NN Inc (NNBR) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the NN, Inc. third-quarter 2010 conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator Instructions). This conference is being recorded today, Thursday, November 4, 2010.

I would now like to turn the conference over to Ms. Marilynn Meek. Please go ahead, ma'am.

Thank you. Good morning and welcome to NN's 2010 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 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 today's press release. The same language applies to the comments made on today's conference call and the 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 an overview of the quarter, and afterwards, we will open up the lines for questions.

With that said, I would like to turn the call over to Rock. Rock, please go ahead.

Thank you, Marilynn, and good morning, everyone. Thanks for joining the call. With me today in Johnson City, I have Jim Dorton, our Senior Vice President and Chief Financial Officer; Will Kelly, our Vice President and Chief Administrative Officer; and Tom Burwell, our Corporate Controller.

Today, Jim will offer an analysis and commentary on the third-quarter and year-to-date results through September 30, 2010. Then I will conclude the call with additional comments regarding the third-quarter performance, as well as our revenue outlook for the remainder of the year.

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

Thanks, Rock. Good morning, everyone. NN continued our recovery in the third quarter. Adjusted for currency, sales were up 45% versus the third quarter of last year, and that's up 38% if you include the currency hit. Profitability from normal operations is improving as well, and our cost base is much lower than before the recession.

The third quarter is typically seasonally lower than the second quarter, but the drop this quarter was less pronounced than in a normal year because there was more production in the summer in Europe, and the industrial markets are now beginning to recover. Nevertheless, we did experience some seasonal margin erosion versus the third quarter. For the gross margins, excluding nonoperating and nonrecurring items, the gross margin was 19.3% versus 20.8% in the second quarter.

We make several adjustments to reported net income to arrive at a calculation of income from normal operations. These adjustments total $4.8 million and are outlined in the press release. The adjustments include $2.5 million in plant closing and restructuring costs; $1.3 million in noncash foreign currency losses; and $1 million of startup costs associated with the new multiyear sales programs at our Whirlaway division.

Excluding these items, we had net income of $3.8 million or $0.23 per share. Including the items, we had a net loss of $1 million or $0.06 per share.

Of these excluded items, the startup costs and inefficiencies at Whirlaway will continue and peak in the fourth quarter, then phase out early next year. And Rock will talk more about that in a moment. We could also have some additional foreign currency gains or losses, although we have reduced our exposure considerably by converting many of the inter-Company loans to equity.

SG&A is up compared with last year, primarily because of the reinstatement of salaries and performance-based compensation plans to prerecession levels. SG&A was up minimally from the second-quarter level due to currency translation and severance costs.

Depreciation was down $700,000 versus the second quarter. It has now been 10 years since we entered into the Euroball acquisition, and the 10-year depreciable lives of many of the assets acquired has passed, so these assets are now fully depreciated.

The average tax rate was unusual again this quarter. As I have explained in past quarters, we are not booking a tax benefit or cost for income or losses in the US at this time, so the only tax cost that comes through the income statement is the actual tax liability in Europe, where we are currently profitable. Thus, while we have a net loss in total, we still have tax expense.

We are, though, accruing a US tax loss carryforward that will provide cash flow in the future. We are using a 25% blended tax rate in the fourth quarter for planning purposes, but the actual rate will be difficult to project.

Looking at the balance sheet, receivables are up $17 million year to date, primarily due to the sales increase over last year. Inventory is up $3.3 million, although our days of inventory outstanding are down three days as we continue to manage the upturn efficiently from that point of view.

We paid down $5 million of debt during the quarter, as our collections have begun to catch up with our increased sales levels in the first half.

We spent $4.3 million in capital during the quarter, over half of which was for the new sales programs at Whirlaway. Year to date, we have spent $8.7 million on capital, and we will spend up to $8 million more in the fourth quarter.

During the quarter, we ceased operations at the Tempe plant and incurred severance and other closing costs -- severance and other related costs of closing of $1 million, which was as we had planned. But rather than closing the plant down entirely and stranding some of our customers that weren't going to transfer to the Wellington plant, we ended up selling assets and inventory to a new company headed by one of the original founders of that plant. So instead of scrapping the equipment and inconveniencing some of our customers, we sold $3.2 million of assets against seller financing promissory notes.

Now, due to the nature of this kind of financing, we determined that the fair value of the notes was lower than the face value. We took a charge totaling $1.1 million to write down the notes and to revalue the remaining inventory at the plant. We believe that this is a much better outcome than the original plan of scrapping the equipment and closing down production altogether.

Finally, as mentioned in the press release, our bank credit facility expires in September of 2011. So, technically, it is due within one year. Therefore, we've classified all of the bank credit facility debt as a current liability.

Our current bank deal was amended twice during the recession, and the terms do not reflect our improving financial condition or the changes in the banking market. Therefore, we have already begun discussions with our lenders to put a new bank facility in place. We hope to have a new, more favorable facility in place before the end of the year or early in the first quarter at the latest. However, this depends on many factors, so we can't guarantee that it will be done this quickly. In any case, we are very pleased with the support we have received from our lenders, and we look forward to putting in place a new loan facility that is better for everyone.

One final comment -- we normally have a practice of filing the 10-Q on the same day, or very close to it, that we do our earnings release. But we are planning to file the 10-Q this quarter early next week.

That concludes my financial comments, so I will turn the floor back to Rock.

Jim, thank you. Let me begin with general comments regarding the third quarter.

Revenue, earnings and cash flow for the quarter continued a positive trend that has been in place now for five consecutive quarters, beginning in the third quarter of 2009. Although we broke our streak of four quarters of sequential improvement from the previous quarters in terms of revenue, demand remained strong in the third quarter.

Revenue, net of mix, price and currency, was down 4% from the second quarter, much better than our historical third-quarter comparisons, which have averaged down 8% to 10% based upon seasonality factors, particularly in Europe.

Both of our served end markets, automotive and industrial, continued at overall good levels of demand. Our customers experienced improving levels of demand in both automotive and industrial, with industrial end markets outpacing automotive in terms of rates of recovery.

We continue to see year-to-date improvement in annualized revenue run rate, and now estimate that by year-end, we will be down only 10% from pre-global-recession levels, further evidence of a positive trend in terms of the recovery.

With respect to our margins and profitability, although our margins were down 2.5% from the average of the first six months of the year, the third-quarter European seasonality and the $1 million of startup costs at our Whirlaway PMC business unit were the primary reasons for the reduction. As we mentioned in the press release, moving forward, we anticipate returning to first-half gross profit margins of around 20%, again excluding the impact of the new program startups at Whirlaway.

These startup costs have been and will continue to be significant through the end of 2010. As the operation absorbs business from the Tempe, Arizona, closing and three new programs, we expect that the fourth-quarter startup costs at Whirlaway will be approximately $2 million and will peak in the fourth quarter, as Jim mentioned.

With an expected growth rate of 50% in a single year for this business, employment, production costs and other costs have, out of necessity, been incurred some three to six months in advance of any revenue contributions. At the beginning of the year, we planned that this would be a big transitional year for Whirlaway in terms of both restructuring the Tempe facility as well as the major new programs. However, I think it is fair to say that we did not properly forecast the impact and magnitude of these costs, particularly in the third and fourth quarters. We continue to forecast solid levels of improvement for the Whirlaway division in 2011.

From an operating perspective, our metal bearing components and plastic businesses both have delivered solid levels of profitability for the quarter and year to date.

I'd like to conclude today's call by commenting specifically on the fourth-quarter outlook, as well as discuss our full-year revenue outlook.

We mentioned in our press release this morning that we anticipate full-year revenues to be at the high end of our previous guidance of $350 million to $360 million. This guidance assumes a forecast for the fourth quarter that will be slightly higher sequentially than the third-quarter revenues.

Visibility from our customers continues to improve. Our major customers collectively are forecasting strong demand continuing into the fourth quarter and on into the first quarter of 2011.

Although we will not provide full-year revenue guidance for 2011 until we release our 2010 year-end numbers -- and that will be sometime in March of 2011 -- we do see good momentum based upon our customers' forecasts and the substantial growth in our PMC business unit.

We do anticipate for 2011 that global automotive markets' growth rates forecast in various regions of the world will grow modestly in total, while industrial end markets' forecasted growth rates are expected to grow at higher rates than automotive for the upcoming year.

As we mentioned in the release, we expect our liquidity position to continue to improve, along with the credit profile of NN. To that end, we look forward to putting in place a new credit facility by year-end that will allow for ample capital to fully fund our growth and operating needs for the next several years.

Finally, on November 1, 2010 -- just this past Monday -- we celebrated the 30th-year anniversary of the Company's founding, which occurred on November 1, 1980, at our original manufacturing facility in Erwin, Tennessee. The theme, Celebrating 30 Years of Excellence, also honored our original founders -- Richard Ennen, Michael Huff, Leonard Bowman, Larry Edmisten, Paul Farnor, Denny Richards and [Joel Snyder].

More than 30 years ago, these gentlemen started the Company in a single plant producing two products -- precision balls and cylindrical rollers -- products that account for more than 50% of our current global product mix. We are grateful for the foundational culture our founders created, namely people with a great work ethic, technical competence, and a willingness to do whatever it takes to serve our customer. Their legacy regarding NN's culture still exists today in our operations and our more than 1800 employees worldwide.

With that, we would like to open up the call to answer any questions you may have.

(Operator Instructions). Holden Lewis, BB&T.

Just some bookkeeping items -- so the D&A, which has moved down to this [4.2] level, is that 4.2 kind of the level going forward, or how should we interplay the project stuff you're adding in and the stuff that has come out?

Yes, that is the question, and we haven't really come up with a forecast for next year yet. But I think that we will be in the $17 million to $18 million range next year, in total, depreciation and amortization.

Okay. And that does include your best guess for what gets added due to the project stuff?

Yes.

Okay. And then I guess similarly on, I guess, tax rate, you're looking for 25% in 2010. Do you kind of have a -- you are looking at kind of similar rates in that mid-20s in '09 and '10. Should we be using that mid-20s level in '11 and '12, or are there some things that come back in that push that up to a more normal 30%, 35%?

Yes, we've been so far just kind of holding it at 25%, thinking no tax in the US, and then tax rates in Europe that average probably around 30%.

Okay.

But it's anybody's guess, but we will try to give you better guidance when we give -- we are not giving earnings guidance in the fourth quarter, but when we give revenue guidance, at least we will have taken a look at where the income is going to come from and try to make a better cut at it.

Okay. And then, the -- I guess, I think originally with regard to these foreign-exchange items that are in the other line, the original thought I believe was that it was going to be sort of a Q1/Q2 issue, and then it would moderate from there. But it looks like we had a pretty big number in Q3.

What can we expect in that line going forward? Are we going to see this sort of volatility as the normal course at this point, or do we expect to get this back to being a nonfactor?

Well, we've removed two-thirds of the exposure. So on a normal, ongoing basis, the swing would be only a third of what it had been. So I don't think you're going to see a very big number in the fourth quarter, I would say under $1 million either way.

Okay. And that number -- I mean, it went from being a positive in Q1, a positive in Q2, to a negative in Q3. Is that related to the value of the currency, or what's caused the -- how can we anticipate what that should be directionally?

It's strictly related to the euro and dollar relationship. And so, when the dollar weakens, we have these -- as it has been in the past couple months -- we have losses. When the dollar strengthens, we have gains on these inter-Company positions.

Of course, we have this counterbalancing effect going on that since NN has a lot of its income and revenue from -- coming from euros, then when the euro is stronger, we have more translation, positive translation coming through. But what we see in this other line, strong euro equals losses; weak euro equals gains.

Okay. All right. Fair enough. And then can you just kind of give what the operating cash flow -- do you have that for the quarter?

We normally would wait for the Q on that, but I think we -- yes, I can give you something. Income from operations was $13.1 million versus $9.6 million in the same -- for the nine months -- was $9.6 million in the same nine months of 2009.

Okay, all right. I will jump in -- I will go back in the queue. Thanks.

(Operator Instructions). Mark Parr, KeyBanc Capital Markets.

Great quarter; congratulations. I have -- Rock, I think it was you that mentioned you thought that the fourth-quarter revenues would be up a little bit from the third. And could you talk about the source of geographic contribution, and also if there is any differences from an end market perspective as you look at your business mix for the third quarter, fourth quarter and first quarter? That would be really helpful. Thanks.

Okay, sure. You know, honestly, the recovery on the automotive side as well as the industrial side has been pretty consistent in the Americas, Europe and Asia. Having said that, the recovery in the fourth quarter and on into the first quarter of '11, the industrial end markets have come back more robustly in Europe than they have in the Americas.

Most of our business in Asia, of course, is automotive, virtually all of it. And looking into '11, I think it's fair to say that we are forecasting, based upon everybody else's forecasts, of course, and our customers' forecasts, that we expect better growth rates out of automotive in the Americas and Asia than we do in Europe.

Europe will be just slightly up on the automotive front, but very robust industrial end market growth rate in each of our three major regions. And so North America, Europe and Asia on the industrial side will be -- significantly in terms of growth rates themselves, outpace automotive globally.

So, I don't know if that answers the question or not, Mark. But essentially, the forecasts for automotive in Europe are just slightly, up a couple of percentage points up.

Well, it sounds like -- I mean, historically, your industrial business has been a little more profitable than automotive, I think. Is that fair to say?

That's definitely fair to say. And of course, we've seen good industrial improvement in North America, too. It's just the rate of the improvement in Europe has been more robust than North America.

Okay. And just if I could clarify, because I know that one of the other analysts was asking about the currency issue that goes one way or the other. I mean, doesn't there tend to be somewhat of an offsetting operational issue against that below-the-line item?

Yes, on the translation of euros to US dollars, of course, when we are profitable in Europe, yes. And then we've got transactional issues associated with receivables and selling certain transactions in US dollar-based transactions versus euro. But you know, honestly, Mark, this inter-Company issue is a noncash item.

Right.

We have to recognize it for GAAP. And as Jim mentioned, two-thirds of the magnitude of either the losses or the gains have been eliminated as a result of converting it, converting most of these loans to equity. And so the magnitude moving forward is going to be very limited versus the kind of numbers you've seen in the first three quarters.

Okay. All right, that's helpful. I just -- you are in negotiations right now, or getting ready to start negotiations on a new credit facility. And I'm just, you know, based on other things that you are looking at, is there any color you could give us as far as your expectations for the terms of the new facility compared to what you've got right now?

I think it's fair to say that the covenants will be less restrictive, of course, on things like capital expenditures and other issues. We've been limited, as you know, on the capital side. And I think the other big issues, of course, are the total cost we expect to come down, and I would say significantly come down, as a result of the change in our credit profile.

And so, you know, we are going to get back to more I would say normalized covenant language and leverage ratios and so forth versus what we experienced in the heartache of 2009. And it will likely be closer in language and covenant to our previous agreements prior to the global recession.

Okay,. Well, that's a tremendous testimony to the progress you guys have made. And the negative end markets notwithstanding, you guys have done a great job.

And I guess there was one other thing that I was curious about, which is a question I normally ask Rock, is, are there any kind of cost/price mismatches that you might be experiencing from lags of passing through changes in steel costs, say, over the next quarter or so?

No. What I think I've mentioned, Mark, in terms of the economics and the pricing on steel, we are seeing increases, and we are seeing them beginning in those first quarter of '11, but with our current agreements, with virtually -- well, with all of our global customers, those are passed along as incurred.

Okay, terrific. All right. Well, hey, congratulations on the progress. And thanks for taking my questions.

You bet.

Brandon Osten, Venator Capital.

Good quarter. I've got a question on the adjusted earnings. What's the tax rate implied in those adjustments of that $0.24?

Well, it's applied by depending on where those costs were incurred, and most of them were incurred in the US, where there is zero tax rate.

Okay.

But there was some --

(multiple speakers)

Yes, the foreign exchange has some impact on there, because this occurred in Europe, but mostly falling all the way through.

Okay. If I'm thinking next year in terms of how far along the line you are on all the cost cuts you guys have put in place in the last two years, are there more -- like, what's the magnitude -- you -- I can't remember, it was like a $20 million annual program or something. Is that done now, or is there still a bit more to go?

You said $20 million, Brandon. What was the question again? I'm sorry.

I can't remember the number, your cost-cutting program.

Oh, the permanent cost reductions, in terms of structure?

Yes, yes.

Yes, I think it's fair to say that with the Tempe closure/sale, most of those are -- have been completed. There may be a few others in terms of scalewise that would be lessened, but most of those have been completed.

In terms -- you guys should or at least hopefully will be generating some fairly significant free cash flow starting Q2 of next year.

Yes.

Are there plans to pay down -- because you talk about renegotiating your debt -- are there plans to pay down a chunk of that debt? Or how are you guys looking at your capital structure right now?

Yes, we have aggressive plans to aggressively pay down debt in '11 and '12. Of course, there is, in terms of funding needs, there's additional growth programs and getting back to normal levels of capital expenditures that we have not been at in all three of our business units for the last two years, in 2009 and 2010, based on the restrictions that existed in our current facility. But the plan is to aggressively pay down debt in '11 and '12.

And what's a normal CapEx program for you guys, like $17 million, $18 million?

Yes, yes.

Okay. (multiple speakers)

You hit it right on the head. It's $16 million to $18 million.

Excellent. Thanks a lot, guys. Great quarter, good job.

(Operator Instructions). Holden Lewis, BB&T.

So with the $2 million in additional costs for the new project work, that's going to be about I guess $3 million for the full year?

Yes.

How much will fall into '11, or is that going to be essentially all of it, and then we just begin to [farm out] with the revenues in '11?

There might be a small amount that would fall into the first quarter, Holden. But right now, at least, our forecast is that they peak in the fourth quarter, and the revenues, importantly, start contributing in the first quarter.

Yes, I just -- when you say they peak in the fourth quarter, I mean, that could still be $1.5 million in Q1, which is still below. I'm just trying to get a sense of order of magnitude.

No, we aren't anticipating that at all, in terms of the magnitude of any that would fall over into the first quarter.

But having said that, of course, the timing of these programs, based upon what we know today, is that they will start contributing in earnest on the revenue side beginning in the first quarter, basically almost immediately, on some of -- on two of the three programs, at least.

And are you still looking at sort of $20 million to $30 million in revenues, if memory serves, from those programs? And is the progress in booking additional programs or getting a bigger nut out of all that?

Right now, if we had to guess, it would be about $25 million. I mean, our forecast is -- it's not a guess, but our forecast is $25 million on those new programs. And we do have several others that are potential that honestly wouldn't contribute until late '11 or early '12.

Okay, okay. And then just a last question is sort of on that price/mix number. Obviously, it's along nicely. I assume that that's just sort of inflation running through, for the most part.

Given that you are beginning to see the price of raw materials really stepping up in Q1, would we expect to continue to see that pricing mix number kind of in this $3 million, $4 million range through much of 2011, or is there some reason that that 3Q is a little too high?

Well, with industrial coming back, coupled with what you're talking about on the pass-through side, a combination of both.

Okay, so the kind of numbers we're looking at now are probably reasonable -- it's reasonable to assume that you are going to be in that range --

Yes.

-- going forward?

Yes.

Okay. All right, thank you.

Thank you. And there are no further questions. Management, please continue.

Okay. Let me conclude today's call with a general comment that we remain very encouraged regarding the overall trends with our business with respect to revenue, earnings and cash flow. We do see evidence of continuing momentum, which should provide a good basis for continuing improvement in our performance in the fourth quarter and the first quarter of 2011.

We continue to focus on providing the necessary capacity to serve our customers' increasing demand requirements, and to do so profitably.

Thank you again for listening in on today's call.

Ladies and gentlemen, this concludes the NN, Inc. third-quarter 2010 conference call. If you'd like to listen to a replay of today's conference, please dial 1-800-406-7325. For international participants, please dial 1-303-590-3030, and enter the access code 4379074 and enter the pound key. The replay will be available until November 11, 2010.

Thank you for your participation. You may now disconnect.