NN, Inc.

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) 827-3746, and we would 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 now turn the call over to you.

Thanks, Marilyn. Good morning, and thanks for joining us.

We're pleased to report yet another quarter of momentum in revenue growth and more importantly, in margin expansion.

As an organization, we continue to drive our transformational plan, and we continue to be laser-focused on maximizing our incrementals.

Our profit and our growth, I think, are a good story. So far, we are pleased.

And so with that, I think, we'll just jump right into the financials, and I'll turn it over to Jim, and then I'll come back to make a few new statements.

Thanks, Rich. As Rich just said, we're making a kind of operational and organizational improvements that are growing both the quality and quantity of our earnings.

We dropped 34% of our sales increase to gross profit during the quarter versus last year, and we kept our costs within our budget.

We talked in the past few quarters about improving our earnings leverage as we pursue our aggressive growth goals, and this quarter is another example of doing just that.

Sales were up $8.7 million or 9.3% over the first quarter of last year on the recovering European automotive market and stable U.S. and Asian demand.

Our gross margin, before depreciation, improved in the first quarter to 21.7%, which is up a full percentage point from last quarter and the same quarter last year. And this was after absorbing the losses from our V-S acquisition, which was announced on February 4.

If you exclude V-S, NN would have a gross margin, before depreciation, of 22.4%.

The operating profit margin, likewise, from normal operations, including V-S, was 8.6%, which was also up over a point from the prior quarter and last year.

So the V-S acquisition added revenue of $1.8 million and a net loss of $450,000 in Q1, excluding the 1x acquisition costs. This was better than we had forecast and the integration process is going very well.

We now expect V-S to breakeven by the end of the second quarter, and to make money and be accretive in the second half.

SG&A was up, it was $10 million, up $900,000 over the same period last year. About $500,000 of the increase was the legal and other costs of that V-S acquisition, which we excluded from normal operations in the reported results, as this is a 1x acquisition expense.

$200,000 of the increase was for the SG&A of the new V-S operations, and there were some higher R&D, stock compensation costs with our stock price being higher, and other miscellaneous impacts. Going forward, the quarterly SG&A should be in the low-$9 million range.

We had EPS for normal operations of $0.31 per share, including the V-S 1x acquisition costs, our EPS was $0.29 per share. If we exclude V-S from the consideration, NN would have had EPS of $0.33 per share in the quarter.

On the balance sheet, we have the normal seasonal increase in working capital.

In addition, you can see that Property, Plant and Equipment went up by $5 million, and this was due to the acquisition of $6.8 million of fixed assets at V-S in the U.S. and Mexico, and offset by relatively low first quarter capital spending versus our depreciation rate.

Debt increased by $13.3 million in the quarter due to the cash outlay for V-S of $7.3 million and the seasonal working capital increase.

Capital spending totaled $2.2 million during that quarter versus our stated capital plan for the year of $23 million, and we paid $1.2 million in dividends in the quarter.

That concludes these brief financial comments, and now, back to Rich.

Thanks, Jim. Again, as we've seen for the last 4 quarters, we continue to gain momentum in revenue growth while simultaneously growing our margins.

As a company, we focus on maximizing the incremental profit margin of each and every additional dollar of sales. In fact, in Q1 2014, sales and income from operations are at the highest level they have been since Q1 2012.

I think it's important to note that this sales and profit growth occurred despite what we would deem a generally tepid North American automotive market in Q1, and we also witnessed a fairly meager 0.1% GDP growth across the board.

In Q1 2014, sales in the North American automotive market continued to grow over prior year, albeit at a much slower pace. The growth, I think, was approximately 1% versus as high as double digits at some points last year.

We believe that this -- this slowing is largely due to the significant weather events that impacted the country during January and February. However, the North American production growth during the same period was 6%, so I think it just gives more evidence to the fact that there's a little bit of disconnect due to the weather event, and the 6% growth is more of an impact on NN, directly.

The European automotive market, their recovery continues to gain energy with about 5% growth over prior year, and the European heavy truck market remained strong. Again, it's important to note that European product volume, with 7% growth, exceeded European demand.

We believe that this is largely driven by exports of the premium brands, which continue to perform at/or above pre-2008 recession levels.

Our net sales increased during the first quarter of 2014 from 2013; principally due to the fact as we've outlined, but we don't want to lose the fact that we've also improved share and we've expanded our portfolio through adjacent product expansion.

I think this was evidenced by our quarter-over-quarter sales growth in Europe, which generally, was higher than the 7% of the European market.

Regarding our outlook for 2014. We continue to expect revenues to be largely in the range of $400 million to $415 million with our sales growth of 3% to 7% over 2013, and this excludes the $15 million incremental that V-S has brought to the portfolio.

In general, Q1 2014 developed a little better than we expected despite the negative weather impact of January and February, as well as the somewhat meager GDP growth.

Specifically regarding our newest product line, the V-S group, as you all know, we acquired the assets of V-S Industries at the end of January 2014, and we immediately began the integration into our PMC business.

In general, the Q1 2014 sales volumes developed as planned. We expect sales volume and profitability of this product line to ramp up dramatically over the next 3 quarters and for the product line to turn the profitability corner a full quarter in advance of our model.

This concludes my comments, and we'll be happy to take questions at this point.

Just curious, can you give any more detail on lessons you learned during the V-S integration? And maybe also give us some color on what the margin profile would look like, I know $1.8 million of sales, excluding some onetime charges?

Yes. I guess, the first comment on our lessons learned on the integration is, I think, which we did a very thorough job looking at it on the front-end.

And we're pretty -- we're on track, in fact, ahead of track, on the implementation. So -- I don't know if you have any comments on that, Rich?

Yes. I don't think that we're at a stage where we can sort of bring together an awful lot of lessons learned.

We're still fairly early in the process. The process is going a lot better than we expected.

We don't really have any concerns right now, I think, it's proving to be a credible addition to the portfolio and we're pretty happy. I'm sure, as time goes along, there'll be some lessons learned, but we're really early in the process.

Relative to the margin profile, the expectation is that we get this business to a margin profile that is very similar to our current PMC business. So we expect this to be, certainly, a double-digit operating profit kind of business and everything that fits in that PMC profile, that would be the expectation.

So that's certainly what we're working towards.

Got it. And speaking to the margin, going forward, should we be thinking that gross margin above 20% is an achievable run rate?

Yes. I think that's our expectation, right?

I mean, our story has kind of been margin improvement, margin improvement, margin improvement. And I think, we feel comfortable that where our run rate is -- today is, is about where we're going to be in and we'll continue to try and drive efficiencies around it.

Great. And it was really encouraging to hear your commentary around end market.

For EPS in 1Q, should we kind of consider that as a low point for the year, kind of going forward?

Yes. I'm not sure that we're ready to say that, because we've seen some behavior in the market that could lead us to believe that there was a little bit of flow from what could be Q2 into Q1, so I think we have to be just a little careful around that.

I think if you look at the inventory numbers, you've seen some buildup of inventories, not sure if you're going to get that bleed off. And you've seen some increases in incentive from the automotive, so I think we should be a little careful that this would be the high watermark.

I think we've got to watch Q2 and see how it plays out.

Got it. Just one more and I'll get back in line.

You talked about how January and February are a little bit slow due to weather. I was just wondering if you could talk a little bit about margin in April, to some extent?

Well, I think, March began to behave as we expected. It didn't completely make up for January and February, but keep in mind, March had the significant weather events, as well.

As we kind of bring the numbers from April together, I think, April seems to be a more, I'll call it, sensical month in the marketplace. And there's a little bit of catch-up, but not...

Yes, I would say we haven't -- normally, Q2 is the strong quarter for us. And we haven't seen anything that would indicate that it's not going to follow that pattern.

It looks like Mr. Maher has disconnected.

The next question is from the line of Bruce Geller with DGHM.

Could you elaborate on some of the adjacent market gains that you experienced in the quarter? Because that's really a newer part of the story, and an interesting part of the story, so I'd love to hear more about that.

If you could, elaborate.

Yes. We have -- we've kind of told the story that we have manufacturing processes that we can use to fit into other adjacent markets fairly easily, and we've gone after that.

Most notably, the equipment that we use around making our tapered roller can also be used for various industrial products, specifically, in the hydraulic space. So we've gone after that in a fairly aggressive way and we are experiencing, I would say, quite a bit of success in that space.

And it's coming at a nice time because industrial markets appear to be coming off the bottom, and so, we're picking up some sales from that. Additionally, in the V-S product line, we have -- we've added to the portfolio, in terms of customers, as well as in terms of the type of product we make.

And so, we have picked up some business from -- pull-through business from some customers that, heretofore, we hadn't really done any business with in end markets, most notably, retail markets that we have never touched before.

That's great. Do you have any sense of like an annualized revenue run rate from some of these adjacent markets that you've never gone after before?

We're studying that. I don't think we're ready to put a number out there.

But I think, at the very least, we think it's going to be a substantive number. So maybe next quarter we'll be in a better position to look at that.

All right, that's great. That's impressive.

Could you also comment on the acquisition pipeline? I know that's also an increasing component to the story.

It sounds like V-S has been a success, thus far. But at the Analyst Day, it sounded like you had possibly a few things in the hopper.

So if you could bring us up-to-date on that? That would be great.

Yes. I will tell you that we are as bullish as we can possibly be around the acquisition pipeline.

We expect some good things to happen sometime during the year. We just continue to work these deals.

What kind of valuation multiples are you looking at pre- and post-synergy EBITDA-type multiples on some of these deals you're looking at?

Well, I will tell you that the market is seeing multiples. Depending on what part of the business you look at, you're seeing multiples anywhere from the 6x to 12x, at this point in time, depending on what part of the business.

So we, of course, would always try and do our best to get to the low end on the valuation perspective and perform a little bit better. But that's what we're seeing in the market and I think it's probably only going to get higher because it's -- the market is heating up.

What was the multiple, EBITDA multiple, you guys paid for V-S?

With V-S, because they were a company that was about to go under, we paid -- you have to look at it is a multiple of revenue, so we paid something like 1/2 the revenue. But so most of the other deals we're looking at are not that kind of thing.

They would be -- I mean, ideally, immediately accretive, and accretive on an economic basis, as well, both earnings and economic.

Sorry, I had some technical difficulties. And so, if I ask something that you already answered, that's fine, just let me know and can go back and listen to the replay.

But kind of on -- in general, these acquisitions, obviously, the first one's gone really well. Could you talk about maybe the process in terms of what you're looking for in an acquisition, and then kind of how you look to integrate them?

Since it looks like you have done a good job here with your first acquisition in some time.

Yes. Well, like me talk about the process, first of all, of integration and due diligence.

We have what we think is an incredibly detailed process around how we evaluate an acquisition candidate. It is -- if you printed out the spread sheets, it's probably some 60 pages that looks just about every single aspect of the business.

And, as was the case with V-S, we think when we're done with that, we know the business, at least as well as the people running it at that time, and hopefully, a little bit better, when it comes to laying the business up against a synergy case. We then take that same checklist and we use it to derive our synergy case.

And so we come up with a base case and we put the synergies on top of it. We typically go light, candidly, on sale.

And that's proving to be a good strategy because we're getting much more sale than we put in the model, and so it's always nice to have a little bit of a hedge on the top line. And then, from the synergy case, we drive the actual integration activity, down to an extremely detailed level.

That's kind of the high-level look at the process. When we're looking at candidates, we were pretty open about that in the investor conference, we are not looking at anything that is too far afield from what our expertise is.

So in the precision machining space, for example, if you look at V-S, V-S has a very similar manufacturing portfolio as we do; however, they have a different model. So they are a low-volume, high-mix model, which is the piece of the portfolio that we didn't have.

They have a little bit of medical, which we didn't have. They have a lot of commercial, which we didn't have.

So these things were great adjuncts to our current portfolio and our current manufacturing methodology, while maintaining our ability to run the business, if you will, because we understand the technology and the application specificity around how it's done. And so we sort of take all those things into consideration when you look at any acquisition candidate.

And probably last, but not the least, we talked a lot about making sure we build a balanced business. So we think about the cycles, the economic cycles, and where these pieces of the portfolio fit; because it is our intent, long term, to be, for lack of a better word, a predictable business in terms of shareholder return.

And that means, we have to make sure that we account for all parts of the economic cycle.

Okay, great, that was really helpful. Just real quick on the -- I think you already touched on this, but January, February, because of the weather in the U.S -- I mean, don't you think that would -- that's not really lost sales, that's just kind of deferred sales, basically, that at least in this quarter you should make those up?

I would certainly hope so. And I think indications are, that's probably the case.

But the inventory number did swell, so you look at that just a little cautiously.

Okay. And then, just a final question on China.

I know you invested quite a bit in a new facility there, I guess, last year and the year before. What's kind of driving the business there, in terms of products and end markets?

Well, fundamentally, in China, we've adjusted our strategy. When we initially made our investment in China, it was more around following our multinational customers.

And we continue to do that, but we've made an adjustment to strategy where we're going after the local market and we're finding ourselves fairly successful in building a Chinese business to service China or China end market. That's where the majority of our growth is coming from right now.

Jim, anything? Okay.

Well, we appreciate you joining us today. We are feeling pretty good about the business.

We continue to work, we have a lot of work to do. I don't want to set an expectation that we're anywhere near where we'd like to be.

There's a lot of work to be done, there's a lot of potentials in the hopper and a lot of growth to go after. We continue to maintain the guidance of our strategic plan, and hold on to our discipline around incrementals.

So with that, I want to thank you, all, for joining us today and look forward to chatting with you next quarter.