Good day, ladies and gentlemen, and thank you for standing by. Welcome to the NN Incorporated Second Quarter 2016 Conference Call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. [Operator Instructions] This conference is being recorded today. I would now like to turn the conference over to Mr. Robbie Atkinson. Please go ahead, Mr. Atkinson.

Thank you, operator. Good morning, everyone and thanks for joining us. I am Robbie Atkinson, Vice President, Corporate Treasurer and Investor Relations and on behalf of our team, I would like to welcome you to NN’s second quarter 2016 conference call. Our presenters this morning are President and Chief Executive Officer, Richard Holder, and Vice President and Principal Financial Officer, Tom Burwell. If anyone needs a copy of the press release or the supplemental presentation, please call the Financial Relations Board at 212-827-3746 and they will be happy to send you a copy. Before we begin, I would ask that you take note of the cautionary language regarding forward-looking statements contained in today's press release, supplemental presentation and the risk factor section of the company's 10-K for the year ended December 31, 2015. This same language applies to the comments made on today's conference call, including the Q&A session, as well as the live webcast. Our presentation today will contain forward-looking statements regarding sales, margins, foreign exchange rates, cash flow, tax rate, acquisitions synergies, future operating results, performance of our worldwide markets and other topics. These statements should be used with caution and are subject to various risks and uncertainties, many of which are outside of the company's control. The presentation also includes certain non-GAAP financial measures as defined by SEC rules. A reconciliation of such non-GAAP measures is contained in the tables in the final section of the press release and supplemental presentation. First, we will give an update and overview of the quarter. And then afterward, we will open up the line for questions. With that said, Rich, I'll turn the call over to you.

Thanks, Robbie and good morning, everyone. Welcome to our Q2 conference call. As usual, we'll start with the highlights and then I'll walk you through the deck and then we'll open up the lines for questions. Before we jump into the highlights, I would like to remind the group about our focus for this year. We've been very clear that we felt that there is still work to be done to fully unleash the margins and cash generation potential of the business. We told you that this year would be the year that we would be laser-focused on the operations and we turned the business into a well org machine. While I think this was evident in Q1, I think as we walk though this deck, especially when you look at our margin profiles and where we're going, I think you'll see the continued improvement and the work we continue to do with the NN operating system around the margin potential and around the cash flow profile as we begin to close in on our 14% operating profit strategic target. We've done this in spite of what we call it that's a very sporty industrial market and we'll talk more about that. So let me jump into the highlights, let's go over Page 5. Sales were $214.3 million with PEP contributing $58.4 million. This was slightly below the bottom end of our guidance. The mist on sales was almost entirely due to the weakness in the industrial end market and again we'll talk a little bit more about that. In spite of these -- in spite of the headwinds from these markets, we're able to flex the organization through the appropriate execution of the operating system and deliver on an expected $0.46 a share for diluted earnings. EBITDA was $40.8…

[Operator Instructions] We’ll go first to Justin Long with Stephens. Please go ahead.

Thanks and good morning, guys.

Good morning.

Good morning.

First question I had just to get some context, I was wondering if you could share what percentage of the business today you would define as being exposed to the industrial end market. You talk about the industrial headwinds that you're facing today from a macro perspective, but I just wanted to make sure I was using the right base revenue number when thinking about the changes that we are seeing in the market?

I think roughly all in above 25% to 27% of our business is exposed to the industrial end markets.

Okay. Great. And you gave some good color on the top line impact from what we're seeing in the industrial market, but I was curious what type of mix impact this was having on margins? Do your industrial products tend to carry a higher or lower margin relative to other end markets?

Yes, well I think that question has to be answered in two different ways. I think at the corporate level, there is not an awful lot of mix impact. But within individual businesses, most notably the PVC business, the industrial end markets carry a little bit better margin profile. So when you see PVC performing to the flex rate that they are, they are doing a yeoman job holding that flex rate.

Okay. That’s helpful. I wanted to ask about the CAFE related business as well, it seems like that’s an area where you continue to see strength and had a good quarter. But could you talk about how much CAFÉ-related revenue that you booked in the first half of the year and how you are expecting that to trend in the back half based on your guidance? And maybe one another question on that front, is it correct that most of that CAFÉ-related revenue is in North America?

Yes, the majority of the CAFE related revenue is in North America. There is little bit outside, but again our competitors have the bulk of European business and the stuff we do in China is -- let’s just say older generation product, right, so. So yes, it’s particularly North America. The CAFE business has grown -- just specific CAFE is grown roughly, I am going to 8% in the first half. We expect that to continue through the second half of the year. There is not a huge acceleration only because the bill plans have already been set and they’ve been moving fairly stable. So what’s you have is when we look at the Autocam, we've got about let’s call it 8.5% maybe as much as 9% all in growth in CAFE related activity and maybe 3% all-in growth in non-CAFE. And then of course you have negative growth in the industrial stuff that they have.

Okay. Great. That’s good color. And then I think one of the last questions that I had was on the EBITDA guidance, the adjusted EBITDA guidance for 2016. If you combine the acquisition expenses restructuring and impairment add-backs, that number went from about $3 million to $5 million last quarter in the guidance to just over $13.5 million this quarter, could you provide some more color on what drove that jump in some of those add-backs?

And the answer to that I think we are not seeing that right now. So can we answer that question for you offline.

Yeah, Justin. We don’t have that number at all. So I think it's probably best if we discuss that.

No problem. We can follow-up after the call on that. I appreciate the time. I’ll go ahead and pass it on.

Great....

And our next question comes from Daniel Moore with CJS Securities. Please go ahead.

Thank you. I appreciate the time. In terms of the industrial side, may be you just drilled down a little in terms of what verticals or geographies, you’re experiencing the most incremental weakness in demand.

Yeah, I think, I think if you narrow this down, it’s probably would manifest itself in linear motion first of and followed by let's call it heavy equipment stuff so the Ag market, the construction market a little bit of oil and gas, so those are primarily the market set that are being hit the most. We make a good portion of the product in Europe, but it manifest itself all over the world. It's being shipped all over the world coming out of our customers European, European factory that is primarily I think the biggest one.

And in terms of linear motion, I assume heavy truck any other areas there?

Let’s be careful, it's the European heavy truck right, not the [NASA]. So the European heavy truck, it will be a little bit of rail, it will be -- yeah those are the primary markets I would say.

Okay. And then switching gears a little bit, I just wanted to clarify that I here PEP was up $3 million year-over-year on a pro forma basis in the quarter, is that right?

Roughly yeah.

And operating margins up close to 400, 380 Bps.

Correct.

That’s on a linked quarter basis, speaking on the margin side, so Q1 to Q2 is up 380 basis points.

Sequentially, okay, got it. That helps and those were housekeeping. So one or two more, in terms of cash generation, you mentioned, you're $10 million ahead plan, how much of that is lower CapEx relative to your plan at this point in the year.

Yeah, very little of it is, if you recall first quarter, we made significant move on working cap and we got ahead of plan about five days, we got about five days working capital. We've held on to that. We plan on continuing to hold on to that. So, that really is the bulk of that $10 million.

Yeah, and if you look at our capital spending for the first half of the year, it's about $18 million and that’s right on plan for us. We’ve talked about even last quarter being closer to low end of guidance of our guidance at that point and if you'll remember when you think about an annual run rate there is only so much time in a year that deploying capital. So that $18 million for the year and what Rich talked about earlier was some program delays. Reducing that guidance is more of a second and half number, it really doesn’t have any impact on our, our performance year-to-date and cash flow.

Okay. I think I know the answer to this, but it was the follow-up there, are there any projects or areas of investment that are being pushed out or delayed and any implication for revenue growth and opportunities as we think about fiscal '17?

No.

Okay, appreciate the color. I'll jump back in queue.

We’ll go next to Steve Barger with Keybanc Capital Markets.

Hi, good morning guys.

Hi Steve.

You’ve given a lot of detail on the industrial issues, but I’m curious how much flex is built into the model for other areas, which is to say you feel like you have some cushion in that new guidance range, if you have some negative variation in other places.

Well, I would held to use the word cushion, but I will say that in the other product lines we’ve built in an appropriate flex should those markets begin to display weak.

But to be clear, you’ve not seen weakness in those other those product lines at this point.

We absolutely have not…

So just to frame it up, your overall confidence that these numbers are solid with four months left is high.

I think that’s fair.

Okay. When you look at the 3Q guide of $213 million to $228 million on the top line, where do you think PEP comes in that number? Is that up sequentially or is there some seasonal factor that keeps that flat or down?

They are -- let's see, they would be up -- it would be up sequentially to the tune of about round numbers, let's call it $4 million.

Okay. This has been covered a little bit, but it's a question I get a lot, there is a lot of concern around North American auto sales. So two questions, one are you sensing any change in tone from the customers in terms of production schedules one way or the other. And two, can you talk any more about what you're seeing in terms of conversations around adoption for the fuel efficiency technologies?

Yeah, so as you can imagine we stay pretty close to this. In fact we literally had I just in here, last week for an incredibly detailed conversation. We're not seeing anything that gives us pause for the build rate for the balance of the year. I know that we've seen some blip in sales, but then if you look at the inventory levels they've fallen as well. So if you put it all together, the number seven -- we built a plan on roughly $17 million. And so that looks very doable right now. It looks solid. If anything maybe the market is just a little bit better than that, but we don't see anything that gives us any pause or we're talking to our customers continuously to make sure that we don't get caught with any surprises. With respect to CAFE, increased CAFE adoption, there's a lot of conversation going on. I don't know that we've seen anything yet that let's just think that we're going to accelerate the adoption rate significantly. I think there's a couple of programs here and there but as a wholesale effect of acceleration the CAFE product we're not seeing it just yet, but there is condescension. But my suspicion the robustness there of the market will probably influence that to some degree. I think if the market starts to show weakness I think folks will start to look at dumping old school products a little faster and getting the new school product in track.

Understood. Last question, I'll get back in line. Can you talk about customer conversion from quoting activity for PEP specifically, but also across the units just as an offset to some of the industrial weakness?

Yes, so we're having an incredible amount of success. Landing a larger share of wallet let's say the number of customers on the PEP side, but it's also going both ways. I don't want to miss that right. We have customers that were PEP customers that are now customers of the enterprise and vice versa. So I think it's working out really well. We've launched the sales force and they're out there getting those cross-sell opportunities and it's fairly excited. One of the things that you have to keep in mind with the PEP side of the business while we've won a number of contracts, we are in the starting block and the gun is up, and we're waiting for one agency or another to give us to fire the gun. So the potential for PEP second half of the year is enormous, but it's contingent on till we get an FDA approval, we’ve got to get those federal units to finish their approval process and once that happens then we can go into production mode. So I think when you look at what we had in the pipeline, what's still in the pipeline and what we have landed, we’ve actually won. We're not coming product yet, but we’ve actually won. I think we’re extremely excited about it.

So none of the things that you've won, but don't have approval on are in guidance right?

No they're not.

So if it doesn't have in this year then it just gives you an extra boost in 2017?

That's a true statement. And keep in mind a little bit of the same is true on the industrial side too. Remember our entire firm is on the industrial side when we were getting into this market at the bottom right. So when you look at the product we have for the big fluid power guys that we won those markets are weak, so we now have those products. So again when the markets come up, these are market we didn't play in before that we're now strong in, we’ll realize with that type.

So just to follow-up on that, are there any other areas where you're casting your net into weaker end markets that will give you uplift in the future?

Yeah, so we have a number of projects that we’ve been successful in winning in the industrial space again but we have program delays for the soft end markets.

Right. All right, thanks for the time.

Okay.

The next question is from Stanley Elliott with Stifel. Please go ahead.

Hey guys, good morning. Thank you for taking my questions.

Good morning

Quick question just kind of flush out on the lowered top line guide, you mentioned the industrial piece, I’m assuming most of that is going to come from the PDC business, is that correct?

Yeah, that’s correct.

And could you talk a little bit about, the margin being able to hold the margin of the decrementals and that this has been very good in the quarter especially with the headwinds on the industrial side and the mix issues, can you talk about what’s you’re doing behind the scenes to maintain 25% decremental in the back half of the year.

Yeah, absolutely, we have models in every plant, every product line of the entire business and we have a min max year is what we think we can do if this product comes in at the bottom end of the volume metric scale and we’ve modeled what cost we needed to take out of those particular lines in order to hold the margin, that in addition to our normal scheme of kind of our 3% to 5% cost out every year. So, at least a little bit of restructuring effort that you would say and then may be too harsh a word, I don’t know that we restructured. But certainly we have modified lines to a point where we've been able to take labor out. We’ve modified some quite a few supply chain activities to be able to take some cost out. We're doing our planning in a very different way and in some cases, we’re doing a lot more what we call mix model sequencing, so we can get rid of entire shift. So, it's real granular every day, walk in and tackle work and knowing your cost, literally every day, which is new to the organization but it’s a fundamental part of the NN operating system and its well received and I think it's safe to say it’s working.

And along that lines is there a way to parse out the margin improvement either on a year-over-year basis from NN operating system versus mix and then also certainly the sequential pick up on PEP was quite impressive. Is that all mix or is there something underneath it within the operating system that’s helping push those margins up as well?

Okay. So two question your first question when you think about from the enterprise perspective it's about 60% operating system and about 40% mix that are end market. When you look at PEP, it is almost entirely the operating system. I would say may be 30% mix because we are in the build season, so we're getting, we're getting some volumetric uplift from the residential areas for some -- well the electrical residential area, but that quarter-to-quarter uplift was the operating system right as we continue to integrate the business, we continue to get things into shape, services and all the basic things that we've said we would do as part of integrating the business and reflecting the synergy. So, that’s probably the best way to think about it in terms of PEP.

So it sounds like the PEP, this is tracking even ahead of your expectations, one, make sure I’m correct in that assessment and does that change your long term view on what potentially the margin profile of that segment could end up becoming?

Well, I think I would characterize what’s going on in PEP as this is what we expected to happen alright. And so we feel good about it and if there is upside we’re happy to have it, but I would prefer to characterize it as this is what we expected. In terms of long term margin for that business, I would tell you, I think what we see is, what we expected to see on our internal plan and I think it’s made up appropriately given where we feel we need to be to hit that 14% operating margin for the corporation. So keep in mind this is the way we describe it. The operating margin for the corporation is 13% to 16% bottom of the cycle, top of the cycle, right. So 14% is just in the middle. So there will be times when we will expect PEP to be operating given the volume, north of 16%, well north of 16% and there are times when the cycle that will be down and we'll see the other. So that 14% is just in the middle. We think PEP certainly electrical and the medical those two big pieces, which is the big driver are hitting on just about also in there right now, not all, but just about all.

As far as with these business taking up, I don’t want to put words in your mouth, but you look at this plus what some of the program delays that will sound like that they would also be higher margin business then if the volumes do come back into '17 then incremental is possibly even higher than 35% that you normally lay out?

Yeah, absolutely. Can we get higher than the 35% incremental? Absolutely. But we plan to 35% up and 25% down, that’s -- we will have -- we’ll certainly have those times where volume will be upfront and we get a little bit more 35% and I am sure we will have those times when it won’t be as in the industrial markets.

Perfect guys. Thank you very much.

We are not laying out a case that is -- everything is not on the table. That’s not our planning strategy.

I hear you. Thanks guys, appreciate it and best of luck.

Okay.

[Operator Instructions] We’ll go next to Larry Pfeffer with Avondale. Please go ahead.

Good morning guys.

Good morning Larry.

So, sticking with PEP could you just give us an update Rich on where you are in the SG&A ads and just how that business is building out, now you’ve got your hands on it for few quarters?

Yeah. I think prior to the SG&A ads we're probably just about there. There maybe one or two heads that we're building out a government services business and so there maybe one or two heads that may need to still go into that business as we build it out. There is some pieces that we are looking at on the aerospace side that means something to be add, but that probably won’t come until fourth quarter, maybe be pushed into first quarter. So I think largely where time at the spend level where I think we're going to be. We finished the recapping of the sales force. In fact we had our first all-in sales meeting in Boston just about a month and half ago. So we've now deployed those folks and we’ve gone through the training. So arguably we are little bit ahead of plan and getting that done. I think we plan to get that done, kind of third quarter-ish and we are now finished with that. So I think all-in we are probably at the spend level that we going to be at.

Got it. So further additions are really to support specific sales growth initiatives?

Yeah.

Okay. And looking at the margin guide into the second half, you’ve obviously given some good color on this already, but just thinking about it on a segment-by-segment basis, are you assuming PVC tracks at current levels through the back half of the year and you get a little bit sequential lift in both APC and PEP?

Yeah. I think that’s a good way to think about it.

Okay. And on the revenue side by segment, obviously the color on industrial market is pretty clear but are you anticipating the PVC business tracking down sequentially through the second half on revenue?

No. We think PVC is flat.

Okay. Is that more just the comparables you run into there, than anything in the end market?

No. We have a lot going on in the second half. We have seasonality front. We have that European shutdown. You have less shipping days in the fourth quarter. You have I would say the actions that people take on the channel in the fourth quarter. When you put all that together, we think that’s a flat H2.

Okay, understood. Thanks for taking my questions, guys.

Thank you. And we’ll take a follow-up from Steve Barger. Please go ahead.

Hey, Rich, just to follow-up on that, can you tell us what you're thinking about restocking activity into half across the various businesses? I think you just alluded to it, but any more color?

Yes we're thinking that there is not going to be significant restocking in the second half. I think that best of the information we're getting is all over the map right now. We know that the channel is fairly dry, that’s a comparative statement. So certainly there is opportunity there. But we've not seen anyone move to start that restocking. So in our plan we're assuming that the channel stays at the level that it is right now.

Okay. And any update, I think you’ve talked in the past about how many opportunity for a rating review and maybe a re-fi, is there any update on that?

Yeah, so we have a meeting coming up later this month with the rating agencies and so we will see how that all turns out. And then I think what we do relative to re-fi will be contingent on the market. We're looking at the market every day and if the appropriate opportunity presents itself, we will certainly action that opportunity.

Okay. Thanks very much.

Okay.

And it does appear we have no further questions. I will return the floor to you gentlemen for any closing comments.

Okay. No, I think, we’re all set. Thank you for your time. And again I hope that when you’ve gotten out of this call, is you're starting to see the power of the portfolio and starting to see the pieces of this business manifest itself, especially on a cash perspective. Again we feel really good about our cash. I can't say it enough. And with that I think we’ll close the meeting. So thanks for your time.

And this will conclude today’s program. Thanks for your participation. You may now disconnect and have a great day.