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NN, Inc. (NASDAQ:NNBR)

Q4 2013 Earnings Conference Call

March 11, 2014 11:00 ET

Executives

Marilynn Meek - Investor Relations

Richard Holder - President and Chief Executive Officer

Jim Dorton - Chief Financial Officer

Analysts

Steve Barger - KeyBanc Capital Markets

Keith Maher - Singular Research

Matthew Dodson - JWest LLC

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the NN Fourth Quarter 2013 Conference Call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session and instructions will be provided at that time. (Operator Instructions) I would like to remind everyone that this conference call is being recorded today, March 11, 2014.

I will now turn the conference over to Ms. Marilynn Meek. Please go ahead.

Marilynn Meek - Investor Relations

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) 837-3746 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 Richard Holder, President 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, Rich, I will turn the call over to you.

Richard Holder - President and Chief Executive Officer

Thanks, Marilynn. Good morning and thanks for joining us on this call. As has been the case the last three quarters, we here at NN have continued I think some positive momentum in revenue growth and more importantly growth in margin expansions. As the company as a whole, we are laser focused on maximizing our incremental profitability and I think we are seeing that bear out on a continuous basis across the numbers. Overall, in Q4, from an economic front, the North American automotive market continued its growth over the prior year. The European automotive market continues momentum in terms of recovery and the European heavy duty market remains very strong.

Our quarter-over-quarter sales growth in Europe outpaced the end markets by better than 2 points, which we were very pleased with and we attributed that incremental market share gain to better penetration with many of our existing customers. We did win back some market share and some of our products went into expanded and adjacent areas. So you put all those things together the European market grew 3 or 4 points and we grew about 5 points in the same time period.

I will tell you that while the positive sales momentum in Europe during the last three quarters is encouraging, our overall sales level continued to be impacted by what we feel is still historically low demand in the European auto market. And generally, we continue to see weak NAFTA and European industrial markets performance as well. So while we have sort of developed a pulse in those markets, those markets are still not performing anywhere near what they should and will be. With that said, that allows us to be very bullish, because when these markets return to normalized levels, we are very bullish about our incremental or ability to perform incrementally in those markets. And I think the last quarter has shown that.

As I pointed out in prior meetings, our sales comparison to 2012 continues to be impacted by deemphasizing certain non-strategic products and programs principally this last quarter in our Precision Metal Components and Plastic & Rubber Group. We have shed some products and we have done some rationalization with some products and so that impacted the top line just a bit. Nonetheless, we have experienced good growth and we are pretty pleased with the growth that we have. And these actions continue to help us with our margin expansion and improve profitability.

In summary, Q4 sales, we were up $9.9 million, a 12.4% over Q4 2012 from $80.2 million to $90.1 million. Operating profit from normalized operations was up $3.5 million or 230% over Q4 2012 from $3 million to $6.5 million and operating profit margin from normalized operations was 7.2% in Q4 of 2013 versus 3.7% in Q4 2012. So I think you are seeing the fruits of the tightening of the operations. Pretax income from normalized operations was $3.5 million or 140% better than Q4 2012, which was a $2.5 million with $2.5 million to $6 million movement.

I think with that I will turn it over to Jim to dig a little deeper into the numbers and then I will come back and make a few comments about the economic outlook and company performance in general. Jim?

Jim Dorton - Chief Financial Officer

Thanks Rich. Hello everyone. I am connecting remotely so if I should become disconnected someone there in Johnson City will take over for me. For a number of quarters in a row our profitability performance has improved over the same period of the previous year both in terms of quantity and quality of earnings. In fact, we had the highest fourth quarter gross margin and operating margin since 2006 in this past quarter which as Rich said is indicative of our lower cost base and new focus on incremental profitability.

Rich mentioned that we had sales of $90.1 million or a $9.9 million increase over the fourth quarter of last year. Regarding the incremental profitability we brought 45.8% of the sales increase down to operating profit and this illustrates the kind of earnings leverage we have as sales continued to recover. The increased sales will be as Rich said to improve demand in European auto markets and good automotive demand in Asia and North America. We also benefited from the heavy truck demand in Europe.

We earned $0.25 per share in the fourth quarter versus $0.16 per share from normal operations from the fourth quarter of last year. We did not make any adjustments to normal operations this quarter and because a few unusual items we had tended to offset one another. On a segment basis our precision metal components group is now hitting full stride with gross margins of 23.2% and operating margins of 14.1% both of which now exceed the corporate average. With precision metal components now realizing the products that we expected when we purchased Whirlaway and to begin this product segment in 2006, the timing was very good for our first acquisition in eight years which was the purchase of the assets of V-S Industries announced at the end of January.

V-S brings us much needed capacity, skilled workforce and a manufacturing presence in the fast growing auto production area of Mexico. We are well into the integration process with V-S and things are going well and we believe that the acquisition would be slightly accretive to earnings by the second half of this year and continued to improve from there. And we will discuss this – our progress more fully when we announce the first quarter earnings in May.

Compared with the fourth quarter of last year we had a much higher tax rate on normal operating earnings because starting in the first quarter we had been accruing taxes on the U.S. earnings for book purposes. However, we still have a tax NOL that should allow us to pay no U.S. cash taxes at least through 2014. We paid down $33 million of debt during the year, $17 million was from cash flow and the remainder from the permanent draw down of European cash which we were able to do due to a tax sufficient return of basis transaction late in 2012.

Our debt to EBITDA ratio at year end was 0.8 times, the lowest level in a very long time. As mentioned last quarter, we have plenty of available debt capacity to fund our aggressive growth plans. Capital spending totaled $5.9 million for the quarter and $15.2 million for the year, which was on target with the level I mentioned last quarter. Working capital net of cash and debt was up approximately $10 million versus last year due to the sales increase and an increase in inventory, which was required by our customers. Because of the inventory increase, our cash collection cycle was up about 5 days to 76 days.

Our goal for 2014 is to decrease the cash collection cycle to a level of about 70 days. We paid three quarterly dividends of $0.06 per share in 2013 and the first announced dividend for 2014 was increased to $0.07 per share reflecting our improving outlook. So the total dividends paid in 2013 was $3.1 million. Due to the increase in our stock price and the reinstatement of the dividend, our total shareholder return was 121% in 2013 versus 31% for the S&P 500. So I think you will agree with me that NN had a very good year and we have aggressive plans for more growth and improved earnings from here.

That concludes my comments and now back to Rich.

Richard Holder - President and Chief Executive Officer

Thanks, Jim. Regarding the 2014 outlook, we expect positive revenue momentum – we expect the positive revenue momentum of the last three or so quarters to carry into 2014. We continue to be mindful of this prolonged sort of general economic uncertainty that’s hanging over many of our markets, in particular the sort of global industrial market as well as the European automotive market. Given the strategic initiatives we have already undertaken, which includes as Jim mentioned earlier, our acquisition of V-S Industries.

We expect 2014 revenues to be somewhere in the range of $400 million to $415 million, which means sales growth of about 3% to 7% over 2013. And of course, this excludes the $15 million or so incremental revenue we expect from V-S. So we think we have short of the path to some good growth ‘14 over ‘13. Some of the significant drivers in this growth will be we are seeing stronger demand than we modeled in China maybe not as strong as some of the pundits has put out there, but certainly stronger than we have modeled.

We continue to see a relatively strong North American automotive market and the European recovery, while slow, continues to occur. So we think – we think ‘14 is a pretty good year as we see it right now. Our latest addition to the portfolio of V-S will greatly assist us in the penetration of some adjacent markets. And we talked about that in great deal during the conference in New York. V-S gives us a wonderful addition to the portfolio in terms of the low volume, high mix model in terms of another low cost country location and maybe most importantly in terms of increased capacity for our low mix, high volume model which formally was in the Whirlaway business.

And additionally, the acquisition gives us a nice addition to our global footprint allowing us to better serve existing customers, but maybe more importantly we have added about 7 or 8 new substantive customers to the portfolio globally by doing this acquisition. So you put all these things together, we think ‘14 is a good growth year. Naturally, all these things net of any acquisitions we may make during ‘14, we have a number of deals in the hopper and quite a few of them are probably on the sort of the north side of 70%. So we think we will probably be closing a few deals sometime this year. But we think the growth picture as well as the margin its expansion picture is a good one for ‘14.

Just to sort of recap for those of you who didn’t know we held an Investor Day in New York in January and we have built our new website, we have built our new strategy. And so I would encourage anyone who hasn’t seen that and wants to get to know more about the company to take a look at that, the replay of that webcast and take a look at our new strategic vision.

With that I will conclude my prepared statements and I will take any questions anyone has.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question will come from the line of Steve Barger from KeyBanc Capital Markets. Please go ahead.

Steve Barger - KeyBanc Capital Markets

Hi, good morning guys.

Richard Holder

Good morning Steve. How are you?

Steve Barger - KeyBanc Capital Markets

I am good, how are you?

Richard Holder

Pretty good, can’t complain, it’s finally stopped snowing.

Steve Barger - KeyBanc Capital Markets

Here too, that’s a good thing. First question is on the revenue guidance, 7% to 11% looks good especially relative to last couple of years, but it is below the 21% sales CAGR you have in your walk to $800 million. Just given the deals that you see could you – there could be close – do you expect to close some of that gap as the year progresses?

Richard Holder

Yes, we do. We think that actually maybe just one of the deals, which we think are pretty close to the finish line, will close and exceed that gap.

Steve Barger - KeyBanc Capital Markets

Okay, that’s wow. Exceed the gap, that’s great. And for margin profile whether it’s that deal or any of the others that could be close, are they generally accretive to the corporate margin, ex-purchase cost accounting and all of the other one-time charges that might be there?

Richard Holder

Yes, I will – that’s depending on how the deals fall. Some of these smaller deals are definitely almost immediately accretive to corporate margin. Some of the larger ones will require – should they come to pass will require some work, but should be at least marginally accretive by year end.

Steve Barger - KeyBanc Capital Markets

Got it and if one of the bigger deals happens to fall first, is that – do you have the bench strength to go after that or is there some more infrastructure you have to put in place and I know the company is run lean in a lot of areas for a long time I mean just how are you thinking about that?

Richard Holder

Yes, I think we are ready for that. We have brought on at least one new general manager. We have another new one starting at the end of this month. We are hiring a number of people. So if one of the bigger deals came first, we would still have enough bandwidth to complete probably all of the smaller deals we have circulated. So right now we are feeling pretty good about, no matter how they land we can pull it off.

Steve Barger - KeyBanc Capital Markets

Great, two more and I will get back in line. Are there more product lines you expect to divest or walk away from in 2014 and are all those potential changes built into the existing guidance that you have given for revenue?

Richard Holder

Yes, we are always studying the viability of all the product lines and so that exercise will continue certainly in ’14. At least one of the product lines I talked about it fairly openly in New York, we are restructuring and we will continue to take a look at that, it’s we have made the decision on it just yet for ’14.

Steve Barger - KeyBanc Capital Markets

Got it, okay. And then just based on the mix of organic growth and contribution that may occur from V-S as you go through the year, how are you thinking about incremental contribution margin for the consolidated business in 2014?

Richard Holder

The consolidated PMC business or the consolidated….

Steve Barger - KeyBanc Capital Markets

No, consolidated – yes if I look at the consolidated income statement and you come in at the midpoint or the high end of your – of your organic – sorry your revenue guidance, is that – are you thinking 20%, 25%, 30% consolidated incremental contribution margin, just trying to get a sense of how you see the year unfolding?

Richard Holder

Yes, I think we are thinking about this somewhere in the high-20s and low-30s. So 31, 32ish is how we are looking at this.

Steve Barger - KeyBanc Capital Markets

Right. And obviously that can be skewed by acquisitions or anything else, but as you see it right now assuming nothing else drops that would be your take?

Richard Holder

Yes.

Steve Barger - KeyBanc Capital Markets

Got it. That’s a great answer. Thanks. I’ll get back in line.

Operator

Your next question will come from the line of Keith Maher from Singular Research. Please go ahead.

Keith Maher - Singular Research

Good morning. Question about the European market you mentioned grown a bit better than the market. You didn’t mention inventory levels and potential restocking just I appreciate your thoughts in that area?

Richard Holder

Yes. I think Jim talked about that just a little bit. Our inventories grew slightly because one of our customers is sort of rekindled their inventory plan. And we think at this point we are at a – they’re in an optimal level, we’re in an optimal level. So I don’t think there will be anymore inventory building. I think everyone is running a lot, their models are a lot leaner than they were prior to this slowdown. And I think that will probably remain that way for the next year or so which actually is good for us is putting a little bit more pressure on us to increase velocity in that, that actually works well for us especially in our European factories.

Keith Maher - Singular Research

Okay, thanks. A question just on V-S acquisition and maybe acquisitions in general. V-S isn’t that large, $16 million run rate. I was just thinking what are the opportunities there to grow that revenue given now that they’re going to be part of the company with much stronger financial than operational resources I mean can you give out and really accelerate growth in these smaller acquisitions after you make them?

Richard Holder

Yes. I think the way to think about V-S is while they are at a $16 million run rate they are more along the line of about $50 million business, right when you think about their total capacity, equipment, factories, workforce and the like. So it’s a business that can scale to something around $50 million or so on the top line. That’s one piece. Within that business, the low cost country model allows us to move business from what was our Whirlaway business to the Mexico operation at a lower cost later in the lifecycle of the parts. And prior to this, we didn’t have a model that allowed us to hold on to that business. So now we can control the entire lifecycle of many of the products that we have and we don’t have to divest when they go into aftermarket. So it’s an increase in margin.

And maybe the third thing to think about is with that – with the acquisition of those assets came some really good application engineering talent and some really good sales talent and maybe that maybe proving to be the most exciting part of the acquisition to-date. Really good sales talent, they are out there, they are bringing to the corporation opportunities that we haven’t seen before, customers that we haven’t seen before. And so we’re feeling pretty confident, pretty bullish about this acquisition. So it looks small on the outside, but we think in a year from now we’ll be looking at this and say it will guide me at about $50 million, $60 million acquisition. It just seem like it was a $10 million, $15 million acquisition.

Keith Maher - Singular Research

Great. That was really helpful. And – sorry.

Jim Dorton

This is Jim. I just want to add one thing to that. In that business the bids that we get or the business we go after usually has a five to seven year life and usually is in $5 million to $10 million annual revenue range. So the business comes in good size of chunks when you win it.

Keith Maher - Singular Research

Okay. And I do have a couple more questions I think probably for Jim. One, that kind of the anticipated CapEx and depreciation targets for 2014, can you share that?

Jim Dorton

We have not – we didn’t put those out there. I’d tell you that normally we have a target in the general range of half of our depreciation for maintenance and then in the last couple of years we have also had about equal amount for growth CapEx?

Keith Maher - Singular Research

Okay.

Jim Dorton

So, I am not sure if we are going to release the number this year later, but that’s a general model.

Keith Maher - Singular Research

Okay. And then just a final question on the tax rate you mentioned no U.S. taxes through 2014, so what should we think about the tax rate for this year and then kind of beyond this year, when you start paying U.S. taxes, what’s that going to look?

Jim Dorton

Well, the tax rate we are accruing taxes at the normal rate in U.S. So my comment was that because we have a net operating loss, we won’t pay any cash taxes in the U.S. So that’s a cash flow item. But our tax rate is a weighted average basically a weighted average of our rates around the world and where in Europe we will pay about 25%, China about 25%, U.S. 35% plus in local. So depends on where the profit is. We tend to have blend of about third in the mid – well in the low 30s, 31%, 32%, 33% something like that. It just depends on where we are earned the money proportionately.

Keith Maher - Singular Research

Alright, that’s all I had. Thanks.

Operator

(Operator Instructions) And your next question will come from the line of Matthew Dodson from JWest LLC. Please go ahead.

Matthew Dodson - JWest LLC

We have seen the Europe car registration getting incrementally better in the past six months, can you help us understand what you are seeing from your customers and when will they need to restock their inventory if this demand is actually getting better?

Richard Holder

Okay. I think when what we are seeing is – I will characterize it as a slow and methodic recovery. Okay, we are not seeing any indications of a big bubble because we think what happened is there has been some – there has been substantive capacity shedding. I think some of the middle level brands are still pulling down some capacity. And so there is still some manufacturing rationalization taking place. With that said, we think demand is creeping along climbing about a 3%-ish or so and we don’t think there is any restocking to do this year. We think that in part in the fourth quarter and what’s going on in the first quarter. They will have returned to the stocking levels that most of them are going to want to run at for the balance of ’14 unless there is some significant movement which we don’t anticipate. We don’t think second half of the year we are going to see doubling or we are still seeing that, we think it’s going to be a relatively smooth curve.

Matthew Dodson - JWest LLC

You are saying that the inventory is still very lean and they are still doing hand to mouth and we need – from them to change that and add more inventory we will need a significant ramp up in demand is that what you are trying to?

Richard Holder

No, I am not saying that at all, I don’t think inventory right now in the system for many of those guys I don’t think they are hand to mouth. I think they are probably not running at 30, 20 end days or 30 calendar days. They are probably more along the lines of 15 or so end days. And I think that’s where they are going to stay. I think that’s the model, that at least as we understand that will be the model for Europe I think for the balance of the year. And should they see demand outside of that model, they are just going to push the pressure backwards to increase the velocity. I don’t think anyone is going to add much more to their existing inventory for 2014 based on the numbers that are out there today.

Matthew Dodson - JWest LLC

Perfect, thank you very much.

Operator

There are no further questions at this time. I would like to turn the call back to management for closing remarks.

Richard Holder - President and Chief Executive Officer

Okay. Again, thank you for joining us. Let me reiterate, we think ‘14 is going to be a pretty good year. It’s certainly going to be a continue year of growth. And we are all pretty excited. So we are looking forward to chatting with you again on our first quarter conference call. And with that, I will sign out. Thank you very much.

Operator

Ladies and gentlemen, this concludes the conference call for today. Thank you for participating and please disconnect your lines.

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