NN Inc (NNBR) 2005 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the NN Inc. second-quarter 2005 results conference call. (OPERATOR INSTRUCTIONS). I would now like to turn the conference over to Susan Garland of the Financial Relations Board. Please go ahead.

Thank you. Good morning, everyone. Welcome to NN Inc.'s second-quarter 2005 conference call. If anyone still 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.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 overview of the quarter, and afterwards we will open the line for questions. Now I would like to turn to call over to Rock. Rock, please go ahead.

Thank you, Susan. Good morning, everybody, and thanks for joining the call. With me this morning I have Jim Dorton, our newly appointed Chief Financial Officer and VP of Business Development, as well as Will Kelly, our Chief Administrative Officer. As you may be saw in the press release, Jim comes to NN with a very strong background in both financial management and importantly business development with both private and public manufacturing companies. We're really pleased to have him join our management team and know that he will make real solid contributions in the future.

Today we are going to throw him to the wolves and let him participate in the call here, and he is going to offer an analysis and commentary on the second quarter, as well as our year-to-date results through June 30th, and then I would like to conclude the call if I could with just some specific comments regarding the overview of our business, as well as an outlook for the balance of the year.

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

Thanks. Let me first say how pleased I am to be with this quality company. NN has a great business and a really great management team, and I am proud to be a part of it.

I'm also pleased that my first quarter here was a good one. Sales and net income are up strongly over last year as the Company executed on its business plan in growing business with core customers, adding new sales initiatives and passing through material price increases.

Compared with last year, sales were up 11.8% for the quarter and year-to-date. Volume for existing and new customers made up 5.1% of the increase, higher prices accounted for 3.3%, and currency impact made up the remaining 3.4% of the increase.

The fluctuation in the dollar/Euro exchange rate does make the analysis of the financial statements complex this year. In the first half of 2004, the exchange rate averaged around 1.22. In the first half of 2005, the exchange rate was 1.29 which was an increase of around 6%, and this caused the increase in our reported sales. Comparing the results to the year-end rate gives the opposite effect. Exchange rate ended last year at 1.36 and is now at 1.21, so compared to our early earnings guidance for the year, sales were actually lower because of the exchange rate. And that is why Rock's comment in the press release refers to a possible negative impact of the exchange rate in the second half of about $0.04 per share.

We can go over that in more detail. I know that is confusing, but we will be glad to answer questions about that later.

Moving on, SG&A spending was lower than the comparative period's last year due to lower Sarbanes-Oxley expenses and continued tight control of spending. As a percent of revenue, SG&A in the mid 8% range is closer to our historical norms. Just looking at the second quarter, SG&A was down 744,000 versus the same quarter last year. Adjusting for currency, however, the actual decline was about $900,000. Net income was up 80% compared with the second quarter of last year and is up 46% year-to-date. Again, this is very close to our business plan.

We had earnings per share of $0.21 versus $0.12 in the second quarter of last year, which is a 75% increase. Year-to-date EPS was $0.44 versus $0.30 last year.

During the first half of the year, we successfully passed through steel price increases to customers, and we believe that margins in the second half will continue to be strong. We did have some cost increases for resin in our Injection Molding business that caused margins to slip in that part of the business, but we are in the process of raising prices to compensate, and margins should recover in that business in the second half.

I would like to mention that one of the impacts of passing through substantial raw material price increases is that while we may be able to protect our margin dollars, the margin percentage slips somewhat. This is just the algebraic effect, but our profitability remains intact. You will note though that that does have an impact on the percentage of our margins.

Taking a quick look at the balance sheet, you will note that working capital grew fairly substantially during the quarter compared with the end of the year. This was mostly due to our strong sales growth, but the impact was that we did not generate much free cash flow. During the second half of the year, we are going to squeeze working capital back down to allow for our planned repayment of debt. We're also going to take a hard look at our capital budget to see if we can trend some spending. We believe that with the combination of strong earnings, lower working capital and possible reduction in some capital spending, we will still be able to hit our debt reduction goals by the end of the year.

So that is a brief review of the financial statement highlights, and we will take specific questions at the end of the call. And now I will turn the call back to Rock.

Thanks, Jim. Let me conclude today's call if I could by commenting specifically on several business issues including our Level 3 program, the startups at Slovakia and China and again an outlook -- I will conclude with an outlook for the balance of the year.

As we mentioned in the first-quarter call as well, our Level 3 program is delivering very solid results but certainly not at a rate we would like to see based upon the established goals that we have for the program. I have mentioned historically that we have this very lofty goal in a variety of areas relative to cost, quality and productivity improvement.

During the first six months of the year, the program initiatives did improve gross profit margins, which is a non-GAAP measure by approximately 2% from operations. That 2% improvement was offset by the resin cost increase at IMC which Jim mentioned, as well as the negative margin impact of material pass-through of dollar cost increases associated with the steel inflation.

We do remain committed as a company to what I will call the institutionalization of lean Enterprise Six Sigma and total productive maintenance skillsets necessary we believe to drive long-term improvement processes at NN. In light of that, in addition to the more than 50 managers globally who will receive Level 3 training and are now back in their operations in lean Enterprise total productive maintenance, our current year program includes 13 managers that are receiving in-depth Six Sigma specific training with the goal of having all 13 of these individuals black belt certified by year-end.

If I could, I would like to shift to Slovakia and China for a minute. It is important to emphasize by the end of this year 2005 we will have invested more than $15 million in these two operations. Initially both investments center on our core bearing ball business, but we are positioning the physical infrastructures of both facilities to provide for not only future ball manufacturing expansion but other bearing component manufacturing as well.

The investments in Eastern Europe and China for us at NN represent a commitment on our part to follow our customers geographically and remain in close proximity to their expansion plans for both Eastern Europe and China. Both facilities we believe will also serve to ensure our long-term competitiveness in these important regions of the world.

The building in China is scheduled for completion by the end of August. We anticipate the beginning of limited production of high-volume automotive application precision balls during the fourth quarter of this year.

In Slovakia we are investing in additional production capacity to expand our ball product offering out of the facility. In addition, we have recently acquired an adjacent facility to our existing building. The acquisition of this building will double our available manufacturing space in Slovakia and provide for future flexibility regarding additional ball and other bearing component manufacturing.

I would like to conclude today's call if I could by talking about an outlook for the balance of the year. With respect to demand, we touched on it briefly in the earnings release, but our customers continue to forecast good levels of demand in both their automotive and industrial served markets through the end of the year and through the third and fourth quarters particularly. Although as we have mentioned before, Europe tends to the lower in the third quarter based upon seasonal adjustments and holidays.

Industrial end markets continue to exhibit double-digit growth rates versus prior periods, while North American automotive in particular has been buoyed by recent employee discount programs. It is important to note that without the impact of whatever happens with currencies for the last half of the year our revenue plans -- our revenue actual revenue is essentially on plan for the year to date, and we don't see any change for the last six months.

We have also mentioned in the release the continuing inflation of the steel situation in the U.S. marketplace in particular and moderate increases -- more moderate increases in resin prices at our IMC operations. Although we're passing these increases along to our customers, it does create a significant strain in our historical relationships with many of our long-term customers. In that end, we are proactively trying to develop new sources of global supply for our ball and roller steel requirements in an attempt to alleviate this crunch both from a supply and cost perspective which has resulted primarily from too few suppliers supplying the specialized product we require for our ball and roller operation.

We also mentioned in the release the overall impact of currency potential impact I should say. The original plan at the beginning of the year in our original guidance was based upon an exchange rate of $0.00 to $1.33. With the strengthening of the U.S. dollar by around 9% recently and if it stabilizes at the rate of around $1.20, we anticipate an impact on full-year earnings of around $0.04 a share. All translation-related. While there has been a small impact in the first six months, the majority of that $0.04 impact would occur in the final two quarters of the year.

Finally, we are continuing our strategic focus on profitably growing our core bearing components business. We see ongoing opportunities to meet the increasingly competitive needs of our customers, while at the same time focusing our business on profitable growth opportunities for the balance of 2005 and beyond.

An important aspect and an important point of the strategic focus on our bearing components business is a focus -- a continuing focus to improve the quality of our financial returns moving forward. We have several strategic initiatives underway and under development to that end.

With that, Jim, Will and I would be glad to answer any questions you might have.

(OPERATOR INSTRUCTIONS). Michael Greenwald, BB&T Capital Markets.

You mentioned on the last call that Slovakia was breaking even, and China is obviously still in that drag. But what is going on in Slovakia? Is it now profitable, or I guess what is the operating performance there?

The operating performance continues to hover around breakeven, and in fact part of the initiative that I talked about toward the very end of the call deal with in particular a product -- the first product line that we put in there to get the plant up and started. We have raised the price of that product offering effective July 1st to reflect the fact that even the startup margin and the returns that we would have like to seem coming right out issue are not what we would like to see, and we have raised the price as I mentioned July 1st through effective July 1st. So we anticipate the margins will improve in Slovakia.

More importantly, though, in terms of improving the margins there long-term is the issue of expanding the product offering with balls initially to other served end markets. The initial product that we put into the facility is high-volume automotive-related part of the selling prices and the margins tend to be lower, but that we still feel adequate returns will occur. So we're looking for good improvement there over the last half of the year as kind of a long answer to your short question.

So you have increased product offering to include more industrial applications?

Well, industrial and other applications that are automotive-related that tend to be higher volume but also higher margin, higher quality requirements, for example, in terms of precision and related quality requirements.

Okay. And what is your -- you mentioned steel is still an issue. Is this July 1st increase, price increase, I guess what I'm getting at is what is the outlook for steel going forward? Do you still expect it to be a gross margin drag, and is the price increase to cover the resin going to completely offset the cost pressures?

The price increases will offset the dollar increases.

Okay. For both?

Yes. We really honestly anticipate at least a stabilization -- you know, we really don't know what is going to happen in the U.S. through the end of the year now. That is negotiated in as well substantially.

In Europe it is variable based upon scrap surcharges, and those happen to be coming down and coming down a little bit essentially kind of what we planned at the beginning of the year just based on what everybody was forecasting, but they are coming down in the last six months of the year in Europe.

One last question. You mentioned the expansion in Slovakia and some other cost initiatives or some other capital expenditures, but you noted that for full-year to make your debt reduction plans you are going to decrease capital expenditures. So what is getting eliminated?

I'm not sure. Jim says that there was a commitment -- it was a commitment to look at capital and to see what makes sense. We have not made any decisions yet on that for the last half of the year, but we obviously want to look at what happens with working capital and some of the initiatives we have got going there. But I can tell you that from a prioritization perspective that China and Slovakia are top priorities, and as well we would not anticipate should any reductions in our capital budget be required to meet our stated debt reduction goals that it would occur -- that reductions in Slovakia or China would be part of that.

I mean what other major CapEx programs are going on, though?

We have a variety of capital programs in our existing North American facilities, as well as our European facilities that exist as part of running the business.

Yes, but that does not -- but the major ones are the China and Slovakia. So I guess it is just every -- maybe a reduction in just general (multiple speakers) --

Yes, it is safe to say that 50 or 60% of our capital spending for this year is associated with Slovakia and China, and the other 40% is from our existing operations.

All right. Thank you.

Larry Baker, Legg Mason.

Just to stay with Slovakia for a minute, with the capacity expansion there, can you talk about sales potential in dollars or capacity outlook for 2006 and sort of what that would look like?

Not yet. We really are not prepared to do that yet, Larry, because we just acquired within the last week this additional square footage, which I mentioned on the call doubles the available square footage in terms of our ability to put product in there, and we are as we speak kind of in the planning processes relative to what that might mean for not only balls but down the road other components as well.

So I really would hesitate to give you a number out of in terms of revenue out of Slovakia, other than to say that we obviously from an infrastructure perspective are positioning ourselves to produce a very critical amount percentagewise of our total production requirements in Europe long-term out of Slovakia.

Okay. Then just can you remind me what the original capacity or the revenue capacity of the original (multiple speakers) --

Yes, it was 10 to $15 million (multiple speakers).

I had 12 in my memory bank but --

Yes, that is right.

Mark Parr, KeyBanc Capital Markets.

This is actually Christopher Jones. I am filling in for Mr. Parr this morning. I might have missed this, but how much do you guys see your EPS being impacted as a result of higher resin costs?

That impact was in the first six months, and frankly the reason why is that the resin prices were gradually ratcheted up over a period of month-to-month over a period of six months, and so we have responded with increases as we speak to our customers at IMC. And so we don't anticipate an impact in the second half of the year, and the impact was around a $0.01, $0.015 in the first six months.

Okay. And what are the potential earnings benefits as a result of lower steel prices in the second half?

No change -- the lower steel prices occurring in Europe as part of the scrap surcharge reductions that we are seeing were forecasted in our guidance, in our original planning process. But we don't see an increase in earnings as a result of that occurring. It is pretty much on plan. And as we mentioned in the U.S., it is going the opposite way. We have actually incurred a large increase effective July 1st through the end of the year. That is being passed along in terms of material pass through.

(OPERATOR INSTRUCTIONS). Michael Greenwald, BB&T Capital.

Just a real quick one. Pricing in the quarter was I think 200 did you say -- I think it was 270 basis points or did -- I think you mentioned 3.5% in the call. Was that for the first half?

That was --

You mentioned 3.5 -- 3.3% (multiple speakers)

That was in the first half. That was the impact in the first half of our 18 million sales (multiple speakers)

Okay. And in the quarter I think I have, if my math is correct, 270 basis points? So with these new -- with these increased with -- I guess I'm trying to get the impact of what the level of increases were for the ball-related price increases in Slovakia? What impact on the basis points is that going to have? What level of degree are you talking about?

Michael, I'm a little confused. I think (multiple speakers) for the last half of the year, Michael?

Yes.

I mean Slovakia, don't forget Slovakia in terms of revenue is a minuscule part of our total overall Company at this point. And so the margin improvement in Slovakia in terms of impacting the margins for the last half of the year even with the price increases is pretty small. If you're asking for a number, it would be less than 50 basis points.

Okay. Well, you put quite a few price increases on your ball-related products in the first half of the year to cover the steel prices. And I'm just trying to get a degree of what type of acceleration we can see in pricing due to the new price increases?

In margin?

In overall revenue growth, and margin would be great, too.

: We could probably quantify that better for you. We don't have it laid out like that right here, but the main point is that the price increases have maintained our gross -- well, our margin levels so that that is why our guidance on the second half is so far only affected by currency. But we do really have --

Another kind of answer to that, though, and I think this is important, is that in the U.S. the increase effective July 1st on the material front was 26%. Passing that along dollar increase to our customers with no -- attempting to recapture the margin -- deteriorates margins in our U.S. businesses slightly.

Having said that, I spoke to the Level 3 improvements for the first six months, and we anticipate kind of that level or greater improvement in the last six months for Level 3 to deliver to offset that kind of margin erosion associated with material pass-through.

Okay. As some of the larger, the big three automakers have such strong sales or expected sales in last month and in the quarter current month, have you seen a large or a steep impact in uptick in orders as there has been some talk of some production increases? Have you guys see an impact on that?

A light impact, because if you look at the overall -- these sales increases came out of inventory, and the adjusted billed rate is up slightly. I think it is up 5%. So in our U.S. business, which is 35% of our total, yes, we have seen some increase. But 5% on 35% is still a pretty small number.

At this time, we have no further questions in queue. I would like to turn the conference back to management for any concluding comments. Please go ahead.

Our concluding comments are just thank you again for participating in today's call.

Ladies and gentlemen, that does conclude the NN Inc. second-quarter 2005 results conference. If you would like to listen to a replay of today's conference, you may dial 1-800-405-2236 and use passcode 11034682#. Thank you again for your participation in today's conference, and you may now disconnect.