NN, Inc.
Q3 2014 Earnings Call Transcript

Published: 4 Nov 2014

[Operator:]

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the NN, Inc. Third Quarter 2014 Conference Call. [Operator Instructions] This conference is being recorded today, November 4, 2014. I would now like to turn the conference over to Mr. Robbie Atkinson. Please go ahead, Mr. Atkinson.

[Robbie Atkinson:]

Thank you, operator. Good morning, everyone, and thanks for joining us. I'm Robbie Atkinson, Corporate Treasurer and Investor Relations Manager. And on behalf of our team, I'd like to welcome you to NN's Third Quarter 2014 Earnings Conference Call. Our presenters this morning are President and Chief Executive Officer, Richard Holder; and Senior Vice President and Chief Financial Officer, James Dorton. Also here are Will Kelly, Vice President and Chief Compliance Officer; and Tom Burwell, Vice President and Chief Accounting Officer. If anyone needs a copy of today's press release, please call the financial relations board at [phone], and they'll be happy to send you a copy. Before we begin, I'd ask that you take note of the cautionary language regarding forward-looking statements contained in today's press release, and in the Risk Factor section of the company's 10-K for the year ended December 31, 2013. The same language applies to comments made on today's conference call, including the Q&A session, as well as the live webcast available at www.earnings.com. Our presentation today will contain forward-looking statements regarding sales, margins, foreign exchange rates, cash flow, tax rate, acquisition 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 non-GAAP measures is contained in the tables in the final section of the press release. Before we begin, I'd like to mention our upcoming second annual Analyst Day, Thursday, February 5, 2015 in New York. We hope everyone will be able to join us. First, we'll give an update and an overview of the quarter and then afterwards we'll open up the line for questions. With that said, Rich, I'll now turn the call over to you.

[Richard D. Holder:]

Thanks, Robbie. Good morning, and thank you for joining our Q3 investor call. Q3 2014 will undoubtedly be remembered as one of the most exciting quarters of NN history. The summary of the quarter is a true testament of teamwork, focus and drive by all involved. In Q3, we closed 2 acquisitions, RFK in Bosnia and Chelsea Grinding in Jackson, Michigan. We did so, while continuing to improve our operating performance and our market penetration. As positive as those events have been, our fourth acquisition and most transformative deal was finalized during the quarter. A wonderful deal that allowed us to fill out our precision machining components portfolio and I think it's safe to say, as you look back on the quarter, that the speed at which the team has executed the transformation of NN into a diversified industrial company has been credible, and has certainly set a reference point for our future. With that said, I'll turn it over to Jim to walk through some of the financials and I'll return in a minute to talk to some other issues. Jim?

[James H. Dorton:]

Okay. Okay. Thanks, Rich. As Rich mentioned, the third quarter was a very exciting time for NN. Our financial performance, it could be broken down into the tale of 2 companies, the old NN, i.e. before acquisitions, and the new NN. And geographically it's a tale of 4 continents, North America and Asia and Europe and South America. I'll try to break these -- this analysis out in a simple way so that you can clearly understand how we did in the quarter. Of course, we had significant acquisition and integration related expenditures during the third quarter. We are calling out and excluding the costs that were expensed from normal operations, so that we can focus on actual operating results. During the quarter, we expensed $11.4 million pretax or $9.2 million after tax of the acquisition and integration costs. This equates to $0.50 per share. We'll put all this detail in the 10-Q, which will be filed most likely next week. But for those of you working on your financial models now, let me go over the details. The $11.4 million of excluded costs breaks down as follows

[Richard D. Holder:]

Thanks, Jim. In just a moment, I'll address our integration efforts, followed by some commentary around the legacy business. But first I want to speak to the change that we made in our financial reporting. As Jim mentioned, starting with this quarter and moving forward, we'll be highlighting income from operations as a key metric for measuring our performance. We believe adjusted income from operation -- operations, which strips out nonoperating, nonrecurring and items specifically around acquisition-related costs is the best and truest indicator of our performance. So as you look forward into '15, that will really be our focus. We think you can really see into the operations by looking at these numbers and so we'll be talking about it on a consistent basis. Now let me change gears. As you're well aware, during the first 8 months of 2014, we closed 4 acquisitions, V-S, RFK, Chelsea Grinding, and of course, Autocam. These 4 acquisitions combined represent approximately $280 million in increased full year revenues. Each of these acquisitions contributes key elements of growth to our -- within our strategic plan. Some of these elements include our enhanced product offerings, entry into adjacent markets, increasing global footprint and a whole host of other things. We can't say enough about how happy we are around how these fell into place relative to our strategic plan. In order to appropriately execute and continue executing the strategic plan, during the third quarter, we moved forward and got a really strong start to our integration efforts, especially around Autocam. We named J. R. Widders, Senior Vice President of Integration and Transformation and began to position the appropriate functional and operational leaders and teams under his leadership. The focus of the integration and transformation team is to manage the integration of our acquired businesses and more broadly drive the processes and tactics necessary to transform the entire NN into a premier diversified industrial organization. The combining of NN and Autocam is truly a transformational event. The acquisition brings NN access to critical growth markets and the ability to capture global market share and fuel-efficient technologies, such as gasoline direct injection systems, high-pressure diesel injection systems, variable valve, variable cam timing and all of this, in addition to our legacy businesses, which was electronic power steering and a high precision shaft portfolio. Additionally, Autocam brings a very strong management team and a robust fully integrated information systems platform. We have renamed our Precision Metal Components group, the Autocam Precision Components Group as we believe the Autocam name is clearly the leading brand in the precision machining space. The Autocam management team has been given operational ownership of our former Precision Metal Components group, with the expectations that we will create a much stronger combined operating system for the new integrated business. From the beginning, we have planned to take the best of Autocam and the best of NN and apply it throughout what we will now call the new NN. Again, this job, the shepherding of this integration effort and this overall corporate transformation, will be the job of the integration and transformation team. Beyond the depth of talent, quality of systems and new markets that Autocam brings, the most exciting part may very well be the way the 2 cultures have merged. Throughout the due diligence process and through the integration, the management teams of the 2 businesses have always worked extremely well together. During the third quarter, we've had numerous integration events between the management teams and we now have a level of business alignment that I personally have not had the pleasure to witness this early in the process. Changing gears to the other 3 acquisitions. The other 3 acquisition integrations are going just as well. We've made great improvements at the former V-S Wheeling in Juárez facility and we're beginning to see wonderful sales growth coming out of that organization. We've made numerous operational, safety, information systems and accounting/internal control improvements at the former RFK in Bosnia, along with capital and infusion of capital spending, and we're seeing great successes there. And finally, we successfully moved the integrated production of the former Chelsea operation into our Erwin, Tennessee operation and shut down the factory in Jackson. As important as our acquisitions are to the future growth plans, so is the continuous improvement of the legacy business. We've demonstrated for the last 6 quarters that we continue to gain momentum in revenue -- in revenue growth and more importantly, in margin expansion. Excluding the effects of acquisitions, sales grew approximately 3.9% in Q3 2014 versus Q3 2013. Sales volumes drove that increase, with Asia and North America being the 2 largest growth areas. Our Asian location benefited from the 10% plus increase in China auto production, plus growth on filling the additional capacity that we added to the plant in the first half of 2014. Our North American operations continue to benefit from a robust North American auto production, as well as stronger sales in the HVAC market globally. Europe, on the other hand, was a bit of a mixed story. We continue to see growth outpacing the European auto production as we continue to benefit from our share gains and our current trend -- I'm sorry, in the current trend of growth in the exports of premium European brands to Asia. However, the heavy truck market declined quarter-over-quarter as the Class 8 engine cycle pre-buy cools in Europe, and we -- we've seen that in this quarter and I think Jim mentioned earlier, we will certainly see the effects of that in the fourth quarter. Additionally, we continue to be impacted by still a weak European industrial business. I'd be remiss if I didn't highlight as I have done probably every 1 of the last 6 or so quarters, that we are still off our historical highs in Europe. We expect the market to come back and we are well positioned from a cost perspective to drop substantive incrementals to the bottom line when the market comes back. We think as these markets display a pulse in 2015, we continue to position ourselves to take greater share in Europe and enhance our market position. Regarding the 2014 outlook, we now expect 2014 revenues to be in the range of $490 million to $500 million, including approximately $103 million of incremental revenues from our 4 acquired companies. These sales levels will equate to about a 3% to 7% growth over 2013 for the base business and an overall 31% to 34% growth for the entire corporation. That concludes my comments and now, we can open the line for questions.

[Operator:]

[Operator Instructions] We'll first go to Steve Barger with KeyBanc Capital Markets.

[Steve Barger:]

It sounds like you're really feeling good about future profitability, and just to start, can we confirm the prior view? You previously had guided to 2015 at $725 million in revenue, $125 million to $135 million in EBITDA. Any change to that?

[Richard D. Holder:]

Yes, yes. At this point in time, we have no changes to that. We feel pretty good about those numbers and we're not seeing any real indication that economically, that there’ll be any issues.

[Steve Barger:]

Great. And Jim, if I caught it, it sounds like it sounds, like quarterly D&A is going to be around $8 million or $32 million annually. Is that a good number?

[James H. Dorton:]

Let me take a quick look.

[Thomas C. Burwell:]

Steve, this is Tom. I think it’ll be more like $11 million on a go forward basis with all the acquisitions in. Plus you've got to add in a couple of more months of Autocam because we only have one month of Autocam in there.

[Steve Barger:]

So you're saying annual D&A closer around 40, 44?

[Thomas C. Burwell:]

It would be about 13 a quarter with Autocam in.

[Steve Barger:]

Okay. 13 a quarter. Got it. Can you help us with quarterly SG&A? I think the recurring number was around...

[Thomas C. Burwell:]

I'm sorry, that was...

[Steve Barger:]

I'm talking about D&A, D&A. So SG&A, you're saying is going to be 13 a quarter, that's good.

[Thomas C. Burwell:]

Yes.

[James H. Dorton:]

It looks like it should be about $9.8 million a quarter.

[Richard D. Holder:]

Yes. $10 million a quarter. $10 million a quarter.

[Steve Barger:]

And that is for depreciation and amortization?

[Thomas C. Burwell:]

Right. And there's significant amortization because of the upfront cost on the debt financing that we did.

[Steve Barger:]

Got it. Okay. I just wanted to get some of those housekeeping things out of the way. I know it’s early in this process but as you've gone out and talked to customers about Autocam in the broader PMC segment now, how -- can you talk about just what the reaction has been? What are the -- what's the early read on how they're feeling about the new NNBR exposure?

[Richard D. Holder:]

Yes. I've got gotten out personally to see, I would say, all of our probably top 10-ish customers on both sides of the equation. And the response has been extremely positive. I think we went into this deal thinking that the customers would really like the combination and I think we walked away after meeting with customers realizing that they love the combination. There's a couple of things that putting this together really excites the customers about and most notably, the fact that we have the expanded portfolio and we can handle our product across the entire life cycle of the parts. So we have the low-volume, high-mix production. We have the high-volume, low-mix production and maybe the most exciting thing across the board is we have a Mexican low-cost country facility, which really seems to be exciting for the customer base.

[Steve Barger:]

And what are your goal...

[Richard D. Holder:]

No. I think the other thing that they appreciate is just the overall scale of the organization. I think we had a thesis that said that the automotives, especially, would appreciate a larger organization that can bring R&D efforts and other pieces of the value equation to the table. And I think we're seeing that appreciation as a larger more scalable organization.

[Steve Barger:]

And one of the goals out of the gate when you came on board, Rich, was deeper penetration into existing customers. Do you think this new product set or manufacturing expertise or prowess allows you to pursue that as well?

[Richard D. Holder:]

Yes, yes. Absolutely. And there's a number of ways that, that's taking place. First and foremost is probably the cross-selling efforts. We now have, again, a wide portfolio that we can take a look at all of our blue-chip customers and sell the entire company to that customer. And most notably, our plastic business is probably gaining from that more than any single business within the company. They have a fairly stellar set of RFQs out there, more than probably this business has seen in, I don't know, maybe ever, as a result of this cross-selling effort. So that's pretty exciting. I think the other thing that is allowing us to penetrate is when we acquired RFK, we acquired -- one of the things that came with it was a low-cost, high-quality tooling expertise. So when you look at RFK, when you look at Autocam, when you look at the former Whirlaway business, all of -- we have our own robotics, we have our own specialty machining and we have our own tooling capabilities, which is -- you put that together, it's allowing us to bring some value to the customers that our competitors, quite frankly, were struggling to bring and we've seen that already taking place. So we're pretty excited about it.

[Steve Barger:]

And you talked about a level of alignment that's ahead of your expectations or I think you said you hadn't seen that before in other situations you've been in. Given that success, how's you're thinking about how you can leverage the entire platform evolved? Or is it too early in the process to really flush that out?

[Richard D. Holder:]

Yes. I think all it's really done was serve to further validate our original integration thesis. We clearly think that we're moving faster, and we're ahead of schedule from where we thought we would be, especially given the alignment of the management teams and so on. But I don't think we're at a point yet where we're willing to say the timing is a little bit better or the number is bigger. We're just feeling even better about the numbers we have out there as the timing we have out there.

[Steve Barger:]

Got it. I'll ask one more and then get back in line. Your focus on operating income going forward, I think, makes sense. Are you going to give us historical operating income by segment to help us model the company that way going forward?

[Richard D. Holder:]

Yes, yes. And we kind of floated that out there last year in the -- we've talked about OP in the Investor Conference last year and what it looked like by segments and where we thought we needed to get to. So absolutely, we'll float that out there.

[Operator:]

And we will now go to Keith Maher with Singular Research.

[Keith Maher:]

Could you talk -- I remember -- could you talk maybe a little bit more about the synergy you talked about just from the Autocam previously? I know we're only 2 months in but it sounds like things are going pretty well, and if there's any change to kind of your expectations of the amount of synergy you're going to get out of the integration.

[Richard D. Holder:]

No. I think the numbers we've floated out there -- and it's on the website in the presentation, are still good. I think if anything, we are more secure around those numbers than we have been throughout this entire process and we're as secure around the timing, as well. I think the difference today is it was a small group of leaders and folks that did the due diligence, that came up with the -- with those numbers, and today, it is 3 levels of management that's completely bought in and working detailed plans to execute those numbers. So we feel very good about the synergies.

[Keith Maher:]

Okay. That makes sense. I have a question, going back to the depreciation and amortization, just want to understand that, that the number you gave, it includes the debt expense amortization, as well as intangible amortization, that's the all-in number?

[Thomas C. Burwell:]

Yes. Yes. That would be the all-in number.

[Keith Maher:]

Okay. And what are the intangibles?

[Thomas C. Burwell:]

And the numbers are preliminary and we have not finalized our purchase accounting but we believe they'll be in that -- right around that $10 million.

[Keith Maher:]

And what are the intangibles to $51 million? What is it related to?

[Thomas C. Burwell:]

Primarily customer relationship intangibles.

[James H. Dorton:]

But there's also the trade name of the various companies that we purchased.

[Keith Maher:]

Okay, cool. And I don't know if you could give us maybe your thoughts on what the gross margin is going to look like kind of in the short-term, then maybe at quarter end and just longer term where you think that might end up?

[James H. Dorton:]

Yes, again, we're not trying to guide you to any particular numbers here but we did say in our acquisition model, that we've tradition -- NN has traditionally been in about the 20% gross margin, that's about the appreciation. After Rich came, we made some changes, we moved that up a couple of -- maybe 100 basis points or so. The acquisition model showed that we should be, for the first full year, without synergies, in the 23% range, and right now we're not changing that.

[Keith Maher:]

Okay. Great, that's helpful. And in terms of debt, obviously, you're going to work to start paying that down. Do you have any target, say, by the end of 2015 where you expected that level to be?

[James H. Dorton:]

Well, we've made projections, we -- in general, NN is positive cash flow after CapEx of a fairly significant amount and we think about applying most of that to the debt. With the growth in EBITDA, I can't remember what we have on the website. I don't think we showed that but we would get into the 2x debt to EBITDA pretty quick. Yes, or let's say, higher end of that after year 1 but...

[Keith Maher:]

Okay. That's helpful. And any guidance on CapEx, for the balance of the year? Are you -- or you're thinking about, say, for 2015?

[James H. Dorton:]

I don't -- we're not ready to give 2015 yet. We're still looking at the plans. And what I said about this year is I think we're going to fall in about the $23 million range even with the Autocam due to delay in some projects that we originally had on the table in Europe. So that's where I think we'll be.

[Operator:]

[Operator Instructions] And we'll take a follow-up question from Steve Barger with KeyBanc Capital Markets.

[Steve Barger:]

The margin profile of the other 3 acquisitions, Chelsea, V-S and RFK in the quarter. And specifically on V-S, has that kind of crossed -- is it tracking to your expectations and any sense on profitability for that one?

[Richard D. Holder:]

Yes, it's tracking a little ahead of the model. I think we said -- I want to say it was second quarter call, we saw the integration efforts was going a little faster than we originally anticipated and we thought we would enter into the wonderful world of profitability earlier. Well, we've done that and we're pretty excited about that. In addition, we're seeing some nice things happening on the top line. So pretty excited about V-S.

[Steve Barger:]

Inventory of $87 million on the balance sheet in the quarter. Is that the right level on a go-forward basis or will there be -- do you need more inventory through the system? And then in general, I'm just trying to get to whether working capital is going to be a source or a use as we go into 2015.

[James H. Dorton:]

As far as we know, that's a pretty good level. It does represent the seasonal -- there's usually some adjustments in Q3 because of the seasonal drop in shipments in Europe but that's probably a reasonable level. Our days inventory outstanding seem to be about right.

[Steve Barger:]

Okay. And just trying to back into the implied organic growth in 4Q. It looks to me like it's probably low single digit, 2% or 3%. Is that -- how should I think about that in the context of the original guidance of 400 to 415 versus the 490 to 500? Is there actually a step down in organic for the legacy?

[Richard D. Holder:]

No. I will tell you that I think we are almost dead on the number. If you -- without going into too much detail, I think what you'll find is if there's any deviation at all, its FX.

[Steve Barger:]

Okay. So just from a pure business standpoint, you're -- if things are tracking the way you had expected it at this point in the year?

[Richard D. Holder:]

Yes.

[Steve Barger:]

And you had mentioned...

[Richard D. Holder:]

It always look like something better, but yes, we think the outlook is -- has been pretty accurate.

[Steve Barger:]

Got it. And the -- Rich, I think you mentioned that some of your customers were pushing for longer payment terms in the auto space. Anything -- has something changed there? Or what's really driving -- any background color around that comment?

[Richard D. Holder:]

Yes, candidly, I don't think the environment has changed. I think we -- I think we're just more noticeable. I really do. I think that's what happened to us, so there's good and bad for -- associated with performance and I think we've just fallen on a couple of people's radar screens relative to this issue so the discussions have started.

[Steve Barger:]

Do you feel like you have a good position to be able to hold the line?

[Richard D. Holder:]

Yes. With some of the bigger customers, we think we can strike an agreement that won't be too painful for us, or at least an agreement that we can make up the difference.

[Operator:]

[Operator Instructions] And we will take a follow-up question from Keith Maher with Singular Research.

[Keith Maher:]

Could you give more color on Europe? I mean, it seems like in certain areas, we've seen some improvement, I guess, in the last 3 quarters. Is it getting worse? Or is it just kind of -- I mean, just kind of your color on Europe, is it...

[Richard D. Holder:]

Yes. I think -- I don't think Europe is getting worse. I think candidly, when you look at the continent, it's fundamentally flat, right? For us, it is a more positive feel because we're taking advantage of the export market of the premium brands. So we're seeing sort of our unfair share of that piece of the equation, as well as we've taken share from our competitors. So it feels a little bit better to us, I think, than maybe some others or that the market would indicate. With that said, the truck market is -- has cooled. So in Q4, if you look at our business, we really benefited nicely, volumetrically at least, from the truck market in Q1 and Q2. That's just not going to be there in -- it wasn't there in Q3 and it won't be there in Q4. So net of it all, I think it's a positive story but it's a bumpy road. I think at the risk of maybe putting too much out there, I think -- I don't think we can look at Europe anymore, right? France is going one way and Italy is going in the opposite direction. So if you look at it, in our market, Italy is growing and France is shrinking. We are at the point where we are disaggregating Europe to figure out what we do, where and when, but I think as a continent, we think it's flat. And it's flat, it's probably flat next year.

[Keith Maher:]

Okay. I'm guessing this might be in the Q but I guess SKF is, obviously, falling. I mean, I guess as a percentage of sale. It seems SKF is still your biggest customer. And did Autocam have any large customers?

[Richard D. Holder:]

Yes. Autocam -- Robert Bosch is Autocam's largest customer. But the combined organization, SKF is still our largest customer. They are 20% to 23% of our business.

[Keith Maher:]

Okay. And you didn't mention -- were there any discontinued operations in the quarter? Any -- anything you got rid of or sold?

[Richard D. Holder:]

No.

[Operator:]

It appears there are no further questions at this time, I would now like to turn the conference back over to management for any additional or closing remarks.

[Richard D. Holder:]

Thank you. I guess in summary, I would actually like to pass along my personal congratulations to the management team for what I think is a wonderful job that has been done the entire year, but most notably in the third quarter. It was a lot of work to complete this acquisition and to continue to run the business while doing it and I think the team performed at an admirable and elegant fashion, so I want to pass along my personal congratulations to the team. I think we're extremely excited about the future and we're pretty comfortable about integration and with that, I think we'll close the meeting. Thank you.

[Operator:]

A replay of today's presentation will be made available today, November 4, 2014, at 2