NN, Inc.

Thank you, and good morning. Welcome to NN's conference call today.

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 that you take note of the cautionary language regarding forward-looking statements contained in today's press release.

The same language applies to the comments made on today's conference call and live webcast available at www.earnings.com.

With us this morning is Rock Baty, Chairman and Chief Executive Officer; and members of the NN's management team. First, management will give an update and an overview of the quarter, and then afterwards, we'll open up the line for questions.

Rock, would you like to begin?

Sure. Thank you, Marilyn.

Good morning, everybody, and thanks for joining the call. With me here in Johnson City this morning, I have Jim Dorton, our Senior VP and CFO; Will Kelly, our VP and Chief Administrative Officer; and Tom Burwell, our VP and Chief Accounting Officer.

Today, Jim's going to offer an analysis and commentary on the fourth quarter and full year results through December 31, 2011, and then I'm going to conclude the call with additional comments regarding our 2011 performance, as well as provide our revenue outlook for 2012. With that, I'll turn the call over to Jim.

Thanks, Rock, and good morning, everyone. Revenue-wise, the fourth quarter of 2011 was essentially flat with the fourth quarter of 2010 at $96.3 million, but the mix was quite different.

Europe was $9 million lower in revenue. Asia was $2 million higher, and Whirlaway was nearly $7 million higher.

We are into $2.8 million or $0.17 per share more than last year, and that's $0.03 per share more from normal operations. The cause of the -- the profit turnaround at Whirlaway was more -- more than offset the lower European revenue.

Now a portion of the European revenue drop was due to the bankruptcy of our German subsidiary and the loss of some of that business, but the majority of the drop in European revenue was due to lower demand in balls and rollers.

The fourth quarter revenue was also lower than the third quarter, which was very unusual. This is again due to the weakness in Europe.

Normally, we see a seasonal rebound in the fourth quarter, but due to inventory adjustments and some demand weakness arising from what was at that time in the fourth quarter, a great uncertainty over the 2012 European economic outlook, we actually had a decline in revenue. If we had had a normal seasonal rebound, our Q4 revenue would have been about $106 million instead of $96 million.

As of today, we are seeing a more optimistic outlook from our customers in Europe, but order levels remain a little lower than planned for balls and on plan for rollers in Europe.

Europe is still somewhat of a question mark for 2012, but the outlook seems more positive than a few months ago. We are in $4.9 million or $0.29 per share in the fourth quarter.

We had an intercompany FX gain of $0.05 per share and tax and other non-operating adjustments of $0.04 that we are excluding from normal operation. So our earnings from normal operations were $3.5 million or $0.21 per share.

This was slightly below the consensus estimate and the difference can be attributed mostly to the shortfall in European revenue.

For the full year, we have revenue of $424.7 million, a 16% increase over 2010. We are into $20.9 million or $1.24 per share.

Removing those non-operating gains through the year, we earned a record $18.6 million in net income or $1.10 per share. And there's a reconciliation of the non-operating adjustment at the end of the press release.

And also Rock will talk -- will discuss some of the fundamental business factors for the year in a moment.

Compared to 2010, we were more profitable due to our higher revenue on top of our streamlined manufacturing footprint. However, our cost of sales as a percentage of revenue was higher as we caught up on maintenance and supply spending that had been cut to the bone in the recession year of 2009 and also 2010.

But we can already see that this impact of higher spending has run its course by the fourth quarter, and we're spending more in line with our lean footprint in 2012.

For the fourth quarter, SG&A was $7.5 million or 7.8% of revenue. Had European revenues been in line with our normal seasonal pattern, the percentage would have been 7.1% for the quarter and for the year, down from 8.3% last year.

So you can see the continued earnings leverage we have as our revenue grows.

Depreciation was $4.4 million in the quarter, which is up from $4.0 million last year and in line with guidance that we had given. The increase is due to the new capital that we put in place this year.

Interest expense was $1.1 million, down from $1.6 million last year. The reduction is almost all related to lower rate in our revised credit agreement.

We have $1.1 million of other income during the quarter, the majority of which I've already mentioned is the non-operating foreign exchange gains on intercompany loans.

Regarding taxes and the tax rates, we're still not accruing taxes on U.S. operations, so our blended rate is a mix of the international rate which usually comes out between 20% and 25%.

The rate was unusually low in the fourth quarter at only 5.4%, but this was because of a nonoperating adjustment to the deferred tax asset in Slovakia, which we did exclude from normal operations. And if you add that back in, the fourth quarter rate would have been about 21%.

We spent $4.6 million in capital during the quarter, bringing the total for the year to $20.3 million, which is in line with our budget for the year. During the year, we caught up on items we delayed on spending -- capital spending items we delayed in 2009 and 2010, plus we invested heavily in our new programs at Whirlaway and for our tapered roller expansion in the U.S., and we will see higher revenue in 2012 based on these strategic investments.

In 2012, we will complete the first phase of the expansion of our ball plant in China, which will ultimately allow a doubling of capacity at that plant. We will also continue to invest in tapered roller expansion and in tapered roller cost reduction in the U.S.

and in the Netherlands. We should spend between $15 million and $20 million in 2012, over half of which is growth investment that will bring higher revenue later in '12 and in 2013.

We had $4.7 million of positive free cash flow during the fourth quarter on a reduction of working capital due to the lower sales rate. For the full year, we had a negative free cash flow of $5.8 million due to the working capital build on a 16% sales increase.

We had underestimated the working capital build in 2011, so we weren't able to repay debt during the year as we had forecasted. However, we do have an aggressive goal of debt repayment in 2012 of between $15 million and $20 million, which we think should be achievable based on our earnings projection and relatively flat revenue.

That concludes my comments, and now Rock will talk to you more about 2011 and 2012.

Let me begin my comments regarding 2011 by stating that during 2011, our revenue, earnings and EPS all represented record results for NN as a company and a continued turnaround, which began in 2010 from the depths of the global recession results of 2009.

For the full year, on an increase in volume-related revenue of $35 million from 2010, the net adjusted for currency and material pass-through, revenues were up approximately 10%. We improved earnings from normal operations by 68% from $11.1 million in net income in 2010 to $18.6 million in 2011.

That represents an increase in profitability of $7.5 million for the year, 21% of every incremental revenue dollar dropped to the net income line in 2011. Our EPS from normalized operations also grew from $0.67 a share to $1.10 a share, up 64%.

From an operating perspective, the good news is our core Metal Bearing Components division, which represents 73% of our total business, delivered record earnings. This division's restructured, leaner global footprint, along with good operational performance, combined to achieve the excellent results for the year.

In the negative category, 3 issues impacted our profitability for the year. First, the rubber and plastics business unit, notably Industrial Molding in Lubbock, Texas, and the Precision Metal Components business, Whirlaway, were disappointing.

While IMC remained profitable during the year, they did struggle with manufacturing efficiencies for much of the year. Like Whirlaway, they have good momentum based upon recent improved manufacturing results heading into 2012.

While Whirlaway was clearly the biggest issue with a significant loss for the year, as we mentioned in the release they experienced a turnaround to profitability in the final 5 months of 2011, they also have good momentum moving into 2012.

Finally, European negative economic factors impacted our fourth quarter revenue incrementally from Q3 '11. For the first time in recent memory, as Jim mentioned, we were down at NN in the fourth quarter versus the historically seasonally low third quarter by 5%.

This 5% reduction was driven all by the European downturn.

It was a record year in revenue, earnings and EPS, but the year had significantly higher earnings potential than we realized on the basis of the 3 issues I just mentioned, IMC, Whirlaway and Q4 European revenue softness.

I would like to conclude my comments today by commenting specifically on our 2012 outlook. We mentioned in our press release this morning that we're forecasting full year revenues for 2012 to be in the range of $450 million to $425 million.

The midpoint of the range, $420 million, if achieved, would represent essentially the same revenue as 2011 after adjusting for currency from material pass-through. At that level of demand, we anticipate good capacity utilization rates in our global plants, with enough spare capacity to capitalize on any incremental improvements and demand should they occur.

We also mentioned in the release that our revenue forecast for the year includes good organic and economic growth in North America and Asia, both in the automotive and industrial markets, offset by a forecast of mild recessionary reduction in demand, and we forecasted 5% continuing for all of 2012. During the first quarter of 2012 today, we have witnessed improvements in Europe from the Q4 '11 level I mentioned earlier, but still revenues in Europe for Q1 '12 are running at lower levels than we experienced a year ago in the first quarter.

Although we do not provide annual or quarterly earnings guidance at NN, we did mention in the press release that our 2012 earnings forecast reflects good improvement in operating margins, net income and EPS for the upcoming year.

Our belief is based upon several factors. First, a significant sling in profitability at Whirlaway.

Our 2012 first quarter trends in that business, so far, are headed in a very positive direction. Second, improvement at IMC for the full year based upon good revenue growth combined with operational improvement.

And finally, improvements from our Metal Bearing Components business where the leaner, restructured global business is able to withstand a forecasted 5% European reduction in demand and still maintain good levels of profitability during the upcoming year. Of course, a big variable is what will happen in Europe for the year, as well as the rest of the world from an economic perspective.

Based upon that uncertainty as that currently exists in our Serbian markets, particularly Europe, we believe our 2012 revenue and earnings forecast are realistic and achievable.

Finally, during 2012, we are focused on debt reduction and the further strengthening of our balance sheet by the end of the year. With improvements in earnings, working capital requirements and a slight reduction in capital spending, we anticipate year-end debt levels to be much lower with corresponding improvements in leverage ratios.

Our resulting debt levels and balance sheet should position our business for continuing growth in 2013 and beyond.

With that, we'd like to open the call to any questions that you may have.

So just, I've got several questions in no particular order. But I guess, first, can you talk about demand for balls and rollers in Europe now that we're almost a quarter into '12 and maybe talk about how that's tracking relative to that 5% down expectation for the year?

It's essentially right on the 5% expectation, Steve. The experience [ph] in the first quarter thus far is about 5% down.

Okay. And as you talk to your sales guys on the ground over there, is that kind of how you expect 2Q to trend?

Do you think there's any variance in here? And where's the risk, to the upside or the downside?

As we said, it's certainly unpredictable at this point in terms of the uncertainty over there. But we -- everything that we heard from our customers, as well as -- especially when we were developing our business plan, we had thought 5% was the number that kept coming back.

In terms of out into Q2, as we've mentioned before, we don't give a lot of visibility in our business, no more than 30 days. So there's really no -- I can't split and tell you that Q2 looks much different than Q1 at this point.

And I would also -- you asked the question, and it's a good one, is there upside or downside, I would say neither.

Got it. Okay, did you -- net margin for Whirlaway in the quarter, can we have that yet?

Or is that -- do we have to wait?

Yes. No, we need to wait on that.

But I think we had mentioned, maybe in the last call, that they did -- I think approximately the 2, they were profitable for the last 5 months, and that certainly continued, minimally profitable, but that has really improved going into this year.

That's great. So as you -- I know you don't give guidance, but just trying to get a sense for where this can go in 2012.

First question, do you expect it to sequentially increase as we go through the year, or is it kind of stepped up to a sustainable run rate? How do you think about that, the cadence?

On Whirlaway, Steve?

Yes. It's Whirlaway specifically, right?

They have some seasonality in their business relative to the HVAC European market. But as we look at the first quarter and on into the second quarter specifically, the cadence is definitely accelerated in terms of what we see in their contribution versus even when they became marginally profitable last quarter.

But we're seeing improved margins and improved earnings from Whirlaway in the first quarter. And we expect that to continue to accelerate on into the second.

Great. And for the -- sorry...

No, I was done, that was it.

Okay. For the full year, should we be thinking like very low single-digit or could that be mid-single-digit on a run rate as you exit?

Or any color that we could have?

Single-digit after-tax returns, or what are you

asking here?

Yes, net margin. Right, net margin.

Well, we really probably shouldn't respond to that in any meaningful way and it's relative to -- but I would say that in terms of our expectations for them in '12 and what we're seeing in the first quarter is that their returns are approaching, on an after-tax basis, our corporate averages. I mean, they're still slightly lower, but they're getting up close to our corporate averages.

That's great. And I'll try this one other way from a consolidated standpoint.

You said 21% incrementals on the net income. Is that a sustainable kind of run rate as you go forward on flat revenue?

Yes, actually, of course if our revenue guidance proves to occur for '12, we wouldn't have any incremental revenue in the upcoming year. But the 21% is, as I mentioned, a little lower than what we would have expected on the basis of the 3 issues that I mentioned for '11.

I mean, honestly, we would have expected 4%, 5% more than that 21% in a normal year from our operations, both Whirlaway and IMC we're thinking [ph], as well as the drop in European revenue, of course.

And just to clarify, I said that we're going to have incremental revenue based on the capital investments that we made. And that would be true in those organizations at Whirlaway, at IMC and in China.

And that would be -- we get the flat year because of the down in Europe.

And Steve, one other comment, and I'm not sure that we totally pointed it out in the press release, but we have really good growth organically and economically. It's more organic than economic, both honestly, in Asia, specifically China, in North America.

So it's -- versus 2009, it's a tale of 3 regions. And 2 of our 3 global regions are doing very, very well.

Europe is not right now.

One is to ask you a little bit about kind of the below the line sort of sales numbers. Usually, you break it into sort of organic pricing mix, acquired and currency.

And this time, I think, you sort of intermingled the pricing mix and currency bits. And I kind of wanted to get a sense of sort of what was the pricing mix piece and the currency piece in Q4, and what are you kind of thinking about as you go into 2012 for those pieces?

All right. Let's see.

[indiscernible] Sorry, we're consulting on the -- Yes, okay, the -- why don't you go on that?

All right, in general, as was mentioned in the press release, we had good volume at Whirlaway in China, but had down volume in Europe, so that was almost virtually flat. But the rest of it was we had raw material pass-through of almost $2 million, and that was offset by some unfavorable mix.

Price was about $800,000. So it -- basically, most of it was raw material pass-through.

There's little bit of price.

So the raw material pass-through stayed positive, too?

Yes.

And then the mix was a negative 0.8?

No, the price was a positive 8. The mix was a negative 2.

Price was a positive 8. The mix was a negative 2.

Okay, so I think -- go ahead. So that price mix piece was basically a negative 1.2 then?

Is that right?

No, basically, it was a push. It was a positive $0.9 million because of the price.

The raw material pass-through and the mix pretty much offset. Price was the differential.

I got it. So that price mix piece that's been running north of $4 million for the balance of the year, that was basically 0.9.

I guess, you're talking in percentage terms, but basically...

No, I'm talking in million, $878,000.

Okay. So that piece that's been running north of $4 million, that came in at about $0.9 million in Q4?

Yes.

Okay. And then organic growth was kind of flattish to slightly negative and then the balance, I guess, that comes down to currency.

Okay, got it. How are you looking at sort of that price mix piece going into 2012?

I mean, do conditions look such at this point that that looks reasonably flattish?

Yes.

Okay. And then, obviously, I'm trying to get a sense of what the organic looks like.

I mean, what are you expecting out of foreign exchange then as you go into -- in terms of its impact next year?

The average rate for this year is the $1.39, and we expect approximately about $1.30 next year. And that's what we built the plan on, so on 40% of our revenue.

All right. So $1.39 down to $1.30, you said?

Yes.

Okay. And then can you give us that -- 2012, where did the revenues at Whirlaway kind of finish up for 2011?

And what are you expecting the increment to be in 2012? And I'm kind of curious, I think that right now, you've been sort of wrestling with, I think, 2 or 3 contracts, but you originally had 1.5.

Is this -- given where we are with Whirlaway, do we now move forward with the other contracts or have they kind of gone away as we sort of move through this? How has all that played out?

Well, we're essentially -- Holden, the start-up phases of all the programs we talked to you about in '11 are done. And I would say that we're operating -- not I would say, I would say that we're operating all of the new programs at good levels of manufacturing efficiency and quality and delivery.

And so many of the issues that we talked about the first 2 quarters, in particular, of '11 are behind us. And we're capturing pretty much the full revenue expectations out of the programs toward the end of '11 and on into '12, although the '12 revenue is up over '11 on the basis of more normalized run rate in those new programs.

And so we're actually forecasting just -- the total increase is how much?

5%

5%, almost 6% for them in terms of just pure organic growth on the basis of more units in '12 than '11.

Yes, I was just going to say in terms of the pipeline for new business, there are opportunities there that could change things, and that those are decisions that aren't locked in yet by any means.

Recently, I think the contracts you were looking to capture, it was $20 million to $30 million in annualized revenues. Was that the right number?

Yes.

And so how much of that revenue run rate did we actually capture in 2011? And where do you think you're going to come out in 2012?

Do we just assume that you're kind of that $25 million run rate in '12?

Yes. It's a mixed bag a little bit, Holden, because we have the Tempe, Arizona, facility that as you know we sold at the beginning of the year.

So I would tell you that we captured about $25 million of the expected $30 million in 2011. And then we expect another $5 million to $6 million in '12.

And but again, having said that, we have opportunities out there that could impact '12 revenue positively that we haven't laid in on relative to investments or moving forward. So but as of right now, and what we've mentioned in our earnings forecast is $6 million out there.

Okay. And when you talk about expecting earnings to be up in 2012 over 2011, obviously, your message there is don't trust the revenue so much, get volumes and the profit drivers internally, and I get that.

But what is the base numbers that you're talking about the when you reference that? Are you talking about $1.24 that you put up all-in, in 2011 as kind of being the baseline that we should compare that comment to or some other measure?

Well, we're talking about the EPS from normal operations. So $1.10 is the base.

And you've got all the foreign currency -- most of the foreign currency gains that you really have to peel the onion back and take that out, Holden.

Right, okay. So $1.10 is kind of what you're talking about?

Yes, the $18.6 million in earnings and the $1.10 is what we're speaking to when we say we see improvement.

Okay. And that $1.10, does that include all the expenses related to Whirlaway, correct?

Yes, sure. That's a good question because we did flow out some of that in 2010.

Right. So that $1.10 number is just outside the losses for Whirlaway.

And it's just out those foreign exchange, it had a little bit of restructuring, that's how we should look at that?

No, the $18.6 million includes the full operating losses that we will report for Whirlaway for 2011.

I have just one question. On the costs of sales, I understand the explanation for the slight production issue in 2011.

But do you have a target or guideline you're looking for in the 2012, like 20%? Or is there something that you're working toward in your...

Yes, it's a very good question. And, yes, we absolutely have a target of margin improvement in our -- baked into our business planning process.

I'm not sure that we want to go public with what that margin improvement is, so I apologize. But I mean, we do have good margin improvement baked in.

And as I mentioned, relative to lower earnings leverage, if you will, a big piece of that margin improvement is the Whirlaway improvement, but also IMC, those 2.

Did you say working capital is going to decrease this year? Or how should I think about that?

You should think about working capital being relatively flat this year because on relatively flat revenue. And then, that happened to EBITDA, pretty much dropped down to the free cash flow line.

We ate up all of our EBITDA last year in working capital increase.

Right. But we're normalizing -- but that was just based on rising revenue, right?

So there's nothing -- was there an abnormal build that you get back? Or are you just kind of at the right run rate for $420 million revenue?

We're now at the right run rate. There was some -- a little bit of unusual activity in the way accounts payable played out that we didn't forecast properly.

But that's normal, that's at a normal run rate now. We also had a little bit of shift in our shipment mix to countries where because of long delivery times, we had longer -- we had to increase our day sales outstanding slightly just because of structural issues.

But that's stable now, too. So we think we should be flat on working capital.

Okay. Modeling question, tax rate, how should we thinking about that for '12, statutory?

I keep telling -- I keep using this 25% number. It's going to be a blend.

Of course, the U.S. marginal rate is higher than that, but we have all of the corporation's corporate expenses in the U.S.

that tend to moderate the U.S. income.

So I've-- my best guess is 25%. Well, let me say 25% to 28% when the rate comes back, when the U.S.

comes back. Now, and at the time when that does come back, we'll book a huge, which we'll account as non-operating gain as we take the reserve off of our U.S.

DTA. But that will be a big number, but it'll be non-operating.

Yes. And I know there was some maintenance spending in 2011.

Is that mostly behind us? Are there any unusual gross margin pressures that we look at 2012?

No. No, as long as we continue to execute like we have in the last few months at Whirlaway and we'll see some margin improvement at IMC, a smaller operation as well, and higher volume in some of these programs will be good, too.

Yes, I know there's the modeling questions of the seemingly unpredictable line item. That other line, the degree to which it kind of swings around as it relates -- or as a result of the ForEx down on debt.

What should we kind of be thinking about for next year? I mean, now that you're looking at the euro or sort of the foreign exchange rate being down a fair bit, I mean, what does that translate into in terms of other, and what do you kind of modeling and/or building in on that line?

Well, everybody here is saying that's going to be a loss. But I mean, that's a question that if we built the plan at $1.30 and it stays $1.30, it would be nothing.

So why would you -- why are you...

On the basis of euro, on a regular...

Yes, so if euro goes back to $1.35, for instance, that will be a loss. If the euro stays at $1.30, we should be relatively no gain, no loss.

Okay. So if the average is north of $1.35, then there's a loss.

If it's $1.30, you're good and say if the average is less than $1.25, then you probably have a gain. Is that the way to look at it?

No, the $1.30 is the base mark. We ended the year with $1.30.

And so to the extent that as at any period in time, any measurement period, a month or quarter or the year, it's the average rate is -- the ending rate is higher than the $1.30, then we'll have a loss. If it's lower than $1.30, we'll have a gain.

Thank you. I'd like to conclude today's call with a general comment that even with the uncertainty in our economic outlook I mentioned previously, we are well-positioned to deliver good earnings improvement for the upcoming year.

We are encouraged regarding the earnings leverage we see in our business for the upcoming year and look forward to the execution of our operational business plans for 2012. Thanks again for listening in on today's call.