NN Inc (NNBR) 2013 Q1 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the NN Inc. first quarter 2013 conference call. During today's presentation, all participants will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator Instructions). This conference is being recorded today Tuesday, May 7, 2013.

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

Thank you and good morning. Welcome to NN's conference call. If anyone needs a copy of the press release, please call my office at 212-837-3773 and we will be happy to send you a copy.

Before we begin, we ask you to 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 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 then afterwards, we will open up the line for questions.

With that said, Rock, I will turn the call over to you.

Thank you, Marilynn. Good morning everybody and thanks for joining the call this morning.

With me in Johnson City I have Jim Dorton, our Senior Vice President and Chief Financial Officer; Will Kelly, our VP and Chief Administrative Officer; and Tom Burwell, our Vice President and Chief Accounting Officer.

Today Jim is going to offer an analysis and commentary on our Q1 2013 results and I will conclude the call with additional comments regarding the quarter as well as providing updated guidance on our revenue outlook for 2013.

With that, I will turn the call over to Jim.

Thanks, Rock, and good morning, everyone. I would like to start out by saying that we counted up and this is Rock's 65th conference call with NN and that is quite a ride for any CEO and we just wanted to say thank you for that.

Okay. So onto the quarter. We did not see a fundamental recovery in Europe and Asia markets during this first quarter but we did see some pockets of improvement. Sales of $93.8 million were 10.3% below the first quarter of last year but up 17% from the fourth quarter. European sales of tapered rollers were stronger than expected and sales of balls or also a little better than expected.

The US automotive markets were fairly strong in terms of unit sales but production on some of the platforms that NN serves was soft due to inventory levels for the US automakers. We saw some of this we mentioned in the fourth quarter and it continued into the first quarter as well. Asian markets were still fairly weak with sales a little above the fourth-quarter levels for us.

So to summarize the demand situation, we can say that the US remains fairly strong but that the recovery in Europe and Asia has yet to begin in earnest. We believe that our major customers are still keeping tight inventories and so we haven't seen much evidence of a reversal in destocking impacts that we mentioned in previous quarters. We are expecting still an improvement in volume in the second half based on some modest market recovery and improving inventories.

Meanwhile, our profitability performance remains quite strong. Gross margins of 20.6% were above our plan and well above the 18.1% we had in the fourth quarter.

EBITDA margins from normal operations were 11.4% which was also above our plan and the fourth-quarter level. Our level three continuous improvement program continues to deliver excellent savings that are offsetting the impacts of low volume and inflation.

I would like to note that the gross margin change on the 10 million sales decline was at a 21% rate whereas we expect gross margins to increase at a 30% to 35% marginal rate. The fact that the marginal decline was at a much lower rate level shows our ability to hold down fixed costs in a difficult environment.

Net income from normal operations was $3.6 million or $0.21 per share. This compares with net income from normal operations of $6.6 million or $0.39 per share in the first quarter of 2012.

Gross margin percentages were at the same level as last year which is really good considering the 10% lower revenue. The difference in net income from last year was primarily due to the lower sales levels and higher tax rates which as you will recall from the fourth quarter are higher now that we are again taking tax expense against earnings from US operations.

The effective tax rate this quarter was 32.8% versus 18.2% in the first quarter of last year when we did not accrue tax on US operations and we would expect the tax rate for the remainder of this year to be near the first-quarter level.

We had three items that we excluded from normal operations during the quarter. The first is the exclusion of the foreign-exchange losses on intercompany loans totaling $552,000 pretax or $350,000 after-tax or $0.02 per share. We exclude these gains and losses each quarter and they typically net out during the year.

The next excluded item was a charge for an early retirement program at division and a reduction in force at another unit totaling $415,000 pretax or $301,000 after-tax or $0.02 per share.

The last item was the exclusion of some follow-on costs related to our European cash repatriation project which we completed in the fourth quarter and this had an impact of a little less than $0.01 per share. You may recall we talked about this in the fourth quarter that project and we did exclude all of those cost from normal operations in the fourth quarter.

So in total, we excluded $749,000 in after-tax costs or $0.04 per share from normal operations during the first quarter.

SG&A was $9.1 million during the quarter including the nonoperating items that I just covered. This compares with $8.1 million in the first quarter of last year and $7.3 million in the fourth quarter of this year and we thought this was worthy of some explanation. The fourth-quarter number was unusually low due to year-end adjustments of accruals so the apparent increase over year-end is artificiality high.

However, SG&A spending was approximately $1 million higher than we expected due to several nonrepeating items that include restructuring and severance costs that I mentioned; recruiting and relocation costs; professional fees for completed projects; and foreign exchange on non-US dollar sales and those are foreign exchange gains and losses that we always include in normal income.

Going forward for the rest of this year, we would expect SG&A to average about $8.1 million per quarter from normal operations which would bring the total to 8.9% of revenue for the full year using the middle of our revenue guidance range and this is fairly near our historic average. The other income statement items were in line with the previous year and with our plan.

We are still on track to have higher pretax income and EBITDA in 2013 than in 2012 which was a record in both net income and EPS and this assumes no further weakening of the US market and some very modest recovery in Europe and Asia.

Looking at the balance sheet, you will see the normal seasonal impact of the low December sales versus higher sales in February and March. AR was up $15 million but DSO actually dropped slightly. We kept a tight control on inventory so we actually had a decrease of $1.6 million in inventory and a 10-day decrease in days of inventory. Payables were up slightly with the higher volume levels.

We had capital spending of $3.2 million during the quarter which is in line with our announced plan of $17 million for the year. The majority of the spending as expected was for new sales programs at Whirlaway.

As mentioned last year, we will gauge capital spending to the actual business levels we would see for the remainder of the year.

So for the quarter, we had negative cash flow of $5.5 million which is in line with our normal seasonal trends. We continue to expect to have positive cash flow in 2013 at similar levels as in 2012. This will allow us to fund debt reductions, acquisitions and dividends or buy backs if declared.

That concludes my comments. Now Rock will give you some further information on the quarter and the remainder of the year.

Thank you, Jim. I will begin with general comments that pretty much mirror what Jim said regarding the first quarter.

Revenue and earnings for the first quarter were up actually 6% from our internal business plan which again we anticipated continuing soft demand in Europe when we built the plant. As expected, we experienced sequential growth from the fourth quarter of 2012 in each of our businesses based upon seasonality that Jim also mentioned.

Total revenue was up 17% from Q4 of 2012; however, consolidated sales revenues of $93.8 million during the quarter were down 10.2% in comparison to the first quarter of 2012.

The results on the revenue front were mixed. North America revenue remained healthy however we were impacted in the first quarter by inventory adjustments at two of the three automotive OEMs in North America. Asia was essentially flat and Europe was down 11%. As Jim mentioned, the European reduction was associated with recessionary conditions continuing in much of the EU region we serve.

From a profitability perspective, the first-quarter EPS of $0.21 from normal operations was down from $0.39 in the first quarter of 2012. Nearly 25% of that difference was associated with the increase in taxes associated with recognizing tax expense for our US entities that Jim mentioned, while the balance of the earnings reduction was volume related.

From a margin perspective, the results were very encouraging and better than our beginning of the year objectives.

Total gross profit margins of 20.6% were virtually identical to the first quarter of 2012 margins on $10.7 million less in revenues. All three of our business units continue to contribute to very good margin improvement and margin performance given the revenue pressures we are currently experiencing.

As Jim also mentioned, our Level 3 program is producing exceptional results companywide.

I would like to conclude today's call with general comments regarding the outlook as we have it and then some general comments as well.

Based upon our first-quarter results which were slightly better than our internal plan, as I mentioned, we anticipate full-year revenues in the same range as we guided in March, namely $365 million to $375 million. Although Europe is still the big unknown, we expect revenues in the second quarter to be very close to the revenues we experienced in Q1.

As Jim mentioned, we are still forecasting marginal improvement or recovery for the second half of 2013. If we experience that incremental improvement quarter to quarter, we are very well positioned to leverage the additional revenue into meaningful earnings improvement.

In our earnings release, we reconfirm that our cash flow and debt retirement goal for the year remains at $15 million. As we mentioned previously, our balance sheet is now well positioned to support complementary acquisitions in our Metal Bearing Components business as well as with the Precision Metal Components business as well as a renewed focus on shareholder value actions.

Finally, the search committee of the Board has made real progress with respect to recruiting a new president and CEO. We anticipate the timing of a public announcement naming my successor and the transition to a new CEO to remain at or near the annual shareholders meeting which is scheduled for next week, May 16.

I would like to now open up the call to any questions that you may have and any answers we can provide.

(Operator Instructions). Steve Barger, KeyBanc Capital Markets.

Good morning, guys. Sixty-five conference calls, congratulations.

Thank you.

Rock, I heard you say that you think 2Q revenue probably looks like 1Q. I missed it if you said what you think the sequential operating margin looks like? Do you think that you can drive that up via lower SG&A spending or will it look similar?

It will be up slightly based upon lower SG&A spending.

Okay. Can you frame up your revenue decline by region versus what you think the end market was down? And especially in Europe, how much did you underperform the end markets?

I wouldn't say underperforming the end markets per se in Europe. They really track basically with what the production rates particularly in automotive were down, Steve. So if you think about it in terms of our total revenue miss versus 2012, about 60% to 65% of that miss was in Europe and that was all absolutely in line with the production level reductions principally in automotive.

Then call it another 20% or 25% associated with the issue in North America that we outlined in our press release as well as Jim's and my comments. That was really two OEMs, GM and Chrysler -- not the sales data that has been coming out. That is still very, very positive but if you look at the first quarter with respect to those two OEMs which is where we have the predominance of our business either second or third tier, those were down call it 8% to 9% in Q1.

Their production rates in Q1 were down 8% to 9% in 2013 versus 2012, similar to the first quarter in 2012. We saw that and -- but I guess that -- but we consider that to be a one-off situation moving forward. I think their production rates will line up with the improving sales rates moving forward.

Okay. Was it pretty much all volume or was part of the 10% decline giving up price?

Virtually all volume. There was a little less price on the side of pass-through but by and large it was virtually all volume.

Okay. And your end market outlook projects improving volumes in the second half on modest recovery and improving inventory. Can you quantify what modest recovery means? Is that low single-digit revenue increase year over year or is that more like a mid-single against the easy comps?

Low single.

Okay. Is the commentary about expecting modest revenue recovery based on actual conversations with customers or are you just thinking that we are running at unsustainable levels that have to reverse at some point?

I think that from our perspective, it is based on two things. One is the issue of this inventory situation and not being able to continue. And then the other of course is talking to customers and of course listening to what they say not only to us but publicly as well.

Got you. One more question and then I will jump back and see if anybody else is in line. Accounts receivable increased by about $15 million in the quarter. Are you seeing customers push out terms or slow down payments or what is going on from a working capital standpoint?

There are no change in payment terms there. As I mentioned our days sales outstanding actually declined slightly and so it is all volume related and it is related to the last part of November, December low volume versus the higher volume in January and February -- well, February and March.

Okay. I will jump back in line and if nobody else is there, I will come back.

Thanks, Steve.

Keith Maher, Singular Research.

Good morning, gentlemen. I was wondering if you could maybe talk a little bit more about inventory levels out there at your customers just a little bit more color. Are there particular regions or segments where you think things are in pretty good shape now and others where you think maybe the inventory clearing is not necessarily completed yet?

Keith, what we saw in the fourth quarter was kind of at the end of the year, several automakers in the US that Rock mentioned decided they had enough inventory and they cut back on their orders through the first tier suppliers and then that cut back our orders and we saw that continuing on into the quarter. Even though you saw good robust sales numbers but there was just a little bit over building that has to get through the system in the US.

In the European market, there it is we think a little bit different. You are actually seeing in some of the models that we end up with our product in the volume -- the demand is down and you see still good demand on some of the European luxury models and less so on some of the lower tier models and that is where we end up having the predominance of our sales.

So there you have an actual kind of a demand still being held back but the impact on the inventory situation is more in the US.

Okay, all right. That was helpful. I realize most of the investment this year in CapEx is related to Whirlaway. I wonder if you could talk maybe about some of those programs. I don't know how much detail you can give us but do they have the potential to have better margins than some of your existing Whirlaway business and kind of the timing as to when we would start seeing revenues from some of those programs?

In terms of -- some of the programs have better margins and some are about the same. In general though, we are going to have higher revenue levels that will help us absorb the fixed costs there which will be an increase of profitability there and all these programs we are investing in now don't start new revenue until 2014.

Okay. That is all I had. Thanks a lot.

Ross DeMont, Midwood Capital.

Rock, congratulations on your tenure. It is well done.

Thank you so much.

In terms of -- we had listened to the commentary out of your largest customer in Europe and on their calls and slides, it sort of indicated that they now had inventories in line with production and that they weren't expecting to take down inventories that much more. We were somewhat encouraged by that because we understood that destocking was a part of the problem that you had faced.

But it sounds like you didn't experience an abatement of the destocking in the first quarter. Is that fair to say?

Not a whole lot. That is correct and so that is the basis for some of why we think marginally and incrementally quarter over quarter we could see improvement. Even if there is no real improvement in market conditions and economics.

But the current guidance of $365 million to $375 million doesn't presume much improvement on the destocking front. Is that a fair way to characterize it?

A little bit and we commented that low single digit improvement.

Okay, got you. Because now if second quarter is roughly like first quarter from a revenue level that would mean $185 million in the first half, that would mean your guidance implies something like $178 million to $188 back half. That almost makes it sound like -- that sort of implies potential sequential decline in the back half as opposed to an uplift that. I guess it seems like there is a bit of a disconnect there.

Well, yes, of course you have seasonality in our business relative to our first half versus a second half particularly in Europe the third quarter is very seasonally down. But having said that, I think that as we look at it, it is still a virtual unknown to us of course in terms of what could transpire. But we just look at it that seasonally incrementally we could see low single-digit improvement in the third and fourth and sequentially versus the first and second at which case our revenue guidance would be a little bit on the conservative side.

Okay, okay. Fair enough. Just to make sure I heard you correctly, you are currently thinking EBITDA in 2013 is at or above '12 levels?

That is correct.

Yes, that is right.

Okay, that is all I have got. Thanks so much, guys.

(Operator Instructions). Bruce Geller, DGHM.

Good morning, guys. How far below trendline would you say Europe is running? It is obviously down a lot but I'm just trying to frame in revenues how far below normal it is because I'm trying to get a sense as you build your way back, you mentioned the 30% incremental margin. I am just trying to get a sense for the kind of earnings leverage you may get as that comes back towards trendline?

Hello, this is Tom. The one data point that we had from looking at the market data was new car registrations within the Eurozone and quarter over quarter those were down about 10% and that was from an already lower about 8% to 10% down in Europe last year. So you're looking anywhere from 15% to 20% down from where we were in 2011.

What does that translate into revenues though for you guys? Roughly what are you running today versus what you ran on average from 2007 through 2011? I am just curious how far below normal fairly normalized demand you are?

I was going to say about $40 million or $50 million worldwide below where we should be with the same market share that we had a couple of years ago which we don't think has changed substantially.

Baty: We were a $420 million company in 2011 and now we are down to $360 million and most all of that volume that we have seen drop in Europe in particular.

So you don't think there is any market share shift at all in there?

No, not really.

Okay.

The European picture, a lot of it, as Jim said earlier, is which programs and platforms we are on and which -- some of the higher class higher margin or premium brands BMW and Audi are not down as much as the Peugeots, Renaults, and Fiats. A lot of it is just the mix of which platforms you are on.

Okay. So it sounds like the third quarter is where you expect to see the inflection point on the revenue side?

Yes, but I would also caution a little bit on just that the third-quarter inflection point as you put it that that is also seasonally and sequentially down historically for us since we have been 40-plus% of our revenue has been in Europe. We see a sequential reduction in the third quarter based on seasonality only.

Okay. And in your prepared comments you made reference to the expectation for positive cash flow similar to 2012. Were you referring to operating cash flow or free cash flow or both?

Free cash flow but I guess it would be both because capital spending is expected to be at roughly the same level.

Roughly similar so even with the higher tax rate you would still expect your free cash flow to be in similar range?

Yes.

That is pretty good considering the environment out there so that is encouraging.

And remember even though we are accruing taxes on the US, we have a large NOL left over from the 2008, 2009 timeframe. So it won't really impact cash tax for a while for probably a couple of years at least. That is one reason why the tax doesn't really matter on the cash flow.

Okay, I see. And then again with respect to cash flow, I know that you have made reference on past calls and even in this release to potential strategic initiatives one of which my assumption includes a possible reinstatement of the dividend. How does that play into your commentary about expected debt repayment and free cash flow similar to last year?

Any acquisitions and/or reinstatement of a dividend decision exclude -- are excluded from the $15 million objective relative to cash flow and debt retirement. In other words, the $15 million does not consider anything that we might do acquisition wise or on the shareholder side relative to a dividend or share buyback.

Fair enough. Lastly, acquisitions or strategic initiatives are things that you have spoken about for a while without much really happening in the recent past. I am curious what your pipeline looks like, how close you feel you might be to some things taking place this year?

We have some really good activity. I think I mentioned in the March call in terms of pipeline in both Precision Metal Components as well as Metal Bearing Components. And I would say that they are far enough along to present to our Board in our upcoming Board meeting but I would also say that we have a transition in my position. And of course, our new president and CEO will absolutely want to weigh in on the strategic acquisition front as well.

And so I'm not sure that that will ultimately create some big delay in terms of executing on the strategy long-term. But the shortest of short terms my successor is going to want to weigh in on it.

That makes a lot of sense. That was actually going to be my next question is how do you present an acquisition to the Board when you have not even announced a new CEO? So that all makes sense. I appreciate you clarifying that.

Great.

(Operator Instructions). Steve Barger, KeyBanc Capital Markets.

I know you guys may not have an exact answer at hand for this but I'm wondering if you can help quantify the positive impact of the Level 3 programs? What do you think the operating margin or the decremental would have been a year ago if you had had this revenue level? Is there any way you can frame that up?

Yes, it would be down in the 17% to 18% range. Level 3, Steve, since we instituted it in 2005 has been delivering marginally 2% to 3% on the revenue front or the margin front year in and year out.

Did you say 2% to 3%?

Yes. Actually last year was 4 but I mean on average in the eight years that we have been added, it has ranged from 2% to 3%.

So going back to the prior question, your -- the implication is that you should have much better leverage when the revenue does return?

Absolutely. That is a message we tried to deliver in the press release as well as our comments this morning. And if we didn't deliver it, I want to deliver it based on your question right now.

Good. Message received. Last question from me, given the level of activity that you are seeing in the end markets and how you are projecting revenue to go, how are you thinking about your current manufacturing footprint? And I guess the question is directed primarily at Europe. Is it where it needs to be or is there any rationalization work that needs to take place?

We really do not anticipate any additional rationalization of any of our European manufacturing facilities in the medium term at all. As you know, we rationalized in 2008 and 2009 two facilities there but in our product mix, balls versus tapered rollers and our operations in the Netherlands and Italy and Slovakia, we are sized just about where we need to be and not only at the current depressed level but we are ready, willing and able to respond to the increases in demand hopefully in the next 12 to 24 months given our current footprint. So no real changes there.

So even if the European situation dragged on a little further than we expect and let's hope that doesn't happen, you think you can control costs to the point where you can maintain a reasonable level of profitability and it is really just a waiting game for volume?

That is exactly right, Steve and once again, I think I tried to say that if you just look at where our revenues are in Europe today versus where they were at in 2008 and 2009, in some cases some of our plans are about at the level they were in 2009 in the global recession, when the global recession hit.

And we hemorrhaged red ink in 2009. We are profitable today on those same levels and a lot of it has to do with the fixed costs that were removed as I mentioned but a lot of it has to do with the continuous improvement activities going on in each of our facilities globally. So --

Right, not to look too far ahead but I guess the implication again of the Level 3 activities and the operating leverage inherent in volume suggests that if you got into a nice sustained uptick that operating margin could go to double digits at some point?

Hmmmm. (multiple speakers) Yes, I will --

Rock, you are leaving.

Yes, I am leaving, that is right but I would also say that at the current level of revenue, there is nothing to preclude us from a cash flow operating cash flow perspective that would preclude us from executing on the strategy. And by that I mean our balance sheet is going to continue to remain healthy and continue. We are going to continue to pay down debt pre any acquisition activity of course. And so we are comfortable from a strategic perspective that yes, we can execute aggressively on the growth initiatives now, we don't need to wait for market improvement to make that happen.

That is great detail. I appreciate the time, gentlemen.

Thank you.

(inaudible)

I just had a couple of quick questions. My first question is given how weak the yen has been, are you seeing the Japanese exporters become more aggressive?

I would say not in any great detail or not -- we haven't seen a whole lot of that. Of course the Japanese, our Japanese competitors have manufacturing facilities in each of the regions that we compete with them. They have facilities in Europe, they have facilities in North America and of course they have facilities in Japan.

So the exchange rate hasn't had a big impact on them becoming more aggressive out of their Japanese facilities and exporting into Europe and/or the US as an example that at least we have witnessed in the last six to nine months.

Okay, that is good. My second question is on the acquisition pipeline. Given how good the core business is today despite the depressed conditions, are you seeing a lot of acquisitions that are either better businesses than the core business that we have or cheaper in terms of valuation or both?

It is interesting. I can comment on a couple of situations in the pipeline and say that from a EBITDA margin perspective, we aren't interested -- one of our screens of course is that I'm not going to say never here because as somebody else mentioned, I am leaving.

But one of our screens of course is to look at the margins that the current businesses and potential targets are achieving and how they relate to our core business and our total corporate averages. And one of our screens is that we don't want to do anything dilutive margin-wise and we have been able to find nice businesses that are at or above our current margin and in consolidated margins.

So that hasn't really been an issue thus far. Moving forward I think that there is plenty of opportunities that will be at or above our core business margin-wise.

But those businesses that you have higher margin, I would presume that they are trading significantly higher prices than what we are trading at?

Of course we have talked about this and when our enterprise multiple is below 5, that is true but we also don't think that we have to execute on some of these acquisitions. We don't think we have to be in the stratosphere with respect to significantly above 5 relative to what some of these business could be acquired for.

Okay. Thank you. I appreciate it. Without knowing more about the potential acquisitions and knowing a little bit about NN, it just seems like the benchmark or the baseline against which the acquisitions should be compared seems like an acquisition of 2 million or 3 million of our shares which are trading at a pretty good price in a business that we know well and obviously like.

Very good. I appreciate that input.

Great. Thanks very much.

Thank you.

I am showing no further questions in the queue. I will turn it over to management for closing remarks.

I will conclude today's call with a summary comment regarding our current view and outlook for 2013. We have already mentioned the economic outlook of course and particularly in Europe and that it remains uncertain. But I also said in the Q&A that at these reduced sales levels our resulting level of profitability and cash flows remain very healthy and more than sufficient to begin an aggressive execution of our current strategic growth plan. For that reason we remain very optimistic regarding our outlook at NN and the ability to resume our top and bottom line growth into the immediate future.

Thank you again for listening to today's call.

Ladies and gentlemen, this does concludes our conference for today. If you would like to listen to a replay of today's conference, please dial 303-590-3030 or 1-800-406-7325 with access code 461-5406. Thank you for your participation. You may now disconnect.