Good day and welcome to the NN, Incorporated Third Quarter Earnings Conference Call. Today's conference is being recorded. At this time, it is now my pleasure to turn today's call over to Mr. Mark Schuermann. Please go ahead, sir.

Thank you, operator. Good morning, everyone, and thanks for joining us. I'm Mark Schuermann, VP, Treasurer and Investor Relations. I'd like to welcome you to NN's third quarter 2019 earnings conference call. Our presenter this morning is Interim President and Chief Executive Officer, Warren Veltman. Also attending the call is Tom DeByle, SVP and Chief Financial Officer. If anyone needs a copy of the press release or the supplemental presentation, please contact Abernathy Macgregor at 212-371-5999 and they'll be happy to send you a copy. Before we begin, I'll ask that you take note of the cautionary language regarding forward-looking statements contained in today's press release, supplemental presentation and the risk factors section of this company's 10-K for the year ended December 31, 2018. The same language applies to 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 the company's control. The presentation also includes certain non-GAAP 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 the supplemental presentation. Warren and Tom will now provide commentary on the business and discuss results, and we'll open the line for questions after our prepared remarks. With that said, Warren, I'll turn the call over to you.

Thanks Mark. As this is Tom and my first NN's earnings call, we revisited some of the previous earnings calls to gain a better understanding of the information that our shareholders and analysts would like us to present. Based on that review, we have revised the company's earnings presentation to present additional information regarding the group's financial performance and outlook, adjusted results and the financial analysis of working capital and capital expenditures. I hope you find our presentation more informative. Let's start with an overview of the third quarter. Our sales for Q3 were 213.9 million, up 4% from the prior year and were driven primarily by organic sales from our life sciences group, where sales were up 15.6 million or 20% from one year ago. The third quarter operating income and EPS both improved over Q3 2018. GAAP operating income margin expanded 70 basis points from 2.9% last year to 3.6% this year. EPS also improved from a loss of $0.48 per share one year ago to a loss of $0.13 per share in Q3 2019. Adjusted operating income margin in 2019 was up slightly to 12.9% from 12.8% in 2018, and our adjusted EPS was $0.27 this year versus $0.30 in 2018. Please note that adjusted net income was 11.4 million this quarter and 8.7 million in Q3 of 2018, and the number of weighted shares outstanding increased 46% to 42 million shares, resulting in an EPS number lower than the previous year. Both reported EBITDA and adjusted EBITDA increased consistently between the periods, with adjusted EBITDA increasing to 40.2 million in Q3 2019 or 18.8% of sales in comparison to 18.2% of sales the previous year. NN generated 17.5 million in free cash flow in the third quarter, an increase of 29.4 million over the same quarter…

Thanks, Warren. Please turn to Slide 7, which compares our third quarter results on a GAAP basis to a non-GAAP basis. As the new CFO at NN, I chose to break down our adjustments into two categories for better transparency. One category is referenced as special items on the slide. These are onetime unusual expenses. The other category, called integration non-ops, includes transition and integration expenses the company has historically captured due to the number of acquisitions made over the past few years. The second category of adjustments also includes foreign exchange effects on intercompany loans and some amortization items. The next slide will provide more detail of our adjustments. Still on Slide 7, reading from left to right for both the third quarter 2019 and 2018, the first column shows GAAP reported numbers and calculations derived using GAAP numbers. Second column shows the first category of adjustments to special items, which you will recall are generally nonrecurring adjustments. The third column is non-GAAP, excluding special items. The fourth column shows the second category of adjustments, integration non-ops. And the fifth column is the total adjusted non-GAAP, which considers both categories of adjustments. Stepping back for year numbers highlighted on the right side of the page, you can see both green and red shadings, indicating both positive and negative variances. Gross profit on a GAAP basis increased 90 basis points. Non-GAAP gross profit, excluding special items, increased 60 basis points and total adjusted non-GAAP gross profit increased 70 basis points. Operating income on a GAAP basis increased 70 basis points. Non-GAAP operating income, excluding special items, increased 90 basis points, and total adjusted non-GAAP operating income increased 10 basis points. EBITDA on a reported basis was up 110 basis points. Non-GAAP EBITDA, excluding special items, increased 120 basis points. And…

Thanks, Tom. We have presented additional information for each of our operating groups, starting with the life sciences group on Page 14. The 20% year-over-year sales increase has been driven primarily by our orthopedic and delivery system or case and tray products, yielding an improvement in margins over the prior year. Adjusted operating profit has increased to 21.8% from 20.7% for the prior year. As a reminder, approximately 70% to 75% of the adjustments from the GAAP results are due to intangibles amortization. We have also seen expansion of our reported and adjusted EBITDA margins. Our positive margin trend is the result of continuous process improvement, installation of automation and improved performance of our international operations. Our backlog is 186 million, a 20 million reduction from Q2. We have recently launched our new sales and ops planning application that allows us to proactively interact with our customers and improve the process of matching product requirements with expected delivery dates. As this application is more fully implemented, we expect that it will result in a reduction of our backlog. As we look forward, we expect Q4 to continue the positive trend as it relates to year-over-year comparisons, with a greater than 10% growth expectation in the upcoming quarter. 2020 growth expectation is tempered somewhat at 5% to 9% as we do not expect the same level of new product introductions that occurred in 2019. As we expect, and we expect continued margin improvement due to leveraging incremental sales, while continuing to improve our manufacturing processes during the latter stages of the Paragon integration plan. The mobile solutions business summary is included on Page 15. Mobile sales are down 10.7% from a year ago due primarily to sales declines in North America due to programs moving to end of production, delays in…

[Operator instructions] Our first question will be from Rob Brown with Lake Street Capital Markets.

First, on the life sciences business, I think you talked about growth rates in 2020 in the high single digits. Could use a little more color there. And is that a slowing from your prior thinking? Or is that, sort of, in line with your expectation?

I think that's in line with our expectation. One of the things that we've been expecting due to the significant number of new product introductions in that business was that that would, that pace of the new product introductions would slow down starting in the first quarter or the first half of next year. And we're seeing that in our business. So the growth, this single-digit growth rate from 5% to 9% is in line with our expectations.

And then in the Mobile business, I guess, I just wanted to clarify your thinking there. How do you see that at this point with this market cycle? Is it down again in 2020? And I think you said new programs maybe offset some of that, but help me understand, I guess, why that business should not decline in 2020 again.

We don't expect a decline in 2020 primarily due to some new program launches that, frankly, we anticipated in 2019 that were delayed. We've also had, we've seen a delay in some of the volumes due to the tariff environment. And we've been working with our customers to make sure that some of the capacity that we have in place today is more fully utilized in 2020.

And then the last question, I guess, on the financing discussion. You talked about, you said that you're, sort of, resetting your thinking on, what are, sort of, the alternatives you're looking at? And what's the timeline you're hoping for?

I think the most important thing for us there is that we put a capital structure in place that is aligned with our strategic plan. So we're going to be very thoughtful in the way that we go about this. We haven't set a specific timeline. We understand the urgency surrounding it, so we're approaching it with that in mind. But we are continuing to talk to our lenders and going through various structures and trying to optimize the structure that would make the most sense for us, vis-à-vis our strategic plan.

Our next question will be from Steve Barger with KeyBanc Capital Markets.

Really nice improvement on the slide deck. My first question is, how long have JP Morgan and the law firm been engaged? I'm just trying to get a sense of where we are in the strategic review.

Both of those, JP Morgan and Simpson Thacher, are trusted advisors to the company and have been for an extended period of time. More recently, we've focused some of their efforts to helping us evaluate our strategic options. So we'll go forward with that, with them and are excited about the prospect.

Did that process start a couple of months ago or a couple of weeks ago?

It's more recent than a couple of weeks ago, excuse me, more extended than just a couple of weeks ago. The board goes through annually a planning process where we evaluate the strategic direction of the company. So for us, it's an ongoing process. With the recent changes that we've seen in the business as it relates to the goals of deleveraging, and we've had to redefine how we look at the strategic plan, and we're in the process of doing that. But it's an ongoing process.

It's really great to see the 32 million in cash savings geared toward debt reduction. Can you give any early look at how you think about 2020 free cash flow? And realistically, is there a path to significant debt paydown without asset sales?

Yes, there is. It's through better working capital management, obviously, with the elimination of the dividend, looking at certain, let's say, plant optimization movements along with these SG&A reductions. So we have a line of sight that we're going to be reducing debt in 2020.

I think, Steve, what you've seen to in the third quarter with the $17.5 million reduction and our expectation for the fourth quarter, this management team and this board is extremely focused on deleveraging the business. And this is, in our view, just the beginning of that.

Yes. No question. Good job on free cash flow in Q3 and expected Q4. Is it reasonable to think going forward that you could be free cash flow positive in all the quarters? Or are you still going to be a draw in the first half and then a source in the back half?

I don't want to promise anything at this time. But I mean, ultimate goal eventually would be positive free cash flow every quarter.

The seasonality of the business, too, I would add, Steve, the seasonality of the business, the first quarter is the one where we come out and there's some inventory build and some receivable build, and we're analyzing some of that right now. But that probably, from a seasonality standpoint, is the most difficult quarter from a free cash flow standpoint.

And last one for me. The press release said the strategic options include a sale or, a part or all of NN. I'm sure it's not lost on you that public and private companies that look like life sciences trade at double-digit EBITDA margins. So if you're going to sell something, wouldn't it be better to divest Mobile and/or Power so shareholders can really get the benefit of a delevered balance sheet and what is really clearly a great business in life sciences?

Yes. We're not going to speak specifically about how we're going to approach that or what businesses are most likely, if any, to be sold. We're going to go through the process with a goal in mind of doing what's best for our shareholders, trying to maximize value and also trying to create a scenario where we have the most certain approach as it relates to deleveraging the company. That's our goal.

Thank you [Operator instructions]. Our next question will be from Daniel Moore with CJS Securities.

And echo thanks for the additional transparency as it relates to the presentation, very helpful. I wanted to start with, maybe just start, Tom, with the balance sheet, and you talked about the cost profile of the potential refinancing of the credit facility. Where are we today? Maybe just walk us through the updated terms of each of the tranches of debt, what your expectations look like for interest expense for Q4. And any color on timing of, sort of, the goal of when you might be in position to improve the overall interest expense profile.

Well, as I said, for our Q4, what we've modeled in to the guidance that Warren went over is that there's going to be no new refinancing before the end of the year. That's what we have in our guidance. Going forward, obviously, with the markets, we will have higher interest expense. We have that one tranche coming up in a year from April that will become current of our Term B. And so we're just looking at various different structures to try to do the best thing for what our long-range plan is. So we're looking at all options at this time.

And then very helpful color in terms of the outlook for 2020 across the segments. Any commentary at this point as it relates to margin profile or potential improvement given some of those cost-restructuring initiatives?

Well, we expect to improve margins as we move forward. As volume increases and plus with our cost reduction and plant optimization, SG&A reductions, margins should improve going forward. But we're not guiding on that until the fourth quarter, which we'll give when we issue our 10-K and have this next conference call, which will be in, probably in March.

Thank you [Operator instructions]. Our next question will be from Steve Barger with KeyBanc Capital Markets.

Primary working cap got down to 203 million in the quarter. Where can that go? Or just how much more cash can you take out of working cap? And where can you get on the cash conversion cycle days as you think about going into next year?

This is just early days for me, Steve. I focus on working capital. And I mean, we're looking at all past due receivables, improving inventory, as Warren talked about, lowering inventory so that we have higher turns, more cash coming in. And I'm looking at just DPO terms, trying to push those out further. So I'm just in the, I've been drinking from the fire hose, and we'll be focusing on this going forward, if you understand.

And just a modeling question, if you have this. How should we think about SG&A dollars or the spend in dollars next year? And what will run rate corporate expense be?

We're still working through that. We'll give further guidance in March next year when we release our Q4.

And just one more. Can we just talk about the CapEx philosophy for Auto? And Warren, correct me if I'm wrong, but I think there can be big differences between launching product you've done in the past, even if it's in a new location, versus something brand new, where you're building the tooling and kind of riding that learning curve. So how are you approaching the market right now in terms of what programs you're willing to look at?

That's a good question, Steve. So when we look at capital across the organization, we're looking at it from a return on invested capital modeling standpoint. And clearly, the mobile group is the most capital intensive of our three businesses. And one of the things that we've been working with the team there is trying to redeploy, or to deploy from a sales strategy standpoint, existing capacity. And that's why we're reasonably confident that we're going to be able to reduce the CapEx spend there in 2020. As an example, if you look at the China operation, we probably have the capacity there to manufacture $60 million of product on an annual basis, which is 40% above the current level from a sales volume standpoint. So the team is focused on selling into existing capacity today as opposed to pursuing programs that will require significant CapEx spend.

And just going back to life sciences for a second. Can you talk about recent conversations or new contract wins? Just give us an update on how the model and the value proposition is evolving in the marketplace.

Yes. We've, obviously, we've had significant success there when you look at the year-over-year comparison, and we expect that to continue going out. One of the things that the team there has done is we've modernized some of the facilities through additional investments and machining capability. And just as important, on the automation side, there's been a lot of automation put in to make us more cost-effective from a labor standpoint. That is ongoing. And I would tell you, some of that action really is what makes us an indispensable supplier to some of our end customers. So the ongoing quoting and the hit rate continues to be extremely positive, and we expect that business to be a solid performer for us, obviously, going forward.

And maybe I missed this, I, in the prior life sciences question, but what would have to happen for you to hit the lower end of that 5 to 9%? Because given the backlog you've seen and the value proposition in life sciences, it seems like that would require a pretty significant end-market slowdown or something.

Yes. I think we're going to stick with the 5 to 9% range. It's hard to speculate what specific events could happen that would drive us to the lower end of the range. That's what we're looking at right now. And certainly, new product introductions can impact that, either positively or negatively, which require an inventory fill, but we will learn more about that in the upcoming months.

Thank you. Our next question will be from Daniel Moore with CJS Securities.

Just a quick clarification on the go-forward guidance, it sounds like in 2020, no longer be backing out transition-related type expenses. Does that indicate the likelihood that those will be fairly minimal from your perspective right now in 2020? Or there, could there be some, let's say, delta between where we've, kind of, finished the year this year and what 2020 could look like from an adjusted EBITDA perspective? Just trying to get a sense of those, your thoughts on the add backs for next year.

So my thoughts on add backs is I don't like add backs. And those are going down substantially next year as there's so many portfolio moves in this business. So it goes down to a minimal result that the business is actually absorbing. We will definitely do reconciliations to the prior year to show what it is. We'll comment in the MD&A on certain things that are, let's say, suppressing margins should we have new product launches, such as we had this year, two large ones, one in mobile, one in life sciences. We'll be very, very transparent, and you'll be able to reconcile.

Thank you. I'm showing no further questions in the queue at this time. This will conclude today's teleconference. You may now disconnect. Thank you.