NN, Inc. (NNBR) Earnings Call Transcript & Summary

Good morning, and welcome to the NN Inc. investor presentation regarding divestiture of its Life Sciences division. Today's call is being recorded. I will now hand the call over to Mr. Mark Schuermann. Please go ahead, sir.

Thank you, operator. Good morning, everyone, and thank you for joining us. I'm Mark Schuermann, Vice President, Treasurer, Investor Relations. I'd like to welcome you to 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. If anyone needs a copy of the press release or the supplemental presentation, please contact Abernathy MacGregor at (212) 371-5999. Before we begin, I'd 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 fiscal year ended December 31, 2019, and the company's quarterly report on Form 10-Q for the 3 quarters ended June 30, 2020. 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, cash and cost savings, future operating results, performance of our worldwide markets and the impact of the COVID-19 pandemic on the company's financial condition and other topics. These statements should be used as 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 the SEC rules. A reconciliation of such non-GAAP measures is contained in the tables in the final section of the supplemental presentation. At this time, I will turn the call over to Warren Veltman, President and CEO.

Thanks, Mark, and good morning, everyone. During the last 3 earnings calls, you've heard me discuss the strategic initiatives process that has been ongoing since November of last year. It's been an extensive process during a challenging environment to which our management team and Board of Directors has devoted substantial attention and energy and that has incorporated an evaluation of a broad range of operational, financial and strategic options with the goal of reducing leverage and enhancing shareholder value. We announced this morning that our strategic process has resulted in a transaction to sell our Life Sciences group by the end of this year. We believe that after a comprehensive review process, this transaction is the right course of action for Life Sciences and fair value for the business. This transaction results in a substantial deleveraging of our balance sheet, from 6.1x net leverage to approximately 1.8x net leverage. Our organization will now sharpen its focus on growing our 2 remaining segments; Mobile Solutions and Power Solutions. These groups serve markets with strong growth potential, deliver top-tier EBITDA margins for the respective industries and are well matched together to deliver consistent cash flow. We certainly understand that our work is not done. Our management team remains united and committed to further streamline our overall cost structure, controlling capital expenditures and a continued deleveraging of our balance sheet in order to allow for a replacement of the still outstanding preferred stock. Page 3 includes a summary of the divestiture. We sold the Life Sciences group for $825 million, which includes $755 million in cash and a $70 million earn-out based on 2022 performance. The transaction is expected to close in the fourth quarter of this year, subject to customary closing conditions. We will use the net proceeds from this transaction to reduce debt via a paydown of principal outstanding under our existing term outs. Now I will turn it over to Tom DeByle, so Tom can summarize the impact of the transaction on our balance sheet and liquidity. Tom?

Thanks, Warren. Please turn to Slide 4. Since Warren and I were named to our positions in September of last year, we have been keenly focused on delevering our balance sheet. During our first 30 days, we announced cost reductions in our overhead spending, in our capital spending and eliminated our dividends. In April 2020, we took further actions to reduce our costs and improve our liquidity due to the COVID-19 pandemic. This slide shows the impact of the sale of Life Sciences to improve our balance sheet and enhance our liquidity. After our sale, our Term B debt will be reduced by approximately $700 million or 90% net of closing costs. Annual interest expense will be reduced by approximately $50 million. Our pro forma debt to capital will be improved from 75% pre-transaction to approximately 35%. Our net leverage ratio was 6.1x at June 30, 2020, will be improved to a pro forma 1.8x as of June 30, 2020. Going forward, Warren and I will be keenly focused on continuing to delever the balance sheet. One of our top priorities will be to pay back the remaining Term B debt and preferred stock. We have made great progress, yet our job is not done. With that, I'll turn the call back to Warren.

Thanks, Tom. On Page 5, we have presented a summary of the value our platform provides to our customers and their recent financial performance. Our business value proposition has not changed. We will continue to focus on providing our customers with a superior engineered solution. Our technology, design and metallurgy capabilities remain world-class and coupled with our extensive manufacturing footprint, we will remain a strategic supplier to our customers across the globe. On a combined basis, Mobile and Power generated $490 million in sales in 2019 with an adjusted EBITDA of $80 million or 16.4% of sales. On an LTM basis at June 30, 2020, sales were $426 million and adjusted EBITDA was $63 million or 14.8% of sales. Note that these combined results do not include our corporate overhead structure. As we discussed on our Q2 earnings call, the LTM June results were adversely impacted by the COVID pandemic. But what is striking is the company's demonstrated ability to maintain solid EBITDA margins on significantly lower sales due to the numerous cost reduction initiatives over the last year. We are now well positioned to generate significant additional EBITDA when sales begin to recover. Moving on, Page 6 summarizes our long-term strategic plan. Our growth strategy includes leveraging opportunities that exist in the electric vehicle market for products such as charging stations, high-performance connectors and electric braking regeneration. In addition, we expect to leverage the recent capital commitment we have made in facilities and equipment for our Aerospace and Defense groups. We will employ disciplined acquisition strategy in this area in order to expand customer relationships and more fully utilize our existing Aerospace and Defense capacity. We also expect to leverage our installed automotive capacity and anticipate that the Mobile group can grow 30% from June 2020 LTM levels without a significant commitment in growth CapEx. We will remain true to improving our operational performance each day. Our focus will be on improving margins through reducing scrap and other variable drivers and gaining additional efficiencies in fixed overhead and selling, general and administrative expense. We expect that we will continue to reduce debt through improved free cash flow. We will maintain our focus on reduced capital expenditures and focus on improving inventory turns and other working capital drivers. Our 5-year plan will incorporate actions to achieve growth rates in excess of GDP growth and have targeted 2025 sales at $600 million with EBITDA margins of 16% to 18%. As I have indicated, our focus over the next 24 months will be on improving cash flow and reducing debt, including a redemption of the preferred investment. Additionally, we have targeted operating with a leverage ratio below 2.0 during this 5-year period. This strategic review process has been long and intensive. I thank all our employees, our Board of Directors and the consultants and professionals that have provided critical guidance and support over the last 10 months. I believe this transaction has established a more financially secure platform from which to grow and improve the value for all our stakeholders. As our team plans -- and our team plans to go forward doing just that. That concludes our prepared remarks, and I will now turn the call back to the operator for questions.

[Operator Instructions] And our first question today will come from Daniel Moore with CJS Securities.

Congratulations on what appears to be a really solid outcome. I wanted to focus on the remaining businesses, the 5-year growth trajectory and the 2025 goals in terms of revenue. Just talk about the building blocks of those goals in terms of what levels of either SAAR or EV penetration or assumed any other color that kind of goes into building that would be greatly helpful. And I've got a quick follow-up.

Warren, are you on the line? Dan, Mobile Solutions growth trajectory for -- we'll continue to penetrate into the EV market through mechanisms around the engine and in the steering columns, and then Power solutions will continue to have the connectors that support the EV market, and plus the Power Solutions will also grow substantially into the smart meter type of market for the home.

Got it. Helpful. And EBITDA margins, I think you referenced 16% to 18% goal at that stage. Is that inclusive or exclusive of corporate?

That's inclusive of corporate. That's right.

Okay. Got it. And the corporate expense, I believe, it looks like, based on your slide deck, you assumed maybe about a $10 million reduction from corporate on a pro forma basis, post-sales puts us at about $20 million or so, give or take run rate. Is that rough math about correct?

I'd say $15 million to $18 million...

$15 million to $18 million.

So it will [indiscernible] further because I mean, the business is $400 million in sales. And of course, we're going to have to correspondingly reduce our overhead expenses at corporate to coincide with that lower volume.

Got it. Similarly, D&A and/or CapEx, any guesstimates for what those should look like on a pro forma basis?

Yes. We're going to keep it around $20 million, $22 million, which is about $10 million to $12 million is maintenance capital at this time. And depreciation over the period, we see as -- it will be consistent with the past. So we think about $30 million -- $30 million, $31 million of depreciation on an annual basis.

Remaining pro forma. Got it. That's helpful. But last for me -- I think that's it.

This is Warren Veltman. I apologize. I inadvertently got dropped from the call. So I'm back on the call now.

Next, I'll move to Steve Barger with KeyBanc Capital Markets.

Is the strategic review finished now? Or could there be other transactions?

Okay. At this point, Steve, it was -- we're really looking forward to getting back into the business and running the business and focus on some of the objectives that we've laid out. So certainly, we're not ruling anything out, but at this point in time, the focus is clearly going to shift to improvement in the business.

Okay. And I see your 4 bullets on the value proposition on the At a Glance slide. But can you just talk in a little more detail about what you see as NN's competitive advantage? And what your vision is for the company?

Yes. I think those bullets summarize it. I mean when we look at the company, even before the announced sale of the Life Sciences group, we considered ourselves to be engineered solutions provider to our customers, offering them solutions across the globe. And as we've communicated previously, when you look at the Mobile group, the technical ability of that group is unsurpassed by any of the groups that we've had in the business previously as it relates to the capabilities, and that is certainly valued by our end customers from a growth standpoint. And when you look at the Power Solutions group, we think that there's significant opportunity on the power side. Another item that isn't listed there is we're really going to spend some time trying to exploit the global platform that we have in Mobile by utilizing some of those facilities potentially for power component manufacturing in markets today where we don't have a presence. So those are just a couple of the additional items that I would draw your attention to.

And do you think that starts immediately? Do you see a path towards incremental power sales just right away?

Yes. I mean that -- this sort of stuff takes time, right? I mean customers typically don't just shift over immediately to a new supplier. But I would tell you that our teams have actually -- John has been in charge of both of the groups now for a period of 8 months. That work -- there was some initial work just to understand the business, get comfortable with it, that type of thing. But that work is in process at this point in time, and we expect to start seeing some of the benefits of that in 2021.

Okay. And to get to $600 million in 2025 implies a high single-digit growth rate. Does that plan include acquisitions? Or is that projected organic?

That's mostly organic. I don't think it's high single digits over a 5- year period of time, but we're viewing that as organic.

So what do you think the growth rate of the portfolio is through the cycle?

Through 2025 from 2019 level, I think it's in the range of 4%, 4.5%.

But you think that's -- is that the growth rate that you would target or have us think about going forward based on these businesses?

Yes. We're looking at a business this year. The trailing 12-month numbers that we just summarized is $426 million. So maybe your single-digit is off of that. I did my calculations out of a pre-COVID 2019 number.

I did my numbers...

So your number is probably correct.

Next we here from Rob Brown with Lake Street Capital Market.

Congratulations on the nice process here. Just wanted to clarify the corporate cost reductions. What areas are you looking at? Can you scale it down? I guess to what degree can you scale down the business to the new level? And how much of the corporate cost activity goes with the Life Science sale?

Well, Tom summarized some of that information. I would tell you, I would be a little bit more aggressive in that area. I mean when we look at the corporate profile today, from a cash expenditure standpoint, we run about $24 million. So we're looking to try and reduce that down to the -- I would push it down certainly to the $13 million -- $11 million to $13 million range. It's going to take some time in order to do that. We're going to have to improve some of our systems in order to do that. But certainly, with the loss and the sale of the Life Sciences business at this point in time, there's going to have to be a restructuring that we look at as it relates to our overall corporate overhead. And that's a process -- we've dedicated a considerable amount of time to this Life Sciences sale effort and the strategic initiatives process. But looking at our corporate overhead and analyzing that more thoroughly is a process that we are just starting to do, and I would call it the Phase 2 of looking at that, right? Because we did make some pretty substantial adjustments to our overhead structure early on in some of our initial cost cutting efforts. But we're going to have to take a look at it now with the restructuring and the sale of the Life Sciences business.

Okay. Good. That's good. And then on the debt pay down, could you just kind of walk through how the cash will be used? And what are the terms on the preferred? Does the preferred have to be paid off first before you address other pieces? Or are there other pieces that can go first? Or how do you sort of see that playing out?

Tom, do you want to take that one?

Sure. So our Term B needs to be paid off first in entirety. And then we will attack redeeming our preferred stock or eliminating that.

Okay. Okay, good. And you have -- you're able to redeem that basically right now, is that right? You have to wait for a period of time.

So I said we're going to apply $700 million basically to our Term B debt, which reduces our Term B debt by 90%. And so we'll have about $145 million remaining. And we've got to pay that off first and then go in and attack the redemption of the preferred.

And next, we'll move to Steve Tusa with JPMorgan.

Congratulations.

Thank you.

What are you guys -- in the base business now, what are you seeing as you kind of come through August here in kind of the remainco business trends wise?

Yes. We talked about that on our Q2 call a couple weeks ago, and we did see a pretty significant rebound on the Mobile side in the June period. When you looked at June sales, they were up 50% over where they were in May. And as we look at the Q3 and Q4 on the Mobile side, our expectation is that the sales will actually continue that trend, and we expect it to be up about 50%, little over 50% in Q3 and Q4 versus the Q2 levels from a sales standpoint.

Okay. Got it. And then just the free cash flow profile of remainco when it comes to kind of forward-looking requirements on CapEx or anything like that. Maybe if you could just kind of remind us of what that profile is?

Yes. We look at the business in -- at this point, we look at 2021 being somewhat consistent with 2019 as it relates to sales and EBITDA, assuming that we're going to rebound a little bit from the COVID pandemic. And then the CapEx profile, as Tom indicated, we expect to be in the $20 million to $22 million range. So we expect to be definitely a free cash flow generator. And I think when you run the numbers on that, that will bear that out with a reduced debt load, and I think it will give us an opportunity to continue to delever and address some of the other issues that we have as it relates to having an opportunity to prepay or pay off the preferred earlier. That would be our...

Right. And then -- and I guess, longer term, is that kind of the sustainable run rate as a percentage of sales? Or does that come down a bit further?

Yes. Does what come down?

The CapEx.

Yes. I think that's definitely a sustainable rate. That allows us some growth CapEx. And what I indicated in my comments was as we look at the Mobile business, there was some significant CapEx that we spent in the 2017/'18 time frame. And really put capacity in place for that business to be able to do somewhere between $340 million and $360 million in sales. And obviously, some programs, we might not have the right equipment. So there could be some growth CapEx needed, but our focus right now is to try and utilize some of that existing capacity. And we think that, that will take us through the next 2 or 3 years. So I would expect us to be focused on that level of CapEx.

[Operator Instructions] And next, we'll hear a follow-up from Steve Barger with KeyBanc Capital Markets.

I know redemption of the preferred is the first focus, but longer term, can you just talk about your philosophy of capital deployment and returning cash to shareholders?

Sure. We'd like to -- I think that from a leverage standpoint, our expectation is that we'll maintain more of a conservative approach on that. Obviously, given what we've gone through over the last year, I don't expect to see leverage levels at what the company has been running, and that's why we've set a goal of 2.0. So I think that once we settle out, Steve, on some of the existing issues that we just discussed are opportunities, I should say, in order to make our balance sheet even stronger, our view would be that we would shift then to look potentially in a disciplined way for some acquisitions that could allow us to more fully utilize some of the capacity that we have in-house today. We have 2 relatively large manufacturing facilities that are underutilized in association with our Aerospace and Defense business. Looking for an acquisition in that area where we could utilize some existing space and cost structure that's already built into the business would be advantageous for us. We'll evaluate that. We'll also be doing the same thing, looking for opportunities that might be more tuck-in or smaller acquisitions that can benefit either the Mobile or the Power group. There may be some opportunities for us to grow our European operations and make that create some more critical mass for us in Europe, and we would probably look at that as well. But again, all this during that whole period maintaining discipline as it relates to overall leverage in the business.

And Mr. Barger, were you done with your question?

Yes. I'm all set.

Next, we'll hear from Daniel Moore with CJS Securities.

Probably an obvious one, but just the delta between the $700 million net proceeds and the $755 million cash you expect to get in Q4. I assume just tax leakage or is there anything else there?

Well, obviously, there's -- oh, go ahead, Tom.

Yes, there's transaction fees that we have to deduct off of that. And if there is some tax payments to be made and some debt-like instruments that were netted off of that. So we've -- so it comes down to about $700 million.

And that will conclude today's question-and-answer session. At this time, I would like to turn the call back over to Mr. Warren Veltman for any additional or closing remarks.

Well, thank you, operator. Thanks to all the shareholders and analysts that participated in our call today. We really appreciate it. We think that in summary, this has been a big step forward for the company. We've created a very a stronger company with a solid balance sheet in which to grow. And we did it during a very difficult time period where we got fair value for one of our assets. So with that, I'll just thank you one more time and conclude the call. Appreciate it.

Thank you. That will conclude today's call. We thank you for your participation.