NN Inc (NNBR) 2008 Q3 法說會逐字稿

Good morning ladies and gentlemen. Thank you for standing by. Welcome to the NN, Inc. Third 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 call is being recorded today, Tuesday, November 4th of 2008. I would now like to turn the conference over to Scott Eckstein. Please go ahead sir.

Thank you operator. Good morning everyone. Welcome to NN's 2008 Third Quarter Results Conference Call. If anyone needs a copy of the press release, please call my office at 212-827-3746 and we'll be happy to 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 webcast available at www.earnings.com.

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

That said, I'd like to turn the call over to Rock Baty. Rock, please go ahead.

Thank you Scott. Good morning everyone. With me this morning, I've got Jim Dorton, our CFO and VP of Business Development, Will Kelly, our Chief Administrative Officer, and Tom Burwell, our Corporate Controller.

Today Jim will provide an analysis and commentary regarding our third quarter results and year-to-date results through September 30th of 2008. And I'm going to conclude the call with comments regarding the global end market economic situation we're currently experiencing and comments regarding our fourth quarter and full-year forecast and guidance.

And with that, I turn the call over to Jim.

Thanks Rock. Good morning everyone. NN was on track for an excellent quarter until the effects of the global economic crisis hit in September. July and August went pretty well with sales remaining above our business plan. But in September we began to see orders fall off. We still ended the quarter in pretty good shape with sales up 5.9% over last year's third quarter, most of that due to currency. And net income from operations was up 80% versus last year. That's excluding the restructuring charges that we booked in 2007. The primary reason for the improvement in earnings from normal operations was improvements in the three operations that were a drag on earnings last year, Whirlaway, China, and Slovakia.

Through most of the quarter, auto demand held up in Europe. In addition, we continued to see fairly strong demand for industrial products worldwide. Our US operations that are heavily dependent on the US auto sector were weak during the quarter as they were earlier in the year. I'm sure you saw the October auto sales numbers that were announced yesterday. So you can see where this decline in business is coming from.

Looking at the year-to-date performance, we remained on our record pace. EPS from operations year to date was up 64% versus last year at a record level of $0.82 per share compared with $0.50 per share last year. Sales also were a record at $349 million for the 9 months, up 11% over the previous year. Excluding currency effects, sales were up $11.4 million or about 4% despite the weakness in the US auto sector.

Obviously the story for 2008 thus far is good operational execution, positive currency momentum, good industrial demand in a relatively stable auto sector in the first three quarters. Unfortunately, a major part of the 2008 full-year story is Q4 and the global economic crisis. As we put in the headline of the press release, we're seeing demand fall at least 20% in Q4. Customers are afraid to order and are clearing out their supply lines. Even though we're taking out all of the marginal cost that we can, a demand drop like this in the short run is going to have a extremely negative impact on our performance. And Rock will talk more about the outlook in a minute.

Looking at the quarter, the third quarter by major operation, we did have a solid performance in the metal bearing components segment in both the US and Europe. Operations in China continued to improve, but we did have a weak quarter as our major customer there took down its inventories and didn't order much. IMC, Delta and Whirlaway, those business units that are heavily exposed to US auto, had a very difficult quarter because of the slowdown in the US auto sector.

NN is impacted in multiple ways by the dollar/Euro exchange rate. In general, we benefit from a strong Euro. During the quarter, the Euro weakened against the dollar from its all-time high of around $1.60 to $1.41 at September 30. This tended to reduce potential earnings from Europe and it also brought down asset and liability levels in the balance sheet. Excluding this currency effect, if you look at working capital, we are still experiencing levels above what we planned this year. Some of this is due to raw material inflation and higher sales volumes. But a significant part of the increase is manageable and should come down in the fourth quarter. Certainly in 2009, we expect to squeeze working capital down as low as possible.

Capital spending totaled $4.8 million for the third quarter in line with our business plan. Year to date, we have spent $13.8 million on capital against a plan of about $18 million. And we should be on or below plan for the full year.

We did not repurchase any stock during the quarter, but we did buy about $1 million worth of shares early in October. Under the current uncertain environment, we do not anticipate purchasing any more shares in the near term, but we will pick up the program again when business conditions improve.

In this uncertain economic environment, I want to spend a minute with you on our financial condition and liquidity position. First, we are financed by a five-year credit agreement, expiring in 2011, headed by Key Bank. And in the bank group, there are also Wells Fargo, Regents Bank, and BB&T. We believe that our bank group is solid and that none of the banks in the group is in danger of failing, although some of the banks could be candidates for consolidation. In any case, we believe that our credit agreement will survive intact for the immediate future.

We are fortunate in that we set up the agreement at a time when borrowing spreads were at historic lows. But we have a-- we now have a committed $135 million credit agreement against which we have $73 million drawn as of today. We are paying LIBOR-- currently paying LIBOR plus 93 basis points with an all-in cost below 5%. And this is at a time when market rates are much, much higher.

Plus we have a fixed rate note with Prudential for $43 million due in 2014-- I'm sorry with $34 million due in 2014 at a rate of 4.98%. So our cost of funds on our $107 million of debt is currently below 5% and should stay that low. And we believe that the financing is secure.

In addition, we have cash on deposit, primarily in Europe, sufficient to fund daily operations for a reasonable period of time in case the US financial system experiences any other short-term dislocations.

Now NN is an unsecured borrower. But we do have financial covenants we have to meet. Our key measure is debt to EBITDA with a limit of 2.5 times EBITDA on the trailing 12 months.

Our current EBITDA ratio is just under 2 times EBITDA. So we have available new debt capacity of about $30 million. Even with this current availability under the agreement, the uncertainty impacting business demand and credit markets today requires that we take extra precautions regarding liquidity. Therefore, we have cut back on non-essential capital expenditures and are eliminating any discretionary spending. And these controls will stay in place until the economy begins to recover.

In summary, NN is in a favorable credit and liquidity position and we have taken steps to maintain that position. We expect to come out of this economic slowdown primed and ready to grow. And I think we all need to hope for a speedy economic recovery and return of consumer and industrial confidence regardless of who wins the election today.

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

Jim, thank you. I'm going to close today's call with comments regarding our results through three quarters briefly. And then comment specifically on the current global economic conditions and how they are impacting our fourth quarter and our full-year forecast and guidance.

I'll begin with comments regarding our overall results for the first three quarters of 2008. Jim just covered those quite well and so the specific details through the third quarter I'll comment on just briefly if I could. Our revenue and earnings results through nine months reflected overall strength in the European economy in general as well as good industrial demand in the North American economy. Our current global footprint with our significant presence in Europe continued to offset the reductions that we experienced and that Jim mentioned with the North American automotive downturn during the first nine months of the year.

In the absence of the current global economic downturn, we experienced solid earnings momentum at NN during the first nine months of 2008. Particularly, as Jim mentioned, in the three operations which were problems in 2007, namely Whirlaway, China, and Slovakia. The improvement in these three operations coupled with continuing strong performance from our US and European bearing components businesses allowed us to perform in a manner which resulted in the record earnings Jim mentioned for the first nine months ending September 30th, 2008, even in a challenging US automotive environment. Our year-to-date EPS from operations of $0.82 a share was up significantly, 64%, from the same period of 2007.

All in all, really good results during the first three quarters of the year. The irony of course for 2008 is the stark contrast between business conditions and results for the vast majority of the year in the sudden change that has occurred in the fourth quarter. That leads me to concluding comments regarding the fourth quarter and full-year outlook.

Let me begin the discussion of our outlook for the remainder of the year by stating the obvious and that is that our overall forecast has changed dramatically since our update during the second quarter earnings release. During our earnings call in the-- during the second quarter, we said and we anticipated a continuing reduction in the automotive markets of North America with a slight reduction in automotive demand in the fourth quarter for Europe. We also forecasted that our industrial end markets in both North America and Europe would continue at healthy levels for the remainder of the year.

The significant change that has occurred was a significant and sudden drop in European automotive demand, coupled with softening in some industrial end markets as well. The magnitude of these forecasted reductions in demand far exceeded our forecast from just three months ago. This global demand drop, namely a significant drop in Europe, occurring in unison with the decline in North America, is obviously a first for us at NN since the establishment of our significant presence in Europe more than eight years ago. Prior to recent developments, our geographic diversity has served us well in terms of buffering us from regional economic issues. That of course, all changed with demand changes in Europe, specifically that have occurred just within the last 30 days.

We have quantified for you in our press release our current outlook for the fourth quarter, a revenue decline of approximately $20 million or 20% from both beginning of the year forecast and the average of our previous quarters for 2008 results. Based upon the revenue reduction in the fourth quarter, we now anticipate earnings to be slightly better than breakeven for the fourth quarter and we are lowering our full-year guidance to a range of $0.83 to $0.85 per share.

Given the swiftness and severity of the revenue shortfall and the resulting impact on our earnings and cash flow, we have implemented immediate actions to mitigate the full year-- to the full extent possible the impact on our businesses. These actions include the following; first an immediate and proportional reduction in variable costs in each of our 14 global manufacturing facilities; second, with the exception of capital spending for new business programs and growth, a freeze all capital; third, the elimination of all non-critical discretionary expenses; fourth, a continuing focus on cash generation and conservation including ongoing working capital performance improvements; and fifth and finally, an ongoing review of our global manufacturing capacity and sizing our capacity to current and long-term market reality.

In closing, I'd like to comment that while the current global economic crisis has severely impacted our current outlook and resulting impact on NN, the underlying foundational improvements reflected in our record-setting earnings results through the first nine months of 2008 are still in place. When demand normalizes, and we certainly don't know when that will occur, we expect the earnings momentum to continue as well. Until then, we will take the necessary actions to weather the current conditions and position NN for future growth.

And with that, I'd like to open the call to any questions that you might have.

Thank you sir. (OPERATOR INSTRUCTIONS) And our first question comes from the line of Holden Lewis with BB&T Capital Markets. Please go ahead.

Thank you. Good morning.

Morning Holden.

Hey Holden.

A couple of things-- I guess the first is, can you tell us what is the impact-- I guess during the quarter how did the three businesses, Slovakia, China, Whirlaway do? And then going forward, I mean do these things slip back into losses in light of sort of the trends that we're seeing now in Q4?

As Jim mentioned, Whirlaway had a rough quarter in the third quarter based upon the acceleration of the continuing reduction in North American automotive. And actually China, in the month of September, also had a rough month of September but they were very good in July and August. And Slovakia performed admirably in, you know the first three quarters in general.

Having said that though Holden, you know we talked in the press release and just my comments just now regarding North America and Europe specifically but I think the other message here is that Asia and specifically what's going on in the Asian markets, there's-- while you don't have negative GDP growth, we are seeing reductions in orders for our Chinese facility in the Asian marketplace and significant reductions. Reductions that are double digit in nature. And so to answer your question, would they go back to the levels of earnings or losses that we were incurring in 2007? No. But will they continue on a track of the improvement that we've seen in the first three quarters? Probably not either. So it's somewhere in between and we don't specifically disclose the earnings by individual operations that you're asking about. But to size it for you, it's a lot better than 2007 but not as good as where we were tracking in the first three quarters of 2008.

Right but I think the three-- without looking at each of the individual units, I think the three business units had sort of achieved marginal profitability in the first half, right?

Yes I think it's fair to say marginal profitability in the first nine months.

Okay and so yes, so it seems pretty clear that those are going to slip back into sort of a loss mode?

Yes, that's fair to say. And but again sizing it versus the 2007 loss, not where we were by any stretch of the imagination in 2007.

Can you refresh us? What was the collective loss in 2007?

We-- as I mentioned we really don't, other than our segment reporting, we've never publicly said what the individual pieces were there Holden.

Okay. And so [Rock] I guess you said you're seeing reductions in orders for the Asian facility now. I missed it in your dialogue but did you mention a single customer had down-- what was the--?

Well yes there was a single customer inventory adjustment issue in the month of September in Asia, our largest customer there for our Chinese facility. But that's a reflection of what's going on globally as well. I mean the automotive business in Asia and certain segments of the automotive business in Asia is down pretty significantly as well.

Okay. Fair enough. Thank you for that. And then in terms of your covenants, obviously with-- presumably you're going to be going to a marginally positive EBITDA. And if this continues on going forward in Europe, looks like it's in its infancy, it's probably not a stretch to think that maybe you could run into sort of a debt to EBITDA issue or what have you with regards to your covenants. How do you perceive that risk right now? And should you breach any of those covenants, what is the, you know, sort of the anticipated consequences?

Yes. I mean it's a good question and we, you know Jim spoke to it just briefly because of our concern there. Having said that, based on the five actions that I just mentioned, including paring capital way back and dealing with the discretionary spending issues and so forth, we can-- given that EBITDA will be lowering, you know lowered over the next 12 months or so, we have the ability to, in managing working capital, we have the ability to pay down a pretty significant amount of debt over the next 6 to 9 months, irrespective of-- almost irrespective of what happens with EBITDA. I don't want to say-- I mean that it's obvious that if it really got bad that that would-- it would impact it.

But in looking at what we physically feel like we could pay down in debt over the next 6 to 9 months and the spread that that would create beyond the $30 million spread that currently exists today, factoring in the reductions in earnings and EBITDA, the associated reductions in EBITDA and we think the risks are pretty minimal. And we're going to do everything we can to ensure that that doesn't happen. Because if it does-- if we were to bump up against a covenant, the obvious remedy there would potentially be that we'd go to market rates on our current facility.

Yes.

And we aren't going to let that happen. So-- but you're right that there's a risk out there long term. Depending on the depth and how long this happens and how long it takes for the economy to respond, there's a risk there that we recognize. But just-- if you just think about it from a pure $30 million exists today based on EBITDA today, you also have to factor in the serious debt reduction goal that we're going to put in place for the next 6 to 9 months as well.

Okay and as you look forward into 2009, I know you're not going to give specific numbers, but is there anything about Q4 that is kind of overheated? In other words, I mean did you get caught such that costs are more dramatic or charges might be in there what have you, so that we don't necessarily take a slightly better than breakeven performance and run it forward into 2009?

I think just the only thing that might be superheated is the reaction of the entire supply base to the slowdown in Europe. I mean not in the US. I mean that's pretty much-- you know that's played itself out in the US. But within Europe, the suddenness of the change and the magnitude of the change and our customers' response to their customers of course is so dramatic that it doesn't necessarily line up with what you hear about the sales rate reductions in Europe on the automotive side. It's more. It's-- the severity is greater. That's not true in the US. I mean look at the numbers that were reported yesterday. But I think there might be some glimmer of hope relative to that relative to what you might-- what we might see in the first and second quarter coming off the fourth. But that's the only thing. There's nothing, Jim there's nothing else or Tom in there that?

I would agree. I mean you saw also Volkswagen come out and reaffirm their guidance for the rest of the year. It seems to be kind of in the face of some of this stuff. So that's why I mentioned the confidence as I think a key factor if we begin to build some industrial confidence out there, so that people will fill the supply chain back to normal levels than that could have a positive influence. But how do you call that?

Okay and what about the general industrial in terms of global trends going forward? I mean have you begun to see that weaken as well?

A little bit in the fourth quarter and a little bit in the month of September, but percentage wise not nearly-- I mean we're talking less than 5% there. And all having said that, we have certain areas of our-- the end markets from customers that are warning us that it could get in double digit reductions over the next six to nine months. But we haven't seen a great deal of that yet. And they appear to be holding up half way decently, honestly.

Okay. So the real question in terms of sort of a breakeven fourth quarter, you would not necessarily carry breakeven into the four quarters of 2009, only because you think there's an inventory destocking that runs its course. But other than that, fourth quarter is kind of a fair representation of the deleverage associated with the volumes?

Yes. You have some seasonality in the third and fourth versus the first and second also. And who knows if that seasonality plays out from 2008 to 2009. But as you know our first and second are much stronger from a pure seasonal perspective than third and fourth.

Okay, thank you.

You bet.

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

Hi guys. This is actually Jason Brocious in for Mark. How are you?

Hey Jason. How are you?

Doing okay. I was just wondering if you could share some of maybe your steel price outlooks for 2009?

It's a very mixed bag on the basis of where the supply comes from in the region of the world. We're actually seeing on the basis of the commodity prices coming down in Europe in scrap, global scrap prices coming down in Europe. We're seeing price reductions from our sources within Europe. But we import steel for our US operations in bearing components, principally from Japan. And we're seeing dramatic increases from the steel producers in Japan. Well effective January 1st.

Okay.

And those, and by the way, our pricing is only three months now. And then of course currency enters into it as well with respect to currency movements on the dollar/yen there. So it's very unstable globally but it's certainly the Japanese situation that we've seen a dramatic increase effective January 1st.

Okay and when might we expect to see some kind of 2009 guidance come from you guys?

We don't guide historically until our February earnings release for the full 2008 results. And we have historically provided guidance for the year moving forward at that time.

Okay, okay. And can you just talk about the-- any new contracts or the magnitude of new contracts in 2009 versus 2008?

Are you talking customer contracts?

Yes. New programs that you might have in place.

Well we have-- I think we've mentioned on several calls that we have several pending new programs in our new platform at Whirlaway. Unfortunately, the benefits of most of those new programs don't hit until late 2009 into 2010. And that's the biggest growth relative to new programs that we see company wide for the next 12 to 18 months. The rest of the business is somewhat driven by what's going on, on the economic front that we just mentioned.

Okay. That's all I have for you guys. Thanks a lot.

Thank you.

Thank you. (OPERATOR INSTRUCTIONS) And our next question comes from the line of Robert Kosowsky with OFI Institutional. Please go ahead.

Good morning guys.

Hey Robert.

How you doing?

Good. How are you?

Good. I was wondering if you could quantify the debt reduction targets that you guys have? I know you said earlier this year you wanted to pay down debt below $100 million, but I was just kind of wondering, given the wave of what's been happening and what cash entering opportunities you guys might have, if there's a debt target you're willing to share with us?

For 2008 or 2009?

I guess through into 2009?

Yes, well I can comment on 2009. We're putting our business plan together as we speak and rolling up the cash flow implications of what 2009 looks like in total, you know what the policy on capital will mean, all those issues. So we don't really have a comment on 2009 other than to say what I said to Holden and that is it'll be a very aggressive debt reduction program for 2009 on the basis of what's occurred. But in terms of between now and year end Jim?

I don't think that we'll have more than about $5 million in total debt reduction.

Okay, so $5 million in the next quarter but then more substantial in I guess first half of next year?

Yes that's fair.

Okay and do you have any I guess comments about some of the cost cutting you're thinking about doing? Does this include kind of like significant revision of the manufacturing footprint? Or kind of what do you guys kind of eyeballing, do you have any kind of quantification for that too?

No specific comments beyond what I said relative to the fact that on an ongoing basis and you've seen some of this from us in our comments relative to other quarterly calls and releases that we're continually looking at our current structure, our current manufacturing footprint. And not only on the basis of what's happened here in the short term, but long term what's the best structure and the footprint. And so that's an ongoing review. And but we aren't ready to talk about any specifics on what that might mean in terms of our review.

Okay and that's prior to continuation of Slovakia I guess potentially picking up some volumes?

Yes I mean we've made I think it's, you know it's-- everybody understands that we've made significant investments in both Slovakia and China. And that those facilities we will continue to invest there. And more volume long term will be produced in those facilities moving forward.

Okay and could you also just give us an idea of some of the magnitude of the new business that you're looking at securing with Whirlaway for 2009 and kind of this past month have I guess kind of new product development and kind of put on hold because of such a kind of bad environment for your customers?

Yes. Actually the new product development and new program development in-- at Whirlaway in the new platform, our new position metal platform is the activity level is very, very high. There hasn't been anything put on hold as a result of the economic condition. In terms of quantifying the magnitude of some of those programs that I've previously mentioned aren't in a position to do that as of yet. But would expect to share something probably in the first quarter, in February when we release.

Okay, but would you expect them to be meaningful to the segment?

They're very meaningful to the segment, yes.

Alright, thank you very much. Good luck.

Thank you.

Thank you. And management, I'm showing that there are no further questions. I'll turn it back to you for closing comments.

Again, thank you for joining today's call. That's all the comments that we have.

Thank you. Ladies and gentlemen, that will conclude today's teleconference. If you would like to listen to a replay of today's conference, please dial into 303-590-3000 or 1-800-405-2236 and enter the access code of 11122000 followed by the pound sign. We thank you again for your participation today. And at this time, you may disconnect. Have a nice day.