NN Inc (NNBR) 2007 Q1 法說會逐字稿

Good morning ladies and gentlemen. Thank you for standing by. Welcome to the NN Inc. First Quarter Results Conference Call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (OPERATOR INSTRUCTIONS) This conference is being recorded today, May the 8th, 2007.

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. Welcome to NN's 2007 First Quarter Results Conference Call. If anyone still needs a copy of the 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 on 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 an overview of the quarter and afterwards we will open up the line for questions. Now I'd like to turn the call over to Rock. Rock, please begin.

Susan thank you and good morning everybody and thanks for joining the call. I have with me this morning 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 and commentary on the first quarter and I'll conclude the call with comments regarding a general business overview. With that, I'd like to turn the call over to Jim.

Thanks Rock and good morning everyone. Results for the first quarter were in line with our expectations overall with a few pluses and minuses. Sales were up $21.9 million or 25.5% compared with the first quarter of last year. $18 million of this was revenue from Whirlaway Corporation, which we acquired in December of last year. Excluding Whirlaway, sales were up $3.9 million versus last year. We had $1.5 million in reductions in price and mix impacts that reduced revenue. And this was offset by $5.4 million increased sales due to translation of a stronger Euro. And as you know, about 57% of NN's revenue is denominated in Euros and the average Euro exchange rate was about 10% higher than the same period last year, which resulted in the higher revenue. Without the currency impact and Whirlaway, sales would have been slightly down from last year which was as we expected.

The gross margin percentage excluding depreciation was at plan at 21.2%, but lower than 2006 by 2.1%. About half of the decrease in gross margin was just a mathematical result of adding in the Whirlaway business at their lower gross margins, as anticipated and Rock will comment on that in a moment. A significant part of the remaining reduction in margins was due to price reductions related to the future move of business to Slovakia and China. And margins should improve as we shift this production to Slovakia and China throughout the year.

As a percentage of sales, SG&A expense was down from 8.9% last year to 8.7% this year. Although in dollar terms, SG&A expense was up 23% due mostly to the addition of Whirlaway but also due to the higher Euro rate and other expenses-- U.S. expenses such as staff cost and stock-based compensation.

The tax rate was 39.3% in the first quarter, up from 35.3% in the same quarter last year and 34.6% in the fourth quarter of last year. The primary difference with the same period last year was that in the first quarter of last year we had a favorable tax treatment on the Italian land sale that we already discussed versus 2004 the difference-- versus the Q4, the difference was the mix of income by country and the higher tax expense for the quarter in the U.S.-- in this quarter in the U.S. We expect the tax rate in Q2 to be in the 36 to 37% range.

The company earned $0.22 per share in the first quarter compared with $0.30 per share in the first quarter of last year, an $0.08 difference. Half of the difference or $0.04 was due to the gain on the sale of assets net of asset write-offs that we had in Italy last year. In addition to that though, U.S. Ball & Roller sales were unusually high last year in the first quarter because one of our major customers accelerated product acceptance in anticipation of elimination of a consignment inventory program. So if you take out the land sale and the shipment acceleration last year, Q1 excluding Whirlaway was down only slightly from Q1 of this year and we would attribute this to weakness in the U.S. automotive market affecting U.S. Ball & Roller, our Delta Rubber Division, and Industrial Molding division.

Sales in Europe were unexpectedly strong in the automotive and industrial segments in Q1 and this strength seems to be carrying through to the second quarter. European margins were on plan in Q1 but were lower than last year due to price and mix changes that were expected.

Whirlaway results were on plan. The new company-- our new company was expected to breakeven and they actually made a positive net income, but not enough to impact overall results much. Due to the nature of many of Whirlaway's sales programs, the business is seasonal and is usually stronger in the second and third quarters and weaker in the first and fourth quarters.

Moving on to the balance sheet, we had our normal seasonal increase in accounts receivable versus year end. Debt was up $7.7 million from year end and cash was up $5.9 million, so net debt increased by only $1.9 million. At quarter end, we did have some cash tied up in Europe, which will be used to repay debt in the second quarter.

Capital spending totaled $3.2 million during the first quarter versus $1.9 million in the first quarter of last year. As you know, we are continuing to build up our production capability in China, which is where the heaviest spending was. We are on budget for Cap Ex this year.

We did not repurchase any stock during the first quarter under our previously announced stock repurchase program. But our share repurchase program does remain active.

At this point, overall cash flow is pretty much on plan and we still expect to hit our debt repayment target of approximately $12 million by year end.

That concludes the financial comments and now I'll turn the floor back over to Rock.

Jim, thank you. I'm going to close today's call if I could with just some comments regarding the overall business. Let me begin with customer news. Late last month, we did agree to new terms of a new three-year supply agreement with SKF which runs through December 31st, 2009. The new agreement represents specific commitments and opportunities for both us at NN and SKF as supply chain partners moving forward.

From a revenue perspective in the first quarter as we mentioned in the release, first quarter sales of $107.9 million were essentially in line with our 2007 business plan that we forecasted for the quarter. While the underlying demand in market conditions were somewhat different than expected by region, our total revenues reflect very different economic conditions based upon global regions.

In North America, a continuing weakness in automotive and new housing starts did impact our U.S. operations negatively from a volume and earnings perspective. However as Jim mentioned, European demand in both automotive and industrial end markets was very strong for the first quarter and fully offset the sales volume reductions from North America. For the next several quarters, we see more of the same, continuing stronger than expected demand in Europe offset by lower than expected demand from North America. No other significant changes versus our original planning process occurred during the quarter, namely currency although recent continuing weakness of the dollar could positively impact revenue moving forward. Pricing, market share gains, and losses were essentially all at forecasted levels.

As a result of demand, currency pricing and share factors not changing dramatically from the levels that we forecasted, we did reconfirm today in the release our revenue and earnings guidance for the full year at $400 million and $0.98 to $1.04 a share in earnings in EPS.

One comment regarding overall revenue and demand with respect to our new acquisition Whirlaway. As Jim mentioned, they were negatively impacted in the first quarter by the lower than expected automotive and overall housing demand levels I just mentioned. Historically their second and third quarters are strong, helping to offset some of the cyclicality of low third-quarter revenues from our base business in Europe. New product programs at Whirlaway will begin in the second and third quarter and offset some but not all of the reductions that will occur should housing and automotive continue at the same demand rates for the balance of 2007. We however, believe that most of these same issues are short term and market demand related and remain very optimistic regarding our long-term ability to profitably grow the new business.

Although the current margins as Jim mentioned at Whirlaway are lower than our corporate average, a combination of strategic pricing and market diversification, full implementation of level three and organic growth are ongoing initiatives that we believe will lead to enhanced margins in the future.

A final note on the ongoing integration process. Our corporate manager of level three, Jeff Hodge, is leading cross functional teams from NN and Whirlaway in a highly focused and structured approach with a goal to achieve full integration of our new acquisition as quickly as possible. Individual teams are focused on the functional areas of financial reporting, quality systems, human resources, manufacturing and engineering technology, sales/marketing, information technology, supply chain and level three. The obvious goal is to integrate best practices in each of these areas and of course learn as much as we can from the relative strength and competencies from both organizations.

I'd like to transition now to a discussion of margins and specifically operations in general. Operating margins were 7.3% for the first quarter, essentially on plan for the first quarter. With the exception of Whirlaway, we now have fourteen global manufacturing facilities, eight in the U.S., five in Europe, and one in China. I think it's really important to note that of our ten core bearing components facilities and I'm excluding for a moment the four plants that make up Whirlaway, three plants in Ohio, one plant in Arizona that I just discussed, the profitability varies a great deal with each of these facilities in our core business.

Having said that and prefacing my comments with the disclaimer that there's always room for continuous improvement, our operations in Erwin, Tennessee, Mountain City, Tennessee, Lubbock, Texas, Veenendaal, the Netherlands, Kilkenny, Ireland and Pinerolo, Italy continue to perform solidly from a profitability point of view. Our facilities in Danielson, Connecticut, Eltmann, Germany, Kysucke NoveMesto, Slovakia and Kunshan, China currently are not meeting our minimum expectations regarding profitability. While the reasons for the lack of profitability in each of these facilities vary, the results clearly are not acceptable. I believe the board is holding management accountable. Management is holding management accountable. Particularly in our startup operations in Slovakia and China, improvement has taken far too long to achieve the results we expect and require. Historically, we have exhibited as an organization a solid competence in the ability to improve profitability in both startup operations and acquisitions. And I remain confident of our ability to achieve improvement moving forward. In the final analysis, improvement in these four operations represent a real and specific opportunity for enhanced profitability for the company in the near and long term.

Finally, we remain committed to the growth objectives outlined in our business strategy that we've articulated in previous calls; namely low teen compound annual growth rates in both revenue and earnings over the next five to six years. Our three major product platforms, metal bearing components, rubber and plastic components, and precision metal components all have key growth initiatives clearly articulated as part of our overall strategy. Growth for growth sake is clearly not our objective. Rather top line growth and business improvement initiatives that enhance both qualitative and quantitative profitability remain our overall long-term goals moving forward as we execute our strategy over the long term.

With that, I'm going to conclude my comments and open the call to any questions you might have.

Thank you gentlemen. (OPERATOR INSTRUCTIONS) Our first question is from the line of Holden Lewis with BB&T. Please go ahead.

Great. Good morning. Thank you. First on the balance sheet, while conceding that there was a little bit of improvement from fourth quarter on the receivables, frankly fourth quarter was pretty bloated itself. And I think that you had said that there was going to be some timing related issues there. And I guess I just would have expected to see more improvement in the receivables line in Q1 given that Q4 was supposedly a timing issue because-- And so I guess I'm curious about if there's any issues arising in terms of collections or why we didn't make more dramatic progress in Q1 given where we started off Q4 at?

Hi Holden. Yes that's-- I'm not surprised that you had that analysis of the situation. But as we went back and looked at it, we didn't find any problems. What we found was additional kind of timing issues in Europe, but we don't have any structural problems with receivables. We have relatively slow collections in the U.S. and that's been something we've been trying to deal with for some time. But the bulk of our receivables are in Europe and they're pretty timely. It's just a matter of timing. So--

Cause in Q4 your receivables I think were up 34% year over year versus what a 13% increase in the revenues. I was under impression that we had finished the year up in a condition with receivables that we weren't all that pleased with.

Yes. No, I'm not sure about that. Also the receivables are slightly bloated because the Euro was up 10% versus last year and was up quite a bit over year end. So that's part of the increase, not a whole lot of it.

Okay and then can you-- you know you sort of talked I think a bit obliquely about sort of aggressively addressing the four plants. Can you speak a little bit more specifically about what has been identified as the problems there that has made it slow? What exactly we're doing to address it? And give us a bit of a timeframe. And you've made comment earlier that you had had some price reductions ahead of a shift in production. How does that play into that statement please?

Holden, this is Rock. We-- I think that it's fair to say that specifically in the startup situations of both China and Slovakia that we have been disappointed in the results associated with the time that it's taken to achieve the production levels that we expect, the quality levels that we expect, and the profitability levels that we expect out of both operations. And I'd also say that while it's going to sound like an excuse, we have plenty of company with other companies kind of worldwide here that share the same kind of startup issues associated with both Eastern Europe and moves into China. Language and cultural issues associated with training employees is much more cumbersome and much-- takes much, a much longer time than we had originally kind of outlined frankly. And we, I think early on made some errors in judgment on manufacturing processes that we put into the facilities that has been rectified in the last quarter or two.

But the combination of kind of the manufacturing technology processes and the whole training issue of employees and stabilization of employment in both facilities has just been incredibly time consuming. And as I mentioned in the press release or in the call I mean, it's been very disappointing to us. And we frankly aren't used to having these kinds of results as a management team.

And but I do think in the first quarter, I visited both-- I physically visited both Slovakia and China. And the trends are positive in both operations relative to the issues that I just outlined that have been kind of holding back production levels and achieving the quality levels that are required. And the overall trending on the issues of manufacturing process, employment stability, all those issues are trending very positively over the last six months. And so we see positive trends in those two operations moving forward.

With respect to Danielson, Connecticut, which is our seal operation, that operation actually from a cost perspective was-- we incorporated that facility as well as IMC into our new Rubber & Plastics business and under James Anderson's leadership. And the facility itself from a manufacturing cost perspective is-- has dramatically improved since October 1st when we integrated it as part of a new division, new platform under James' leadership. So the cost structure is improving dramatically. It's a volume issue there where the seal business has been particularly hard hit by heavy truck, heavier SUV platforms that aren't selling well and the production rates are much lower than kind of the light truck, passenger car automotive build rates that you hear about. So that's a-- it's purely a volume issue at Delta Rubber versus some of the other operational issues that I mentioned in Slovakia and China.

And in Eltmann, Germany, frankly it's an issue associated with our cost structure. And the issue in particular is among other things is wage cost structure. We're in the process of negotiating with the union's works council as we speak to deal with those issues. We have a new leader in Eltmann, a new managing director in Eltmann that's getting very positive results on a variety of issues associated with cost. And the trends there are also positive over the last six months.

So we've developed specific time lines and specific actions in each of these facilities as we always have ongoing. But from a pure accountability perspective, the results haven't been there. I can't sit here and tell you that they have. I have great confidence and I'm an optimist regarding our management team's ability to do it long term and short term in the next three quarters of '07. Short term in the next three quarters of '07, I consider that short term. I know shareholders tend to view it long term, three quarters, but I do think that there's a sense that the improvement is occurring and that we're really starting to see results.

China in particular has been a volume problem principally more than some of the other issues I mentioned, although we've certainly been dealing with language and culture there. But it's been a volume issue and we do have pretty significant volume moving into the facility in the second and third quarter with new capacity being added as we speak. And so I think that particular situation again we see kind of a general improving trend.

Holden, did I answer everything? Was there any other-- was there a second part of that question that I didn't hear?

Obviously it begets other questions. But the second part of the question and then I'll jump back in the queue was you made reference about price reductions ahead of shifting production in Slovakia and China?

Yes, yes, okay I'm sorry. That was it, yes. That is commitments that we've made to our customers to shift certain automotive-related ball production to both Slovakia and China under a certain timetable. And that timetable started in the kind of mid first quarter on into the second and third quarter. So it did impact the first quarter the fact that we didn't shift the level of production that we thought we would particularly to Slovakia. And secondarily, a little bit to China, not much there frankly.

And so those-- we have made commitments as part of the SKF contract I just mentioned as well as all of our-- a lot of our customers particularly in Europe although globally in Asia as well to produce automotive-related balls in those lower labor cost areas or plants moving forward. And to the extent that the timing is delayed, it impacts the margins which Jim articulated in the first quarter in Europe in particular.

All right, so basically you guaranteed a price that you could only make your profit margin if it was produced in the low wage country. And because you didn't get it out of the low wage country in time, but you had to still change the lower price, it hurt the margin?

That's correct.

And is that all gone in Q2 or how long is that issue drag?

Well it drags into the second quarter and potentially into the third but should essentially be eliminated by the fourth based on our current timing in terms of production ramp up. But it should essentially be gone by the fourth quarter and diminished in the second and third as we continue to increase production.

Okay, great. Thank you.

You bet.

Thank you. Our next question comes from the line of Mark Parr with Keybanc Capital Markets. Please go ahead.

Hey thanks very much. Hey Rock.

Morning Mark.

How's it going?

Good, how are you?

Good, good. Hey I've been listening to your comments and it's really helpful to get a sense of what-- where the opportunities are for upside over the course of the year. I guess one question I had at Whirlaway what is their exposure to the housing market in terms of their total--?

It's approximately 30% of their total revenue.

Okay.

The HVAC market, which is the air conditioning market not heating but the air conditioning market and the compressor market where they have pretty complex components going into air conditioning compressors is tied totally to housing starts Mark.

Okay.

And housing starts as you know are down double digit, which is impacting them in the short term for sure. Climate can overcome some of that. And to the extent that there's a warming, temperatures start to warm up quickly here in the spring, it can offset from a replacement perspective some of the reduction that they're seeing on new housing starts. Cause replacement business is a big part of it as well. It's a big part of the market as well.

People aren't replacing their air conditioners in February.

Well yes that's a problem in the first quarter.

For a minute I thought you were going to say that Whirlaway was a global warming play or something. But--

It was-- I'm glad you saw through that. It was-- that was part of it of course.

Okay, so I guess our-- in your revised guidance or in your reiterated guidance for the full year--

Yes.

What are your assumptions for the housing market?

Our assumptions for housing and automotive are more of the same as I mentioned in the-- my comments regarding end market demand. Kind of more of the same for the balance of '07 frankly, which means that Whirlaway's revenue given no changes will be down from our original plan, but we see other end markets in our base core bearing business that are going to be up. And so kind of the net impact of all that is no change from guidance that we currently provided.

Okay.

Okay.

Looked like the revenue numbers-- can you break the revenues between Plastics and Bearing components? I know you gave us a Whirlaway number in the--

I think we can do that in the Q which is going to be filed on Thursday. Our new segment reporting does a much better job of, in our opinion, and that's why we had adopted it Mark. But the segment reporting deals with the three platforms that I mentioned in my-- at the very end of my concluding comments. Metal bearing components, rubber and plastics and the new platform, which is essentially Whirlaway at this point.

All right. If I could just ask one question, I remember you had-- a couple of years ago you had made an, kind of an initial or preliminary attempt at making some penetration into the Chinese market. And that was something that you walked away from for a number of reasons, which I think were different than the issues that you're dealing with now. But could you talk a little bit about both the timeline and how much patience that you've got both in China and Slovakia before you kind of begin to back away from those operations?

Yes, we really have no intention of backing away. We need to physically be in both locations on the basis of proximity to our customers. Many of our customers by the way and it was a comment to Holden Lewis, but many of our customers are struggling in the same manner that we are in the same parts of the world regionally.

Is it an issue with finding people that will stay? You read these--

It's not in China. I mean our turnover in China's been relatively minor. Our turnover historically in Slovakia was very high but has stabilized now. And of course, you know Slovakia's a very popular location Mark. I mean it's-- there's a lot of new investment going into Slovakia and the availability of-- as you know our labor content is not a high percentage of our total costs so we don't require a great deal of employees, but the employees that we do have, have to be highly trained and skilled in our operations on the plant floor.

So we don't have any intention of backing away from either location and in fact on the revenue side for China in particular, we've gotten some commitments from customers that look to fill that facility up based on the current capacity rather quickly here in the next several quarters. And so we're still-- there's no kind of put the white flag up the flag pole relative to our thoughts with respect to either operation. And as I've mentioned, it's not a question of well can we make it work? And let's maybe back away. We have to make it work as a management team and a company. We have to. Our customers need us there and we need to be there in order-- we're going to make it work period.

Okay. If I could ask just one more question on the new SKF three-year contract--?

Yes.

Can you talk a little bit about the minimum volume levels? I guess the Euro is probably helping to offset some of the weaker shipping momentum or hasn't that kicked in yet? Could you give us some more color on that too please?

Yes, we-- I think we've mentioned this isn't anything that we haven't said publicly before, but as you know we had 100% of their business for six years.

Right.

This new contract calls for a 5% reduction in overall volume in '07 which is fully reflected in our forecast and 5% in '08. So a 10% reduction off their European volumes. Now we do business with SKF globally in other parts of the world that that's not impacted there in some cases, in North America as an example.

Okay.

So, but about 10%. And reduction and it goes, as I mentioned, through the end of '09.

Okay, all right.

Was there another part of the question that I missed Mark or was that it?

I was-- you know you're looking at the volume but I'm guessing, I'm thinking about the pricing and the--?

Yes, fortunately or unfortunately we filed this and we're actually obtaining the signatures as speak. But this is-- this will be filed as a public document sometime well in the next, we think in the next week or two.

Okay. All right, terrific. Hey thanks and congratulations on the progress. Good luck in Slovakia and China.

Thanks Mark.

Thank you. (OPERATOR INSTRUCTIONS) Our next question comes from the line of Robert Toomey with E.K. Riley. Please go ahead

Hi, good morning.

Good morning.

It looks like despite the higher receivables you did have positive cash flow in the quarter? Is my-- is that correct?

No, we built our debt balance, net debt by 1.9 million so I would say we were $1.9 million negative cash flow.

Okay and can you comment on what you think your cash flow will look like for the full year?

Yes for the full year we've forecasted that we'll generate net of capital spending, dividends and our other and working capital changes that we'll be able to repay around $12 million of debt. So we would say net positive cash flow of around $12 million for the year if everything hits well.

Okay the second question I have is I guess you talked in you discussions about the outlook for your various markets. My question was are you seeing any signs of improvement, any inklings of improvement in demand in the second half as you look into Q3, Q4, particularly in the U.S. But I guess you're saying housing and automotive pretty much the same, is that what you're seeing now?

Yes, I mean if we had to handicap it right now, we'd say pretty much more of the same in both of those end markets. And those are pretty significant drivers for our North American demand. I mean there's other general industrial demand in the U.S. that's been relatively good. But that's kind of reflected in our expectations for the year already. But it is those two end markets that were essentially-- as I mentioned, the one kind of unknown on the replacement business in the HVAC market is the climate issue, which could change.

Okay. Just a follow-up on your-- on the questions that came up on China and Slovakia, some companies I've talked to have said that it's very difficult to actually make money in China. And I'm wondering if-- how you feel about your ability to actually make sustained profit in China.

Yes, really a good question and based upon how we started out you could-- it's a great question and a very viable question. I would tell you that we believe that we can be very profitable in China. And in fact our business plan for this year reflects profitability in the fourth quarter for that operation. And profitability out of the operation once we get running at that rate in the fourth quarter on into '08 that kind of levels of what I mentioned in terms of our core business and facilities that are meeting expectations.

But kind of-- this is Jim Dorton. I'll make a comment there that a lot of the companies that can't make money in China have targeted the Chinese local market. And we-- whereas we would like to address some of that market in the future, right now we are selling to major worldwide bearing manufacturers out-- but we're producing in China. So it's a little different than trying to get new business within China.

Okay I see and that-- and then just a couple of other quick questions on Whirlaway. What is their percentage of sales outside the U.S.?

Very small. I think it's-- I can't give you a number. We can-- I think it's less than 5%. Honestly, it's 5 or 6, something like that. But that's a guess and as you would like a number on that, we can either have you call in to Jim after the fact or get you the information some way. But whatever way you'd like to handle it, but it's less than 10%.

No, that's fine. I was just wondering what the opportunity would be for growing--

Well that's an excellent question and we have articulated in all of our integration and synergies associated with Whirlaway's business that they serve a variety of global industrial companies as customers. And they have their customers encouraging them to move into other geographic areas of the world. And we definitely as we saw the acquisition saw the ability to grow it organically via a footprint, a manufacturing footprint in places like Eastern Europe or China. Mexico is an example of a potential expansion for Whirlaway.

Okay and is there anything in general in talking, you're looking at your markets and talking to your customers and potential customers, what your feelings are generally about the overall global industrial environment right now? I mean we follow some of the auto suppliers and it seems like the auto, the global auto end markets are actually quite healthy overall. And just wondered if you had any comments about the general long-term outlook for some of your key markets?

Yes I do. I mean I think that and as I mentioned in the-- in kind of my comments, it's a mixed bag of course but generally speaking the levels of automotive production globally and you know the reductions even in North America while they're short term in nature. If you just kind of look at the global production and what's going on in Europe and Asia in particular, they're very-- the levels are high and provide good opportunities for us to grow our business and keep our facilities from a utilization perspective, running at high levels given our customers' overall demand.

And so I wouldn't say there's-- I don't want to sound pessimistic at all relative to kind of the long-term outlook over the next 18 to 24 months associated with the end markets on automotive. Even housing in North America and the impact on Whirlaway, most people are predicting that that's not-- the new housing starts in particular is-- there's going to be improvement there in the fourth quarter of this year and on into '08. So, I think it's a short-term issue in North America in particular, but globally we're-- we see good demand levels.

Okay and then one last question if I might. Could you just give us a quick update on your progress on acquisitions as one of the key parts of your long-term growth? Anything like obviously you can't comment on anything new in particular, but how do you feel about your ability to find other acquisitions to augment your growth?

It's a good question. And we have a specific focused metric in place relative to the whole process in terms of targeting potential acquisition candidates as strategic add-ons to the Whirlaway acquisition. And I would tell you that the fragmented nature of the end or the kind of the competitive dynamics of the end markets that they-- that Whirlaway serves and the participants in the end markets and the actual target customers when we look at the end markets that they're serving and target companies, there's a big pool of potential acquisition candidates. So as we kind of handicap it, we say we kind of like the probabilities moving forward.

I would tell you however that as a management team and certainly as a board, our focus is concurrently on looking for pipeline, you know filling the pipeline of potential acquisition candidates and making contacts associated with that. But we're also definitely focused on integrating and achieving the full value and the improvements that we need to at Whirlaway.

There's great organic growth opportunities at Whirlaway as an example that would have-- you know with a good sales marketing strategy and the globalization of their product line and targeting new end markets for their existing facilities and competencies, all those things are what-- a big focus as well. We really don't want to take our eye off the ball on the integration and organic growth at Whirlaway while we're doing the other and we won't. But I obviously can't comment on any specifics of companies that are in the pipeline or aren't in the pipeline but lots of activity there in terms of developing the pipeline as we speak.

Great. Thanks very much.

You bet.

Thank you. Our next question is a follow-up question from the line of Holden Lewis. Please go ahead

Thank you. Just so I make sure I understand sort of the broad outlines of the SKF deal, the deal goes through '09. You're going to see a 5% reduction in volume in '07 and '08 and then '09 just kind of at the '08 levels? Is that right?

That's correct.

Okay and then what about price downs? Are there also price downs on top of the volume reductions that should occur?

Yes I spoke to those and they're principally centered around movement of product to Slovakia and China. Holden, there are smaller reductions out of existing operations.

Right so you-- there's price downs in there and you plan on offsetting those with the movement to the--

Principally yes.

Okay.

Yes I mean that's the majority of it, yes.

Okay and okay fair enough. And then you signed the contract or I guess you're in the process of signing the contract here imminently, was there any of that 5% reduction in volumes out of SKF in Q1 or is that something that's kind of on the come?

Well it's-- we're not totally sure because their demand was so strong in Europe just the total economic growth demand that we're absolutely not positive that anything came out in the first quarter frankly.

Okay cause that's what I-- I'm kind of curious about the revenue guidance at $400. I mean it seems like maybe the U.S. got a little bit worse although frankly, I mean everyone kind of thought was going to happen with trucks and housing. I mean none of that's real surprising. Whereas Europe I would say was an upside surprise. And then of course the currency was an upside surprise. And so I'm having a hard time kind of staying with $400 million just based on what you're seeing in the markets. And I'm wondering if the SKF is kind of the difference or how I should be looking at that?

Well yes, I mean-- first of all 5% in dollars I think we said was approximately $4 million U.S. dollars annually, contractually. You know around $4. So just a little bit better than expected economic growth offsets that immediately. I'm talking about for '07.

Right, right. No I understand. I'm just, like I said, I think that Europe was an upside surprise and the currency was an upside surprise and it seems like most of the weak elements in the U.S. were kind of known entities. And there but you kept the revenue guidance of $400 the same. And I'm kind of-- I'm just-- I'm having a hard time seeing how the revenue guidance shouldn't go higher?

Shouldn't go higher? Because 60% of the revenues coming out of Europe, you're saying?

Yes because you have so much European exposure--

It's 57%. I mean I think that at this point in the year to change revenue or EPS guidance based upon everything that we see, all the dynamics we see just wouldn't have made sense to us.

Okay, but that's kind of why I was asking if the SKF volume reductions are kind of on the come and therefore some of the strength you saw--

Well yes I mean I do think that they haven't moved the majority of what they're going to move. And we will see that in the second, third, and fourth quarter to answer your question. I mean we don't-- we didn't see a big impact of any of that in the first we don't think.

Okay.

But it's (inaudible) fair to say that if this unusual auto and industrial demand in Europe keeps going on through the second and third quarter and if the Euro remains strong or gets even stronger, probably revenues like-- how much of that drops to the bottom line though is one reason why we didn't focus too much on it. We're not sure how much falls down.

Right. Well that's what my question is, it seems like maybe $0.22 in Q1 and kind of $1.00 being your full year number, obviously you're assuming some back end improvement in the results. And since revenues we kind of know what those are, obviously you must be doing it on the margin. Can you talk about what pieces are going to improve the margin as the year progresses?

Well level three in our newer operations-- in our newest operations at Whirlaway, second, third and fourth quarter. Level three in both Slovakia and China, second, third, and fourth quarter in particular. Level three in our existing operations in our non-problematic operations is kind of forecasted slightly higher in the last half versus the first half just on the basis of that's kind of the way it's worked historically for us in the first two years of, first full two years of the programs. And new programs that I mentioned from a volume perspective coming on at Whirlaway in second and third quarter. And then the overall demand that Jim just mentioned relative to revenue. So--

And the big thing of course, the other thing that Rock's mentioned a number of times is moving the production into the plants where it's been priced has a positive gross margin impact. And that should occur through the remainder of the year.

Okay and can you just sort of comment I think-- if I'm doing the math correctly that your gross margin at Whirlaway was kind of the high 15's sort of you know 15 something?

Yes, 15.9.

Yes I mean what do you-- do you expect that you can get that into sort of the low 20's or what's the potential there and the timing?

Holden that's a good question and we've said one of our-- certainly one of our screens associated with acquisitions is precisely that. I mean if we don't foresee the ability to get a business that we've acquired up to our kind of corporate average over a period of time and I'll define that in a second here, then it probably doesn't meet our-- it definitely doesn't meet our acquisition criteria. And I can kind of click off the acquisitions that we've made that had very similar margins as Whirlaway when we made them. Euroball, Veenendaal, IMC, are three examples of acquisitions we made with margins. Euroball, our two biggest acquisitions, Euroball and Veenendaal had very, almost identical margins to Whirlaway. And they're now at or exceeding kind of the corporate average. So you-- it was a 5% kind of gross profit margin improvement from those operations since we've had them. And we're expecting the same thing based upon the initiatives that I outlined in my comments namely strategic pricing, end market diversification, level three integration, and organic growth. All of those kind of combined over the next year or two years, three years, we expect are going to enhance margins there.

I can tell you that realistically to improve margins by that amount you know 5 to 6 points takes 2 to 3 years not 2 to 3 quarters. But we've shown-- I think we've shown a good ability to do it as an organization. And I think the Whirlaway management team sees the opportunities on the growth side, the end market diversification, and level three as an example moving forward as well.

Okay, okay and then lastly Slovakia and China, I think you said you had lost I think $2 to $4 million last year. Can you talk about sort of what the losses were for Q1 from those two businesses and kind of what you expect the full year '07 number to look like?

I don't think we want to go to that level of detail with you right now Holden. And but--

Have we ever disclosed that kind of level of detail other than our segment reporting?

Certainly not consistently.

Yes I mean I don't think we're prepared to do that publicly in this forum Holden because our segment reporting includes both-- in the precision metal components business segment, bearing components-- it's included in that segment. But we've-- I don't think we've ever disclosed what we're doing or not doing as a general rule in any of our individual plants.

Okay.

Specifically.

Well that's fine. And then just lastly, the turn in Slovakia operations are both in sort of the cost of goods and S&GA right? Or are they down in sort of other income cause they're a JV or something--

No, no, there are-- we don't-- there's no joint ventures anywhere and they're in our cost of goods sold and operating income.

Okay.

The only difference from the past is that we're now fully depreciating-- we're fully depreciating all of the production assets there with a time during part of last year where we hadn't put the assets in service. But now we consider them in service and you see that increase in our depreciation. That and currency are the-- and Whirlaway of course are the only difference in our depreciation, which is higher.

Okay. Thank you gentlemen.

Thank you. Our next question is a follow-up question from the line of Robert Toomey. Please go ahead

Hi, I just had one follow-up and that was just talking about your normal seasonality by quarter. Is the second quarter usually stronger than the first and third? And I guess based on your guidance, does your guidance imply a second half earnings above the first half? I guess--?

Robert we specifically don't give guidance by quarter.

Okay.

But you can look at our seasonality trends and I think Rock touched on this, normally because Europe is on vacation on part of the third quarter, third quarter is usually pretty low. We've got a natural offset to that now in that as I mentioned Whirlaway tends to have their stronger quarters in Q2 and Q3. So before that reason you should see more-- should see less of that third quarter seasonality than normal. Other than that, you just need to look at what you've seen in the past and draw your conclusions from what we've said.

Okay so Q3 with Whirlaway you said should be seasonal, not so much of a seasonal effect?

Right.

Okay. Thank you.

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