NN Inc (NNBR) 2007 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the NN, Inc. fourth quarter results conference call. At this time all participants are in a listen-only mode. Later we will 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, February 28, 2008. I will now turn the conference over to Ms. Marilyn Meek.

Thank you and good morning. Welcome to NN's 2007 fourth 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. 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 will open up the line for questions. Now I would like to turn the call over to Rock Baty. Rock, please go ahead.

Thank you, Marilyn. Good morning, everybody, and thanks for joining the call. With me this morning I've got Jim Dorton, our CFO and VP of business development; Will Kelly, Corporate Vice President and Chief Administrative Officer and [Tom Burwell], our corporate controller. Today Jim will provide details regarding our restatement of second and third quarter 2007 results and offer an analysis and commentary on the fourth quarter and full-year results through December 31 of 2007. I would like to conclude the call with comments regarding an outlook and guidance for 2008. With that, I will turn the call over to Jim.

Thanks, and good morning everyone. The last few weeks have created quite a bit of financial activity at NN which has made our fourth quarter release a bit more complicated. On Tuesday we put out a press release announcing our intention to restate Q2 and Q3 for adjustments to the restructuring charges and impairments that we took during those quarters. And yesterday we filed the amended 10-Qs. So if you have a chance to look at those, they are now available.

As you will recall in those two quarters we booked a total of $22 million of pre-tax charges relating to the restructuring of our European ball facilities and to recognize the slow start of our new acquisition, Whirlaway. Of course our methodology and calculations were carefully done, and they were reviewed by our external auditors at the time we did them. However, after receiving some questions from the SEC about how we calculated the customer intangible impairments at Whirlaway and in Europe, and in justifying our approach we tend to believe that we had been too conservative in our cash flow assumptions, and that we should reverse that part of the restructuring charge related to the customer intangible impairment.

So we reversed $7.6 million of pre-tax impairment charges or $5.1 million after-tax, which added that income back into 2Q and Q3 as reflected in the amended 10-Q's. Also if that weren't complicated enough, as mentioned in the press release we had a change in tax related to the restructuring of our German ball plant. We had taken a $1.1 million charge in the third quarter for severance after announcing a downsizing at that plant. The workers responded in the fourth quarter with a surprising offer to reduce labor costs. And so we reversed our position on the layoff during the fourth quarter, so we had to reverse the severance charge, and this did positively impact the fourth quarter.

And then finally, there was an item that we did not control that occurred, the Italian government reduced the marginal corporate tax rate starting January 1 of 2008 by about 6 percentage points. This resulted in us needing to book a reduction in deferred taxes in the fourth quarter, which lowered our average tax rate from the normal range from operations anyway, from the normal range in the high 30% to only 19% from operations. This will also reduce our 2008 average tax rate by about 1.5% for the full year.

So if you eliminate the impacts of the restructuring and impairment charges and the related adjustments, we had net income from operations of $4 million or $0.24 per share. Without the Italian tax adjustments we would have been at $0.18 per share. And for the year, ignoring the restructuring and impairment, we had net income of $12.5 million or $0.74 per share. There is a table in the press release that lays these numbers out for you if you need help reconciling the operating items with the reported non-GAAP numbers.

As we stated in the press release, results from operations were in line with the revised guidance range that we gave you mid year; even factoring out the favorable tax impacts and the other nonstandard operating issues. In general the bearing components business was stronger than we originally expected in terms of sales but was hurt by the volume and operational startup issues in China.

The Precision Metal Components business at Whirlaway was way off as we expected midyear. But now seems to be coming back somewhat. Our improving outlook for 2008 is based on finally getting volume up in China above the breakeven point, moving Whirlaway back to profitability and continuing to grow the European bearing components business. And also weathering a modest US slowdown.

So focusing again on the fourth quarter results from operations sales were $107 million, up $21 million or 25% versus last year. $11.9 million of the increase was due to the acquisition of Whirlaway, $6.6 million of the increase was due to currency and $2.6 million was real growth in bearing components.

Gross margins before depreciation were down from 20.7% in Q4 2006 to 19.9% in the latest fourth quarter due to having a full-year of Whirlaway at a lower than planned margin plus some price reductions in Europe which were not fully offset by manufacturing cost savings. We believe that we will see an improvement in gross margins in 2008 as operations improve at Whirlaway, in China and in Europe.

SG&A expense as a percent of sales was down from 9.2% in the fourth quarter of 2006 to 8.3% in the fourth quarter of 2007. As the lower SG&A percentage costs at Whirlaway combined with higher sales overall to decrease the overall SG&A percentage. This ratio should further improve going into 2008 with higher sales on the same expense base.

The tax rate for the fourth quarter, as I mentioned, was 19% due to the Italian adjustment, down from 34% in the same quarter of 2006. For the full year the tax rate was 34% with the adjustment, which is about a level we expect for 2008.

Looking at the balance sheet, you can see that we ended the year with $111 million of short and long-term debt, up from $103 million at the end of 2006, an increase of $8 million. We had given you guidance that debt would be down $12 million during 2007, but that was before our share repurchase program and our reduction in estimates.

We purchased $9.7 million worth of NN shares in 2007. In addition, net income was around $5 million less than our initial guidance and working capital increased more than we expected. We do plan to repay debt in 2008 and Rock will discuss that in a minute along with a comment on our share repurchase plans.

Capital spending totaled $19.4 million during the year in line with our initial guidance, which was about 84% of depreciation. Property, plant and equipment went up $4.6 million but this was primarily due to currency valuation and the strength of the euro. Goodwill and intangible assets went down a net of $7.5 million for the year due to the impairments we took midyear offset by the reversals taken when we restated.

That is all the comments I have on the financial highlights, and now Rock will talk about the outlook for next year.

Thank you, Jim. I would like to close today's call with comments specifically regarding our outlook for 2008. I will start with comments regarding revenue and then close with some comments regarding EPS and our profitability outlook.

We expect an overall 5% improvement in our revenue in 2008 from 2007. We finished 2007 at $421 million. We are forecasting full-year revenue in 2008 of approximately $440 million. Our underlying revenue forecast is impacted by several factors, of course overall global economic conditions as they exist today in our served end markets, currency, pricing and net changes in market share and product programs. I will comment on each of these drivers right now.

From an automotive perspective and an overall general economic perspective we are forecasting a reduction in North American automotive of approximately 6% and relatively flat automotive economics in Europe. With respect to industrial end market, good growth, we see good growth continuing in Europe and essentially flat conditions in North America. Positively impacting our year-over-year revenue comparisons is improvement at Whirlaway, and our Whirlaway operation associated with recovery of class 8 diesel engine and HVAC end markets. Both of these end markets were negatively impacted in 2007 by prebuild issues. The prebuilt inventories are gone and more normalized demand is occurring so far in 2008.

The overall net economic impact on our 2008 total company sales forecast for the year is a positive $8 million or around 2% up principally driven by improvements at Whirlaway that I just mentioned and continuing strong demand in European industrial end market. Our revenue forecast from a currency perspective reflects a belief that the overall continuing strength of the euro versus the dollar will continue. And for the upcoming year we forecast a favorable impact on translation of euro denominated revenue of approximately $2 million or around 0.5% for 2008.

Based upon current contract provisions with major customers we anticipate flat pricing globally for 2008, price increases are anticipated in certain end markets and with certain customers offset by slight reductions to major customers via our current contractual obligations. Moving forward I think it is important to say that as contracts expire we intend to raise prices moderately to offset both our historical and current inflation that we see and are witnessing in our business for non raw material costs.

With respect to material costs themselves, we are experiencing an additional round of significant price inflation in steel during 2008. But these increases will be passed along on a timely basis to our customers as they occur. Net market share gains and losses and new programs net to a positive impact of approximately $10 million or 2.5%. And this $10 million of new market share gains and new products is primarily associated with gains in both Europe and North America in our metal bearing components business.

Finally, the vast majority of our global manufacturing operations are operating at good levels of capacity utilization rate in the first quarter of 2008. And as we've mentioned our guidance for the entire year for 2008 assumes the same relative level of economic activity we currently are experiencing we will see in the first quarter, will also continue for the entire year.

I would like to shift to earnings now and with respect to earnings we anticipate EPS in a range of $0.90 to $0.95 a share. The midpoint of the range is up 26% from our 2007 results of $0.74 a share from ongoing operations. The earnings improvement for 2008 is driven principally by the following factors. First profitability improvements at Whirlaway, Slovakia and China based upon improvements in both revenue and operating performance.

Second, the market share gains I mentioned in our metal bearing components in both Europe and North America. Third, a continuing improvement from our Level 3 program which offsets inflation associated with energy and other non material cost. As Jim mentioned, SG&A spending as a percent of revenue will improve slightly from 8.7 in 2007 to 8.6% in 2008. For the year we anticipate gross margin improvement of approximately 1% from 20% in 2007 to 21% in 2008. Our 2008 plans do include objectives to dramatically improve working capital performance after a disappointing year in 2007.

We are focusing on improvements in accounts receivable and inventory; we currently have cash flow and working capital improvement objectives as part of our 2008 plan, they total $6.6 million. Our total debt reduction for 2008 will be approximately $22 million. This amount will be reduced by additional debt incurred associated with our stock repurchase plan moving forward.

To the extent we fully execute the remaining $17.4 million on the board approved plan during 2008; net debt would be reduced by $4.6 million for the full year. Our 2008 plans call for no additional Precision Metal Component acquisition pending improved results and completion for the full-year integration of Whirlaway operations.

To summarize we are cautiously optimistic regarding the opportunity to improve our profitability for 2008. Of course the current global economic situation lends itself to temper our optimism with some caution. However, based upon our current view of the first quarter of 2008, we are seeing concrete evidence of improvements from our three problem operations; namely improving revenues at Whirlaway, China and Slovakia, and good operational performance from all three. We are also seeing continuing consistency and performance from our core metal bearing components and rubber and plastics operations moving forward into 2008.

2008 promises to be a year filled with opportunities and challenges. We look forward to both in the year ahead and returning to enhance performance to year-over-year improvements in both qualitative and quantitative profitability. With that, we would like to turn the call over to questions you may have.

(OPERATOR INSTRUCTIONS) Mark Parr, KeyBanc Capital Markets.

I was just -- I wanted to clarify the fourth quarter operation, you took away -- there were three unusual items. Is that fair as far as the quarter was concerned? Or is it just or is the reversal of the union situation did that not impact the fourth quarter at all?

It did impact -- we reversed $1.1 million of the severance charge that we took in the third quarter. And we did not count that as an operating item either in the third quarter or in the fourth quarter when we reversed it. So we ignored that (multiple speakers) and that is $1.1 million pretax and also $1.1l million after-tax. And then so we ignored that, and the Italian tax adjustment would be the other thing that we -- somewhat that is not really an operating item, but it would be in the $0.24; without that, we would be at $0.18.

Terrific. Just wanted to make sure I had that clear. So as we are looking at, as we are kind of looking at what the real number is heading into as far as the quarterly run rate the fourth quarter number is an $0.18 number.

That's correct.

Is that fair to look at? Rock, one thing I was curious about, could you give us an update on the situation in Europe with SKF and Euroball and how that contract is looking '08 versus '07? And any update you can give us also on the INA/FAG situation as far as the progress that you've had with that contract?

Well, we have existing contracts with both customers on the ball business, Mark, that were in the middle of a three-year contract with SKF. And the INA-Schaeffler contract actually expires at the end, essentially at the end of 2008. But SKF goes out through the end of 2009, early 2010. And so and those contracts, as I mentioned in my comments with respect to pricing have in the second and third years very small reductions in price versus what they had in the first year of the contract. So this is the first year, honestly in probably four or five that the net pricing impact on our business overall is a push. We are not forecasting an overall reduction in prices for the first time in five or six years on the basis of where we have non major contracts, non major customer contracts in place. We are raising prices.

Okay, is your pricing language inclusive of raw material pass-through, or is that.

It is. It absolutely is. And Mark one of the things that we had happen to us back in '04, if you'll recall was the issue of a delay of almost a twelve-month calendar year dela0y in some of our contractual language. And now, as I mentioned, we are seeing significant inflation on the raw material front globally. It doesn't matter if you consider European producers or as you know some of our major sources are in Japan. Significant inflation there, either via scrap surcharges or on base unit prices. And those costs are now passed along as they occur contractually. And of course where there is no contract, we will pass them along, as well. But it is really frightening in terms of the amount of increases that we are seeing.

Can you help quantify that in terms of dollars per ton?

Yes, I think we are seeing double-digit increases. On our base 52 100 -- I'm talking on our metal bearing components business now Mark, for balls, rollers, metal cages. We are seeing double-digit increases in the range of 10 to 12%. And it is driven -- well, you follow the steel markets and industry better than we do, of course, but certainly being driven by both scrap and virgin material commodity pricing increases.

It is amazing what is going on, on the flat rolled spot market has gone from 5.40 in December to 7.80 in May in the US.

Yes.

And it is trailing Europe. Europe is up more.

We do have -- we've got annual pricing in place on unit prices we face scrap surcharges which are going crazy. And where we've got six-month firm unit pricing with no scrap surcharges of course midyear -- well January first they went up and they are also going up midyear.

I had one other question, then I will pass it on. If you look at China and Slovakia's revenue contribution, can you give us some color on what that would be '08 versus '07?

We see about a 6 million improvement in revenue in China, $6 million to $7 million improvement in revenue in China '08 versus '07 and about a couple million in Slovakia. Slovakia, their operations had stabilized even into the fourth quarter 2007 in terms of financial performance, and we are continuing to see that on into '08. And then of course at Whirlaway -- did you ask about Whirlaway?

No, but I would be delighted for some more color on that as well.

Whirlaway is really interesting because this prebuilt issue is essentially gone and it was a significant factor in the overall revenue decline that was experienced from '06 to '07 in that business. And our customers in both of those end markets, the prebuilt issues associated with HVAC and the SEER 13 energy rating, energy efficiency rating are gone. And you can say well, the housing market is still flat, flat on its you know what -- but the reality is that prebuilt had about a 50% impact on the overall reduction, as well as housing being down another 50. So we are seeing really good improvement on both the class 8 truck diesel engine side of things, as well as on the HVAC market. And those particular end markets are up 5 to $6 million for Whirlaway versus what we experienced in '07. And that is really nice business that incrementally new business in terms of economic demand for us in '08 versus what we experienced in '07.

And those numbers are inclusive of market share gains or exclusive?

When I talked about overall the economics, not market share, but when I was in the call my comments were on the economic side, that is the bucket that that would belong in.

Good luck in '08. See how you guys do. I guess Bush is saying we're not anywhere close to a recession today, and the market has been doing nothing but go down since he started talking. So we'll see. Thanks.

Holden Lewis, BB&T.

Good morning. The currency, did I hear right that you said you thought the currency impact in '08 would be half a percentage point?

Yes, but obviously if the dollar continues the slide that it has in the most recent area over the last couple weeks, as an example Holden, then that number would be much bigger. And we really finalized our plan back in the fourth quarter at around $1.40. So to the extent that it continues to trade up in the high $1.40 to $1.50, then we would expect some positive impact on both revenue and Euro denominated profitability on the translation side.

Because I mean for the full year in '07 it was about a 5.9% contribution to revenue growth, right?

Yes, but the only basis we have for forecasting that because nobody knows is essentially where it was when we developed our plan back late in the fourth quarter.

Okay, and so the number that you assume in there is basically an average of $1.40 for the year?

Yes.

And on the premise that the contribution is greater than that what is sort of the profit impact of an incremental dollar of foreign exchange revenue? Is that meaningful?

Yes, it is because we have a significant amount of profit coming from our European operations in terms of total euro profitability. So a move from $1.40 to $1.50 is significant.

Even at the profit line?

Yes, on the translation side.

Yes, because every dollar of euro profit we make now comes through for every euro we make comes through today at $1.50 -- but we built the plan at $1.40 and so in translation alone there is that inflation factor on net income.

All right. Just wanted to make sure I understood since that looks a little bit conservative based on today's numbers; understood.

If you've got a view that the euro is going to stay up where it is today, then we are a little conservative.

Okay, and the reason I was asking is because looking at what it has been doing in order for us to get to your $4.40 number, that really assumes taking down the organic growth rate quite a bit. And it doesn't sound like you are seeing any material change in the markets that you are facing that allows you to put up about 4% organic growth or so during 2007. So the message was not that you would necessarily expect deceleration in sort of core business?

With the one exception of our North American exposure to -- on the North American automotive front.

It sounds like that has been -- (multiple speakers) but that has not been stellar to date either, right?

Well it hasn't but I mean we are taking it down another 6% versus the average of 2007. And if you do that, you look at the build rates that they are projecting now for light truck and passenger car, most people are projecting around a 6% reduction.

Okay. Fair enough. In terms of pricing and mix can you give a feeling -- I believe that in the prior quarter this year you have had some negative net pricing impact. Can you talk about what that number might have been in Q4? And again am I hearing right that you are kind of thinking that for '08 the pricing issue should be largely zero?

Yes.

Okay, what was it in Q4?

It was not in Q4, nor was it in for the total year of '07, as I mentioned.

It was not what?

It was not flat in '07.

Pricing was a negative.

Yes, it was.

What was that negative in Q4 roughly?

Negative pricing -- and this is versus the same quarter last year was $3 million.

Okay.

So we lost $3 million off the topline versus the same period last year just due to price decreases.

And is that more than what you had seen earlier in the year?

I don't think we have the year-to-date number here but it is probably fairly --.

Holden, let us get back to you on that because it doesn't annualize. It certainly does not annualize to 12 for the year.

Yes. It doesn't seem like it even really --

No, no. I'm not quite sure why the number is that high based on the bridges we've done for 04.

We can follow up afterwards. But even so, whether it is down 12, down 4, whatever it is, why is it that you believe that pricing will be flat in '08 versus '07?

These multiyear agreements have lower reductions in years two and three than first-year. And in '07 we had first-year going on with a couple of major customers, number one. And that is point number one. And point number two is we are raising prices in non contractual areas of our business as we speak.

Got it.

And so those essentially offset.

Okay, so you do still have minor drags out of the INA and SKF contracts, but it is being offset with benefits elsewhere?

Yes.

And then as you get into '09 do those minor drags go to basically nothing and therefore you can expect to start seeing some positive price contribution as you look out further?

Yes, as I mentioned I mean this is a sensitive situation of course because we -- we got in the discussion on the runaway inflation associated with our raw material costs. But we have inflation that our Level 3 improvements have essentially been offsetting the last three or four years. And with no real impact on margin because of the combination of inflation on the one hand and price reductions on the other. And if you think about what that does, Level 3 has delivered a great deal of benefit. But it is essentially offset both inflation and the price reduction. Moving forward, we are experiencing inflation in '08, and we did in '07 and we did in '06 and a lot of non material related costs, energy. And everybody knows that energy is way up. And we simply can't continue to absorb those without it being reflected in our selling prices long-term. And so we are acknowledging that when contracts renew with our major customers.

As much as currency was sort of based on $1.40 number raw materials have been spiking more dramatically really quite recently. So obviously subsequent to your planning processes what impact does the recent run in materials have sort of on the guidance?

Well, none; because the intention is to pass it through which would increase revenue beyond what I mentioned in my details on the revenue forecast. But it's a corresponding offset in terms of price increase on raw material. So really no impact on the EPS guidance in any way.

But it could raise the revenue above expectations?

Yes, it could.

But reduce the gross margins below expectations?

Well, yes, there is a small percentage where it would just passing along the dollar increases would reduce the margins.

Okay, and then last and I will jump in, the profitability of your three businesses, 3 problem units China, Slovakia and the Whirlaway, how much did we lose in that business in '07 collectively? And what are you expecting in '08 from those three areas?

I'm not sure we are willing to share what we lost collectively from the three but suffice it to say that all three lost in terms of magnitude of losses first with China, second was Whirlaway and third was Slovakia. And for '08 we are anticipating China to be slightly profitable, Whirlaway to improve to a good level of profitability although still well below where we expect them to be long-term, and Slovakia just marginally above breakeven. In Slovakia we have a pricing issue on a major contract there that we are dealing with. But we've, in our guidance we've assumed that no change with respect to that current contract. But it is fair to say, Holden, that those three operations and our focus on improving the results out of those three are a big part of our 26% improvement in EPS. I would also say that the $0.90 to $0.95 has some tempering in it associated with the current economic situation.

So Slovakia you said was largely neutral for '08. Didn't you say in Q4 it was already kind of there?

Well, the last two months of '07 it was there.

And you can't build on that in '08?

Well, they have really done operationally they have done a good job but we have this pricing issue on a major contract that is a significant drag for them right now.

(inaudible) what you've been doing?

Yes, not incremental; its existing business that we've had in the plant since we started it. And the contract actually goes through the end of '09, and we are trying to deal with that right now. But no, nothing to report.

But you've got it stable but you think there is going to be $2 million in extra sales that come in which you should leverage and I guess you are going to lose that leverage from incremental price issues?

What is the actual incremental (inaudible). It is slightly above breakeven, but as I mentioned it was a loss, a significant loss in '07. So there is a big turn there, as well.

Okay, and then China and Whirlaway, you sort of expect those to go to profitability. Are any of them showing any progress through the fourth quarter, or is that still sort of purely speculative?

It is not speculative on the basis of what we're seeing in the first quarter. My comments said we're seeing concrete evidence of real improvement there in both operations on the basis of our booked business on the revenue side. And of course we are seeing good improvement on the operational side as we implement Level 3 specifically at Whirlaway.

Okay, so you are seeing that move towards profitability in the numbers year-to-date?

Yes, and Holden it's not a situation like '07 where we said we were hoping the last six months of the year especially in the China situation for the business to evolve. This is we are getting firm orders. We are shipping against those firm orders and we are seeing real improvement so far in the first quarter. And that is true at Whirlaway, too, based on the improvement in HVAC and diesel as well as some other new business with existing customers.

It is not one of these is all back end loaded things?

It is not a hockey stick.

I will jump back in. Thanks, guys.

(OPERATOR INSTRUCTIONS) Robert Toomey, E.K. Riley Investments.

Good morning. I didn't see a reference in the press release to cash flow, and I wondered if you can just comment on operating and free cash flow in '07 and do you expect to be free cash flow positive in '08?

I actually tried to touch on that briefly in my comments. We anticipate free cash flow in net debt reduction in '08 of approximately $22 million. That $22 million of free cash flow and corresponding net debt reduction will be offset to the extent that we repurchase the remaining $17.4 million of stock that remains available to repurchase based on the board's original plan and approved plan of $25 million. So the stock repurchase plan, of course, is something that we can turn on and off on the basis of how we see the individual, the economy going, whether we are meeting plan objectives, meeting cash flow objectives, the inventory and receivable improvements that I mentioned -- all those things. And so but in total if the plan, as we proceed out through the year, the intention would be that we would continue to buy back stock at that kind of rate.

At the rate similar to the fourth quarter?

Well, there is $17.4 million remaining on a $25 million total plan. And so if you net the $22 million of free cash flow against the $17.4 million, we would still see a $4.6 million full-year reduction on net debt.

Okay.

Is that clear?

Yes.

I made comments about '07. In '07 we actually net, we had negative total free cash flow of $8 million. We increased debt by $8 million but we repurchased $9.7 million of stock. And so and we had forecasted that we would have $12 million of net free cash flow. And so $9.7 million of it was the stock that we bought back. $5 million was our miss on the net income line. And then we had some working capital increase that we did not forecast that we hope to reverse next year in '08.

And why do you think you can do better on working capital in '08?

We have a specific plan with both inventory and receivables that makes us, leads us to believe we can get there and we have new measurement techniques this year to watch it, and we are watching it more closely and we think it is manageable.

If we talk quite a bit about the currency impact generally speaking would you say that you have to like the weak dollar in the sense that it makes you guys a lot more competitive, and do you see that opening up as you look out longer-term -- if the dollar does stay -- if the dollar does not strengthen significantly, do you see that as a competitive advantage? And do you see further business growth opportunities due to the weak dollar?

Good question. Honestly we have structured the company globally and regionally to support our customers with local currencies and local cost structures. And it is true that a weak dollar certainly helps our business. We still export some out of the US, but by and large our European business is served by our European manufacturing operations and our North American businesses served by our North American manufacturing operations. But of course a weak dollar from a translation perspective translating our euro denominated profitability certainly does help. And to answer your question, we certainly like seeing a weak dollar versus a strong dollar in terms of the competitive dynamics of the entire business.

A quick comment on Level 3. You did seem to indicate that you seem to be pleased with the fact -- you said earlier that they are helping to offset inflation. Is there further to go on Level 3, and how much more impact do you feel you can see from Level 3 and has it met your objectives, and do you think there is more to go with that?

Good question. It is not only offsetting inflation in our business, which has been significant, as I mentioned over the last two to three years but it is also been offsetting the price reductions by and large. I mean, our margins have deteriorated. Some of it is associated with the Whirlaway acquisition. But as we look at our core business and our base business our margins have held in there pretty solidly in terms of no decrease and no real increase either. So it is accomplished both, not just inflation, but offsetting the reductions in price.

Moving forward we really -- it has been pretty stable in terms of the amount of cost reductions and quality improvement we've seen in the first full three years of the program. And honestly talking to, reading and talking to other companies that have been at it a little longer than we have, we don't have any reason to believe that there is a big major falloff that will occur over the next two to three years. Continuous improvement in the plan and the skillset that we're putting in place companywide, we continue to train and engage more and more middle to middle managers and employees on the shop floor in the process. And we see it as a continuous improvement process that still has legs for a lot of years to come.

Great; couple other quick questions, if I might. You talked earlier about raising prices and that some of these, particularly in some of your non contractual business you're raising prices where you can. Is there a risk that you could open that up to increased competition, and how are you managing that issue? Are you seeing competitors coming in and bidding for business at very aggressive prices that might impede your ability to raise prices?

It is a good question, and of course, the competitive dynamics vary greatly by each of our individual business units. And individual products. In our ball and our core ball and roller and metal components business, which I referred to today, we have limited competitors, although they are very viable competitors and very large competitors in that business.

So in any pricing decisions, you obviously evaluate whether or not -- what the competitive dynamics are, what the response might be from your competitors. And, of course, there is always risk when you raise prices that a competitive response might mean a loss in share.

But having said that, it's at least our belief that our competitors face the same issues that we do. And I think more importantly, our customers do. And our customers by and large in a lot of their end markets have been raising prices and getting price increases. I mean, that is important. That's an important bit of information in the whole approach to our customers, because we certainly don't want to damage their long-term profitability to the extent they can't pass it along. But in a lot of end markets, they are pressing price increases along and doing it successfully.

Generally, if I might ask one more, generally speaking if you assume like a lot of the economists are assuming, we have a better economy in the second half of '09, till we get back more to a normal time of economy in '09 and 2010, would you say generally speaking that you are as optimistic about the longer-term prospects of the business, more optimistic?

I wondered if you could give us a little bit of a feel for kind of the longer-term position of the business and how you feel about your ability to grow and gain share long-term, because I think you did mention that you gained some share in the fourth quarter.

Actually for 2008 --.

2008?

-- was the share gain that we saw in both North America and Europe. But honestly, we do have specific end markets, especially with our new acquisition of Whirlaway that are tied directly to how housing is doing, and housing started it all, of course.

But having said that, we got hit with a double whammy of both the prebuild and long-term housing reductions that are going on in terms of the overall market. But I guess I, in terms of the end markets we currently serve, the fact that we've got the geographic diversity globally now, where more than 65% of the total company is outside of North America and we have a natural countercyclical ability to offset something that might happen in North America. Of course, everybody says well, if the US has a recession, everybody else will suffer as well.

But frankly, 2008 is a good example of the fact that our global business offers some cyclical relief, countercyclical relief. Europe still is very, very -- the industrial side in particular is very strong, and automotive is not down nearly; it's essentially flat. So to answer your question, I think if we have -- if the last half of '08 in North America in particular improves, '09 should be enough, much better than what we've seen and what we are seeing in terms of our guidance for '08. Because as I think I mentioned to Holden when he was on the phone, that our guidance does -- our $0.90 to $0.95 does have an element of the economic doldrums that we are seeing in the US.

Just one other question related to guidance. Your gross margin guidance, does that include your best assumptions for both foreign exchange and pricing and raw material impact? I'm sure all of that is factored in there, but I don't know if you can provide any color on that.

It is with the exception as we were mentioning of the currency translation. The currency translation impacts not margins necessarily, but overall total net income and EPS. And that, as we mentioned, if it stays at the current rate, the dollar/euro exchange rate that we are currently experiencing, there is potentially upside there.

Okay, great. Thank you very much.

Holden Lewis, BB&T.

Thank you very much. On the productivity side of things, I heard what you said there about sort of expecting no real change, but it is kind of hard to see what the impact of what you've been doing to date is, given all the other kind of crosscurrents in the numbers.

Can you give us a sense, either in terms of dollars or in terms of sort of margin contribution, over the past few years and in 2007, what has Level 3 contributed to the model to give us a sense of what we think '08 is going to look like?

Level 3 has contributed on average around 3% improvement on revenue, Holden. The first three years it has been very consistent at around 3% of overall revenue.

That is basically the same revenue at 3% lower-cost or actually 3% point increase in margin?

It is -- I'm not sure I -- ask the question again.

Are you saying that the 3 percentage point improvement, that is so your margin would be up 3 percentage points on the same revenue stream you are saying that the dollar would have.

If we didn't have inflation and if we didn't have the price reductions the two pieces that I talked about that were offsetting, the Level 3 savings were offsetting.

Okay, so.

What I'm saying is if look at -- you ask a good question and Level 3 has been contributing about 3% of revenue, in terms of pure savings.

Right, okay, so in terms of dollars on the same revenue stream you would deliver the same revenue on 3% less dollars of cost?

Yes.

Got it. Okay, and you expect that same sort of rate to continue in '08 and any sense of when this matures to the point that it becomes less of an incremental contribution, or is this something you will have into the foreseeable future?

I, as I mentioned I think its got plenty of momentum for the next three years, at least, maybe longer. There is great opportunity on the productivity front, as well as the pure Lean initiatives and Six Sigma on quality improvement. So we don't see a reduction in the near term, for sure.

Okay, then on sort of the cash flow side again, it looks like the last two years including '07, your CapEx expenditures have really ramped towards the second half of the year, and it looks like that happened again Q4 and the second half of '07. Give us a sense of sort of that pattern and kind of what you are expecting; what that has gone to, what you are expecting, etc.

There is a natural cycle that occurs based on CapEx that the last six months of the year are always heavier than the first six, just purely on the basis of approvals and reviews of capital projects and so forth. But I am not sure we can give you specifics relative to '08.

I'm wondering the plan.

The plan shows us more of a first-half but I think that cycle of -- you get the budget approved and then you start the year and the spending tends to happen a little bit later. Although the money that we have to spend this year to finish out China has already been committed so that will go early. It could be a little different this year.

In terms of dollar amount obviously the last few years you've been in heavy investment mode. Are we coming to the end of that now that China is kind of finishing up and so we can expect CapEx numbers to be lower in upcoming months or upcoming years?

Upcoming years, yes. '08, though is very close to '07, a little bit less, about $1 million less.

I'm sorry if I missed this earlier. Did you give some detail as to why the working capital number has sort of proven to be a disappointment this year and any color on that?

On the inventory side there were a variety of operational and overall structural issues associated with Europe restructuring where we were in a position of having to really build inventory throughout the year to deal with the restructuring that we were contemplating in Europe. And so on the inventory side that was the reason for the miss. Receivables, any particular comment there, Jim, other than -- I would tell you that we've had issues with receivables for a couple of years. We are seeing really good (inaudible), it sounds silly but based on purely putting some goals and objectives and more of a focused, organizational focus on it we are seeing improvement already. But there wasn't anything particular structurally in the receivable side of it in '07 that was a disappointment.

So inventory is kind of the issue but it sounds like that is somewhat temporary, particularly now that you kind of come to some agreement in Germany. Have you again, you worked down the inventory meaningful.

Yes, and that is the intention for '08. It is precisely that. And the improvement that I mentioned in terms of $6.6 million is very close to equally split between receivable improvement and inventory reduction.

Working capital in '08 you are expecting to actually be a contributor to cash overall, not a drag to it?

That's correct.

Probably about 6 million, 6, $7 million. Okay, great. Thanks, guys.

Robert Toomey, E.K. Riley Investments.

I just want to follow-up on that last question about the contribution from Level 3; you said 3% of revenue. Is that 3% cumulative since the beginning of the program, or is that like 300 basis points per year?

Per year.

Okay. That's a pretty significant then.

Yes.

So has the price decreases that were built into the contracts that we have are significant, as are labor inflation and those kind of things, too.

Energy inflation.

Energy, so it is absolutely critical to operations.

Okay, thanks for that clarification.

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