so far is that you've been able to do that?

Yes. Not without -- not without difficulty, but yes.

Okay. And then the facility you're doing China, is that purely a company-owned facility, or is there any partner in that?

100 percent owned by NN.

Okay.

New greenfield plant, 100,000 square feet, completion of construction in May.

Okay. Great. Thank you.

Mark Parr, Keybanc Capital Markets.

Hey, good morning.

Morning, Mark Parr.

Can you guys hear me all right?

Yes, sir.

Okay. I'm on a strange phone today. Could you talk a little bit, Rock, about the source of the market share growth for '05 and also perhaps could you give a little more color on the capability of the Chinese operation.

Okay. Mark, the market share improvement over approximately 11 million is split pretty -- is split almost equally between the -- our U.S. operations and our European operations. Around 4 to 5 in the U.S. and the same in Europe, and there isn't one specific operate -- it's spread pretty much across our manufacturing and business units equally. IMC has new business for '05. Delta Rubber has new business for '05, U.S. Ball and Roller has new business for '05. And in Europe, Veenendaal has captured new business outside what was traditionally all SKF when we acquired the business --

-- what's the -- what's the non-SKF mix at Veenendaal now?

It's still a very small percentage, Mark. Moving forward into '05, I would say it's still probably less than 2 to 3 percent.

Okay. All right.

But we obviously hope to grow that.

Right.

And in terms of the response on China, we -- we're coming right out of the chute. We want to do high-volume specifically automotive-related products, balls. We're starting the facility up with a product offering of precision balls, although the intention long-term, we have -- we have enough space in terms of land to almost double the size of the facility beyond the initial 100,000 square feet we're producing. And our intention long-term is to produce a variety of components if it makes sense, and our customers want us to do it, and request us to do it. But coming right out of the chute, a limited number of ball sizes, hope to be high-volume automotive-related products.

Okay. And just one last question. In your internal numbers for '05, is there any significant shift in the relative profitability of the regions?

Regions of the world or business units?

Regions of the world, but, yes, anything that you could give us from a color perspective on profit contribution from the -- people like Delta and IMC and those guys. That would be helpful, too.

You always ask the difficult questions, Mark. [ Laughter ] We -- other than the business unit segmentation in our K reportings, I don't think there's any significant shift. We've got -- we've got improvement in Europe to the question of the -- one of the previous callers, I think Michael, on the issue of Slovakia, and we see improvement in Veenendaal. In the U.S. we've got improvement forecasted as well, though, in places like Delta Rubber and IMC and our U.S. Ball and Roller operations. So there's good improvement in all of our operations, driven because of the issues I tried to cover in the call.

Yes, Rock, I was trying to figure out which operations were really -- if there was something that was going to disproportionately benefit in '05 which might have left some dry powder for '06 and '07.

Yes, I don't really see that. I mean, I can't give you any guidance that says one operation is really going to turn substantially higher or improve substantially higher than any of our other.

Okay. One last question, Rock. Given all the work you've been doing on free cash flow and reducing debt, it's clear you've got a lot of dry powder. Could you give us an update on how you see acquisition opportunities or additional -- perhaps divestitures by your customers. Anything new at Timken, Torrington, that you might be able to pick up looking into '06, '07? How's the pipeline look for the chunks of business from an acquisition standpoint?

I think we've mentioned before, Mark, that we have ongoing -- we have an ongoing pipeline in our core competency business in order of core competencies, we define that as the precision ball business and then followed by precision metal rollers. Retainers would kind of be the third area -- retainer/steel would be the third area of emphasis. And we're very active, continue to be very active.

And most of the activity centers in those 3 areas that I mentioned in terms of our current components and if you -- you're right if you look at 2005 and my comments in the conference call associated with our funded debt-to-EBITDA levels at the end of the year in the absence of any acquisitions, would be under 1.5 times. And so we do have -- from -- I mentioned before that kind of a self-imposed funded debt-to-EBITDA level is 2 times. That's a comfort level we've always had as a company from our Board of Directors perspective as well as management. We're under that, and -- we were not for all of '04, I might add.

We were essentially bumping up against the 2 to 2.3 times. And with the improvement in EBITDA plus the further debt reduction, we do have as you put it, some dry powder, and we want to be actively engaged in looking at specific opportunities and they're out there. Having said that, Mark, as you know with the exception of the EURIBOR deal, we have tended as a company to do -- want to do smaller deals and more of them to not only limit the financial risk associated with acquisitions, but the integration risk as well. And so I guess -- I don't know if that answers your question. I can't be real specific, but I hope it does.

Thanks a lot, Rock. I appreciate it. And congratulations on continued progress.

Thanks, Mark.

Larry Baker, Legg Mason.

Good morning.

Good morning, Larry.

Just a couple of questions. One is could you tell me the -- your Sarbanes-Oxley cost expectation in your '05 guidance?

We said half. We said a reduction of half of the numbers that I outlined.

Sorry. I missed that. Thank you very much.

You bet.

And then just to go back to steel expectations, you said you expect a 50 percent increase -- I'm sorry, 20 percent increase mid-year in the U.S. What -- would the European increase be this -- a similar amount?

No, no, Larry. As a matter of fact, the reason I kind of address the 2 areas of the world differently is that it's totally different in '05 in Europe versus what we're experiencing in the U.S.. In Europe, the only -- because we've had this long-term supply agreement with our principal supplier over there, it was a 6-year agreement. The unit prices go up just moderately. Very small amounts, but where the inflation occurs is in scrap surcharges.

Right.

And so very small increase in unit prices in January 1st of '05 from them, but the scrap surcharges in '04 were the problem in Europe. In '05, they're coming down from a peak in '04, and all the forecasts are saying that scrap surcharges in general are going come down through the balance of the year. So '05 -- for Europe, it's relatively good news. But it's the U.S. piece, where we're buying from 2 principal Japanese suppliers where the weak dollar has continued to impact our suppliers there. We buy in U.S. dollars, and the other big issue in the Japanese market is their domestic market. Demand is good there and so that is impacting their ability in terms of allocations.

Okay. And then finally just one more, in terms of currency, your -- in terms of your forecast, what does that say for the Euro versus the dollar? Looking for --.

The assumption in our plan is around $1.33.

Okay.

In the Euro.

Okay. That's year average?

Yes, year average.

Okay, great. Thank, Rock.

You bet.

Brian Raphine, Morgan Dempsey Capital Management.

Good morning, guys.

Morning, Brian.

Got a question for you, Rock. Relative to the 4 approved suppliers, specifically the Japanese in chrome alloy 52100, is the sourcing from Japan -- is the lack of suppliers around the world is because this is a niche volume specialty steel, is it a metallurgical purity? What specifically restricts you to just 4 suppliers?

Couldn't have but it better than your first comment, which is it's a niche supply -- supply situation in terms of the specific product. The steel itself, 52100 chrome is not. Our bearing customers -- our goal [ph] bearing customers use it in all of their inner and outer races, a lot of their steel that goes into the finished bearing.

But when you take it in billet form -- the 52100 in billet form and roll it in a rolling mill to get it into wire coil rod form, that's where it becomes specialty in nature and almost specialty in nature in terms of specifically serving ball and roller manufacturers globally. And so, we talk about the supplier concentration in terms of a risk profile in our business. We've been talking about it since the Company went public for 10 years. And we are working diligently to approve concurrently with our customers other suppliers around the world. We've been doing that for awhile, however, and there's -- there's progress that looks good but I can't tell you that a year from now we'll have 2 or 3 more suppliers.

Let me ask you, relative to -- is there an ability with your six-year supply agreement with Europe being a little easier on allocation, is there ability to play Europe against the Japanese suppliers? I mean, if they're reflating [ph] their own internal demand, there are problems and they're allocating to their own domestic demands, is there any supply surplus with your Europeans? Because if you're transferring across from the Pacific Ocean to the Atlantic, the freight obviously is kind of a wash, I would think.

Yes. The freight and duty is kind of a wash, but the allocations globally from these 4 -- essentially 4 approved suppliers are really tight.

Okay.

So going from one to the other or whatever, Europe is a little bit -- I guess the, the better question, at least from our perspective is can -- and we will obviously do this, if allocations are a little bit -- eased a little bit in Europe from our principal supplier in Europe, we would, obviously, want to help our U.S. facilities out in that instance and would.

Okay. Can you quantify from the standpoint of wages, salaries, hourly rates, benefits, the different between Eltmann, Germany, and Slovakia?

Yes, I can.

Yes, magnitude, level. Obviously, you're talking currencies and then I understand what --

Slovakia's total loaded wage rates with benefits is 15 percent of that of Eltmann, Germany.

15 percent. Oh, okay. So fairly significant.

Fairly significant.

What from the standpoint of experience, culture, the ability to adapt change -- your Slovakian labor versus your German.

You know, it's a really good question and it's something that in any startup you struggle with initially. We've put products in Slovakia initially to overcome the issue of getting the plan up and started and trained. But we've found the employees in Slovakia to be very -- really great worth ethic, willing to learn. The management team that we've got, I think I've mentioned before, we like to put local management in place in terms of where we are regionally in the world, and it's going very, very well in Slovakia.

Any differences, Rock, relative to infrastructure? I'm thinking water, sewage, electrical brownouts, transportation, rail, between Slovakia and Germany?

No, not really. And if you saw the -- George W. speaking in Slovakia last week, Slovakia -- the infrastructure improvements are just remarkable versus the last 7 or 8 years. There's a four-lane, what we'd call on the expressway going from Bratislava to our facility that's just gorgeous. It's brand-spanking new. No real issues associated with utilities. I will say that the utility costs and the other kind of overhead costs, there's not a great deal of difference in Slovakia versus our other European operations.

Okay.

It's principally labor.

Okay. Can you kind of give us a ballpark on where your capacity utilization is, say your ball and roller versus Delta Rubber versus IMC. Obviously, you're kind of cross continents --

Yes, I mean I would just like to leave it that the low is probably 80 percent and the high is probably 90 in every one of our facility -- to get operation-specific, they're all in the 80 to 90 percent range and it can vary month-to-month.

Well, how many shifts are you running in the ball and roller side?

We run 3 shifts 5 days a week and have Saturdays, obviously, available for -- for buffers in terms of capacity. Up or down --

-- Okay.

-- On demand, and that's principally true in all of our facilities. We have a couple of facilities that run 7 -- 7 days a week, with different shift structures, but by and large, they operate 5 and 3.

Okay. Okay. So you're fairly -- you're carrying a fairly full load on the shift side.

Yes. And the 80 to 90 percent, by the way is based upon a 5 -- a 3 -- a 5-day schedule.

Yes. Okay. That's fine. Great. Great. Relative to -- you guys kind of mentioned the Sarbanes-Oxley 404, a million five, and I think you said your -- the auditors were 400 percent off their original estimate. Is -- and NN from my 10 years being involved with your operations as an analyst, you don't hit me as people that run a business fairly scattered.

You have certainly fairly high operating logistics and policies and the documentation issue -- is it just the matter of integrating the foreign cultures, I think you mentioned 10 facilities, 7 countries, 7 different languages. Is that where the disparity is in trying to put the Sarbanes-Oxley on an international basis, or -- because it sounds like you guys kind of got hit broadside on that.

We did. There's 2 factors. Although, I want to say that the 2 factors when our third party providers looked at our business knew these factors existed at the beginning of the year. So to say that those things added to the complexity, they did. But when they gave us the estimates, they knew the complexity of our business. We're a pretty complex business for a small-cap company of 330 million in revenue.

Right. Right.

And we're spread out. We don't have -- we tend not to have centralized IT systems in -- total company IT systems are decentralized. That impacts it. The international nature of the Company impacts it as well. But I -- there's another piece and that is it definitely was a learn-as-you-go for us in terms of -- many of the regulations were coming out throughout the year. They weren't set in stone at the beginning of the year either. So it's a combination of all of those things but, obviously, you said it. This is not -- we control our expenses and our levels of production and budgetary issues throughout the Company and have since the Company was founded in 1980.

Right.

And so it's just -- it's just -- it's frankly just disgusting.

Yes.

What's happened.

Yes.

Having said, that I don't want to -- I don't want to talk totally and completely negatively associated with SOx 404 because I really do believe that as a result of our internal people going through the process of documenting internal controls, testing them, remediating them, and retesting, we're a stronger company financially as a result of going through all of that. It was painful to do, obviously, for our shareholders, too, but we're strong, and I think our financial reporting will be strengthened. So at the end of the day, the 404 piece, part of the Sarbanes-Oxley legislation, I think, accomplished what it was meant to accomplish, but I guess my question is, At what cost?

Yes, have you guys had to add any internal audit staff?

No. We're -- as I mentioned in the call, we are using Jefferson Wells as an outside service provider. Will Kelly is heading up the internal management effort to leverage internal financial resources with Jefferson Wells to create this function that is required affective January 1st of this year.

So that's longer hours for Will then, basically.

Yes. He's used to it.

He's used to it. Okay. Relative to -- and we've spoken in the past about some of the large integrated bearing manufacturers, outsourcing their roller production. Where is that going into '05, Rock?

The -- both balls and secondarily rollers, it varies greatly by part of the world in terms of Asian bearing producers versus the European and North American producers, but we still see good opportunity in both -- less of an opportunity as I've mentioned in balls versus rollers, but there are 95 percent -- 90 percent of the total market is still captively produced by our customers in virtually every form in tapered, cylindrical, spherical, and needle. And so we see good opportunities in rollers -- continue to see good opportunities there.

You haven't made much progress the last 4 or 5 years, and that's not specifically on you because it's obviously -- you have to pull that captive element out of that and get those customers -- you have to get.

Yes, I think what -- we tend to look at it a little bit differently. Not only captively, but does it make -- we've invested in our Erwin roller -- cylindrical roller-making operation. I mean, that business has grown to almost $10 million from 5 just 3 or 4 years ago, with good margins. And we tend to view this -- the roller opportunities just in general as not only organic -- potentially developing the capabilities that we have now with both the tapered roller situation in Veenendaal and the cylindrical in Erwin, as potential either outsourcing or as developing organic or greenfield-type operations to enter some of these other roller markets.

Just another question on Walterboro. What was kind of the age of the plant? Did you lose anything from the standpoint of labor skill sets or was it a newer plant or an older plant?

We actually, I think, began, constructed the plant in 1984, Will --

'86.

'86. Excuse me. And when we made the decision to consolidate from 3 to 2 -- and that was really a result of looking at the EURIBOR deal and the fact that were supplying Europe out of our 3 U.S. facility before we did Europe -- EURIBOR, we made the decision based upon a variety of very specific criteria to close Walterboro versus closing either our Mountain City, Tennessee plant or Erwin, Tennessee.

So, the decision proved to be a good one on the basis of the positive earnings that continue to come out of the remaining 2 facilities in U.S. ball and roller. And I think we -- we obviously made the right decision. In terms of the marketability of the real estate, I think we would have had difficulty in any event, regardless of what facility was closed, selling industrial real estate.

Sure.

It's not a hot commodity right now.

Right. Right. Can you -- can you talk about any new business ventures, either on a product basis or maybe a industry geographic segment relative to IMC and Delta Rubber? Any new ventures, any new diversifications in your product mix?

With Delta Rubber, not -- not new diversification in terms of end-markets served. Delta, as you know, or we've mentioned, is totally focused on new bearing seal business. And they have captured new share for '05 with both Timken and some of our other larger customers, and so they've got new nice growth projected for '05 coming off good growth of '04.

So that business has grown really based upon what we had in terms of the expectations in our original acquisition. IMC's growth is in the -- is in the range of, I guess, 7 to 8 percent this year. There, it does tend to be diversified away from bearing retainers and into other precision plastic businesses or products. And -- but both IMC and Delta show good top -- revenue growth in '05.

Okay. Relative to -- and I think you had mentioned, too, somewhat strained relationships with your customers, due in part to what I think you're talking about, the pass-through. If you're expecting another 20 percent increase on the steel side, is that going to further strain these relationships? I mean obviously these end customers got to realize the supply chain logistics, and you can only eat so much margin.

Yes, it's just a very difficult issue in the U.S. and Europe both. We have had a historical relationship with our customers that acknowledges fully the competitiveness of their market and have been in an environment over the last 7 to 8 years where we have been taking costs out of our operation and passing savings associated with productivity and cost improvement on to them, and therefore, them -- providing them the opportunity to do the same with their customers in the whole supply chain. That when you -- when you go -- do 180-degree turn on that kind of trend, it psychologically is huge as well as just a reality of what they're facing in their business. I've looked at the numbers as well as anybody. I mean, to me, the inflation numbers continue to be low. I don't understand that.

If you look at commodity prices and oil prices and all the other things, it eventually has to be -- has to show up in the form of higher prices and, therefore, inflation. I mean, these guilt situations, the entire supply chain passes it along ultimately to the consumer. I think you're going to see more of that in '05 than in '04.

Relative -- and I think somebody else had asked relative to your end-markets, and you had mentioned that you're about 60 to 65 percent end-market automotive but you thought the general industry had a better growth profile for '05. Do you see the general industry -- general industrial, do you see that growing faster, and maybe at some point being 50 percent of your business versus the kind of 2/3-1/3?

We're constantly looking at the customer -- customer concentration issues, supplier-concentration issues as well as end-market concentration issues in our business as part of our long-term strategy. And -- yes, anytime that you're 65 percent automotive, whether it's second or third tier, you look at automotive concentration as an issue moving forward in terms of new business development, acquisitions. It's always a criteria we look at. But looking at it this year, even with automotive being down slightly and the current build rates in the U.S. and North America -- or in Europe, excuse me, our overall level of demand given that is good. I mean, we're comfortable with the overall dynamics from an economic perspective.

Let me ask you relative -- specifically germane just to the automotive area. Do you find it easier or less difficult? Sometimes the U.S. big three, Detroit, The Big Iron Guys tend to have been fairly difficult relative to forcing design engineering costs down into tier 1, tier 2, tier 3 without giving some of the margin concessions. Is it easier working with the foreign automotive manufacturers versus the U.S. or are they pretty much globally difficult all the way across the board?

I think our customers who ultimately deal with them, not us, would tell you it's kind of equally difficult across the board.

Okay. One last one. Health care, wages, salaries, kind of U.S./domestic, what are you seeing, benefit inflation, health care?

Health care in the U.S. continues to be a big deal.

8 to 15 percent increase.

8 to 15, depending on our individual operations. And in terms of wage increases, inflation, I think we budgeted around 3 percent in our 2005 plan, kind of globally.

Okay. Thanks, guys. Appreciate it. Hang in there.

Thank you.

All right.

John Walthausen, Paradigm Capital Management.

Yes. Great. Thanks. A couple of quick questions. In the guidance for the new year, what are you assuming the tax rate would be?

We expect the '05 tax rate to approximate the '04 tax rate. Consolidated.

Which is like 36.5 type.

Yes, maybe slightly higher. There was a fourth quarter benefit related to an '02 item --

-- Great.

-- In 2004 that lowered that.

Okay. Good. Good. And -- so then when I go back and look at it clearly, although we're not looking for much actual real volume increase, we are looking for better margins, can you talk about what impact pricing or mix might have on that?

Product mix or pricing?

Well, it -- both. It's sort of individually. I mean are we, are we looking for pricing -- setting aside the issues of -- .

No, yes. Actually I can -- I will say this. Passing through just the dollar impact of the increases --

Right. Right.

-- Which is what we're doing with our customers actually has a negative impact on margins.

Exactly. Exactly. [Inaudible -- multiple speakers]

So the approximate 2 percent improvement in margin for '05 is essentially improvements that we talked about in terms of passing through some of that. You lose a little bit as well as improvements -- the other improvements we talked about. So in the environment we're in, talking to a customer about I need to maintain my margin for -- as a percent of revenue because -- because of this inflationary situation is pretty difficult.

Right. Right. So, if I'm understanding correctly, you anticipate that aside from the cost-pass through of steel prices, pricing will be relatively flat and that really the improvements in margin that you're projecting are cost-driven.

Yes.

Okay. Okay. Good. That's what was trying to get at. Thanks.

You're more than welcome.

Okay, sir, we don't have anymore audio questions. Please go ahead.

Thank you again for joining today's call.

Ladies and gentlemen, that concludes today's teleconference. You may now disconnect.