NN Inc (NNBR) 2007 Q3 法說會逐字稿

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. Later we'll conduct a question and answer session, and instructions will be given at that time. (OPERATOR INSTRUCTIONS) As a reminder, this call is being recorded today, Thursday November 1, 2007. I would now like to turn the conference over to Ms. Julie [Tu] from Financial Relations Board, please go ahead ma'am.

Thank you, and good morning. Welcome to NN's 2007 third quarter results conference call. If anyone 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. This same language applies to comments made on today's conference call and live web cast 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 overview of the quarter and afterward we will open up the line for questions. Now I'd like to turn the call over to Rock Baty. Rock, please go ahead.

Thank you Julie. Good morning everybody, and thanks for joining our call this morning. I have with me this morning Jim Dorton, and CFO and VP of business development; Will Kelly, our Chief Administrative Officer; and Tom Burwell, our Corporate Controller.

To start the call this morning, Jim will offer an analysis and commentary on the third quarter and the first nine month's result of 2007, and then I'd like to conclude the call with some generally business overview comments. With that, I'd like to turn the call over to Jim.

Thanks Rock, and hello everyone. Just as a general comment, I would like to start out by saying that results in the third quarter from operations were consistent with our guidance last quarter, and the preannouncement in July. at that time we could see that our new Whirlaway division was going to fall short of 2007 revenue expectations, and that China would also be below plan. Our base metal bearing components business was expected to continue to show strength for the balance of the year. All of this was true in the third quarter, and we achieved sales and profitability levels in line with our guidance.

As we announced last quarter, we took the remainder of the restructuring and impairment charges for the restructure of European ball operations and other charges during the third quarter. The charges that we ended up booking in the third quarter were slightly higher than we anticipated when we announced it last quarter. In additional to completing the European restructuring, we also took a charge for the reduction in value of certain intangible assets related to our acquisition of Whirlaway.

This came about because of the large reduction in sales volume at Whirlaway this year. Because of that, we reassessed the intangible assigned to the customer lists, and this resulted in a pre-tax write down of $5.6 million. This is an amortizable intangible asset, and so this write-off will actually reduce amortization expenses in the future, so it will have a small net positive impact on future earnings.

Altogether we took restructuring and impairment charges of $7.1 million pre-tax in the third quarter. $5.8 million of this is non-cash, and only $1.3 million will be in cash. After tax this amounts to a charge of $5 million even, or $0.30 per share. Combining the restructuring and impairment charges in the second and third quarters, the total is $22.3 million pre-tax, or $19.9 million after tax, which is $1.17 per share. Of this $22.3 million the only cash portion is the $1.3 million that we booked this quarter.

So for the quarter, excluding these charges, we had net income of $1.8 million or $0.11 per share. This compares with $2.6 million or $0.15 per share in the same period last year. The difference is primarily the loss at Whirlaway, combined with the inefficiencies of moving our ball production from the U.S. and Europe to China and Slovakia.

Sales were $99 million, compared with $74.9 million, an increase of $24.1 million or 32%. $15.6 million of the increase in sales was the addition of Whirlaway. $3.8 million of the increase was currency translation due to the appreciation of the Euro, and $4.8 million of the increase was real growth in bearing components.

For the year to date, excluding the charges, we had net income of $8.6 million or $0.51 per share. This compares with $11.3 million profit or $0.65 per share for the same period last year, and last year we had included in that a net $0.04 per share gain on the sale of land. Excluding the gain, as with the quarter, the year to date difference is primarily the difference in Whirlaway, the loss at Whirlaway, combined with inefficiencies related to moving ball production to China and Slovakia.

Year to date sales were $314.3 million, up $69.9 million or 29% over last year. Whirlaway accounted for $11 million of the year to date increase, currency translation made up $13 million of the increase. The remaining $6 million was growth in bearing components, partially offset by unfavorable price and mix.

Looking at the results for the quarter and year to date, excluding the charges at Whirlaway, we see pretty strong growth in bearing components, but little of it dropping to the bottom line. The key is for NN to get our new plants profitable now that we are shifting significant volumes to these new plants. Start up and learning curve inefficiencies are the problem, and we are working hard to fix these issues. We do expect 2008 to show much improved performance from our new units, which will result in a major swing in profitability if we are successful.

A few more items, the tax rate for the quarter was only 11% as a result of the restructuring charges not having much of a tax benefit. Excluding the charges the underlying average tax rate is high at about 45%, and this is because we're currently making most of our profit in high tax areas, and making little in low tax countries like Slovakia and China. This should also turn around in 2008 if we are successful in improving profitability at the new operations.

Looking at the balance sheet, our cash balance is down $4.3 million from last quarter, as we were able to repatriate cash from Europe to pay down debt in the U.S. Total debt is down $3.5 million versus the second quarter. Working capital remains at a generally high level, which is not unusual for this time of year, but we still have some safety stock inventory in balls to deal with the restructuring to make sure we meet customer commitments. We think inventory will decline through the balance of the year.

Also you will notice on the intangibles line, the good will line, you'll see the $5.6 million reduction associated with the Whirlaway customer intangibles that I just mentioned.

Capital spending totaled $6.0 million during the third quarter and it was $12.8 million year to date, which is on plan and similar to last year. We're continuing to build up our production capability in China, which is where the heaviest investment was, and this will continue until the middle of next year.

We were active in our share repurchase program during the third quarter. We repurchased approximately 309,000 shares for $3.2 million, and we are continuing to buy aggressively at the current price levels.

At this point in the year overall cash flow is below plan, due to a working capital build up, lower profits at Whirlaway, and the share repurchase program. Last quarter I stated that I thought we could still meet our debt reduction target of $12 million, but if we keep buying back stock aggressively we will not hit this target. But we still anticipate having at least a small debt reduction for the full year at this point.

That completes my financial comments. And now back to Rock.

Thank you, Jim. As I mentioned, I'd like to close today's call with comments regarding our general business overview.

As Jim mentioned, in his comments, from a revenue perspective, we continue to see really good demand in our base metal bearing components business, particularly in Europe. Global demand in automotive end markets remains flat to slightly down, year-over-year, but, again, at healthy levels overall, from a pure demand perspective and capacity utilization perspective.

Year-to-date sales for the total company, during the first nine months of 2007, were $314 million and ahead of last year by around $6 million, after adjusting for the impact of currency on Whirlaway.

In comparison to 2006, good demand in Europe and global industrial markets in general, offset lower demand in North American automotive markets. For our base business, we anticipate business demand to be better in Europe and flat in North America for the fourth quarter, vs. the first three quarters, moving forward.

With respect to Whirlaway itself, no real change from our full year downward revision we outlined in the second quarter earnings release and conference call. Specifically, we expect full year revenues of approximately $67 million, down $13 million from our original plan of $80 million. While Diesel engine and HBAC end markets remain significantly depressed, the outlook for revenue improvement is promising at Whirlaway for 2008. As we mentioned in the release, our revenue and earnings guidance for 2008 will be provided in February of next year during our year-end earnings release. However, we are in the final stages, developmental stages, of our 2008 business plan.

Our initial forecast, particularly in comparison to recent history, reflects very good revenue growth in our metal bearing components business, led by new business awards in our ball and roller business specifically. In addition, new business and share improvements at Whirlaway are forecasted for 2008. These improvements should offset fully the revenue miss that we experienced in 2007, as a result of the HBAC in diesel engine and market reductions.

With respect to the building of our new precision metal components platform, we remain committed to creating a sizable platform that will complement our base business over the next five years. A key part of that growth strategy, as we've mentioned before in other conference calls, is organic growth at Whirlaway, as well as acquisitive growth which will be complementary to their existing business. Because of the disappointing earnings result in our first full year of ownership, it is our intent to limit acquisition activity in the near-term until we fully stabilize and achieve the organic growth and the profitability we anticipated for the business at the time that we acquired it in December of 2006.

For the remainder of 2007 and on into the full year of 2008, we are focused on six key business objectives. First, fully developing, targeting and organic sales and marketing plans for all three of our product platforms; second is leveraging our level 3 program companywide; third completing the customer approvals and revenue timing issues for our China facility; fourth, stabilizing the operations in Slovakia; fifth, strategic product pricing reviews in all of our product platforms and finally, sixth, fully achieving the accretive earnings potential at Whirlaway.

Our U.S. ball and roller operations and in Europe ball roller and cage operations and the rubber and plastic operations continue to operate at good levels of profitability, cost and quality improvement in customer service.

Finally, I'd like to conclude my comments by saying that we would like to restate our belief in commitment to executing on our long-term business strategy. Although 2007 has been an obvious disappointment, the current plan represents a sound vision and solid foundation to profitably grow our business in the near and long-term.

With that, I'll conclude my comments and we'd be happy to answer any questions you may have.

(OPERATOR INSTRUCTIONS).

Our next question comes from the line of Mark Parr from Keybanc Capital markets. Please go ahead.

Hey Rock.

Hey Mark.

Hey, congratulations on the quarter.

Thank you.

Hey, hi; did I hear you say that you thought Whirlaway in '08 could be back to $80 million?

My statement was that we think that the sales growth there will replace what we lost in terms of revenue for 2007. So, maybe just a little short of $80 million, but that's a pretty good estimate.

All right, so that's - can you talk a little bit about the source of that growth? Are there new customers or new markets? Or, is that just the existing, status quo, customer base?

I touched, just briefly, on the issue of marketing plans but, in that particular business, since we acquired it, we've obviously been focused on specific marketing plans to target new end markets and potentially new customers. And there's a lot of good work going on, with respect to that, applying their excellent engineering and sub assembled component, precision metal component products to end markets that would provide value for customers in those end markets. And there's no real new business associated with that marketing planning that I'm talking about for 2008, Mark. Although, in terms of our plan there isn't. We're hopeful that the last six months or so we might see something.

The new business is coming from either share improvements with existing customers and/or improvements with existing customers, not necessarily share related. And some of it relates to HVAC and diesel but not a whole lot. We do, on the HVAC side; we do have share improvements that will assist bringing that business back without any real improvement on the housing starts. So, but by and large, it's new business with existing customers.

Okay. And just looking at the -- now, you said that the bearing component business is looking better for '08. And, I guess, just for a review, I mean, you talked about, I think, three pieces. You talked about European auto, domestic auto and the industrial business. Could you just talk a little bit about the relative sizes of those three in the bearing components arena and maybe give a little color on perhaps the potential magnitude, upside, on the revenue front for next year?

Yes. As I mentioned, we really, certainly, don't foresee any huge increases on the automotive front, globally; with the exception of Asia, of course. I mean, automotive in Asia is growing at a much better clip than the continent in Europe as well as in North America. So that, and our end markets, as you know, Mark, are about 60% related too, by default, because our customers' end markets are to automotive.

So, that 60% is relatively, it will be relatively, flat from an economic growth perspective, moving into next year. The economic growth perspective on industrial end markets, particularly in Europe, which is where we have a big predominance of revenue, is very strong and the forecast continues to be for very strong growth on the industrial side in Europe.

One of the real emerging markets there, that is driving some great industrial products and markets is wind energy. There are large bearings and rolling elements used in all the windmills that are being put into wind energy over the next 10 years in Europe. That's somewhat true in the U.S. as well. So, industrial growth rates can be as low as high single digits up into the low teens. And that, generally speaking, is 35 % to 40% of our consolidated revenue in our metal bearing components business.

But what I was really speaking to, Mark, in terms of growth beyond just the economic growth that we've seen in metal bearing components over the last couple of years, anyway, is new business, specifically in balls in North America and Europe as well as our roller business. And specifically, in our roller business, some growth in cylindricals as well as tapered rollers. And so, we're encouraged by that, relative to an outlook for '08.

In terms of specifically what that means in terms of our percentage growth and/or what it means in terms of dollar revenue, we'd prefer to wait until February of next year to outline that.

Okay and just, if I could, while we're talking growth prospects, and I don't know how much color you gave in your release on the upside for China next year but could you give us some sense of the order of magnitude for upside potential there?

I think we mentioned, in the second quarter, that over 50% of the revenue that we're planning on for 2008, in China, is transfers and Jim alluded to it in his opening comments; are transfers out of our existing operations in Europe and the U.S. And the timing of those transfers and the approval process are some of the issues associated with why the revenue has been disappointing in China this year.

Okay.

And we have specific timing for, probably, 60% of what we hope to load China with next year, in place. And it's toward the end of this year or early in the first quarter of next year. There's a remaining 40% that may not require, necessarily, approval but that is going to require a fixed order from customers that we're planning on. There's no reason to believe that it won't materialize. But it's kind of a 60/40 split for 2008.

Okay, great. I'll get back in queue; I don't want to monopolize but thanks for that color.

Thank you and our next question comes from the line of Michael Corelli from Barry Vogel and Associates. Please go ahead.

Hi, good morning.

Good morning.

Just a couple of questions; on Whirlaway, I'm assuming there's no purchase price adjustment possibilities or anything like that?

No. This particular adjustment was more suited to a write off than cracking back open goodwill and sticking it back in there.

No, I understand that, but I meant as far as the price that you paid for the acquisition. I mean, there was no performance related part or anything like that?

No.

Okay and, as far as the balance sheet, I mean, obviously, with these charges and with the share repurchase, you're reducing your equity and your debt is not reducing that much. Are you concerned at all about the leverage? And is that one of the reasons why you're pulling back on the acquisition activity?

No, it isn't. Our bank agreements, all of our long-term debt agreements, have provisions to exclude non cash charges from consideration. So, it doesn't really impact our lending situation at all.

And Michael, I think the point that our funded debt to free cash flow or EBITDA, which is what we like to measure, we're still very conservative on that front. And the board commitment for a $25 million stock repurchase pro forma, if you look at it on a pro forma basis through 2008, calendar year 2008 by month, we don't exceed funded debt to EBITDA beyond our self-imposed 2 times in any period.

Okay. And, as far as China is concerned, what -- I mean, I guess, you were just talking about some of the details there. But it's taken longer than you expected to get these approvals to move the business over there? Is that more or less the summary?

That's the essence of the issue, yes. And we have specific timing, as I mentioned, on about 60% of it firmly in place. And we actually have some contingency plans, relative to other business, that could potentially move in the event, that wouldn't require approval; that could potentially move, should the other 30% or 40% timing be delayed. And we're working on both contingency plays, as we speak. But, we've got all hands on deck to insure that we get that volume in there, the sales, revenue and production volumes, at a level that operates at, initially, breakeven and then above breakeven, of course.

And then, considering these timing issues, I'm surprised that I read that you were adding capacity there. Could you explain that?

We are. We're adding capacity; we're actually spending the last $6 million in capital, about $3 million for the balance of this year and then $3.5 million or so; Jim, is that correct?

Yes.

...on in to 2008, to fully build out the capacity of the existing infrastructure relative to the plant itself. And, that commitment is there because we believe that the growth in Asia is there, that long-term, the revenue will not be an issue and that there is adequate demand to achieve both fully building out the facility, we will have spent $15 million or so in capital, to create $20 million or so in incremental revenue. And we believe there's $20 million of business there in the medium term; and by medium I'm talking on into 2009, and that we have to capitalize for it.

Okay, and then as far as capital expenditures, what are you expecting this year, and any early thoughts on next year?

This year I think we already announced it at approximately $17 million or $18 million; I don't remember the exact number. And next year it should be about the same, and that is high for the kind of growth rates that we're seeing, but it's because of finishing up China. The next year it should be lower.

Okay. And then just a question on 2008, it sounds like you have some optimism right now, despite, I guess, the recent results. And at Whirlaway, if I read it properly, you're saying that you expect to gain some share with your existing customers, plus you expect some of their businesses to improve. Is that kind of why you expect to do better there?

Yes, although I would tell you that the side of the improvement on Class A truck and diesel engine and housing and HVAC coming back is a very small part of that improvement that we're relying on. I mean it's probably less than 10% or 15% of the total improvement for the full Whirlaway 2008. The rest is improved share and/or new programs with existing customers. I would also say that in terms of Whirlaway itself, our ability to do applications marketing and end marketing into other markets where their competencies apply is excellent. And we still believe that that business can grow very nicely organically long term. Of course the selling cycle is a little bit longer in terms of getting approval and getting programs up and going, but I think we'll be rewarded in terms of a nice organic growth rate there over the next 24 to 36 months.

Okay, thank you.

Thank you. (OPERATOR INSTRUCTIONS) We do have a follow up question from the line of Mark Parr from Keybanc Capital Markets. Please go ahead.

Thanks very much. Rock, do you have any updated guidance on steel price increases for you guys in '08.

Yes we are seeing price increases effective January 1 from both Europe and Asia and they're in the 3% to 5% range. Europe is fixed for all of 2008 at around that range; the U.S. is a six month cycle, so we don't know what will happen in mid year 2008. But for right now it's in a range of 3% to 5% and we're passing that along with no timing delay globally.

All right. Is that the base price and is not inclusive of any alloy surcharges?

No it's a roll up of the entire, of what we're expecting for the total, including surcharges, Mark.

Okay. That's it, I'm sorry, it already got answered. Thanks again Rock.

Thank you.

Thank you. Our next question is a follow up from the line of Michael Corelli from Barry Vogel and Associates. Please go ahead.

Just two quick questions; one you mentioned that you're going to reduce amortization as a result of the good will write off; what kind of quarterly amortization will you not have?

It's miniscule, I think over the course of the year it's less than a penny.

Okay. And as far as the business in China, I know you mentioned you think you can get to $20 million, how much of that is transferred business, and how much is incremental?

50/50.

Okay and what kind of benefit will you get on the business that's transferred?

The business that's transferred right now, as Jim mentioned, is the exact polar opposite of a benefit, because we're transferring business out of the U.S. and Europe in 2007 where we were making -- we had good profitability into there, of course operating below break even, but moving forward we would hope to improve margins on the business as we move it a couple of hundred basis points.

Okay, thanks a lot.

Thank you. (OPERATOR INSTRUCTIONS) Our next question comes from the line of Holden Lewis from BB&T Capital Markets. Please go ahead.

Hey guys, it's Sean Williams in for Holden. Just a quick follow up on the pricing. Could you talk about what the dollar impact was in the quarter?

I already mentioned the sales number, sales were, if you want to call it inflated, by $3.2 million, just from the currency, and the net income impact was $173,000 after tax. So not that great on the net income side.

Okay. And could you just talk a little bit about the progress you're making with rolling through some of the pricing on your customer contracts?

We have, as you know, two major contracts with SKF and the Schaeffler Group, and those won't come up for pricing review until the contracts renew. On other business that is coming through, in some cases we're finding that we do have the ability to review pricing, and in some cases there's a good likelihood of getting some improved pricing on a case by case basis.

All right, thank you.

Thank you, and our next question comes from the line of John Rogers from Ferris, Baker, Watts. Please go ahead.

Good morning.

Good morning.

I just had a question on the -- what effect does moving the $10 million of production out of the U.S. and European operations into China have on those U.S. and European operations? Is that business being replaced, or will there be margin contraction in those businesses?

That's a good question. It does have an impact, and it is having an impact in 2007, but long term as we look into 2008 and '09 we've, as I mentioned, in metal bearing components specifically, in balls specifically, we have some new nice business loading into North America and secondarily Europe, that we hope will replace most of it.

Okay, thanks.

You bet.

Thank you. (OPERATOR INSTRUCTIONS) I'm showing that we have no further questions at this time. Please continue with any closing remarks that you might have.

Thank you again for listening to today's call.

Ladies and gentlemen that does conclude our conference for today.