NN, Inc.
Q2 2019 Earnings Call Transcript

Published: 9 Aug 2019

[Operator:]

Good day. And welcome to the NN Incorporated Second Quarter Earnings Conference Call. Today's conference is being recorded.At this time, I would like to turn the conference over to Mr. [Mark Sherman], VP, Treasure and Head of Investor Relations. Please go ahead, sir.

[Unidentified Company Speaker:]

Thank you, operator. Good morning everyone, and thanks for joining us. I'm Mark Sherman, VP, and Treasurer in Investor Relations. I’d like to welcome you to NN's second quarter 2019 earnings conference call. Our presenter this morning is President and Chief Executive Officer, Rich Holder. Also attending the call is Robbie Atkinson, EVP, Life Sciences. If anyone needs a copy of the press release or the supplemental presentation, please contact Abernathy MacGregor at 212-371-5999, and they'll be happy to send you a copy.Before we begin, I'd ask that you to take note of the cautionary language regarding forward-looking statements contained in today's press release, supplemental presentation and in the Risk Factors section in this Company's 10-K for the year ended December 31, 2018. The same language applies to comments made on today's conference call, including the Q&A session as well as the live webcast.Our presentation today will contain forward-looking statements regarding sales, margins, foreign exchange rates, cash flow, tax rate, acquisitions, synergies, future operating results, performance of our worldwide markets and other topics. These statements should be used with caution, and are subject to various risks and uncertainties, many of which are outside of the Company's control.The presentation also includes certain non-GAAP measures, as defined by SEC rules. A reconciliation of such non-GAAP measures is contained in the tables in the final section of the press release and the supplemental presentation.First, we'll give an update and overview of the second quarter and Rich will provide commentary on the business and discuss results. Then afterwards, we'll open up the line for questions.With that said, Rich, I'll turn the call over to you.

[Rich Holder:]

Thanks Mark. And welcome to the organization. As usual I'll go through the highlights and walk through the second quarter, will give some guidance and we will then open the lines for questions. So let's jump right in the page 3. Second quarter highlights. Sales in the second quarter were $221.7 million. We experienced sales growth of $25.3 million almost entirely driven by the Life Sciences Group. Acquisition contributed $19.5 million in the quarter.Adjusted EBITDA of $39.6 million as our operating performance was in line with our expectations. And our acquisition, integration and synergy capture continue to either be on track or slightly ahead. The adjusted operating margin decreased 20 basis points to 12.4% compared to the prior year, as we continue to be impacted by slowing global vehicle market. Life Sciences margins conversely expanded 60 basis points on a comparative basis.Adjusted diluted EPS of $0.25, let me spend a little time on this. Our EPS was impacted by about $0.04 in the quarter. We elected to repay some of foreign debt which we felt was a more appropriate and efficient use of cash. But effectively accretive and effective tax rate issue for us within the year relative to cash repatriation and such. And so we anticipate the impact to be $0.06 to $0.10 impact over the course of the year. But it was a wise move to do around relative to our leverage and relative to our use of cash overseas.On the cash flow basis, free cash was for Q2 was a use of $7.8 million, which was better than expected. As you know, our typical high watermark for cash usage is usually the second quarter and generally we generate cash for the remainder of the year. So we view the fact we used some $.7.8 million better than plan as a positive condition. As we move on to page 4, again net sales of $22 million, 12.9 % growth compared to prior year. EPS of $0.25 compared to the $0.38. Of course, we had the issuance of 14.4 million shares in Q3 of last year. Our gross margin is up to 26.2% versus 24.3%. This is almost entirely around the continued synergy realization within the Life Sciences business, as well as significant cost reduction issues that were taking within the Mobile Solutions business. And we'll talk to that a little bit more as we as go on.SG&A was flat to 2018. As we move on to page 5, adjusted operating margin 12.4% versus 12.6% in Q2 of 2018. I think it's important to note that the again the Life Sciences' margins expanded by some 60 basis points but was almost entirely offset by the decremental associated with the Mobile Solutions business given the slowing end markets. All-in-all, when you take it all together, I think, it's still a very credible operating performance for the quarter for the enterprise. EBITDA margin of17.9% for the quarter and our outstanding senior debt and leverage at 5.1% which is flat to Q2. Again, as I remind you seasonality typically dictates that second quarter is our high-water mark for cash usage and therefore for leverage.And so we're very pleased that we were able to keep our leverage condition flat. And, of course, we expect now to begin to bring that leverage down through H2. As we move over to page 6, little bit more about the businesses. Life Sciences sales of $91 million, organic growth of 25% on a year-over-year comparative basis. Let's just be clear. We are now rounding the part of the year where it is a like to like comparison because we've now owned all the businesses or going on 12-months and so when we speak about organic growth, it is truly in the -- I'll say the normal definition of organic and services. We continue to outperform the Life Sciences business relative to growth.Integration and synergy capture is either on plan or slightly ahead of plan. And so that's a very positive move and you see that reflected in the operating margin of 22.4% better than expected. And our performance in the businesses is largely driven by our success in the Orthopedics market. So the business is doing well.As we move on to Mobile Solutions as is usually the case, it's the tale of two worlds almost. Mobile Solution is subject to some significant headwinds in the global vehicle market. Sales were $79 million for the quarter versus $88 million last year. And operating margin of 7.2% versus 11.1% last year. We have executed some significant cost reduction initiatives in this group. We are ensuring that we are appropriately right-sized within the organization and we do expect margins to improve through H2.I'll talk a little bit more about the conditions of all the businesses going forward shortly. As we go to page 8, Power Solution, sales effectively flat; operating margin at 19.6% which was in line with our expectation. I spoke to you last couple of quarters that we had been impacted by a customer supply chain issue. That issue has been abated. We did take the effect of that issue one month into the quarter and for the remaining two months of the quarter. It's been abated and as we look out into the year, we expect that condition to be completely resolved. And so it now becomes a non-issue going forward.So as we go to the summary of the quarter, $221.7 million in sales for the quarter. $25.3 million sales growth driven by Life Sciences; EBITDA of $39.6 million, adjusted operating margin of 12.4%; adjusted diluted EPS of $0.25. And our leverage is better than expectation for the second quarter.So what I'd like to do now which is -- we've kind of done the last couple of years is to take a minute and sort of revisit the assumptions that we built the plan on. And gave the initial guidance on and see where we are relative to that. And give you kind of our outlook on the second half of the year. So if you go to page 10, I'll walk you through that business by business and then the overall company. So as we start in Life Sciences, we initially felt that as we came in the 2019 we'd have a solid macro backdrop. We anticipated a 12% to 15% organic growth. And, of course, we felt that our synergy capture and our integration efforts would be appropriate and would drive further margin expansion.We are, in fact, seeing all those things taking place. We see continued strength in the broader end market not only orthopedics but some of the other end markets that we are participating in. And our organic growth is expected to be at or above our initial assumptions. And our synergy captures will either meet or exceed the plan in 2019. So, again, a good story for our Life Sciences business primarily our late cycle business. As we flip the script to our early cycle business, our initial assumption in mobile was that we would grow between 1% and % largely on the backs of the continued CAFE adoption and the new programs coming online and reaching production levels.We expected our adjusted operating margins to normalize in the second half of the year. And the business performs appropriately. As we look forward, we see significant weakness in the global vehicle market. And I will tell you the market was trending down as I'm sure everyone knows. But this latest round of geopolitical strike has caused an even greater rapid deceleration in the market especially in the Chinese market, which is affecting our JV and our WOFE in a significant way. The new programs that we were launching in Europe are in fact being launched. So we are reaping the benefit of no longer having to incur those costs. But they're being launched that severely reduced volume, even less than we originally expected.And so as we look at the business now we think for the year that business will probably experience between a 7% and 10% retraction in the top-line, largely driven by the Chinese market, which is down in the right now 17% to 18%. As we move over to Power Solutions, Power Solutions is largely where we thought it would be net of the supplier -- customer disruption that took place earlier this year. So we -- that reproduction is --of that customer disruption has been resolved. The new programs of being launched on schedule. And so we're adjusting our year-over-year growth from, down from 6 to 8 to 5 to7 simply on the backs of assuming that we are not going to make up for that customer disruption that took place earlier-- early in the year.So when you net all that together for the entire business I think our top-line growth is going to continue to be driven by Life Sciences obviously. And we'll be sort of around in general where we thought we would be. We have launched a significant amount of cost reductions within the enterprise especially focused on making sure that the Mobile Solutions business is right sized and we have --we can drive an appropriate decremental as we go through that business. And our leverage is fundamentally in line with our expectations at this point.So let me just take a minute in case it's not incredibly obvious to everyone listening, this is an organization that is laser focused on delevering the business. We understand the importance of it. We understand that everyone is paying attention to this. And to that end, we have launched a number of initiatives. And so we are reviewing all of our non-core assets up to and including our real estate holdings for appropriate of actions to be able to accelerate on delevering. In fact, just yesterday we signed the agreement to sell our prior corporate headquarters in Johnson City.And so sometime in the third quarter that cash will be finding its way to --into the enterprising and helping in the delevering efforts. Beyond that we have some $20 million to $30 million in opportunities within the enterprise to drive cash that we are actively pursuing. And will continue to pursue for the balance of the year. It's important for me to point these out because these are largely non-operational cash issues. And so as we migrated to sort of a pure operations free cash definition, you will not see these numbers reflected in our free cash. Right and so I think it's important and we will make note of these things as we go forward, so you can tie it all together. But fundamentally these are on non op line. So I think it's important to understand that.With all that said, let's move over to guidance in page 12. I think with the macro backdrop that we see particularly in the global vehicle market, and with the level of uncertainties around some of the trade issues that are going on in the tariff issues that are going on, we just absolutely felt that the prudent thing to do was to in fact revise our guidance. And so we're taking our net sales from what was $870 million to $890 million to $860 million to $870 million, almost entirely back of what's going on in the global vehicle market.We're maintaining our operating margin largely on the backs of the cost reduction work that we're doing. And the right-sizing work that we're doing. We feel pretty confident that our margins will be in the zone. Our EBITDA goes from $166 million to $174 million to $158 million to $165 million; again the margins are going to stay in line. EPS mainly on the tax impact in large way goes from $1.10 to $1.30 to $1.00 to $1.15. And free cash again goes from $40 million to $50 million to $30 million to $40 million. But again let me remind you, there is a number of cash issues that will go to what leverage and the like that are not showing up in this free cash number. Because our definition is cash from our-- we have an operational definition of free cash.So we can move forward to page 13. In the third quarter, we expect sales to be between $217 million and $222 million and EBITDA to be between $40 million and $44 million.With that we will move to open the line for questions.Our first question comes from the Steve Barger from KeyBanc Capital Markets. Please go ahead, sir. Your line is open.

[Q -SteveBarger:]

Hey, good morning, everyone. First questions on the guidance at the midpoint the revenue guide came down $15 million, EBITDA came down $8.5 million, neither of which is too surprising I think given mobile trends. But can you talk about how that reduction flows through to the $10 million lower free cash flow? Shouldn't working cap be a benefit with lower growth to some degree?

[Robbie Atkinson:]

Yes, Steve, this is Robbie. Yes, so I think what you'll see in our free cash flow guidance is we wanted to make sure that we took into account all the actions that would need to be done in order to achieve those cost reductions inside of that. So there could be some one-time costs related to cost reduction initiatives that are in there as well. So we allowed a little room for those things. You are correct that the company will be focused on working capital as a benefit in the second half, we think that's true. And then we also think that the engine that will help drive to the top end of the guidance on cash flow will be the CapEx, as we think our CapEx spending this year will be less than originally anticipated as well.

[SteveBarger:]

Got it, that's great. Did you say how much you'll generate from the Johnson City building? And how much of the $20 million to $30 million in non operating cash flow could be generated in the back half?

[Robbie Atkinson:]

Yes. So the Johnson City building will sell for between $4 million and $5 million. I don't have the exact number in front me. I think it's $4.2 million. That'll happen in the third quarter and then the other opportunities are around our real estate portfolio, we're reviewing that. We, all of that $20 million to $30 million would be in the back half; you'll know when the Q comes out later today. That in the first half we had $10 million of positive items on the investment line, which is where that would show up. That we've already taken action on. So if you look at it for the entire year, if we're able to make something or if we have something that makes sense on the real estate portfolio, you could see something closer to $50 million in total actions taken this year to help make sure that we're accelerating our deleveraging profile.

[SteveBarger:]

That's great. And can you talk about the CapEx cycle in Life Sciences? Where are you in terms of the equipment upgrades? And can you talk about what's been added in terms of dollars you can ship per quarter in terms of order to shipment times? Because, obviously, a really nice growth rate in margin there. I want to see if you can still continue to accelerate that.

[Robbie Atkinson:]

Yes. It's a good question, Steve. So we have made a lot of progress as you know you were there. We put a lot of automation in our case and tray business, which is an area where we've had a lot of focus on making sure that we can bring our lead times in as appropriate. We've done things to create capacity inside our implant and instrumentation business. We're focused on our med surg business in the Northeast around how we create more capacity around our surgical staple business with our customers. And so we are doing a lot of things across the portfolio. We would still expect CapEx inside of Life Sciences in 2019 to be slightly elevated relative to sort of the ongoing sort of 5% of sales view that we would have. We think it's probably more like 6% or 7% this year.But if you look at what we're doing, I think you can see the benefits of it in our margin expansion. And then in our revenue expansion. And we would, and I think it shows Steve to your point and if you look at where we were last quarter we had a greater than $200 million backlog. We've been able to bring that down to just under $200 million. So we've made $10 million or $12 million progress in the second quarter, while maintaining our order book and order patterns, so that we're not -- so that we're seeing the consistent type of order entry that we want to see on a go-forward basis.So we're really pleased with the progress we've made. And we think obviously as we look forward into 2020 that we're going to have the capacity in place. And the ability to continue to meet our customers demands while pulling down our backlog.

[SteveBarger:]

That is great and last question for me. Just broadly speaking any changes to the trend to the outsource manufacturing in the space. And are you seeing more competitors come in or just any market backdrop you can give us.

[Robbie Atkinson:]

Yes. So I think if you look at our customers' behavior, they clearly are looking at how they shrink their supply chain and that obviously benefits us is one of the largest and one of the few global suppliers that they have. Also with our ability to design and develop product for them, we've benefited a lot from our ability to design both from an OEM perspective and put product in the marketplace for them, help them get at the market as well as in terms of our design for manufacture capability.So I think our customers' behavior continues to move in a way that benefits us. From a competitive standpoint, yes, I think everybody is looking at the marketplace as an opportunity to challenge that people run into is that it really is a difficult market to get into. The requirements around regulatory compliance and others really create pretty significant barriers to entry. And so we continue to see the same competitors as strategic competitors to us to our clients. And really not a lot of new competitors coming in that have the type of scale and design capabilities that would create a different environment for us than the one that already exists.

[Operator:]

Our next question comes from Daniel Moore from CJS Securities. Please go ahead. Your line is open.

[DanielMoore:]

Good morning, Rich, Robbie. Thanks for taking the time. Taking about Life Sciences, is the very helpful color on the backlog and how you're working through it. Is the 25% organic growth is that all end market growth? Is there some level of inventory build with new products and new customers? Maybe just help any color on that would be helpful.

[Robbie Atkinson:]

Yes. So, Dan, good morning. Yes, I mean, I think look I think the end market is growing in the high single digits if you were to look at it across the board. We don't really see a lot of turbulence in that number. We think it's going to be pretty static throughout the remainder of the year. I think if you look at our growth beyond that it's really driven by a couple things. It's driven by our sales team which is, I believe we have the best sales team in the industry really driving our unfair share of wins in terms of how we compete against our -- against our competitors.I am doing that using the full breadth and services of the portfolio that we've put together. And so that's really what's driving a lot of that out growth. Our customers certainly have launched programs this year. So if you look at the large joint market, there are a number of new products come in the market this year. And we were able to win and beyond those platforms. And so we're certainly benefiting from those volumes. And I think if you were to ask me if 25% is a sustainable growth rate forever, I think the answer would be no. But we're really pleased with it. And it is enhanced by those product launches and so we're outperforming our marketplace and we're proud of that.But it really is on the backs of working strategically with our customers and making sure we get on the right platforms as they go to market.

[DanielMoore:]

That's perfect. And you answer the question that maybe I didn't ask with perfect clarity. So thank you and then just shifting to Mobile Solutions, obviously, this is huge assumptions embedded in this, but if the market kind of stabilizes around the current run rate in terms of global build rates what would that imply for the range of top line growth for your business for next year into 2020, given the platform's ramping up and what kind of operating margin range would you think be reasonable? I know you want to get into 2020 guide but just trying to get a sense for once we get through the decremental if we leveled off at these build rates what that picture could look like.

[Rich Holder:]

Yes. See your point there's a lot of assumptions in there. If we saw, I would tell you if we saw stability around billed rates inclusive of the new platforms that are coming online or have come online, certainly it would be my assumption that our margin profile would certainly return to normal in 2020. Candidly, we would have already taken out the appropriate level of structural cost and the like and so. It would be a significantly different profile to the business as we go forward. So we'd be much better to do that. The other thing is we have had a few wins in the industrial market. The general industrial market that also put a tucks into that business that comes online in 2020. So I would tell you if we were to stop and we would be flat from where we are today that business next year would probably grow probably two points maybe a little bit more depending on how successful we are with some of these industrial programs.

[DanielMoore:]

Very helpful. And lastly as we look to 2020 as well just based on the current portfolio and market conditions, how much remaining restructuring or integration expense would you expect to incur? Just trying to get a sense for how we might close the gap between kind of your adjusted numbers and GAAP numbers obviously ex amortization next year.

[Rich Holder:]

Yes. And so when you look at 2020 there is very little, there is some remaining acquisition and integration cost around Life Sciences. I would tell you for the entire year it's probably a number around between $5 million and $10 million max. Beyond that and ex amortization that gap is effectively close.

[Operator:]

We will now take our next question; it comes from Rob Brown from Lake Street Capital Markets.Rob Brown from Lake Street Capital Markets. Please go ahead, sir. Your line is open.

[RobBrown:]

I just wanted to dig into cost reduction flex just a little bit more. How long --what's the timing on that? And how long does it take for you to get set for full fully realized?

[Rich Holder:]

Well, we have a number of actions there; there are actions that candidly will be realized within the quarter. There are further actions that will be realized within the entire half. And candidly we will put in some actions in place that will be right sizing the business for 2020. So it spans the entire happen into next year.

[Robbie Atkinson:]

Yes. Just to reiterate what Rich said, I think it's important to know that this is not just about the second half of the year. This is about making sure that our portfolio and our cost within the portfolio align with the environment that we're operating within. So it's cost reductions beyond the end of the year.

[RobBrown:]

Okay, good. And then what's your current CapEx expectation for 2019?

[Robbie Atkinson:]

Yes. So I think if you look at where we are from a CapEx perspective, we would expect CapEx to be in that $40 million to $45 million range for 2019.

[RobBrown:]

Okay, good. And then and then switching to Life Sciences, you've gotten some revenue synergies that you talked about, but what would you say in terms of getting that effort put in place in terms using the rest of the business to drive growth there? Is there more to go or do you feel like you've got that machine running now?

[Robbie Atkinson:]

Well, we're running well but there's a lot of work left to be done. I mean we are still a couple points away from our long-term target that we laid out last year 24% to 26% operating profit, which would translate to about 30% EBITDA. This quarter we were 22.5% and I think for the year we'll be around 21.5%, 22% maybe operating profit. So we still got some room to go on the portfolio in terms of making sure that we've realized all the efficiencies that we need to realize. And we're on track and in some places ahead of plan in terms of those cost reduction initiatives.Clearly, the sale synergies are additive to the plan. And we're really pleased with how we're performing there. But we are still very, very focused on getting our cost structure right across that portfolio. And then really just getting underway. There are a ton of opportunities that we're really just getting underway on in terms of how we work together with our partners in Mobile Solutions and Power Solutions on creating devices and sub assemblies that meet our customers' needs and help them in places where they need our systems and bring a product to market.

[Operator:]

We do have one follow-up question from Steve Buerger.

[SteveBarger:]

Thank you. Yes, I just want to go back to mobile, just make sure I heard you right. You can flex the cost structure fast enough to see a margin increase in the back half. Is that your view?

[Rich Holder:]

Yes. I think we will be at the very least flat to better than where we are today. That is certainly what we think we can pull up. I would say this as barring any further degradation in the end market, right. I've got to put that caveat in there.

[SteveBarger:]

Understood assuming --but your guidance is down 7% or 10% sounds like the rate of decline in the back half will be a little less severe than the first half. Is that a function of easier comps or do you see some stabilization?

[Rich Holder:]

Yes. I think that's more a function of -- I think it's a function of both. I think we are hearing from our customers that there should be some stabilization. I think a lot of the data out there saying that the market is nearing the bottom barring any geopolitical issues. So between that and our ability to sort of move on these cost issues, we think these two will be a little bit less choppy than H1. Keep in mind in H1, it's a really, really tough comp, right. H1 in this business, Q1 in this business last year was a record-setting quarter. It was $94 million or something like that. Q2 was pretty close it was $88 million --$89 million, so, yes, H1 was very definitely tough comp.

[SteveBarger:]

Yes. In the past we talked theoretically about what would happen to adoption rates for CAFE standard products if auto production slowed. Now that we're here, what are the customers saying? And what do you think the OEMs will do given the environment that we're in?

[Rich Holder:]

Yes. So, I think, what we're seeing is acceleration, a slight acceleration of the adoption rate, but the problem is they're launching the platform but it's not coming with any substantive volume, right. And so we're not seeing that pop that we'd hope or we'd like to have seen. So they're sort of making up for the inventory difference, if you will, by slowing of the new platform and killing, some killing off the old platform. So the adoption story continues to hold. The volume story is a bit shaky. Now there are different issues in different markets. You look at a market like China. What they've done is substantially accelerated the adoption story, but what that is done is in large part almost brought the normal production cycle of the cars that are being built now throughout that on almost to halt, right. I say that a little bit for effect but it's really come down substantially because now folks know that there is a new emission standard that is coming. It's very near. The adoption is there. And so the sales of the car sitting on the lots now go real negative real fast or they're highly discounted.

[SteveBarger:]

I understand. So you're saying they're clearing out the inventory of the old models to get ready for the adoption of the new.

[Rich Holder:]

Right and then adjusting the inventory using a decline or a diminished volume for the new.

[SteveBarger:]

Understood and last question for me to the extent that you can talk about it. Any update on the CFO search?

[Rich Holder:]

Yes. Look, we are hoping that we are in our final throes. We're very happy with the candidates that we have. We've down selected and we are very hopeful to that we could conclude this in short order.

[SteveBarger:]

Short order meaning potentially in 3Q?

[Rich Holder:]

That would be our -- certainly in the back half of the year.End of Q&A

[Operator:]

Thank you .Well, as there are no further questions in the phone queue at this time, I would like to hand the call back over to you Mr. Holder for any additional or closing remarks.

[Rich Holder:]

Okay. Thanks, operator. With that we will bring the call to a close. Thanks for joining us and as usual if you need any further information feel free to reach out to Mark at Investor Relations and/or Abernathy MacGregor. Thanks so much and have a good weekend.

[Operator:]

This will conclude today's call. Thank you all for your participation. You may now disconnect.