NN Inc (NNBR) 2005 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the NN, Inc. Third Quarter Results Conference Call. At this time, all participants are in a listen-only mode. Following today's presentation, instructions will be given for the question-and-answer session. If anyone needs assistance at any time during the conference, you may press the "star" key followed by the "zero" on your pushbutton phone. As a reminder, this conference is being recorded today, Tuesday, the 1st of November 2005.

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

Thank you. Good morning. Welcome to NN, Inc.'s Third 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 a live webcast available at "www.earnings.com."

With us this morning is Rod Baty, Chairman and Chief Executive Officer, and members of NN's management team. First, management will give an update and overview of the quarter. And afterwards, we'll open up the line for questions.

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

Susan, thank you. Good morning, everybody, and thanks for joining the call. With me this morning I've got Jim Dorton, our Chief Financial Officer and VP of Business Development; Will Kelly, our Chief Administrative Officer; and Tom Burwell (ph), our new Corporate Controller.

Today, Jim is going to offer an analysis and commentary on the third quarter, as well as our year-to-date results through September 30th. And then I will conclude the call with comments regarding an overview of our business and an outlook for the balance of the year 2005.

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

Thanks, Rod. While the third quarter results showed our continued growth versus last year, revenue, gross profit margins, income from operations, net income and EPS were all up.

Net income was up 19% versus the third quarter of last year and 35% year-to-date. Earnings per share were up 15% for the third quarter and 33% year-to-date. Although we are below initial guidance levels, this is still a pretty strong performance versus last year. Compared with last year, revenue in the third quarter was up 2.9%, and year-to-date revenue was up 8.7%.

I mentioned in the press release that the year-to-date revenue increase of $19.7 million is made up of roughly 1/3 each of price pass-through, new volume and currency. Regarding currency, for the year, about 60% of our total revenue was denominated in euros.

Versus the first 9 months of last year, the euro strengthened against the dollar by about 4% from an average rate of $1.22 last year to an average of $1.27 this year, resulting in an increase in reported revenue of about $5 million. Our initial guidance, however, was based on a euro rate of $1.33, which was closer to the year end rate.

So versus the guidance rate, the euro has weakened, resulting in a shortfall versus guidance of about 4.5%, or about $7 million. Likewise, translating euro-based net income to dollars resulted in a shortfall to guidance of about $0.23 per share year-to-date, and we estimate between $0.04 and $0.05 per share expected for the full year.

Year-to-date, SG&A expense continues to be below last year's level. Adjusting for currency, SG&A is $700,000, or 3% lower than last year.

In our October 18th press release, we mentioned a hit for the adjustment of our corporate tax rate. In the third quarter, we made a one-time adjustment to our tax expense related to distribution of European earnings. This had an impact of about $0.01 per share and bumped the tax rate up 3.4% for the third quarter.

And this is a one-time adjustment that should not reoccur. However, there is another tax impact that we should discuss. As you may have noticed, our tax rate has been much higher than planned this year. In our initial guidance, we expected a blended tax rate of about 38%. Our actual tax rate year-to-date is almost 41%.

The reason for this is that the areas where volume is below plan happened be in low tax rate countries. And this results in an unfavorable mix for tax. The tax mix impact is about $0.02 per share in the third quarter, and if you combine this with the one-time adjustment that I just mentioned, you'll see that $0.03 of our variance from initial guidance this quarter is due solely to tax.

Another item. In early October, Delphi Corporation filed for bankruptcy. We sell balls and plastic molded parts to Delphi. At quarter-end, we were owed about $220,000 by Delphi. And we took a reserve for 100%, which has about a $0.01 per share impact on EPS.

As mentioned in our October 18th press release, we are continuing to do business with Delphi, since they have secured post-bankruptcy financing at this time, but we'll continue to monitor their credit situation.

In comparison to our original business plan, we experienced lower ball volume in Europe of about 2 million euros in the third quarter and a little over 3 million euros year-to-date. This lower ball volume was partially offset by higher demand for rollers and metal cages in Europe.

All net, the reduction in European volume had an impact of about $0.02 per share in the third quarter. For the fourth quarter, we expect ball volume to improve, but still remain below plan. For the full year, we expect the impact of the lower volume in Europe to be about $0.04 per share.

Now, taking a quick look at the balance sheet, you'll see that we paid down about $4 million in debt during the quarter, for a total of about $5 million year to-date, adjusted for currency. Working capital balances remained higher than planned, partly due to higher volume.

We expect to pay down additional debt in the fourth quarter with a total annual pay-down of about $10 million. Higher working capital balances are being offset by lower capital spending, which should end the year well behind the planned level of $17 million.

So in conclusion, let me just recap these major EPS factors for the full year. We have lowered -- in our October 18th press release, we lowered our guidance by $0.13 per share for 2005. This is made up of the tax impact of $0.03 to $ 0.04 a share, a currency impact of $0.04 to $0.05 a share, and the Delphi write-off of 1 penny a share.

So removing these items, only about $0.04 of our shortfall to initial guidance is due to business factors, which are primarily the volume shortfall in Europe. In total, our revised guidance still represents a 90%-plus improvement in EPS and net earnings over last year.

So those are the financial statement highlights. And I'll now turn the call back over to Rod.

Thanks, Jim. I'd like to conclude today's call by commenting specifically on several business issues.

First, Level 3. As we've mentioned in the two previously quarterly conference calls, our Level 3 program focusing on lean enterprise, Six Sigma, and total productive maintenance continues to abide very good improvement results on both the quality and cost front.

It's important to understand that during the first 9 months of the year, the Level 3 program has delivered approximately $4.9 million in pre-tax savings and an associated 2% improvement in gross profit margins, a non-GAAP measure. We anticipate the 2% improvement to carry through to the final quarter of 2005, and final pre-tax savings of approximately 6.1% -- or $6.1 million will be realized for the full year.

As we have also mentioned in previous calls, the improvement in gross profit margin percent has been offset by virtually an identical 2% reduction of material pass-through associated with deal inflation. We really are very encouraged by both the momentum and the commitment of our operating managers and employees, as we continue the implementation and integration of Level 3, and the resulting improvement process at NN.

During the third quarter, we completed Six Sigma training phase for 13 managers globally. During the next several months, a Black Belt certification project will be ongoing throughout the Company. Coupled with our initiatives associated with lean and total productive maintenance, the Six Sigma Black Belt certification of 13 managers will provide additional improvement in process control, quality and cost, moving forward.

Secondly, I'd like to discuss Slovakia and China. As we mentioned in the press release, both Slovakia and China remained focal points in our strategy to follow our customers, both geographically, as well as a very important commitment to ensure our long-term cost competitiveness in both Eastern Europe and Asia.

With respect to China, there has been no real change from the last update provided. The building construction is essentially complete, with limited production expected to begin late in the current quarter.

In Slovakia, new production associated with the SNR acquisition, which was recently concluded, will be added to existing production of automotive related products, beginning in early 2006. Although the overall levels of production and profitability of the plant have been well below expectations during 2005, excellent progress is being made with record levels of productivity achieved late in the third quarter of this year.

We believe positive momentum now exists from both our manufacturing capability and sales volume perspectives to meet our internal expectations when we started the plan, moving into 2006.

Third, I'd like to talk about an outlook for the balance of the year. With respect to overall sales revenue, our customers continued to report good levels of demand in their automotive and industrial served markets through the end of 2005. Although we experienced a reduction in the third quarter from planned levels of revenue, it's important to note that companywide revenue, including Europe, total forecasted revenue for the year of approximately $325 million is more than a $21 million improvement from 2004.

Pricing associated from raw material cost increases and currency account for 50% of the increase. The remaining $10.5 million in increase represents around a 3.4% volume/share improvement from 2004. However, the end market and geographic markets are mixed.

In the US, total new volumes and share will account for about 90% of the improvement, while Europe impacted by second-half revenues lower than expected, will finish the year essentially flat from 2004 levels. Within Europe, our tapered roller and metal cage business is up approximately 12% versus 2004, while our ball business will be down around 3% for the full year.

The discrepancy points to the relative strength of the heavy truck market and certain industrial end markets in comparison to little growth in the light vehicle market in Europe and a lower demand in certain ball-consuming industrial markets.

In Europe, our 6 year supply agreements associated with the original Euroball venture with SKF and INA expire in mid-2006. We are currently in negotiations regarding new agreements for the balance of 2006 and beyond with both customers.

From an overall certain market perspective, we continue to estimate that roughly 65% of our components in total annual revenue is automotive and end-market related, with the balance of 35% serving a wide variety of industrial end market. The implications for NN are that we have a very different outlook with respect to our 2/3 end market.

For automotive in both North America and Europe, the forecast is essentially more of the same. That is, relatively healthy levels of overall demand and production, but no growth in the near and midterm outlook. Contrasting the automotive market is the broad category of industrial markets I just mentioned, where demand continues to grow at very healthy double-digit, low-teen annual growth rate.

The combination of these two factored end markets result in expected annual economic growth in the 3% to 4% range in the near and midterm outlook. Of course, the emerging markets in Asia, from both an automotive and industrial perspective, are growing double-digit and long term. As we expand our presence in China, we can expect to benefit from the associated improvement in growth rate.

From an earnings perspective, Jim touched on the previously mentioned three issues impacting full-year earnings negatively versus our original guidance -- namely, currency, tax rate, and the volume drop-off in Europe. While we are very disappointed in the impact that these three issues have had on our full-year results, our revised forecast and guidance for net income for the year remains a record at NN.

I have mentioned that we are encouraged by the result in the context of the history of the Company, but we are still unsatisfied in terms of the quality of the earnings moving forward. We have several critical actions associated with improvement in this area, including the continuing implementation of Level 3 I mentioned previously.

Finally, I'd like to touch on strategy. We are continuing our strategic focus on profitably growing our bearing component business. In early October, we announced the acquisition of SNR's ball business. This business will be integrated into our existing European ball facilities, primarily Slovakia, beginning in early 2006.

The SNR transaction is an excellent example of our continuing focus on growth via acquisitions related to our core business. We continue to see acquisition-related growth opportunities as a key ingredient to our long-term growth objectives, along with geographic and product offering expansion.

With that, I will conclude my comments. And Jim, Will and I, as long as there is a little time, will be glad to answer any questions you may have.

[OPERATOR INSTRUCTIONS]

Our first question is coming from Holden Lewis of BB&T Capital Partners. Please go ahead with your questions, sir.

Morning, guys. Thank you. In a couple areas, it appears there is some deceleration that I was looking to get some color on. First, in the tax, you noted that year-to-date, you know, Level 3 has improved the margin by about 200 basis points. But at the same time, in Q3, it looks like that contribution was no more then the 90 basis points, just your improvement in cost of products sold to sales is all Level 3. And I was really curious whether that means that we're seeing some decelerating contribution from that source or what might be behind that?

Yes. Holden, this is Jim. I think the odds -- we looked at that more on a year-to-date basis. But I think when we look back at the quarter, what we'll see is a part of the -- we didn't recover all of the price increase in raw materials in the third quarter. And, therefore, that's hiding some of the Level 3 savings. But we'll reconcile that out. I think it does work out, and I don't think you're going to see any deceleration.

Okay. I'm sorry. What has the Level 3 have to do with the raw material recapture? I just -- I didn't draw that connection.

When you're doing your analysis on the improvement in gross margin --

Okay.

-- the gross margin actually would have gone down because of -- we didn't recapture all of the raw material price increases in the quarter.

Okay. Got it.

Holden, that's specifically related to IMC on the resin front.

Got it. Okay. And that's actually the next question that leads into nicely is pricing in Q1 got to about $3.1 million revenues, in Q2 was it $2 million, and in Q3 it's $1.6 million. I understand you're having some additional resin pricing pressures. But why are we seeing the price increases put in place at the beginning of this year not flowing through in somewhat more similar magnitude? It seems like that's actually decelerating and we're giving some back or something.

No. There is no giveback. But I think it deals -- the pricing-related pass-throughs deal with the timing of the material increases themselves. And so in Europe and North America, for example -- in Europe, most of the increase occurred in the first quarter. In the US, we've had increases beginning January 1st and on into the second quarter and less increases in the third and fourth. But in the US, as I think we've mentioned before, our pricing is only 6 months pricing on the raw material front. But the magnitude of the increases has continued to reduce in terms of the impact throughout the year.

Okay. So is that so the pricing number that you give is net of any new cost increases?

We are raising price associated with -- to correspond exactly with the timing of the raw material increases. And those raw material increases have diminished from the beginning of the year; the impact from the beginning of the year to where we are through the third -- the end of the third quarter.

Right. But I thought that the price increases put in at the beginning of the year were intended to offset last year's raw material increases.

That's true in Europe, but it's not true in the US.

Okay.

There is a big disconnect in terms of the way we buy and source raw material, and our pricing mechanism's in place for raw material in Europe versus the US.

Okay.

Europe is fixed for the year; the US is not.

Okay. All right. Thank you.

You bet.

All right. Thank you, Mr. Lewis. Our next question will be coming from Mark Parr of KeyBanc Capital Markets. Please go ahead with your question, sir.

Hi, guys. It's actually Joel. Mark had to step out for a moment. I was just wondering, looking at '06, if you can comment between the prospects for organic growth versus pricing by market in the US and in Europe?

Joel, not really prepared to talk about '06 yet. And in fact, we are in the process right now of developing our annual business plan for '06. And I believe our communication of our outlook for '06 will occur in our year end press release. We haven't established that date yet. We'll --

Towards the end of February.

Towards the end of February.

Okay. Thank you very much.

You bet.

All right. Thank you, sir. [Operator Instructions]

And management, there do not appear to be any further questions at this time.

Okay. Thank you again for participating in today's call.

Thank you. And this does conclude the teleconference for NN Incorporated third quarter results conference call. If you would like to listen to a replay of today's conference, you may dial 303-590-3000 or 800-405-2236. The access code to use on either number is 11042432. Those dial-in numbers again; 303-590-3000 or 800-405-2236, using the access code 11042432. You may now disconnect. We thank you for using AT&T Teleconferencing. Have a very pleasant day.