NN, Inc. (NNBR) Q1 2021 Earnings Report, Transcript and Summary

Good day and welcome to the NN Incorporated First Quarter 2021 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Mike Danehy, Director of Investor Relations and Financial Planning. Please go ahead sir.

Thank you, operator. Good morning everyone and thanks for joining us. I'm Mike Danehy, Director of Investor Relations and Financial Planning. I'd like to thank you for attending today's business update. Our presenters this morning will be President and Chief Executive Officer, Warren Veltman and Tom DeByle, Senior Vice President and Chief Financial Officer. Yesterday afternoon, we issued a press release announcing our financial results for the first quarter ended March 31st, 2021 as well as supplemental presentation, which has been posted to the Investor Relations section of our website. If anyone needs a copy of the press release or supplemental presentation you may also contact Lambert and Company at 616-258-5788. Before we begin, I ask that you take note of the cautionary language regarding forward-looking statements contained in today's press release, supplemental presentation and in the Risk Factors section in the company's annual report on Form 10-K for the fiscal year ended December 31, 2020 and when filed the Company's quarterly report on Form 10-Q for the three months ended March 31st, 2021. The same language applies to comments made on today's conference call, including the Q&A session as well as the live broadcast. Our presentation today may contain forward-looking statements regarding sales, margins, foreign exchange rates, cash flow, tax rates, acquisitions, synergies, cash and cost savings, future operating results, performance of our worldwide markets, the impact of Coronavirus COVID-19 pandemic on the company's financial condition 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 non-GAAP measures is contained in the tables in the final section of the press release and the supplemental presentation. Reviewing the agenda for today's call, Warren will provide an overview of key highlights from the quarter, followed by a detailed financial results update from Tom. Warren will then discuss our segment results and end-markets as well as the outlook for the remainder of 2021. At the conclusion of the prepared remarks, there will be a Q&A session. At this time, I will turn the call over to Warren Veltman, President and CEO.

Thanks, Mike and good morning everyone. If you would turn to page 5, we will review some of the highlights for the first quarter. The solid momentum we achieved in the second half of 2020 continued and in many ways even accelerated into the New Year. With the tailwinds of economic recovery boosting our business and that of our customers, we are encouraged by the progress being made to overcome the impacts of the COVID-19 pandemic. We completed our refinancing during the quarter, which has substantially reduced our overall cost of capital and put NN on a stable long-term financial footing that will provide the flexibility we need to achieve our 2025 growth and margin targets. With the broad recovery, we achieved another strong -- another quarter of strong growth in revenues both sequentially and year-over-year. We saw this growth especially in our automotive products during the quarter, which had a significant influence on our Mobile Solutions business, which grew even faster. The impact of our many cost improvement and operational initiatives undertaken in 2020 generated solid results in the quarter with year-over-year increases in both GAAP and adjusted financial results along with a high conversion of EBITDA on the incremental sales. We also maintained our focus on working capital by increasing turns for the third sequential quarter resulting in a rebound and free cash flow generation. Turning to page 6, we have summarized some of the other key highlights for the quarter. As I mentioned, our business continued to rebound from the significant impact of the COVID-19 pandemic as sales for the quarter were $126.8 million, up 9.1% from a year ago and up 6.5% from last quarter. The improvement in sales volume coupled with the operational improvements we have implemented resulted in significant improvements in operating income and EBITDA as well as earnings per share. Reported operating income improved to $1 million versus a loss from operation of $103.9 million one year ago though of note that the prior year results included a significant goodwill impairment. Non-GAAP adjusted EBITDA was $16.9 million or 13.3% of sales, up from $10.1 million a year ago when adjusted EBITDA was 8.7% of sales. GAAP EPS from continuing operations was a loss of $0.46 per share versus a $5.96 per share loss from a year ago. I would note that the loss from the current period was driven primarily by costs associated with the refinancing transaction and the elimination of our interest rate swap. Our adjusted net income from continuing operations was a profit of $0.05 per share versus a loss of $0.16 per share in the prior year. Now I'd like to turn it over to Tom DeByle. So he can provide a more in-depth review of our financial performance for the quarter. Tom?

Thanks, Warren. Please turn to slide 7, which highlights the big picture view of our first quarter results along with the continued recovery in our sales trend. We saw a much stronger increase in our adjusted EBITDA than you might expect given our usual incremental margins. With an $11 million increase in revenue, we achieved a $7 million increase in our adjusted EBITDA, which is higher than our normal 40% variable margin flow through. Sales volume, JV net income and the impact of absorption into inventory increased EBITDA year-over-year. Note that management made a conscientious decision to increase inventory to prevent supply disruption impacting our customers. The improvement in EBITDA was partially offset by the impact of temporary cost reductions such as gain sharing, which was reinstated at the beginning of 2021. Looking at the bottom chart, we can also see the continued recovery in our markets as reflected in our net sales. After falling dramatically in the second quarter of 2020 due to the impact of the COVID-19 pandemic and related production shutdowns at our customers, we have seen rapid sequential recovery over the past three quarters. We anticipate the recovery to continue into 2021 as we move past the pandemic-related impact and shift to more normal growth pattern. Let's go to slide 8, which provides a look at our continued focus on working capital management. The recovery in working capital turns as continued with higher sales and continued prudent working capital management is showing an improvement over the past three quarters. Net working capital at the end of the first quarter was $114.8 million, compared with $104 million in the prior year, an increase of $10.8 million there. This is primarily due to an increase in accounts receivable ultimately driven by higher sales volume within the quarter. Inventory was also higher as previously mentioned to prevent supply disruption impacting our customers. Working capital turns were 4.4 turns versus 4.5 turns in the prior year. Sequentially, working capital turns continue to improve from 4.3 turns in the fourth quarter. Turning to slide 9, we highlight the disciplined approach we have taken to capital expenditures over the past year and remain focused on prudently managing our cash. You can see on an absolute basis, we have reduced capital spending by 26% compared to 2020 and in comparison to depreciation expense we have come down from nearly 100% of depreciation to about 70%. Cash capital expenditures were $5.5 million or 4.3% of sales for the first quarter, compared with $7.4 million or 6.4% of sales in the prior year. We approach capital expenditures in terms of both sustainability as well as growth. Over the past, we have eliminated or deferred projects that were not of immediate need and even as we invested in projects critical to our long-term growth. In addition, we have available capacity at a number of our facilities we remain flexible in responding to increased demand as it continues to rise. Slide 10 shows a chart of our free cash flow for the quarter. Free cash flow was $2.4 million in the first quarter compared to a use of cash of $1 million in the prior year, which still included Life Science. Our free cash flow in 2021 will be impacted by two items in future quarters. First in the second quarter, we will be negatively impacted by a $9 million cash tax payment related to the spin off of the Life Sciences business. Second, we are estimated in the fourth quarter that we will receive the tax refund of approximately $11 million due to the loss carrybacks under the care of that. We are focused prudently on managing our working capital and capital expenditures while improving our profitability to increased free cash flow throughout the year. Please turn to slide 11. Net debt at the end of the first quarter was $123.3 million versus $768.9 million in the prior year, a decrease of $645.6 million. The reduction was due to the paydown of debt following the sale of Life Sciences and our recent refinancing. Our net leverage ratio stood at 2.3 times at the end of the first quarter, down from 5.4 times a year ago. Maintaining a leverage ratio at/or below three times. It's important for our long-term growth initiatives as that alleviates concerns from our customers and suppliers regarding our long-term financial stability. A couple of more points before I turn the call back to Warren. First, we have over $75 million of liquidity as of March 31 2021 and currently have not drawn on our revolver. Although our liquidity decreased by approximately $17 million versus the fourth quarter of 2020, we believe we have ample liquidity to support our needs. The refinancing decreased the size of our revolver from $60 million to $50 million and we had a $5.1 million increase in working capital versus our fourth quarter of 2020, resulting in a decrease in our cash balance. Second, in the lower right-hand chart you can see that our term debt increased from the fourth quarter 2020. This is due to our refinancing as we shifted our capital structure from a higher cost preferred stock to a lower cost term debt. With that, I'll turn the call back to Warren.

Thanks Tom. On page 13, we outline our view of current market conditions within each of our operating groups. Within Mobile Solutions we have seen a continued recovery of automotive production with 2021 North American volumes expected to increase 24% and nearly reaching the levels of 2019. The industry is also combating the ongoing shortage of chips that are essential for a variety of applications within each vehicle as well as the shortage of materials such as specialty stainless steels. With these supply chain issues we remain proactive in supporting our automotive customers through various actions including increasing inventory safety stock, which has generated positive customer feedback. From an industrial perspective, the medium and heavy truck markets continue their steady growth in North America Europe and China, which has driven demand for diesel engines. Specifically with China's CN6 emission standard deadline of July 2021 approaching, we are experiencing accelerations of volume prior to the effective date. Within Power Solutions, power companies have continued to justify and execute upgrades for aging infrastructure to prepare for installations of smart grid systems, green power generation and storage solutions. We believe grid infrastructure investment will continue to grow with future power demand resulting from increased penetration of electric vehicles in the market. The current administration has also prioritized green initiatives and carbon reduction in the recent $2.25 trillion infrastructure proposal. With renewed focus and incentive on electric vehicles and the related grid infrastructure necessary to support them, we expect to see additional demand to benefit both of our business segments over the long-term. We have presented additional information for each of our operating groups starting with Mobile Solutions on page 14. Mobile Solutions sales grew 11.3% in the first quarter from one year ago as we saw continued recovery from the pandemic as well as strong growth and general industrial demand driven by e-commerce logistics. GAAP operating profit for the first quarter was $6.1 million, compared to an operating profit of $0.3 million in the prior year. Adjusted operating profit increased nearly 377% to $7.1 million or 9.1% of sales from $1.5 million or 2.1% of sales last year. Adjusted EBITDA increased to $14.9 million or 19.2% of sales from $7.4 million or 10.6% of sales in the first quarter of 2020. The increased profitability was driven by the higher sales volumes, fixed cost absorption in inventory, increased variable margin resulting from our cost improvement initiatives and the impact of our Chinese joint venture. Let me address our China joint venture for a moment. We saw strong growth and improved profitability from our joint venture during the quarter as it contributed $1.4 million to the bottom line, an increase of $1.7 million from one year ago. Our JV generated over $23 million in sales during the quarter almost tripling the sales from the year earlier period. Obviously we are pleased with these results and look forward to continued excellent performance throughout 2021. Looking forward, we see continued strong demand in most regions, but managing supply chain requirements and manpower will be, key to our success, as both remain issues due to the pandemic. We will continue to focus on free cash flow through disciplined capital spending and working capital management. On page 15, our Power Solutions Group experienced a 5.8% year-over-year increase in sales in the first quarter, which was driven by an increase in precious metals pricing particularly -- partially offset by lower overall demand, which continued to be adversely impacted by the COVID pandemic. Prior year sales and many power solutions markets did not begin to see an impact from COVID, until the second quarter. In addition, Q1 2021 sales were also adversely impacted by inventory adjustments for smart meter components, at a key customer. On a sequential basis, Power Solutions recognized 5.1 million of sales improvement over Q4 of 2020. Although our total sales were positively impacted by higher precious metal costs, these cost increases are directly passed through to customers at lower margins, resulting in a headwind to overall margins. GAAP income from operations for the first quarter was $2.4 million, compared to $2.6 million in the prior year, excluding the goodwill impairment impact of $92.9 million from the first quarter of 2020. Adjusted operating profit decreased to $5.5 million or 11.2% of sales, from $7 million or 15% of sales in the first quarter of 2012. Adjusted EBITDA decreased to $6.8 million or 13.9% of sales, from $8.4 million or 18.1% of sales in the prior year. Prior period results were adjusted to exclude certain development costs and new facility costs, incurred before the commencement of normalized production which, are included in our operating results for 2021. Looking forward, we see consistent demand trends in Power Solutions, but we remain cautious given the continued uncertainty in the pandemic recovery. We will remain protective of cash flow in the segment through prudent working capital and CapEx management. As I conclude my remarks on page 16, we share our outlook for the remainder of the year. With the continued uncertainty surrounding the COVID pandemic and related recovery, we are still not in a position to implement formal guidance at this time. But we wanted to share, how we see the rest of the year, the rest of 2021 unfolding. We expect strong growth for the first half of the year, particularly in the second quarter, compared to the heavily impacted results last year. Material shortages, including semiconductor chip shortages, driving OEMs to selectively shut-down certain production facilities could create both -- excuse me inconsistent consumer demand and production interruptions. Our teams will focus on supply chain and logistics to ensure a source of material supply to meet, consumer demand -- customer demand. Free cash flow generation will remain a priority as we remain disciplined on capital investments and working capital optimization. We will continue our efforts to achieve synergies between our Mobile Solutions and Power Solutions businesses both, in terms of revenues and costs, leveraging client relationships and operational best practices across the organization. Additionally, we will evaluate our global facility footprint for optimization and other continuous improvement cost reductions. As per specific measures underlying our 2021 outlook, we continue to anticipate CapEx of approximately $22 million, as we look to make necessary investments to support our long-term growth. In addition, we expect depreciation in the range of $33 million and amortization of approximately $14 million. In summary, we started the year strong with solid growth in revenues group profitability We expect the economic recovery momentum, we have seen in Q1 to continue into Q2, but remain wary of certain stress points I have discussed, associated with shortages of material and labor. In spite of these challenges, our management team will remain focused on meeting our customers' expectations for both, delivery and quality over the coming quarters, while continuously improving our cost structure. That concludes our prepared remarks. And I will now turn the call back to the operator for questions.

Thank you. We will begin the question-and-answer session. [Operator Instructions] And the first question will come from Steve Barger with KeyBanc Capital Markets. Please go ahead.

Good morning guys.

Good morning, Steve.

Good morning.

Good to see some things stabilizing. But you did note unpredictable volumes through 2Q, but that your mix should mitigate some of the chip shortage. First, do I have that right? And second, do you expect revenue will be up sequentially, in Mobile?

First, you have it right. We are concerned about the semiconductor chip shortage Steve. But a lot -- a significant portion of our product in North America ends-up on SUV and large truck platforms. I should say, a disproportionate share of it, majority. And that has protected us somewhat, because the OEM that's a high margin product for them. So they are prioritizing that as it relates to supply shortages. So we've I think benefited somewhat from that. As it relates to sequential -- I mean, we were looking at the second quarter. At this point, we're seeing consistency of volumes, in comparison to the first quarter at this point in time.

Consistency, okay.

Yeah.

And slide 13 says North American auto production is expected to recover 24% from last year. Do you expect your mobile segment will be up a similar amount?

Again, we're not going to give guidance over the long-term. But certainly our volumes fluctuate with overall automotive productions. But we are a global supplier, right? So that statistic was primarily related to North America.

Right. Still, is it a reasonable way to think about what the year-over-year increase could look like?

I think so. I mean, as the overall automotive production volumes recover we should benefit from that, certainly.

And what about, the Class eight side or heavier trucks, do you have confidence in the production schedule, or is there a risk to disruptions for the same reason?

Yeah, I think that, obviously, we actually in that business -- we have had some interruptions because of material shortages, unrelated to the semiconductor chip issue our teams have. This is something that has been -- I wouldn't say pervasive, but it has cropped up throughout the first quarter where we've had to solve problems, in conjunction with the cooperatively with our customers and so far we've been -- our teams have been very diligent in fixing any of those types of situations. So I think wary of the word, we're still wary of that but we – as it relates to overall volumes in our discussions with our customers, we expect those to hold reasonably well throughout the end of the year.

Got it. And one more for me. With all this talk about chip shortages and just investment flowing in that direction for capacity, do you make any parts for the semiconductor capital equipment part of the world or is that something you've explored.

It certainly is something that we've explored and I – we would have to look into the – the exact amount but my guess is that on the Power Solution side, there are some connectors and product that we made that ends up in semiconductor or electronic related applications for sure.

Got it. Thanks.

The next question will come from Dan Moore with CJS Securities. Please go ahead.

Hi, good morning, it's Pete Lucas for Dan. Can you just talk a little about your expectation for gross margins over the next couple of quarters in light of rapidly rising steel prices and the impact that's going to have?

Yes, Tom I'll take that one to start. We've talked at length about our ability to pass through material cost to our customers. Most of the contracts. I would tell you on the mobile side, most of the contracts that we have allow us to pass through material price adjustments, where there is a movement greater than 10%, and depending on the customer relationship that true-up occurs. In some cases that occurs quarterly in some cases that occurs at the end of each year, where we sit down with the customer and review the cost of materials, primarily the specialty stainless steels and either get paid back or pay the customer, depending on which way it goes. Right now obviously there is more pressure on the upside. So we would be talking to our customers about a price increase and our contracts allow us to do that. On the Power Solution side we have the ability as it relates to precious metals. Those metals are actually priced on the day of shipment. So that's a real time price that's passed through to the customer on the day of shipment. As it relates to other types of materials, typically we have the ability to reprice the new purchase orders are given because that business is not, although we do have some long-term supply arrangements that's not the norm in that group. So we do have the ability to reprice as customers order new products.

Very helpful. Thanks. In terms of general industrial demand, it seems to be gaining momentum there. As far as looking at that from our side, any particular end-markets or geographies worth noting that standout here?

Well on the GI side we do report our business with diesel engines and diesel dosing in that because it's not passenger car related and that has been a strong product group for us so far in 2021.

Great. Thanks. And the last one for me, just in terms of looking at M&A, how do you think about that going forward, in terms of how would sourcing deals, what size deals you're focused on and are large deals on the table and if, so what type of leverage would you be comfortable with going forward?

Yeah we are – when we did our Investor conference call about a month ago, we talked a little bit about that and I think our thought process is consistent. What we would like to show here is some positive free cash flow over Q1 and Q2. We are starting to look at some transactions to see what's out in the marketplace and what could set us. Certainly, if we saw the right fit and the size was right, it would be something that we would look at probably in the third or fourth maybe early 2022 period. We'd like to get our leverage down below three, that's our objective. On an overall basis and to maintain that type of leverage position, would we go up to 3.5, if something really fit with our strategic plan and gave us an additional technology or landed us a better position with a strategic customer. Certainly we would evaluate that.

Very helpful. Thank you very much.

You bet.

[Operator Instructions] Our next question will come from Rob Brown with Lake Street Capital Markets. Please go ahead.

Hi, good morning. Just wanted to follow up a little bit more on the kind of the market disruption risks. It sounds like Q2 is sort of you're managing through it, but how do you kind of see that playing out for the back half of the year, do you sort of see that now as uncertain. Do you feel like it can kind of stabilize this gives a sense of how you sort of see that stepping out for the rest of the year?

Yes, I think for sure it's going to be with us, at least that risk will be with us through the end of the second quarter and based on what I've read and what we're seeing, it's probably going to be there in the third quarter as well, given the time frame that it will take some of the semiconductor chip manufacturers to bring on additional production lines. So we're looking at it over the next six months. Certainly, it is something that our teams are aware of and focused on. We do get production schedules on the mobile side, which would be most impacted obviously from an automotive standpoint and those schedules tend to run out for a period of 10 to 12 weeks that are – they're not firm but they're planning schedule. So it gives us a reasonable amount of comfort, subject to any unusual interruption that may occur, as it relates to what we can expect in Q2. Q3, right now is a little bit we're expecting a reasonably strong Q3 and Q4, but again, we don't have any current forecast from customers and we want to see how things develop with how the OEMs are dealing with the chip shortage going forward.

Okay. Thank you. And then on the Power business, some of the new growth areas you've talked about, are you in terms of getting customer activity for sort of the EV products in particular, I guess, are they in the design and discussion stages. Are you quoting on things and maybe give us and how the pipeline is looking there for that market.

Yes, I would tell you, it's fluid. Our teams are focused on it product is being sourced every quarter. We -- I would tell you in the last six or seven weeks, we received new business awards and $3.5 million to $4 million of product that ends up on electric vehicles, battery electric vehicles some of that relates to connections -- electrical connections within the vehicle some relates to as an example power steering system that is solely going to be used on a battery electric vehicle. So it's been a focus as we've talked about of the teams our sales groups from a strategic standpoint those are the programs that we're looking at, and we're pressing hard on to get those awards and we've seen some pretty good traction, I would tell you, over the last five or six weeks with some awards that are on battery electric vehicles. So it's ongoing, obviously, it will take time and as we've talked about. We think that transition maybe is a little bit longer than what's portrayed in the media, given some of the constraints that may exist with the ability to manufacture batteries in that volume charging infrastructure and those types of things.

Okay. Thank you very much. I’ll turn it over.

The next question will come from Steve Barger with KeyBanc Capital Markets. Please go ahead.

Hey, thanks for the follow-up. Warren on your comment about the power companies accelerating efforts to drive great upgrades. Are those initiatives funded and approved by regulators, or is that more of something that you just kind of see out there as a wish list?

No, I think Steve every public utility has to go through their process, especially, if they're making an investment. As I understand it if they're making an investment they have to look at their rates to make sure that it supports the investment in each individual Utility has to work with the regulators in order to get that type of investment improved. So I would just tell you based on the research that our team has done what we're seeing in the marketplace and talking to experts and people that are engaged in the process in the marketplace. That's how we formulated our decision and how we view that from a growth perspective.

And as you look at that once those programs start, how long does it take to benefit you and does that give you quarters or years of incremental work as a grid upgrade project size?

I think most people think and I am in that group that the great infrastructure is going to happen over a longer period of time. So I think that for us continuing to pursue our existing customers on that expanding our breadth of reach in wallet share with them is going to be critical. And then I think that that will benefit us for a long period of time and I would say a decade. This is going to take some time to update a grid and an infrastructure across this country and many countries that has been in place for 50 years to 80 years right or more.

Yes, all right. It seems like it's been a long time coming and it's certainly been slow to materialize. So hopefully, we're going to do that. I mean, how do you track those projects for planning that business whether it's grid upgrade renewable projects or smart meter installations what sources do you use?

Yes. So we use -- we have different market research firms that we utilize for that. On the automotive side we use IHS. Obviously, we use a company called MarketsandMarkets. It's another one that we used for research. And then obviously you've seen the company's interest in this has manifested itself in putting industry experts on our Board. We have one of the preeminent individuals with knowledge about how green renewable energy is going to be connected to the grid, including battery storage and those types of things. Apologize for that there is a lot more running outside my also you can hear that, but so we're excited directionally and where we're going and the knowledge that we have on the Board that will assist us in developing and fine-tuning our strategy.

Yes. Makes sense. And Tom just a couple of quick ones for you. What should we use now for quarterly interest expense?

Quarterly interest expense it will be roughly $4 million -- no, excuse me, $3 million going forward.

$3 million. All right.

Yes.

And minority interest certainly had a nice benefit this quarter is that a good run rate?

We're not giving guidance, but, yes, I mean, as Warren talked about it earlier the JV is going very strong. So I would say that that would probably be reasonable.

Okay. Thanks.

Great. Bye.

[Operator Instructions] This concludes our question-and-answer session. I would like to turn the conference back over to Warren Veltman for any closing remarks. Please go ahead sir.

Well, thank you for your time this morning and listening to our results for the quarter. Obviously, we're very excited about the quarter not only the sales and the earnings, but the free cash flow during the first quarter was certainly in our view a significant accomplishment. And again, I appreciate the time and wish you all a good day. Thank you. Thank you again.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.