NN Inc (NNBR) 2006 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the NN Inc. third-quarter results conference call. At this time, all participants are in a listen-only mode. Following today's presentation, instructions will be given for the question-and-answer session. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded today, Monday, October 30, 2006.

I would now like to turn our conference over to Susan Garland with the financial relations board. Please go ahead, ma'am.

Thank you. Good morning. Welcome to NN Inc.'s 2006 third-quarter conference call. If anyone needs a copy of this morning's press release, please call my office at 212-827-3746 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 at www.earnings.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'll open up the line for questions.

Now I would like to turn the call over to Rock. Rock, please go ahead.

Susan, thank you. Good morning, everybody. Thanks for joining the call. With me this morning, I've got Jim Dorton, our CFO and VP of Business Development; Will Kelly, our Chief Administrative Officer; and Tom Burwell, our Corporate Controller. Today Jim is going to offer an analysis of our third-quarter results and year-to-date results through three quarters ending September 30, 2006. I will conclude the call with general comments regarding overall business conditions including an outlook for the remainder of the year and comments regarding the recent organizational announcements that support the long-term execution of our five-year growth strategy.

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

Thanks, Rock, and good morning, everyone. Sales in the third quarter of $75 million were flat with the same period last year. However there were some significant differences. Compared with last year, we experienced a volume reduction primarily as a result of weaker automotive sales of $3.1 million. This was offset by higher selling prices of about $0.8 million and a positive currency effect of the stronger euro at $2.2 million.

Results for the nine months were similar with total sales down $1.1 million or 0.4%. The volume reduction was $3.6 million and it was worsened by a $2.7 million currency effect, both of which were mostly offset by $5.2 million in higher prices from raw material passthrough increases.

Gross margins were down slightly from the second-quarter level in the same period last year. The level three program was successful in offsetting inflationary effects and the impact of higher energy costs this year and we recovered steel price increases through product pricing. The reduction in gross margin was primarily due to the effect of lower sales volume without an offsetting reduction in fixed overhead costs.

SG&A expense was down $7.2 million during the quarter, about flat with the second quarter and up slightly from last year due to the expensing of stock options. SG&A remains slightly below budget so far this year. Interest expense was $0.1 million below the second-quarter level and slightly below last year.

Interest rates were slightly higher in the third quarter compared to second quarter and we wrote off $95,000 of capitalized debt costs in the third quarter, which was charged to interest expense. Offsetting these expense increases was the capitalization of some interest related to the construction of our Slovakian plant. On net, a slight decrease in interest expense.

As you may have noted on the balance sheet, our cash was unusually high in the second quarter and thus our debt was also higher than it should have been. We had accumulated cash in Europe that required some structuring to repatriate. This was completed just last week. So subsequent to quarter end, we repaid approximately $8 million in debt.

On September 21, we entered into a new five-year $90 million revolving credit agreement led by KeyBanc. The new agreement has substantially better rates and more flexible terms. As I just mentioned, we wrote off most of the capitalized loan costs related to our old credit facility during the third quarter. The new agreement has a $30 million accordion feature which has a preapproved option to increase the size by that amount if we need it in the future for acquisitions assuming there's no major changes in our credit picture.

As of today, we have approximately $16 million drawn against the credit facility which gives us a pro forma debt to EBITDA ratio of 1.2. We are on track to hit our 2006 debt repayment target of $10 million, but this depends somewhat on how quickly we repurchase shares. We have spent approximately $2.5 million repurchasing shares this year as part of our announced $10 million 18-month program. We repurchased approximately 157,000 shares of NN stock during the third-quarter for approximately $1.8 million and this brings our year total to 214,000 shares repurchased.

Now on other items on the income statement, other income was a net positive of $550,000 during the third quarter and this was primarily due to the strengthening of the Slovak koruna against the dollar euro, which as I mentioned last quarter, is difficult to predict. We are taking steps to reduce the swings caused by this currency exposure by resetting our capital structure in Slovakia and we hope to complete this by year-end.

The tax rate was 40.7% during the third quarter, which was slightly higher than last quarter but significantly lower than the same quarter last year. The differences result primarily from the mix of income from countries with high-end low tax rates. Versus last year, we're making a lot more money in Ireland with a 10% tax rate, which lowers the overall rate, but versus the second quarter we made less in China and Slovakia, both with low tax rates. All things being equal, we believe the tax rate should be at about the same level in Q4 as it was in Q3.

In terms of net income, we made $2.6 million or $0.15 per share, which was flat with last year. On a macro basis, lower gross margins due to volume were offset by the positive currency impact I discussed. Year-to-date earnings were $11.3 million or $0.65 a share, up 14% from the prior period -- from the same period last year due to the stronger first half of this year but off about $0.02 per share from our planned model.

Looking at the balance sheet, I already mentioned a high cash balance and our subsequent repayment of debt. We did achieve a nice reduction in accounts receivable versus the second-quarter level, although A/R remained too high. Also compared with the second quarter, you might note that most of our bank debt has been reclassified to long term due to the new five-year credit facility.

Capital spending year-to-date totaled approximately $13.5 million, which is up significantly from the second-quarter pace, but really right on plan. The plan called for spending fairly heavily again in 2006 as we build out our low-cost production facilities in China and Slovakia. So that in total we should spend at about our depreciation level as a company this year. This does exclude around $4 million that we're spending this year to complete the SNR acquisition.

So those are the financial highlights and now Rock will talk more about our business and the outlook for the remainder of the year.

Thanks, Jim. I would like to close today's call if I could with comments regarding our overall business outlook, including a forecast for the remainder of 2006, and discuss briefly an organizational execution progress with respect to our strategic growth strategy.

Let me begin commenting specifically on the overall business conditions and our outlook for the balance of the year. As Jim mentioned, our revenues for both the quarter and year-to-date comparisons from one year ago while on first appearance seem essentially flat, we did experience in the third quarter a reduction in volume after adjusting for currency. The well-publicized downturn in the domestic automotive business was responsible for an approximate $2.5 million reduction in third-quarter revenue for 2006 essentially all in our U.S. Ball & Roller, Delta, and IMC business units.

We indicated in the press release that we expect an additional reduction in the fourth quarter of a similar amount, which will result in lower revenue estimate for the year from $325 million to $320 million. In terms of the industrial end market, they generally remained at healthy levels of demand in both the U.S. and Europe. Automotive in Europe is forecasted to remain at beginning of the year production rates through the end of the year.

Our revenue outlook is off slightly for the year based upon U.S. automotive, but as we pointed in the press release, our overall exposure to big three automotive end markets at NN in terms of the underlying demand is a relatively small 14% of our total $320 million in revenue.

To summarize then from an overall economic and business level perspective for the balance of the year, we anticipate automotive related down economic conditions in our U.S. operations; good industrial demand continuing in both the U.S. and Europe; and automotive demand continuing at historically healthy levels in Europe for the balance of the year.

With respect to our earnings outlook for the remainder of 2006, we are reducing by approximately 7% our beginning of the year guidance for full year earnings to a range of $0.81 to $0.85 a share from $0.86 to $0.92 a share based on the weakness in the U.S. that I just mentioned. As Jim mentioned in his comments, our year-to-date net earnings of $11.3 million and $0.65 a share are around $0.02 a share off from our original business plan and all of the miss occurred in the third quarter based upon the volume reductions.

Our operating results for the quarter and year-to-date continue to reflect good cost improvements associated with our level three program. But volume reductions in the third and fourth quarter have pressured margins for the last six months of the year in comparison to the first half of the year.

Also as we mentioned in previous quarters, 2000 earnings continued to be negatively impacted by the startup costs associated with our two newest facilities in Slovakia and China. This is as much a volume issue as it is a cost issue and as part of our global restructuring of manufacturing operations, we will be loading both facilities with sufficient volume in 2007 to provide for positive contributions in the coming year.

With respect to the Euroball contract extension negotiations, we have made progress with both customers, INA and SKF, and have agreements in principal with both customers and expected completed contracts will be in place by the end of the year. INA is a two-year extension through mid 2008 and SKF a three-year contract extension through the end of 2009.

We have previously communicated the results of the INA negotiations whereby we will lose an approximate $15 million in business principally to their in-house ball facility in Germany and. The results of SKF contract calls for NN maintaining 90% of our existing business over the next three years.

I would like to conclude today's call with comments regarding strategy execution and organization. As we mentioned in the release, we continue to maintain a long-term focus on delivering and executing on our current five-year growth plan. Recent public announcements with respect to our organization changes fully support this focus on execution.

First on May 4 of 2006, we announced the appointment of Kiyoshi Kago as our first representative in Japan. Mr. Kago will expand our capabilities in the Asian region as we expand our Kunshan, China facility. He will play an instrumental role in a key element of our strategy execution, geographic expansion and growth of our existing bearing component products into new world geographic regions. We intend to work diligently over the next five years to expand our market share in Asia, a region for which we have very low share today.

Second, on May 2, 2006 we named Dave Gilson to the position of Vice President of Global Marketing. We have identified applications marketing as a key necessary competency to achieve growth within our current strategy. Dave will be providing the necessary leadership to focus our organization on the market planning activities necessary to achieve results in all three of our stated growth initiatives. First, expanding bearing components on a geographic basis; second, expanding existing products through acquisitions of captive and independent businesses; and third, identification of acquisition opportunities that leverage our competencies in related high precision steel component manufacturing.

With respect to this final objective, we have made good progress in 2006 identifying potential acquisition candidates that are compatible with our articulated strategy of creating a high precision metal component platform within the company moving forward.

Finally on October 10 of 2006, we promoted James Anderson to the newly created position of Group Vice President of our plastics and rubber group, comprising our Industrial Molding and Delta Rubber operations. James joined NN in January of 2005 as General Manager of Industrial Molding. Our new group structure will allow us to capture natural synergies that exist between IMC and Delta in the areas of technical services, engineering, and manufacturing. Good growth opportunities exist for both operations and the new structure will allow us a far more targeted operational and marketing efforts moving forward.

All three organizational announcements convey our commitment to profitably growing our business over the next five years. We continue to believe that the proactive execution of our strategy will deliver long-term value for our stakeholders, our customers, employees, and shareholders.

With that, I'd like to open up the calls for any questions you may have.

(OPERATOR INSTRUCTIONS) Mark Parr, KeyBanc Capital Markets.

Thanks for having your call on Monday. I appreciate that.

Versus?

I wanted to congratulate you on the results. Everyone seems to be struggling with the big three right now. One question I had related to the SKF contract extension, can you quantify the sales delta for us please?

Yes, it will be around a total of $6 million of share loss over a three-year period. $6 million. About $3 million, approximately $3 million in '07 and about $3 million in '08 with no projected losses as of today for '09. It might actually spread out over three years, but the current anticipation is about 3 and 3.

And that would compare to, you said, 15 for INA?

Yes.

One other question if I could. Could you give us an update regarding your outlook for steel pricing heading into next year? And also how the contract, the pricing contract negotiations can help to offset any cost penalties associated with changes in raw material cost inputs?

It is a good question, Mark, in terms of material and it varies dramatically by the region of the world. Generally speaking, we see material stabilizing particularly in our U.S. operations that are importing principally from Asia. Those prices have stabilized at a much higher level than where they were 18 to 24 months ago of course. But in terms of coming right out of the shoot in January of 2007, relatively stable prices for our U.S. operations on the steel front.

We do anticipate from essentially our largest supplier in Europe, a rather significant increase there in base price and there is a lot of historical reasons driving that particular increase that don't necessarily relate to the rest all of what the rest of the world is seeing in terms of steel. But in both situations, both in the U.S. and in Europe with the new contracts, we have the ability to review material quarterly. That is a big change from where we were prior to the extension of the contract, where we were reviewing material on an annual basis.

So that, the increase that we're seeing January 1 in Europe, prices will be adjusted accordingly. And then for scrap, which changes quarterly -- by the way, the unit price increase that I mentioned in Europe, that is a once-a-year negotiation. But the variable piece on the scrap side of things goes up and down and we will lower -- either lower or increase our price on a basis of the scrap on a quarterly basis moving forward.

How does the passthrough to the customer work? Is there an opportunity for arbitrage here in either direction?

Not really. We're pretty transparent with our customers and we have been especially with the realities of what's happened in the last 24 or 36 months. We have been very transparent, and very open in terms of here is the actual cost and here is what we need to be made whole.

Okay, one last question if I could. The loss of business out of particularly out INA but to a lesser extent SKF, provides some incremental capacity for you in '07 and what is your current sense of how you would redeploy that capacity availability?

Without talking specifically, because I can't, in terms of kind of our planning associated with restructuring and rationalization of our global capacity, it is true that we will be expanding our production and the relative share of our production in both Slovakia and China in '07 versus '06 and I guess I just kind of need to leave it at that relative to what will transpire in '07. But we have definite plans in place that we have been working diligently on in the fourth quarter of this year -- actually back into the third quarter and even into the second quarter to position ourselves to make that happen moving forward.

Okay. Thanks so much for your comments and congratulations on continued success.

Michael Corelli, Barry Vogel & Associates.

Just two questions. On the INA, I believe earlier in the year you had said that you expected to lose $12 million of revenue. Did that number go up?

Well, it didn't, Michael. I'm not sure that we were talking in same currency. The 12 million was EUR12 million and in fact that is probably a better number to think about in terms of incremental -- in terms of an incremental loss and the impact of our business as opposed to converting it to dollars, because it is all -- we are losing it pretty much all in euros and it is euro denominated currency as well as the cost structures over there are euro denominated as well.

And what was the percentage loss that that equaled?

It was about 45 to 50% and most of it was a result of them bringing in-house into their German ballpoint business. There was some small amount of that went to a competitor.

Okay. I guess the next question kind of two parts but it is really the same answer is obviously you are losing some business here between INA and SKF. And you've been talking about kind of your global strategy and growth plans and all that. When will we start to see some tangible evidence from these strategies that you're going after and is that part of your plan for replacing some of this lost business?

Of course all of the above. I can tell you that the loss of business that we talked about was a driver, although we were moving in that direction anyway, of the restructuring that I just talked to Mark about. And I also mentioned in my comments that we certainly like some of the activity level associated with potential target companies on the acquisition front and the precision steel, metal component businesses that we have been looking at.

So those activity levels are really -- they have been good for the first nine months of the year and obviously I can't tell you exactly when you might see activity there, but we feel good about it.

Michael, this is Jim. I had a couple of comments there to Rock. In 2005 we did this SNR acquisition, which is our classic bearing component strategy where we bought the ball making machinery and business for SNR. So the SNR business in 2006 did offset quite a bit of the INA loss that occurred in this year. We have also -- were lucky enough to get in another program or two and we have some of that classic ball production or bearing components opportunity still out there. We don't have anything teed up immediately, but there is some possibility that we could get something like that done over the next couple of years. And then there is the precision component strategy that Rock talked about.

All right. I know it is a little bit early to look at 2007, but as far as your thoughts on what might be positive, what might be negative, are you expecting to be able to grow your earnings in 2007?

Can't really comment on 2007 yet, Michael. We generally provide -- historically we have provided guidance in our year-end release for the coming year and that timing we really don't anticipate changing at this point.

All right, thanks.

(OPERATOR INSTRUCTIONS) Gary Lenhoff, Ironworks Capital.

Jim, can you update us what was CapEx in Q3 and what you expect it to be for the full year '06? And if you can give us some range for '07, that would helpful as well?

Okay. CapEx for Q3, approximately $6.5 million, bringing the year-to-date total to $13.5 million give or take a little bit there because we're still finalizing the cash-flow statement. The target for this year should be approximately at our depreciation level, so $16 million to $17 million. And that doesn't include $3.9 million that we're spending for SNR acquisition. Next year we'd don't want to give the guidance on that yet.

Okay. Can you remind me with the refinancing that you have done or the new refinancing, what is your weighted average cost of debt currently? What is the pricing on the debt?

Yes, right now we are paying -- we have a $40 million fixed-rate piece at 4.78% -- 4.89%, I'm sorry. On the new debt, which we have about $16 million outstanding as of today, we are paying LIBOR plus 0.675. So I think that is about in 605, yes.

Okay. When do you expect that the 10-Q will be out with the segment results?

It is due on November 9. We will try to file it a few days before that.

Okay, thanks so much.

We have a follow-up question from Mark Parr.

Thanks very much. Most of my other questions have been answered but, Rock, I was wondering if you could give us an update on the acquisition pipeline that you're seeing. How active is the opportunity that you're seeing out there? What does pricing look like? How much capital do you potentially have in interest in investing into this side of your growth strategy over next 12 to 18 months?

Mark, the last part of that question was how much capital?

Yes. How much money would you feel comfortable investing on acquisitions over the next 12 to 18 months?

Okay. We -- as part of I think I have mentioned before that in terms of the last conference call, we talked about a strategy of doubling the size of the company over the next five years or so. And that we envisioned around -- of doubling the size of the company we envisioned another $300 million to $325 million in revenue in the next five years that about $150 million to $200 million in terms of revenue would come from acquisitions in this precision -- the high precision steel-related component businesses.

So if you think about it in terms of $150 million to $200 million, of course it depends on the multiples and so forth. But several of the acquisitions that we have in our current pipeline are at accretive multiples in terms of valuations moving forward, and we've said historically we would not do a deal that was not accretive coming right out of the shoot. And of course the environment is competitive, as you know, on the basis of private equity out looking at the companies moving forward.

But we in terms of companies that we targeted and that makes sense in terms of bolt-on to our existing synergies and what we have as kind of a footprint as the company and our manufacturing competencies, we are comfortable that we can pay valuations that makes sense for us as well as the seller and still have it be very accretive moving forward.

We said I guess over the next 24 months -- I'm not sure I could say really in terms of the total capital that we'd assigned to acquisitions over the next 24 months, but over the five-year period -- Jim -- the number we were looking at this morning was --?

In the $250 million range. But we have always --

The $250 million would be the amount of -- that would be the purchase price of the acquisitions?

Over five years, yes. That would obviously lend itself to more than $150 million or $200 million potentially in revenue.

Okay.

That would include acquisitions like SNR that are in our --

Plus our captive acquisitions would be included in the piece that Jim just mentioned.

But our goal is to keep the debt to EBITDA at a reasonable level and we would not set any hard and fast rules but kind of a rule of thumb at 2.5 times or less we think we have -- we're getting a little overleveraged.

Okay, terrific. Thanks again for the update on that.

A follow-up question from Michael Corelli.

Just a question about fourth-quarter interest expense. I know there was moving parts in the third quarter. Could you give us any help on what that might look like?

It should be lower. But let me make a quick calculation here. I really need to take a look at this, but I think it ought to be down in the $800,000 range.

Okay, thank you.

There are no further audio questions at this time. Please continue.

Thank you again for joining today's call. Thanks so much.

Thank you. Ladies and gentlemen, this does conclude the NN Inc. third-quarter results conference call. If you'd like to listen to a replay of today's conference, please dial 1-800-405-2236 and enter the access code of 11073922. (OPERATOR INSTRUCTIONS) Thank you and have a great day.