NN Inc (NNBR) 2010 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the NN Inc. fourth 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)

I would now like to turn the conference over to Marilynn Meek. Please go ahead.

Thank you. Good morning and welcome to NN's 2010 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 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'll open up the line for questions. With that said I'd like to turn the call over to Rock. Rock, please begin

Marilynn, thank you. Good morning everybody, and thanks for joining the call. I'm in Johnson City. With me this morning, I have Jim Dorton, our Senior Vice President and Chief Financial Officer; Will Kelly, our VP and Chief Administrative Officer and Tom Burwell, our Corporate Controller.

Today, Jim will offer an analysis and commentary on the fourth quarter, as well as full-year results through December 31 of 2010, and, I'm going to conclude the call with additional comments regarding 2010 performance, as well as provide some guidance on our revenue outlook for the upcoming year, 2011.And, with that, I turn the call over to Jim.

Thanks, Rock, and good morning everyone. The fourth quarter came a long way toward completing NN's recovery. Sales were up 23% over the fourth quarter of last year and 41% for the full year. Adjusted for currency and seasonality, sales in the fourth quarter were just 9.6% below the peak levels in 2008.

While we are approaching our historic peak sales levels, we have a much improved manufacturing footprint and cost profile. So, we are going to be much more profitable as we grow. Rock will talk about our new cost structure and also give guidance on 2011 sales levels in a moment.

So, we continue to see strong demand in automotive, truck and industrial markets. Gross margins from normal operations were 20.1% for the fourth quarter, up from 19.4% in the third quarter. We are excluding $2 million of new program startup costs at Whirlaway from cost of sales from normal operations during the quarter. We told you last quarter that we expected these costs to peak in the fourth quarter and they did, but they are continuing at about the same level in Q1. Rock will speak more about that in a minute.

Also excluded from normal operations was $1.1 million of severance and restructuring costs and $0.1 million of foreign exchange gains on inter-company loans. And, we will continue to break out these non-cash gains and losses on inter-company loans and exclude them from normal operations. SG&A was up $734,000 compared with the third quarter due primarily to severance charges. Excluding these non-operating severance charges, SG&A would have been approximately $7.2 million, which is the run rate that we expect for 2011. Depreciation was $4.0 million, down slightly from the third quarter level.

Due to our plant closures and acquired assets reaching the end of their depreciable lives, our depreciation should stay in this range, possibly $4.3 million to $4.5 million per quarter in 2011. The average tax rate was 39.3% during the fourth quarter, which is higher than the 25% blended rate we said that we expected in the quarter. As previously explained, we are not booking a tax benefit for losses in the US until we have a positive three-year look back on income. This likely will not occur until 2012.

We are booking tax charges for income in foreign locations, primarily Italy and the Netherlands. So, depending on the mix of income and losses, the tax rate can look very strange. However, we expect that US operations in total would be profitable in 2011.

So, we will finally get to see the book benefit of having a 0% tax rate here, blended with about a 28% average overseas rate. So, we are looking at between 20% to 25%, a blended rate of 20% to 25%, for 2011. Into 2012, when we most likely will begin to book tax on US income again, we should see a blended rate of between 30% and 35%.

Net income from normal operations totaled $5.1 million for the fourth quarter and $14.6 million for the full year. Adding back the -- these non-operating items, net income was $2.1 million for the quarter and $4.6 million for the year. We have included a table, on the last page of the press release, to reconcile the operating to non-operating earnings numbers.

EBITDA in Q4, including all operating and non operating charges, totaled $9.0 million. Looking at the balance sheet, receivables were down $3.5 million from the third quarter level, but up $13.9 million for the year, reflecting the 41% increase in sales. Inventory was up $5.3 million for the quarter, as we built some strategic stock to prepare for heavier shipments in Q1. Accounts payable was up $11 million for the quarter, and $18 million for the year. And, we typically see a surge of payables at year-end, and a reduction in the first quarter.

We repaid $9.5 million of debt in the fourth quarter, bringing the total debt reduction for the year to $13.6 million, which did exceed our plan. As you have seen in previous years, we tend to borrow early in the year and repay debt toward the end, and, we think this will be the case for 2011 as well. Our debt to full-year EBITDA ratio, at the end of the year, was just below two times. So, you can see that our credit profile is nearly back to normal.

We spent $6.7 million for capital equipment in the fourth quarter, bringing the totals capital spend in 2010, to $15.2 million. The majority of this capital was spent on growth projects at Whirlaway, and growth projects in tapered rollers. The rest was for maintenance and cost reduction projects. As mentioned in the press release, we plan to spend approximately $23 million on capital in 2011. Approximately two thirds of this is for growth projects at Whirlaway and in metal bearing components, and one third for maintenance and cost reduction.

On January 20, our German subsidiary filed for bankruptcy. This company now is operating under the temporary control of a bankruptcy trustee and there will not be a final determination regarding liquidation until later in the year. As of December 31, we were required to account for the operation as a non-going concern, meaning that we had to write the assets down to fair market value.

So, we took a charge of $308,000 for this in December. When the final deconsolidation accounting is done, later this year, we will write off all of the assets and liabilities and our investment in the subsidiary. However, we do not expect this final accounting to result in a significant gain or loss.

And, finally, as mentioned it last quarter 's conference call, we completed a revision to our bank revolving credit agreement and our senior notes agreement on December 21. These amendments extended the bank agreement for four years, set more reasonable covenant levels and lowered the interest rates. Our weighted average interest charge dropped from 7.8% to 6.2%, which will be an annual savings of over $1 million.

We initially set the bank revolving credit agreement at a maximum of $75 million, with an option to increase it by up to $60 million under the same terms, assuming the banks agreed at the time we asked. On March 9, or yesterday, we increased the size of the facility to $100 million, to provide more flexibility for our growth over the coming years.

That concludes my comments. Now I will turn the floor back to Rock.

Thanks, Jim. I'm going to conclude with general comments on 2010 performance and then get into our guidance for 2011. For 2010, revenue earnings and cash flow all exhibited a remarkable turnaround versus full-year 2009 results. With the exception of the third quarter of the year, we experienced -- for we experienced a normal seasonal reduction in revenue in comparison to Q2 of 2010 results, we have experienced revenue growth in consecutive quarters beginning in the third quarter of 2009, and corresponding improvements in earnings and cash flow.

For the full year, on an increase in revenue of $105 million, we improved earnings from a loss from normal operations of $23 million in 2009, to a profit of $15 million in 2010. That represents a positive swing in profitability of $38 million for the year, 40% of every incremental revenue dollar dropped to the gross profit line in 2010. Cash flow from operations nearly doubled in 2010 to a total of $28 million, from $15 million in 2009.

As Jim mentioned, the dramatic turnaround in our results provided the impetus for a new $100 million credit facility in December of 2010, that allows for more normal financial covenants, debt capacity to fund growth initiatives, and a lowering of our interest cost for 2011 and beyond. From an operating perspective, our core metal bearing components and rubber and plastic businesses both delivered solid levels of profitability for both the fourth quarter and for the full year. While Whirlaway incurred major startup costs throughout the second half of 2010.

Where we expect our margins, Jim touched on it, but our gross profit margins from normal operations were 20% in the fourth quarter, and 19.7% for the full year. During 2010, a culmination of three years of company-wide restructuring actions occurred that consolidated our global manufacturing base, removed excess capacity and streamlined our organizational structure. The bankruptcy of Eltmann, Germany, the sale of Tempe, Arizona and the closure of our Kilkenny, Ireland and Hamilton, Ohio facilities represented very difficult but necessary decisions to ensure our future financial strength moving forward. All of these actions serve to dramatically lower our overall fixed cost structure.

Accumulative restructurings combined with other cost reduction initiatives, resulted in a removal of approximately $25 million in annual, permanent fixed cost reductions. Assuming a continuing improvement in the global economic environment, we do not anticipate any further restructuring actions will be necessary in the foreseeable future. However, we intend to continue to manage our cost structure aggressively to ensure that as volume improves, we do not needlessly add to our fixed cost structure.

To summarize the year, we experienced a dramatic turn around in 2010, made possible by the global economic recovery, the efforts and performance of our more than 1,900 employees in our three business units, and converting our three-year cost reduction actions to improve profitability.

I'd like to conclude today's call, if I could, by commenting on our 2011 outlook. We mentioned in our press release this morning that we are forecasting full-year revenues for 2011 to be in a range of $405 million to $415 million. The midpoint of the range, $410 million, would represent a 12% increase over 2000 revenue levels. Our customers' orders and their forecast, continue to exhibit solid growth into the first quarter of this year, and forecast through at least midyear, are very robust.

Our guidance assumes year over year growth of course, in automotive and industrial end markets in North America, Europe and Asia, and new program business growth at Whirlaway for 2011. The new programs from a revenue perspective are on track to contribute $25 million to $30 million of new business for 2011 and up to $40 million for 2012. Our customers and their served end markets continue to exhibit incrementally higher levels of demand versus what we experienced in 2010.

However, concern regarding the sustainability of the growth for us, moving into 2011, is the recent volatility of oil and gas prices and the potential impact on consumer and corporate spending during 2011. Currently, we see no evidence of any negative impact on short-term demand. Although we did not provide annual or quarterly guide -- although we do not provide annual or quarterly earnings guidance at NN, we also mentioned in the press release that our 2011 business plan reflects significant improvement in year over year revenues and net income from 2010 levels.

If our business plan is achieved, 2011 will resent -- would represent an historical record in terms of net income and EPS for NN. While our first quarter revenues are trending to be very strong in our metal bearing components and rubber and plastic business unit, and well ahead of fourth quarter levels in 2010, new programs at Whirlaway will not begin to contribute significantly to revenue or earnings until the second quarter of 2011. For that reason, costs we incurred in 2011 -- 10 at Whirlaway for the start up will continue on into 2011 first quarter at a similar rate of Q4 2010.

In addition to typical startup costs, there has been a significant manufacture ability issue with a single part representing some 70% of the business on one of our two major programs. The manufacture ability issue, although it's been solved recently, late in the first quarter of this year, has caused us to incur significant costs beyond normal startup costs over the last six months.

We do not believe the issue is our responsibility and therefore have been and are currently in discussions with the customer regarding this issue and commercial release in the form of additional price and/or compensation for accumulated costs. As a result of revenue timing on the new programs and the startup costs at Whirlaway, we anticipate that our first quarter will be our lowest quarter of the year in terms of earnings.

Although the length of the start up and the magnitude of the startup cost have and continued to try our patience, we anticipate a return to profitability at Whirlaway as a result of better matching of revenue and expenses on the new business programs, beginning in the second quarter of this year. It is important to note, however, that based upon the strength of revenue and performance in our base metal bearing and rubber and plastic components businesses, during the first quarter to date, we expect that net income and EPS for the first quarter will approach an earnings record for a single quarter at NN, even with the start up costs at Whirlaway.

We also forecast that total Company earnings will accelerate incrementally from Q1, with significant improvement foreseen in the remaining three quarters of 2011.

With that, I'd like to turn the call open -- or open the call for any questions that you might have.

Thank you Sir. We will now begin the question-and-answer session. (Operator Instructions)Our first question is from the line of Brandon Osten with Venator. Please go ahead.

Hello guys, congratulations. It's a great year and good outlook, despite what the stock might be saying this morning. Just a couple of questions, my hands couldn't keep up with all the stuff you guys were saying. So, I guess what I'm working backwards, you said the queue when you're going to take a bit of an earnings hit from Whirlaway, but you still expect record earnings in the quarter? Is that correct?

That's correct.

When you say record earnings though, are you using the $0.30 adjustment -- adjusted, or are you using the $0.15 GAAP?

We're just saying that historically, Brandon, if you look at what we've done in a single quarter, since the company went public, going back to 1995, that our first quarter would represent -- would approach an historical EPS in that income level, even with absorbing the startup costs at Whirlaway.

Excellent. Okay. And, you guys said that Whirlaway contracts were going to be, I think, approaching $20 million this year and $40 million in 2012, you're hoping?

We actually, I just clarified that in my comments, but I said we expect $25 million to $30 million now, so it's slightly higher for 2011, and running at that rate, will occur in the second, third and fourth quarters. As I mentioned, the first quarter is somewhat limited in terms of the revenue side and then, up to $40 million for 2012.

Okay. And, the additional Cap -- I don't know if it's additional by your plan, additional from what I thought it was going to be. Additional CapEx you guys are spending on Whirlaway this year -- is that due to additional contracts that you guys are seeing right now for start up at a later date?

It is, based upon our ramp-up of revenues and additional revenues with one of the two major programs, and it involves moving up capital from the first quarter of 2012 into the third and fourth quarter of 2011. So that, we can be ready for the ramped up and increased volumes.

Okay just two more quick questions here. I know you guys don't comment on earnings. So, I don't know if this is going to hit too close to the line here, but, you guys look like you did an adjusted operating margin of about 9% in Q4. Is that a good -- is that a sustainable number?

Yes.

We commented on growth margins, saying that we did 20% on a gross margin -- on the gross margin line for the fourth quarter?

Right.

And that is sustainable.

Okay. I was looking at the operating, I think was 9%.

Yes, I mean I -- just looking at the gross profit margin, and looking at 20%, and it dropping to 9.%. So, I guess what I'm saying is yes, I mean I'm not sure if there's anything between gross margin and operating that would be unique in the fourth quarter, but --

Yes, we tend to guidance -- give guidance on SG&A and depreciation. And so, those are relatively fixed, and so, as the gross margin grows, there should be some leverage on operating on the operating margin.

Excellent. And then the last thing, can you guys just more qualitatively talk about your three major sectors, auto, truck, and industrial? I know that truck made -- truck production is supposed to be just a rocket ship for two years before it starts to cycle down again, auto looks good, industrial I don't know as much, but I mean, all these factors seem to be growing at more than 10% here for next two years. You have Whirlaway on top of that.I know you guys don't necessarily know the timing, but can you sort of give me a sense of what your customers are saying in the three different sectors in terms of what their one and three year outlooks might be?

You summarized it very well. What we're hearing from customers, and this applies generally speaking to North America, Europe, and Asia, on the automotive front is that, the year-over-year comparisons, in terms of growth, based on sales rates and build rates, are better than what recent forecasts were just a couple of months ago. I would say that our revenue guidance is somewhat in the mid range between what they are saying now versus what they were saying a couple of months ago. That's true for automotive.

On the industrial front, they are very positive with respect to all the end markets, served end markets, on the industrial side in all three major geographic areas of the world. And of course, you mentioned heavy truck. But, heavy truck in particular, in Europe, which is where most of our heavy truck oriented business is, is very, very strong and that deals with our tapered roller business, and Veenendaal the Netherlands, and it's -- and that plant is running pretty much full out right now.

And so, we don't see anything on the horizon from our major customers, or any of our customers for that matter, other than positive momentum. And, you know, we're two months of the way through the first quarter here, and we've seen that, and we continue to see at least through mid-year, which is about all the further we see visibility wise, but at least at midyear, continuing positive forecast.

That's fantastic. Thanks guys. Congratulations again.

Thank you.

Thank you. Our next question is from the line of Phil Gibbs with KeyBanc Capital Markets. Please go ahead.

Morning gentlemen.

Morning.

I had a question on the pre-tax impacts. We have the after-tax impacts and are you using the stated 39% rate on those as far as the way they are flowing through the P&L?

No. The a -- we are using a 0% tax rate on the impacts that relate to US, like Whirlaway, and then we use the 20 -- either 28% or 25% rate on the European ones that flow through. So, there's not much tax impact in there.

So, those are numbers are pretty good use on a pre tax basis then as well?

Yes they're pretty close. It's only some of the severance has a tax impact.

Okay. And so, right now we are looking for some more startup costs in the first quarter to continue at the same level as you had in the fourth and then declining as the revenues build and you have some more efficiency in the pipeline?

That's correct.

Okay. Can you speak a little bit more about the -- is it a manufacture-ability issue on that 70% of the contract?

Yes. I would be glad to. I think the issue, of course, is that, you know, when a new program gets up and ramps up and gets going, we are quoting and looking at designing collaboratively with the customer on the manufacturing and process issues.

And, this particular part, versus the print, in what we were asked to quote on, is quite different than when we actually started manufacturing it and the functionality in the function itself. And, we have added three to four processes over the last six to seven months to meet what is required for the functionality of the part that were clearly, in our opinion, not specified. And, it's taken us six to seven months to get a process stable and as I mentioned, just this month, the month of March, we really stabilized the process and feel like moving forward now beginning in the second quarter.

We're good to go from a process perspective, but, we've incurred -- many of the cost that we've spoke of -- spoken of publicly were with this single part and this single customer and a vast majority, 80% or so. And so, we are merely saying to the customer, look, this isn't -- this isn't what we agreed to and we need to be compensated. It's that simple. And so, the negotiations are ongoing. They did give us a price increase effective January 1, but it's not sufficient. And so, we want -- we want the vast majority of the start up costs slashed, manufacture-ability issue costs to be reimbursed. It's really that simple.

Okay. Perfect. Then, is there any color you could give us on the steel side of the equation, and how that may be a potential headwind for you guys? Or is it something that you are viewing as a pass-through? Because there's obviously been a lot of pressure on commodity costs.

Yes. That's a great question and of course, we have seen inflation globally on steel and our pass-through provisions with customers, we pass it through as incurred. We don't have a time delay. As we incur in the first quarter for example, increases in raw material costs we pass them through as incurred.

Okay, perfect. And then just lastly here, Rock, the facility charge in Germany or accrual, that was in the P&L in the fourth quarter? And did you cite that as a special item?

Yes. That was included in the restructuring charges in the table of excluded items. It's just $308,000, wasn't much.

Okay. And you gave the number in as far as SG&A, ex items was what again I'm sorry, Jim?

I said that the SG&A was up $734,000 and were it not for the primarily severance charges in there, it would be -- it would have been roughly $800,000. It would have been $7.2 per million. Yes it was up from third quarter to the fourth and that's based on the (inaudible).

Okay so the $734,000 you are talking sequential. Okay.

That was sequential. Yes. And then I was making the point on the $7.2 million that was represented -- representative of our run rate.

Run rate. Okay.

Yes, for 2011.

Perfect. I really appreciate it, guys. I'm really looking forward to seeing how the year turns out here.

Thanks so much.

Thank you. (Operator Instructions)Our next question is from the line of Holden Lewis with BB&T Capital Markets. Please go ahead.

Thank you. Good morning.

Good morning, Holden.

Good morning, Holden.

Not to kind of beat this subject up, I guess, but trying to get a little perspective on the revenue guidance, because I guess-- first on Whirlaway, when you talk about $25 million to $30 million, is that which you expect to get, actually realize in 2011? Or, is that kind of like the full year number and you won't get there because Q1 you didn't deliver?

That's what we expect for the full year.

Okay.

Not a run rate. Not a run rate.That's what we expect in a range of $25 million to $30 million for 2011.

Okay. So, the customer actually increased the revenue expectations quite a bit, to be raising the number to the upper half when you're not delivering anything in Q1, right?

Yes, well, and of course, we've got other programs than the major two that I have articulated.There's another program where volume is up pretty significantly as well.

Okay.

But, yes.

And so, if we take the midpoint of your guidance for both Whirlaway and the rest of the business, Whirlaway alone, at $27.5 million, should contribute 7.5% growth. And you're looking at 410 at about 12.2% growth, which means that really, you know, in your core auto, heavy-duty industrial, you're looking 4.5% to 5% growth. Which seems like a low number for any one of those three.

Yes, Holden, there's one other piece. First of all, I said in one of the first questions, I think it was Brandon's question, but anyway, I said that we really, in our guidance, have probably picked the midpoint between where automotive and industrial growth rates globally were looking in the fourth, late in the fourth quarter early in the first versus more recent data. So, there's probably a midpoint in our guidance with respect to that.

And then, of course the other issue is we don't know how the bankruptcy at Eltmann is going to play out with respect to revenue there. That business is still operating under a trustee, German trustee, and we have three or four major customers out of that facility that are still getting product out of the plant in its current operating state, and we are anticipating a loss of some business as part of this process, maybe $5 million to $6 million annually, $6 million to $7 million, we're not sure, $5 million to $7 million, in our guidance, and then retaining the rest of it. And so, those are the pieces that get to the revenue guidance.

And are those three or four customers that you are assuming you lose the $5 million to $7 million, are those three or four customers that you're already supplying out of other plants?

Yes.

So, why would they have any reservation about you moving the production elsewhere, since they are already being supplied from elsewhere?

That's a very good question. But one of the customers, and the largest customer served out of that operation, has a plant right next door to the Eltmann, Germany plant. Literally right next door with a shared parking lot.

Got it. Okay.

And so, that's the issue.

Okay.

But it's a good question. And, of course, we're hopeful that we will retain a lot of that business as well. But, for right now we're saying 50% of it in total.

Okay, and the next thing in terms of understanding the numbers, how are you -- if I heard correctly, you said your adjusted SG&A in Q4 was $7.2 million, is that right?

Yes.

How do you get there?Because I'm looking at the P&L, you have the $8.1 million, I think, and that does not include the restructuring impairment cost item, which would include the German issue. So, I mean, what's that extra $700,000 or $800,000?

It includes, that includes severance of $800,000.Is that after-tax?

Okay.

What you've got in that restructuring number, you've got the German write-off of $308,000 which has a tax -- it does not have a tax effect. You have severance in -- some in the US and some in Europe, and the European piece does have a 25%, 28% tax effect and so, all of it's there. It's just a little bit obscured by what is taxed, what's not taxed.

Okay. So, when you talk about the $1.1 million in restructuring costs--

Mostly in SG&A.

Okay so, that's the $2.29 million and then the balance of it is all SG&A, not cost of goods?

That's right.

Got it. Okay.

Because it's severance.

Got it. Okay. And the final thing is, I guess, just a little bit more of a perspective question.You know, since you're talking about approaching highs on revenues, in the past your record revenues were around $420 million for the year, you do that in 2007, 2008, and in both those years you also achieved about $0.65 of earnings.

You've talked about doing, I guess, $0.78 or basically $20 million or $25 million in restructuring savings. That's $0.78 to $0.98 in savings. If Germany moves to the high end of that range, I mean why shouldn't we be thinking that at $400 million -- you're approaching $420 million in revenues. Shouldn't your earnings be approaching $1.65? Or is there some other -- or is there something we're missing that might sort of moderate that?

Well, I think that there's a moderation on the situation with Eltmann as we mentioned, and I think there is a moderation with respect to the incremental revenue at Whirlaway contributing at a level that you would be looking at for the total company. And, of course, you know as I mentioned, our patience is running thin there with respect to what's happening, but the reality is that there is some moderation relative to, you're talking about $1.60 number, and I think that that's -- and of course, we don't know some of the downside issues associated with what might happen on the topline.So, I mean, I don't want to downplay what your thought process necessarily, Holden, but I would say that if you wrote a report coming out with $1.60 a share tomorrow, based on what we told you today, that you'd be getting way out in front of what we would be comfortable with --

Okay.

In terms of --

Okay. No, that's fine. So basically, on the same revenues, you'd have a slightly lower margin because of the Whirlaway revenues?

Well that, yes, I mean principally that would be it.

Okay. All right. Thanks guys.

Thank you and I'm showing no further questions at this time. I would like to turn the call back over to management for closing remarks.

Okay. I'd like to conclude today's call with a general comment that we are genuinely looking forward to the upcoming year . We are encouraged regarding the overall strength of the global economic recovery and yet cautious that unrest in the Middle East could lead to historically high oil and gas prices, curtailing, to some degree, the rate of recovery. As of now, as I mentioned before, we see no evidence that oil prices are negatively impacting the short-term economy. We are forecasting that 2011 will represent a year in which NN delivers solid and historically significant levels of profitability and EPS. We look forward to 2011 as a result -- as a year that will allow us to continue to serve needs of all of our stakeholders at NN, namely our customers, employees and shareholders. Thanks again for listening to today's

Thank you. And ladies and gentlemen, this does conclude our conference for today. Thank you for your participation. You may now disconnect.