NN Inc (NNBR) 2005 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the NN, Inc. first quarter 2005 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, Thursday, April 28, 2005. I would now like to turn the conference over to Julie Tu with the Financial Relations Board.

Thank you and good morning. Welcome to NN, Inc.'s first quarter 2005 conference call. If anyone needs a copy of this morning's press release, please call my office at 212-827-3777 and we will 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.disclosure.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 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, please begin.

Thank you, Julie, and good morning, everybody. Thanks for joining the call. I have Will Kelly with us, our Chief Administrative Officer, as well as Steve Fre (ph), our Corporate Controller, this morning.

This morning I would like to provide some analysis on our results for the first quarter, including specific comments on revenue, margins, SG&A levels, debt levels, and net income and EPS. As we mentioned in the release, we are pleased with the overall results of the first quarter. And I think it's fair to say pleased but certainly not satisfied. Many of the difficulties associated with the onetime expenses and the resulting charges from restructuring in 2004 are behind us, and the first quarter certainly reflects that. However, from both a growth and operating performance perspective, we still have significant opportunities to improve our business moving forward.

Let me begin, if I could, by commenting specifically on the revenue for the quarter and the revenue for the upcoming year. As we mentioned, it was slightly below our plan at $86.7 million, but up 11% from the first quarter 2004 number -- revenue. Based upon the knowledge that we have today, we still believe that we are on track for around revenue of 337 million, which was our original guidance for the year.

Automotive in the quarter was lackluster at best; flat in Europe; down in North America. However, industrial demand in both Europe and North America was strong and offset the reductions that we experienced in our automotive market.

37% of the $9.1 million increase we experienced was a result of currency, another 34% associated with price increases on raw material passed through to our customers, and the balance of 29% was associated with new business programs and market share improvements. Looking to the second quarter and future, we expect more of the same; a continuing weak automotive market, with weak results in North America, flat in Europe, offset by continuing good demand in industrial markets. I think it's fair to say that in the current economic environment, growth, in our business at least, for the next -- for the foreseeable future will come from share improvements and new business initiatives, not necessarily economic growth.

From a cost of goods sold and margin improvement perspective, the gross profit -- and I need to remind you that it's not a GAAP measure -- for the quarter was 22%, 2/10 of a percent lower than the first quarter from the previous year but much better than the 18.2% of the fourth quarter of '04 and the 20.9% for all of 2004.

Major drivers for the improvement include the following -- lower levels of inventory reduction in the first quarter of '05 versus '04, material inflation pass-through in the form of price increases to our customers effective this year, January 1 of '05, and the positive impact of Level 3 cost improvements in the first quarter. For the year, we are still forecasting gross profit improvement of approximately 2% as a result of Level 3 cost improvement initiatives and raw material cost recovery.

With respect to spending levels and SG&A, again, on plan for the first quarter as a percent of revenue at 8.6%. We experienced good leverage of our SG&A costs when compared to full-year 2004 costs at 9.8% of revenue. The year-to-year dollar increase in the first quarter of '05 versus '04 amounted to $340,000 and amounts to currency in China start-up offset by lower SOX compliance costs. We would like to again reconfirm that we expect full-year SG&A cost to be lower as a percent of revenue and in a range of 8.5 to 8.9% for the year.

I would like to switch if I could to commenting on overall debt level. While total debt showed a reduction on the balance sheet of $2.4 million, total debt minus cash, which we have talked about in previous releases, actually increased from 63.9 million at year-end to 57.8 million at the end of the quarter. Really two major factors impacted the increase.

First, we had increased working capital requirements associated with the more than 11% increase in revenue, resulting in a $10.8 million increase in receivables at the end of the quarter. First-quarter working capital increases are nothing new at NN and are pretty consistent with our historical trend. And then the second big issue was timing of payments from some of our major customers, particularly at Europe at quarter-end.

Interest expense for the quarter in dollars was slightly higher based upon company-wide average interest rates in the first quarter of '05 of approximately 4.9% versus a flat 4.0% for '04. Our floating-rate debt in the U.S. is currently 5.4% versus our senior notes in a private placement that we accomplished last year at 4.9%. Our European floating-rate debt has remained relatively stable at approximately 4.4%. We expect -- we again reconfirm that we expect full-year debt, excluding the potential impact of any acquisitions, to approximate 12 to $13 million, and the associated funded debt to EBITDA multiple by year-end of approximately 1.3 times.

Finally, I would like to make several comments with respect to our overall EPS and net income results. Net income of 4 million for the first quarter represented a nice 25% improvement from 2004 net income of 3.2 million. It also represented a quarterly record in terms of net income dollars at NN. EPS of $0.23 a share was up 21% from the $0.19 a share we experienced in 2004 on slightly higher shares outstanding in the first quarter of 2005 versus '04.

As we have mentioned during 2004, the earnings momentum established with our acquisitions of the minority interest in Euroball in 2003 and the Veenendaal acquisition in the same year were not fully recognized based upon the results of 2004. Our first-quarter results reflect the full accretion of these acquisitions and we expect that to continue on into 2005.

From a quality of earnings perspective, again we are trending in a positive direction but still not satisfied with our overall returns. Net income as a percent of revenue for the fourth quarter -- for the first quarter, excuse me, was 4.6%, better than the 4.1% we experienced in the first quarter of 2004 and double the 2.3% return for all of 2004.

I would like to conclude today's call, if I could, by commenting specifically on overall corporate performance. As I mentioned, we are now just beginning to capture the earnings potential of many of our strategic initiatives over the last three to four years -- the acquisitions of Delta Rubber, Veenendaal and the minority interest in Euroball, and the start-up investments in Slovakia and China. All of these initiatives and businesses of NN both individually and collectively have created a stronger more competitive company moving forward.

At the beginning of the call I mentioned that we were pleased with the first-quarter results but definitely not satisfied. Our Level 3 program continues to build over solid results, but results that are still not good enough versus the lofty goals we have established in terms of quality, cost and service improvements.

Our employees and the related skills that they possess and the set of associated skill sets with respect to lean enterprise, Six Sigma and total productive maintenance -- we need what we call an institutionalization of those skill sets. And I guess nothing short of a cultural transformation is acceptable with respect to the improvement process. And frankly speaking, we are not there yet.

The improvement process never ends. And because of that fact we continue to see great opportunities to both fully meet our customer needs, provide growth opportunities for our employees, and profitably grow NN in the future.

With that, I would like to open the call. And Will, Steve and I would be glad to answer any questions you may have.

(OPERATOR INSTRUCTIONS). Larry Baker, Legg Mason.

Can you talk a little bit about the Slovakian contribution, and then sort of the second-quarter, maybe third-quarter outlook from China, in terms of maybe revenue contribution and whether it will be positive or negative in terms of an operating income contribution?

Yes. The Slovakian contribution really in the first quarter was minuscule in terms of an absolute accretion or EPS situation, Larry. We are still in a start-up mode there. So, the contribution for the Slovakian facility in the first quarter was really -- there really was no impact, essentially flat or breakeven. We expect that to improve as the second, third, and fourth quarter -- we experience the second, third and fourth quarter and get the operation stabilized.

In terms of China, we have experienced about two or three-month delay there and it's about the same timing that we talked about in the year-end release. We really are not anticipating getting the facility up and going. We will take -- the construction will be done by midyear, about June or July, and began at production sometime in September or October. But, in terms of revenue contribution for the year -- again, very minor amounts. And the start-up costs in China are actually a reduction of our overall earnings guidance for the year. We can quantify -- I think we can quantify that for the whole year in China. It's about $0.02, Larry.

The tax rate in the quarter -- 39. What' sort of the year outlook for tax rate?

I'm going to let Steve Fre answer that.

As you saw in the first quarter, the tax rate was about 39%. And that compares favorably to the first quarter of last year. And to go back to some of the comments that Rock made, it's really driven by the full accretion we're seeing from some of the acquisitions, Veenendaal being one solid example of that, and the earnings growth in countries or locations that have a lower tax rate than the average of last year. As far as the outlook for the balance of the year, the second half of your question, I would expect it to be closer to where it was for 2004 going forward.

So, it should come in at about the 39% rate for the year?

That would be very close.

Finally, the price action on your raw material pass-through -- can you just talk about what happened to raw material prices in the first quarter? And then, your comment about the second quarter -- this is the pass-through quarter-over-quarter, but (inaudible) sequentially (multiple speakers)

Larry, there's no action with respect to material pass-through for the first -- beyond the January 1st, which was significant for kind of a catch-up in Europe in particular. No real action in terms of pass-through in the second quarter. So, kind of a continuation of the material price and prices and selling prices that exist in the first two quarters. Where we will see a significant -- another significant increase is in the U.S. associated with the dramatic increase effective July 1. So, there will be another increase in selling prices in the U.S. to reflect that.

In Europe, as I have mentioned before, the scrap surcharges are where we have seen the variability. And our unit prices have been fixed, but we have been paying the scrap surcharge. Scrap surcharges are coming down. But again, that does not -- because we adjust prices essentially annually, there's really no impact in terms of an earnings impact in Europe as a result of scrap coming down in the third and fourth quarter.

Mark Parr, KeyBanc Capital Markets.

Did I miss you giving any earnings guidance, or did you? Or did you choose not to?

I really went through the pieces, Mark, and reconfirmed the margins and the levels of SG&A spending and the revenue. And so, I guess that would be a reconfirmation of our annual guidance.

I just wanted to double-check on that. Also, could you talk about incremental growth opportunities for the Company a little bit, give some more color on where you stand as far as working through some of the existing initiatives or perhaps bringing more on to the plate? And also, if you could give an update on the CFO situation, I would appreciate that as well.

The search on the CFO continues. And there's a lot of activity but nothing finalized. I have mentioned that we've retained a firm to assist us in that. And we certainly hope that in the second quarter we will have a conclusion to that search, or the process.

With respect to growth and initiatives, both existing organic growth and potential acquisitive growth, we -- as I mentioned, and I think we have kind of mentioned it a little bit in the release as well as the overall -- my comments -- the economics are slightly worse than what we had put together when we did our original plan. Having said that, the industrial side of the business is really much better than what our original plan was and North American automotive is a little worse. So, we are just slightly down versus the first -- less than 1% probably than what we were anticipating in our internal plans for the first quarter on pure economic growth.

If you look at our organic growth, we are right on what we anticipated for the full year in terms of kind of just pure organic growth on what we will call new product initiatives and/or market share initiatives. And with respect to acquisitive growth in terms of continuing our bearing component growth strategy, as we've mentioned before, we continue to see opportunities there and we continue to actively work on those. I'm not prepared to talk specifically about any of them and really can't. But, I think that the Board and management team at NN remain focused on our core business, which we have defined as the bearing components as it's presently constituted, with some potential expansion into new components that we don't presently manufacture, and remain committed on the geographic expansion part of the strategy as well as this captive piece that we've talked about.

That's terrific. One follow-up on that. At this point, how much financial horsepower do you have in terms of availability on existing lines?

We actually will -- we are right now in the process of discussing kind of a restructuring of our current debt, Mark. Because frankly, our debt in Europe is term debt. And as we pay it down, the availability reduces. So, with the private placement that we accomplished mid last year, we paid down term debt with that $40 million private placement. So, what is left is a revolver in the U.S. with about 18 million of capacity. So, that moving forward is not sufficient, given that our fund to debt to EBITDA levels are improving. So, it will require restructuring of our U.S. debt principally, moving forward. And we are actively working on that from a strategic perspective.

Congratulations. The quarter is great news. It's great you're reaffirming the outlook for the year and I look forward to future announcements.

(OPERATOR INSTRUCTIONS). Holden Lewis, BB&T.

On the gross margin, if you assume that that 3.1 million in pricing is just kind of a pure pass-through of the effective raw materials, if you take the 3.1 million out of revenues, you still get a gross margin which is up almost 100 basis points. So, it kind of looks to me like even if you take out the claw-back of the raw material price that you've still got a little bit of sequential improvement on the gross margin line. Is that a reasonable way to look at it? And if so, what was that improvement from?

Yes, it's a reasonable way to look at it. I think the improvement was from the Level 3 cost improvement initiatives that we discussed. I mean, virtually all of it. As well as some impact of the fact that we offset -- I mentioned also the fact that in the first quarter of '04 we had significant inventory reductions versus the first quarter of this year. So, the combination of kind of all three of those things -- you are right. The material pass-through actually deteriorates the margin just slightly because we're passing through purely the dollar impact and no margin. So, in terms of kind of the conclusions on the margin, it's a combination of Level 3 improvements plus this issue on inventory.

What Level 3 initiatives exactly were impacting the gross margin? Can you give some specific details about which projects were there?

We have 40 active projects in the Company right now in Europe and North America. And they all deal with lean initiatives associated with eliminating waste, improving productivity, Six Sigma initiatives in terms of improving variability in the process and improving first-time-through capability, and on total productive maintenance. It's a three-legged stool relative to Level 3, Holden. We have talked about it some. So, there's a variety of active projects in all three legs, including TPM, total productive maintenance. And they are delivering good results. I also mentioned, though, that the results for the first quarter were good but not up to the goals that we have established for the three-year kind of run rate in the program. So, we're pleased, but still there's a lot of improvement still out there in our mind.

You had sort of commented, I think, in the last call -- in the Q3, that you were going to close down some of the German ops. You commented in Q4 that, I think, you were going to be streamlining some of the Veenendaal ops. Are those gross margin effects? Are we seeing some of the progress of those things in this quarter's numbers? And if not, where are we on some of those projects?

We mentioned a restructuring of Germany and the operations at Eltmann. But, that restructuring was a reduction of employment and a transferring of product mix from Eltmann to Slovakia. And yes, there is an impact on that. But, we didn't mention closing the German facility. It was a restructuring where -- approximately 70 to 80 employees reduction. And that is the charge on earnings.

And with respect to Veenendaal, we have been saying all along that the integration of Veenendaal acquisition and the real earnings potential of that business is something that we work on on an ongoing basis. And Veenendaal's improvement in earnings and the accretion that they are delivering has really been very good beginning last year and moving on into this year. So, there's some elements of all those in there for sure, as part of the restructuring.

Looking at the gross margin in another sense, if one looks at the gross margin essentially being flat year-over-year -- we've talked about the lesser impact of inventory reductions, the benefits from Level 3. I guess in some respect maybe we should have been expecting gross margin to be up year-over-year, given that you do have some benefits flowing through there unrelated to the cost of materials. Did we not get a full pass-through? Why didn't we see a higher gross margin?

I think you can't look at -- I think it's not accurate at all to look at the gross profit in a vacuum of first quarter to first quarter comparison, because there's just so many changes in our business structure wise, material cost wise -- some was passed through, some wasn't, so forth. I think you have to look at kind of the average of '04. And that's what I tried to talk to. We're up 110 basis points versus the average of '04. And I would rather talk to that, because I think -- and if you look at where we were -- where we have come from in the fourth quarter even; it's 300 basis points from our fourth quarter. Close to 300 basis points from our fourth quarter.

I guess it just kind of seems like -- I certainly hear you about all the moving parts, but it seems like most of those moving parts are favorable to the gross margin. So, you know, if you held sort of the pricing equal, then you would have expected it to be up year-over-year. And I guess -- are there significant negative drags on that that we should be looking at?

None that I am aware of. I mean, I think -- I mentioned in my comments that our first-quarter gross profit margins were still 100 basis points or so lower than the improvement that we have built into our plan for 2005. And we expect to see that improvement fully develop in the second, third and fourth quarter.

The last thing and I'll drop the subject. Do you get that incremental improvement as we go forward because of getting more pricing to recapture, or is that just because you get -- incrementally you're going to see greater and greater benefits from the Level 3 and some other issues? What is the source of the incremental improvement?

The latter. As I mentioned, we're really just capturing the dollar impact of the increases on the material.

Mr. Baty, we have no additional questions at this time. Please continue.

Thank you again, everybody, for participating in today's call.

Ladies and gentlemen, this concludes the NN, Inc. first quarter 2005 conference call. If you would like to listen to a replay of today's conference you may dial 1-800-405-2236, followed by access number 11028658. Once again, thank you for your participation. Have a pleasant day. You may now disconnect.