Nn Inc Q2 FY2023 Earnings Call

Good morning, and welcome to the NN, Inc. Second Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Alex Steinberg, Investor Relations with NN. Please go ahead.

Thank you, operator. Good morning, everyone, and thanks for joining us. I’m Alex Steinberg, Investor Relations contact for NN, Inc., and I’d like to thank you for attending today’s business update. Last evening, we issued a press release announcing our financial results for the second quarter ended June 30, 2023, as well as the supplemental presentation, which have been posted on the Investor Relations section of our website. If anyone needs a copy of the press release or of the supplemental presentation, you may contact our IR group. Our presenters on the call this morning will be Harold Bevis, President and Chief Executive Officer, and Mike Felcher, Senior Vice President and Chief Financial Officer. We also have a few of our new business leaders available to support our Q&A session including Verlin Bush, our new Chief Commercial Officer, and Douglas Campos, GM of Mobile Solutions, Gunars Vinkels, GM of Power Solutions. Please turn to slide 2 where you will find our forward-looking statements and disclosure information. Before we begin, I’d like to ask that you take note of the cautionary language regarding forward-looking statements contained in today’s press release and supplemental presentation and in the Risk Factors section of the company’s annual report on Form 10-K for the fiscal year ended December 31, 2022, and, when filed, the company’s quarterly report on Form 10-Q for the three months ended June 30, 2023. 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, inflation, supply chain constraints, foreign exchange rates, cash flow, tax rates, acquisitions, synergies, cash and cost savings, future operating results, the 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 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 in the supplemental presentation. Please turn to slide 3, and I’ll turn the call over to our new CEO, Harold Bevis.

Thank you, Alex. Good morning, everyone. It’s an honor speaking with you all today regarding my first few months as the new CEO of NN. Today, you will see that we are already underway with the transformation strategy. We are embracing change and taking decisive actions to accelerate our long-term growth and profitability and become a more predictable company. We have a tremendous opportunity to deliver significant value to all of our shareholders. I have personally spent the majority of my career working in industrial technology industries, and my focus has primarily been on driving transformational change. With four successful business transformations completed and two of them being public companies, I was immediately interested in leading NN through a transformation, as I believe there’s a clear opportunity to return this great company to the leadership position it once enjoyed. As an industry veteran with more than 25 years of experience, I’m deeply familiar with NN's markets, competitive position, and customers. NN has a well-respected and diverse customer set, and although we are expanding, our focus includes new business verticals and markets. There’s plenty of opportunity within our current markets to expand our share with those who already know the value that we bring. NN has decades of engineering and technical expertise. I’ve been very impressed by the talent and operational capabilities we possess. I’m particularly encouraged by the competitive advantage the company has with its vertically integrated manufacturing, which is further supported by a large globally installed base of equipment that’s extremely hard to replicate. That said, our brand assets and talents can clearly be leveraged in a more powerful way. You’ll hear today what our plans are and that we’re already taking immediate actions to begin improving our commercial and operational strategies. This includes plans to increase the size and focus of NN's new business program immediately. Additionally, we are refocusing the organization to better optimize our cost structure, prioritize operational efficiencies, and build stronger financial credibility. We will refocus on the things we do best to drive growth and become a stronger organization. Let’s review some summary highlights from the second quarter. As outlined on slide 4, sales for the quarter were $125 million, and we delivered $10.5 million in adjusted EBITDA. We’ve had a solid first half of the year with new business wins, winning roughly $19 million in new awards. We’re proud to report that we generated $3 million of positive free cash flow in the quarter, marking an important step in the right direction. We are free cash flow positive for the trailing 12-month period. Our outlook indicates that this trend will continue into the second half as we control costs and maintain explicit cash discipline. Looking ahead, we have aligned and are supplementing our leadership team. We are implementing and prioritizing cost reductions to better support our margin profiles and utilize improved margins to self-fund our growth. There are immediate opportunities to grow profits irrespective of sales growth by initiating change in areas where we are underperforming. We are proud of the adjusted EBITDA and free cash flow our business produced in the quarter but are far from satisfied. Our enhanced leadership team and strategy remain focused on increased cash flow generation and profitability improvement. Please turn to slide 5. I want to briefly walk through what our first 75 days together have looked like. I began my tenure as CEO of NN effective on May 22 of this year. My immediate focus was to familiarize myself and get better acquainted with the company while also beginning a deep assessment of our capabilities and team. Within 30 days, I had the opportunity to visit many of our plants globally, as well as our partners in Europe and China. I was able to meet with a few of our large customers face-to-face and meet with our Capital Partners. A key takeaway from my interactions was how important our customized products and solutions are to our customers worldwide. NN has a great reputation for delivering top-tier quality and on-time delivery. Many of our solutions are critical components in our customer's products, and thus we have a deep sense of pride in what we do. We have a significant competitive advantage given our global footprint and vertically integrated facilities. There are clear new actions that need to be taken to better leverage our core competencies. As announced, we are right-sizing our board of directors from nine members to seven as part of our collective commitment to best practices and corporate governance. Please turn to slide 6 in the presentation. NN is now focused on a new transformation plan, and we are preparing to execute at a higher level. I’d like to walk you through the core components of that plan. Our transformation plan is built around an increased organizational commitment to higher sales, profit, and free cash flow and includes five components. The first is getting the top team right. We are focused on aligning our talent and modifying the top team to better position NN for success. This includes flattening the organization to increase agility and speed. I have been using my experience and personal network to supplement our highly experienced NN leadership with proven transformation executives I’ve worked with before. The second component is a commitment to achieving cost productivity and implementing a steady state program. We must increase our organizational commitment to cost leadership as a way to improve our margins. I’m happy to see that we have abundant opportunities to do this. The third component is to improve our business by fixing unprofitable customer contracts and underperforming plants. Specifically, we’re completing reviews of several of these plants and customer contracts and finalizing our plans in each area. We believe there’s at least a $10 million annual opportunity to improve our EBITDA profile through these actions. The fourth component focuses on routinely generating positive free cash flow. This includes better disciplines within our accounts receivable, accounts payable, inventory profiles, and capital spending decisions. NN has not delivered positive free cash flow as a company annually for several years, but we’ve already checked this box on an LTM basis. We intend to perform better on free cash flow generation going forward. Lastly, the fifth point is we’re taking steps to dramatically increase our new business wins program. This includes aggressively leveraging our open capacity and taking a more disciplined approach to pursuing new business wins that will require significant capital spending. In this industry, a win today primarily supports business revenue in 18 months to 24 months in most cases. We’ve reorganized internally among our sales and operations teams to increase our organizational talent to achieve a larger sales growth plan. Please turn to slide 7 in the presentation. This slide introduces you to our new leadership team here at NN that is focused on growing, going faster, and winning more as we integrate our commercial and operational teams together to expand the business while emphasizing cost productivity and generating free cash flow. This team has been developed through promotions internally of strong industry veterans within our company, complemented with a few new leaders that bring proven transformational expertise. Please turn to slide number 8, where we provide a brief snapshot of our new business wins. Year-to-date, our business wins are roughly on track with our internal goals. We’re already in the process of sizing these goals to a higher level. Our global team is now thinking through a larger plan to win at a larger rate. In the first half, electric power steering components for electric vehicles have been the largest segment where we’ve won business. We will expand our product concentration in key profitable areas that we currently serve, like electronic power steering for electric vehicles and also look to expand into new markets, including the medical market, where we see a lot of opportunity. Our ability to design and manufacture submicron precision machining, stampings, and assemblies is unique and applicable to many industries. I’d now like to turn the call over to Mike Felcher, Senior Vice President and CFO, to discuss our second quarter results in greater detail. And then we’ll take your questions at the end.

Thanks, Harold. And good morning, everyone. I’ll start on slide 9. Net sales for the quarter of $125.2 million remained roughly flat compared to the prior year period as our ability to drive stronger pricing helped to offset lower volumes. Last year, second-quarter results included a favorable customer settlement of $2.3 million. From a profitability standpoint, our operating loss of $4 million improved compared to the $4.5 million operating loss in last year's second quarter. We captured approximately $2 million of benefit from pricing and inflation versus last year. However, this pricing benefit was more than offset by the impact of lower volume combined with the previously mentioned customer settlement. Adjusted operating income for the second quarter was $1.3 million compared to adjusted operating income of $0.1 million from the prior year. Adjusted EBITDA results of $10.5 million was slightly below last year’s $10.9 million result. Encouragingly, we are seeing the impacts of the targeted cost reductions flow through to our adjusted EBITDA, totaling approximately $2 million of benefit in the quarter. As we progress through the year, we expect to continue to benefit from cost discipline and addressing underperforming areas of the business. Turning to slide 10. Sales in our Mobile Solutions Group increased 5.2% versus the prior year period, improving by $3.8 million. The increase was driven by improved pricing and new business, and increased volumes from our existing business lines. Mobile solutions adjusted EBITDA results of $7.5 million decreased compared to the $9.1 million in the second quarter of 2022. This was driven by performance challenges in our Wellington and Juarez facilities and the favorable customer settlement in the prior year. Profitability was supported by solid performance from our China-based JV, which helped to offset some operational challenges to our adjusted EBITDA results. Demand for our mobile solutions end market should remain steady as we enter the second half, though we do not anticipate demand growth given the macro environment and commentary made by other public industry leaders. Additionally, we expect operational improvement in our Wellington and Juarez facilities where performance improvement plans are being implemented. Turning to slide 11, Power Solutions segment sales decreased 7.7% year-over-year, primarily driven by decreased electrical and general industrial component sales, due in part to slower housing starts and customer inventory adjustments. The segment's top-line performance felt the impact on volumes from the closure of two facilities as we rationalize our footprint to drive future profitability. Sales performance reflected better pricing in the period compared to last year’s quarter, which positively impacted profitability. Pricing benefits combined with operating cost savings associated with plant closures resulted in adjusted EBITDA of $6.5 million compared to $5.9 million in the prior year. Looking ahead, we expect demand levels in the second half of the year to be consistent relative to our first half. Helping to offset flat demand expectations are the cost and cash flow initiatives that are already underway. Given the market demand expectations and explicit goals to enhance our profits, we will prudently manage our working capital while focused intently on improving our cash flows. Now please turn to slide 12. As Harold highlighted, we are encouraged to report solid positive free cash flow for the period as well as on a trailing 12-month basis. Working capital turns improved in the second quarter to 4.8 turns from 4.5 in the previous quarter, marking the third consecutive period that we’ve improved upon this key efficiency metric. Now turning to slide 13, you can see a snapshot of our balance sheet and liquidity metrics. Net debt at the end of the second quarter was $147.9 million versus $147.7 million in the first quarter of 2023. Our net debt to adjusted EBITDA ratio stood at 3.87 times at the end of the second quarter compared to 3.82 times at the end of the first quarter of 2023. We previously communicated that we were evaluating a potential preferred equity raise; however, given our expectations for continued positive cash generation and the lack of any immediate need for new capital, we decided not to proceed with that. Our transformative plan for consistent free cash flow generation is focused, in part, around a prudent capital expenditure strategy. We will strategically shift and reallocate our capital spending to focus more on business reinvestment to drive growth while appropriately funding maintenance capital requirements in the near term. As we modify our capital spending allocation, we are executing a concurrent plan to improve our liquidity through working capital optimization, cost reductions, and overall operational improvement. There is significant opportunity within our markets and facilities. Now that the team is aligned with the right strategy, we expect to be able to effectively improve our liquidity while maintaining costs and our leverage profile. Please turn to slide 14 for our full year outlook. Consistent with many of our customers and peers, we are revising our outlook and now expect net sales in the range of $485 million to $505 million, roughly flat to the prior year. Adjusted EBITDA in the range of $40 million to $46 million is also roughly flat to the prior year, and free cash flow in the range of $7 million to $13 million represents a significant improvement over last year. Our guidance implies that demand for the back half of the year for both mobile and power solution segments will be consistent with levels seen thus far year-to-date, as well as updated industry forecasts. Our adjusted EBITDA and free cash flow outlook reflects the impact of our lower volume expectations and disciplined cash management. Our free cash flow guidance does not include the CARES Act tax refund of approximately $11 million due to uncertain timing. In conclusion, while Harold and our reorganized leadership team have only been together for a short time, you can see we are taking aggressive and swift action to build a stronger company. Our focus and path is clear, and we have the right team, platform, and capabilities to tolerate our long-term growth and profitability significantly. We’re looking forward to sharing this journey with all of you. I will now turn the call back to the operator for questions.

Our first question will come from Rob Brown with Lake Street Capital Market. You may now go ahead.

Good morning, and congrats on all the progress.

Good morning. Thank you.

You mentioned a number of things regarding your plan in terms of operational excellence. I’d like to get your view on the ability to cut costs and the opportunities you see here. How long do you think that’ll take to get implemented?

Yes. Good question. On our cost agenda, we have a few elements. Firstly, we do have some underperforming areas of the company that explicitly are dilutive. These are getting special attention. You could call them stop the bleeders, but we do have some highly dilutive situations causing us to be held back, and cost performance is a part of that. Number two, regarding procured materials and our conversion costs, we haven't had a routine cost productivity program before. The new Chief Operating Officer that’s joining us will focus on ensuring every plant has a cost agenda to at least offset their inflation, with the ultimate goal to have net productivity. In terms of timing, I think it will take about four quarters to reach full run rate on fixing problem areas. However, we have a more immediate plan for the dilutive situations, which should take us only two to three quarters to address. For SG&A, we have two dynamics. Our Power business is benefiting from electrification and grid investment, so we need to grow that team. Meanwhile, we're stabilizing our overhead structure in Mobile, keeping costs stable. There's a transition underway as the industry moves from internal combustion engines to electric vehicles. Currently, a lot of public firms are guiding a little softer in the vehicle world, which we are also factoring into our guidance.

You touched on the demand environment. Are you seeing it as a slight tweak down? What kind of visibility do you have at this stage in terms of the demand environment?

The public reporters, the OEs, are all painting a slightly softer second half. We’ve embraced that as part of our guidance. Conversely, there's strength in grid investment and electrification. New business wins typically take 18 to 24 months to manifest revenue, and we don’t have significant contribution from new business wins for the second half. In essence, we have a good and bad aspect, netting out to a flat outlook.

Great, thanks for the additional color. Can you characterize the new business pipeline and the momentum you’re seeing in EV and grid growth areas?

On EVs, the transition from combustion engines to electric is presenting a significant opportunity for us as manufacturers modernize their vehicle platforms and allow us the chance to bid on new deployments. The macro environment is advantageous for our company. I would like Verlin Bush, our Chief Commercial Officer, to provide more insight.

Thank you, Harold. Several of our markets are doing well. We’re focused on our EV and grid applications. While residential and commercial electrical applications are down, we’re seeing increasing activity in key regions. We recently made staff changes to support growth in these areas. Overall, we’re optimistic about new business wins and our planned expansion into medical applications once restrictions lift in October.

Thank you, Verlin.

Our next question will come from Tom Kerr with Zacks Investment Research. You may now go ahead.

Hi, good morning. Following up on the last comment about the medical market, is that a big enough opportunity to potentially become a third segment down the road?

It is a significant segment. The types of machinery we have in-house find the biggest market in medical. We're still active in the medical market and have maintained relationships with our medical customers. This offers great opportunities for our precision know-how. We expect it to become a significant segment in the future, potentially even through strategic acquisitions.

What’s the status of your business in China after all the COVID challenges? Is there still room for improvement?

Our China business focuses on mobile and is rebounding after a significant second quarter. We’re stabilizing supply chains and client relationships, so things are smoothing out. We see good opportunities overall.

On the government side, there are incentives for new energy vehicles, which we see accelerating the transition. We're monitoring improvements closely, anticipating opportunities to increase volume.

On the Power segment, can you provide any updates on trends in residential and commercial construction?

Residential markets have been down, but we see steady non-residential activities. There's a significant need for grid investment due to the rise of electric vehicles, which impacts electrification efforts. Let's hear from Gunars Vinkels, General Manager of our Power business for more insight.

Absolutely, the residential market impacts us, but we’ve seen substantial activity in quoting for the industrial side and grid opportunities. This presents a good opportunity because parts can be launched within a shorter timeline compared to conventional processes.

Have you set a leverage ratio target given your current net debt to EBITDA ratio of around 3.87?

We haven’t provided an outlook on a specific target for the leverage ratio but are focused on improving liquidity and reducing the leverage ratio going forward. Our forecast reflects sequential improvement as we move ahead.

Thank you for the insights.

Thank you, Tom.

That’s all the time we have allotted for questions. I’ll turn the call back to Harold for closing remarks.

Thank you everyone for calling in and listening to our company report. We look forward to reporting and speaking with you again at the end of the next quarter on our transformation plan, our ongoing results, new wins, as well as the health of our markets. Thank you very much for your time. Operator, we’ll end the call at this point.

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