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Edited Transcript of NNBR earnings conference call or presentation 8-Nov-18 2:00pm GMT

Q3 2018 NN Inc Earnings Call

JOHNSON CITY Nov 16, 2018 (Thomson StreetEvents) -- Edited Transcript of NN Inc earnings conference call or presentation Thursday, November 8, 2018 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Paul Taylor

NN, Inc. - VP of Marketing & IR

* Richard D. Holder

NN, Inc. - President, CEO & Director

* Thomas C. Burwell

NN, Inc. - Senior VP, CFO & Assistant Secretary

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Conference Call Participants

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* Charles Damien Brady

SunTrust Robinson Humphrey, Inc., Research Division - MD

* Daniel Joseph Moore

CJS Securities, Inc. - Director of Research

* Robert Duncan Brown

Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst

* Robert Stephen Barger

KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst

* Stanley Stoker Elliott

Stifel, Nicolaus & Company, Incorporated, Research Division - VP & Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the NN, Inc. Third Quarter 2018 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Paul Taylor, Vice President of Marketing and Investor Relations. Please go ahead.

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Paul Taylor, NN, Inc. - VP of Marketing & IR [2]

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Thank you, Jonathan. Good morning,, everyone, and thanks for joining us for our Q3 conference call.

I'd like to welcome you to NN's third quarter conference call and talk about our presenters this morning. Rich Holder, President and Chief Executive Officer will be speaking as well as our Senior Vice President and Chief Financial Officer, Tom Burwell. If anyone needs a copy of the press release or the supplemental presentation, please contact Abernathy McGregor at (212) 371-5999, and they'll be happy to send you a copy.

Before we begin, I'd like to ask you to take note of the cautionary language regarding the forward-looking statements contained in today's press release, supplemental presentation and in the Risk Factors section in the company's 10-K for the year ended December 31, 2017. 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 market 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 contains 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.

First, we'll give an update and overview of the quarter, as usual Rich will provide commentary on the business and we will have Tom take you through the numbers and Rich will return with the Q4 outlook, guidance and summary. Then afterwards, we'll open up the line for questions.

With that said, Rich, I'll turn it over to you.

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Richard D. Holder, NN, Inc. - President, CEO & Director [3]

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Thanks, Paul, and good morning. Welcome to our Q3 call. On balance, I would describe the quarter as mixed and challenging. On sort of the negative side, we were impacted by higher taxes due to increased foreign earnings as a result of the Paragon acquisition to the tune of about $0.04 on the EPS line. We were negatively impacted by foreign exchange rates on the top line to the tune of about $2.5 million on the top and right towards -- just towards the end of the quarter, we were impacted by a significant Lake demand push-out in China, that's directly related to the trade, tariff and entire market upheaval issue that the region is going through. This also drove some inefficiencies into our product launches in the area. I'm going to talk a little bit more about that as we go into the deck.

On the positive side of the equation, you'll hear that the business continues to grow organically, is exhibiting the expected operational -- operating profit and we are performing strategically as expected. That is to say, we've always said that we're building a business that is countercyclical in nature. And at some point in time, our early cycle -- early-to-mid cycle businesses, which is our CAFE business, was expected to begin to go into the trough. And when that happen, if we were appropriately balance our late-cycle businesses, i.e., our Life Sciences business, would begin to grow and over the long-term largely offset the dip in the early cycle and still increase the cooperation and therefore the corporate seems to grow. That thesis is exactly what's taking place today. Timing is a little unfortunate, but nonetheless the thesis is proving true and having the diversification within the enterprises is proving to be positive.

As we turn to Page 3, business highlights, sales for the quarter was $206 million. Now this number with outside of our own expectations, so let me take a minute to bridge you through these numbers and -- but you know what happened. Roughly $4 million of the miss from our expectation in that number was due to the late quarter push out by -- within the Chinese market, $2 million of that was the strengthening of the dollar, so that -- $2.5 million actually, and so that was the FX impact and about $1 million of it was hurricane related. We just simply could not shipped to one of our customers before the end of the quarter, but that product is now already in their hand.

I know there was some question about why we didn't see this coming. So, let me reiterate, these are instances that occurred both the hurricane issue and the China push-out issue where instances that occurred towards the end of the quarter, we're talking the last week, the week and a half of September. So it's safe to say that we were fairly surprised at what was occurring. I don't think we could have predicted this hurricane or the upheaval of the issues we trade in inside the China market.

With that said, sales growth for the business was $57.5 million or 39%. The acquisitions accounted for $54.4 million and the organic sales growth overall was $5.1 million or 3.5%. Now this excludes the FX impact, so which hit Mobile Solutions, I'll touch that when we get there. Our Life Sciences business, our late-cycle business, which is what we expect to be coming up as the cycle turns, grew overall at 17%. The legacy business, and that would be the Pre-Paragon businesses the DRT, the Bridgemedica. (inaudible) that is within Life Sciences grew at a 10% clip and the acquired business, i.e. Paragon grew at a 19% clip. So, the growth rate that we expected to see in our late-cycle business -- and are beginning to materialize.

Mobile Solutions grew at 3%. They felt the brunt of, if not all of the FX burden between China and Brazil. And so, on a purest number perspective, they were flat. And candidly, when you look at our expectation versus our actual and results, this is where the issue -- this is where the issue occurred. We're still driving our multi-year programs. They're still in line to launch there will be contributing program in '19. And we think as we look out towards the Chinese market and the global automotive market, they are definitely slowing. We have taken that into account into our outlook and we simply don't think in spite of some stimulus activity going on over there that they're going to bounce back in any meaningful way. We'll talk a little bit more about that as I go through.

The Power Solutions business grew overall 3%. The order growth on the business was 7% and the actual growth out the door in the business was about half of that. This is directly related to timing delays. And so when you go through some of these programs, you receive the order the customer is either burning down some inventory or moving over to a new part number. And so, the cut-in date sometimes miss align. And so what we have is orders on the book that show 7% growth on the business, what the demand in the quarter was about a 3% uplift in the business. And so again, that business continues to perform the way we expected. And we think as these programs go a little longer, we will have better synchronization of timing as these parts are cut in.

As we turn to Page 4, foreign exchange, you heard me say it before, hit us for about $2 million to $2.5 million. I think it's -- somewhere in that area. The Mobile Solutions group absorbed the entire breadth of this FX and so mainly, and the Chinese currency and a little less than the Brazilian currency. From a trade and tariff impact for the quarter, we have been able to impact -- basically to mute the impact of the tariff actions in large part for our customers. We've done a number of supply chain activities. And so within the quarter, there is -- I think very little impact and that's probably a true statement for the balance of the year as well. I will tell you though that we are starting to see impacts around customer supply chain decisions relative to the trade issues and the tariff issues. And we absolutely feel that it will drive a bit of a retooling of the supply chain, as we move into '19.

Overall demand, as -- especially coming out of China. We think we're starting to see direct demand input in that. Again, it is now factored into our numbers, but safe to say that it was a bit of a surprise in Q3, again sort of beating a dead horse here the slowing Chinese auto market. Let me give you a little color on that. The auto market going into the quarter was growing at a clip of about 5.3% to 5.5%. When you saw for the last month of the quarter, the business pulled back -- the market rather pulled back almost 3 point. The issues associated with the pullback was the removal of about 50% of the secondary financing by the Bank of China within the market. And so those are the secondary lenders that primarily focused on the automotive space that give higher than normal bank financing and so because the bank was planning to inject greater stimulus in the system, the supposition is they wanted to get some of those guys out of the system to prevent a buffer.

And so, as they are able to, they can at the stroke of a pen change the construct of that system and they did so. And they removed a little over half of the secondary financing arm of the business -- rather of the market. And so, that impacted direct demand almost immediately. I think, secondarily, the trade and tariff issues are having an impact in the market and I think the other issues -- I think we are just simply experiencing in that market in particular a general market slowdown. And you've seen the government move to push some stimulus into the market. That's just a little color on what's going on in the Chinese market. When you look at our outlook, again, I will tell you we don't -- we're not forecasting any improvement in that market. And candidly, we think it's going to get a little bit more challenging before it gets better.

As we move to Page 5, just a little perspective on our end markets. I think we've been asked with this a couple of times. When you look out towards the year-end, we think our Life Sciences business will kind of end the year somewhere around 8%, maybe a little north of 8% growth rate. The underlying macro trends are strong and continue to be strong and it is performing as expected for our late-cycle business and as designed within our construct. Our general industrial business is expected to grow around between 4% and 5%. Clearly there is an enhanced focus on that piece of the business within our Mobile Solutions group, especially as our global automotive market begins to retrench a bit.

Our aerospace and defense business, again I talked to you a little bit about the alignment of stripping and shipping in sales. We think from an order perspective, we're going to continue and grow about 7%. And we think our sales growth will end up being about 5%. As we look into '19, a lot of our growth in '19 is dependent on getting our new facilities up and running and on track. And those programs are moving along and running well and we are doing our best actually to pull the schedule as far to the left as possible to continue to enhance the growth of that segment.

Electrical, we expect about 6% growth. What's interesting in the segment right now is we are seeing the shift from the demand pattern in the segment of being heavily residential now sort of moving over to non-residential. It doesn't necessarily impact the rate of growth for us. This impacts the type of products that we are pushing out the door. We play equally in both markets and so that market again is behaving as expected. The market that isn't candidly behaving as expected is our CAFE market. We think that market at best through year-end will be up about 1%. We absolutely believe that there is a slowing global automotive market. But as we have told you before, in a slowing or retrenching global automotive market, the reason that we are in CAFE technology has directly to do with the increased content per vehicle, and the increased adoption rate. And as we look at a [16.5 million SAAR] in North America and maybe looking directly into sort of a [93 million SAAR] for our worldwide, we still maintain that our increased content per vehicle, and increased adoption rate will largely offset the dip in the market, given the numbers we're predicting right now.

So another way to say it is, we think this business is setting up to be flat within the quarter and more than likely within '19 and it will be flat in spite of the fact that we will launch business programs and we have the increased content per vehicle, and we have the enhanced adoption rate. I will point out -- maybe because I can't help myself that this is by design. When we put this business together, the reason we went into CAFE was that very reason, was to be able to take advantage of the increased content per vehicle, and take advantage of the adoption rates in a down market. So what we're seeing in the behavior of the market and the behavior of the company relative to that movement in the market is about what we expected.

When you move to Page 6, adjusted diluted earnings per share was $0.30. That was $0.07 higher than the prior year, driven of course, by both the acquisitive and the organic growth, but impacted significantly by the China softness, the higher taxes from foreign earnings to the tune of about

$0.08. We were, -- as you all aware we raise -- we did a secondary offering. Within the quarter, we retired $213 million of debt from that secondary offering. We eliminated our second lien high-cost term loan within that construct. And so, that gives us about $21 million of interest savings per year, slightly offset by an increase in our dividend, but call it kind of $18 million in savings per year on the interest line. We reduced our leverage 1.2x and so we are now sub-5 and the -- and we still maintain our target leverage to get down between 2x and 3x levered within this strategic period. We expect to take 1 turns to 1.5 turns out of the leverage over the next 12 to 18 months and leverage reduction is absolutely our key focus.

Keep in mind that as you view the softness in the quarter, -- as you view the softness in the year, this will not impact our ability to bring the leverage down because it's not going to have a substance of cash flow impact on the business. Right? Again I go back to, by design, as our Life Sciences business grows and throws off the majority of our cash in a moving cycle, we still have the ability to reduce our debt in accordance with our plan. The cash is just coming from a different place than candidly the Life Sciences business is actually a better cash-generating business at this point of the cycle than was the Mobile Solutions business. So our impact is not on for '19 or for the balance of the year, it's not substantively here.

With that let me turn it over to Tom to go over some of the numbers, and I'll be back in a second.

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Thomas C. Burwell, NN, Inc. - Senior VP, CFO & Assistant Secretary [4]

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Thank you, Rich. We're on Slide 7 looking at the financial summary. We'll start with the adjusted diluted earnings per share, which did grow $0.07 over the Q3 '17 prior quarter. These earnings were primarily driven by increased sales volumes, both organically and from the acquisitions that we made and also, it's important to note that the Q3, 2018 EPS was impacted by a higher tax rate to the tune of about $0.04 from a larger portion of our earnings being taxed at a higher rate than the US statutory rate. And additionally, Rich, just mentioned, the impact of the China slowdown hitting us late in the quarter, which was another $0.04 of impact to EPS in Q3 of '17.

Turning to net sales. Sales grew $57.5 million or 39% from Q3 2017. Organic sales growth was $5.1 million or 3.5%. And this excludes the $2 million foreign exchange impact, primarily due to the U.S. dollar appreciating against the Chinese yuan and Brazilian real. We did have the acquisitive sales growth as we mentioned and that added over $57.4 million to sales.

Turning to Slide 8. We'll start with the gross margin. The 2018 Q3 gross margin was impacted about 100 basis points from costs associated with completing the investment for the new multiyear sales programs that we've been discussing the last couple of quarters. Really these are beginning to come to a close. We're completing them within Q3. There will be a little bit of impact in Q4, but for the most part, we've gotten and made the investment in these programs. Additionally, during Q3, we have been incurring startup costs in our Life Sciences business due to the very strong sales growth that we've had in that business and experiencing in order to get production up and ready for growth into 2019.

Turning to the adjusted operating margin. 2018 adjusted operating margin increased almost 300 basis points to 12.8% from Q3 2017, driven by earnings on sales growth, as we discussed during the quarter. Now the margins experienced on these sales both organically and acquisitive are at the expected rate that we target for each of the businesses that have the growth rate. Additionally, the margins have improved in general, as we've grown the most in our higher margin businesses and we've had improved margins from operational efficiency in each one of our businesses.

Turning to Slide 9. The adjusted EBITDA margin grew 110 basis points to 18.2%, due to the overall sales growth and the operating efficiencies that we mentioned. That 18.2%, EBITDA margin is in line with our expectations, as we set for the plan for the year. Turning to SG&A. The SG&A is within our targeted SG&A range of between 10% and 11% of sales. And the year-over-year increase is primarily due to the addition of SG&A from the companies that we acquired, namely Paragon in Q2 of 2018.

Turning to the segments on Slide 10. The Life Sciences Q3 2018 sales include for the first time the full first -- the first full year quarter of Paragon in our results. And so, the first time we have a complete view of what the newly constituted Life Science business looks like. Sales grew $56.2 million within the segment or over 250% from Q3 2017 levels. The acquired entities added $53.5 million in sales. It's important to note that these entities experienced growth of 19% from the Q3 2017 levels that we're experiencing and benefiting from the rapid growth these acquired entities have experienced in recent quarters. Our legacy Life Science business experienced a 10% organic sales growth year-over-year. So both aspects of the business are growing as expected or actually greater than expected in the Q3 quarter.

Turning to adjusted operating margin. The adjusted operating margin of the acquired entities are at the expected pre-synergy levels. The adjusted operating margins of the legacy Life Science businesses have improved year-over-year, about 100 basis points from operational efficiencies and sales growth. Our multi-year synergy plan for the acquisitions will lead to rising margins in these businesses in the coming quarters and they will begin to align with the comparative periods that we've had for this business.

Turning to Slide 11. The Mobile Solutions business in Q3 sale -- despite the headwinds that Rich discussed in China and due to the trade and tariff impact, sales grew 3% organically on a constant dollar basis. This segment was the one primarily hit with the FX. And when you factor the FX in, [via their periods the] sales are flat quarter-over-quarter. It's primarily driven by FX impacts. And as we discussed, those FX impacts were in Brazil and China.

Turning to the adjusted operating margin. Q3 2018 adjusted operating margins were down 350 basis points from Q3 2017. These margins were impacted about 250 basis points from cost incurred, completing the investments for the new multi-year sales programs we've been discussing in the last few quarters. And these programs are set to start up with production rates in 2019 as we discussed before. It's also important to note that we are starting up twice the number of programs during 2018 than we do on a typical year within this business. But it's critically related to the impact in the start-up costs. The remaining 100 basis point drop was due to the impact of the Chinese market softness that Rich mentioned in his comments. And this impacted both our wholly-owned business and our joint venture company in China.

Finally, turning to Slide 12. In the Power Solutions business, sales grew organically 3% in that business from Q3 2017. And as Rich mentioned, they're having an order rate at a much higher rate at 7%. And the adjusted operating profit margins grew 80 basis points from Q3, 2017 levels due to the earnings on the organic sales growth experienced in that segment.

I'll turn it back over to Rich for the Q4 outlook and guidance.

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Richard D. Holder, NN, Inc. - President, CEO & Director [5]

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All right. Thanks, Tom. So as we move to Page 13, just a little commentary on sort of what built into this outlook as you think about Q4, our Life Sciences business, you've heard it was growing at certainly high-single digits as we come to this point in the cycle. The underlying macros are extremely strong and getting stronger. Within the business, we are actually gaining share as well as driving substantive new research and development related growth. And candidly, many of our initiatives, as we put these businesses together and have them function as a single well-oiled machine, are starting to bear fruit. So we're very pleased at where Life Sciences is right now and we're even more pleased that it's operating as it is supposed to within the cyclical design of the organization.

Mobile Solutions will be flat. Again, it -- we think we have a slowing market, but the continued adoption rate of our product, we're calling for a flat market. And candidly, as we look forward, we don't see a lot of benefit in at least not in the next couple of quarters for the stimulus that's being driven in the market. And so, we're looking at this market as a fairly flat market for us and a falling market sort of globally. And so again, the difference between the two is the adoption rate calculus within the market.

Power Solutions mid-single digits. We're converting -- I think I would trick that in to beat out the -- the sales number will be a faster conversion of orders to sales. So again, let me point out, we are getting the orders. So we have the purchase orders. Much of this has to do with when the customer decides to cut in the program or move our product into the next revision. And so right now, we're seeing about a 3% to 4% growth on that base, and we're seeing 7% growth on the auto space. And so when you think through how this optimally work is those two will align in short order. And so, this business will be right at about 7%.

Again, let me stress that when you think about how the enterprise is supposed to operate through the cycle, I'm sure I sound like a broken record. This is how the enterprise was designed to operate. When our early cycle businesses go in, our late cycle businesses come out and we offset the downturn and the entire corporation still grow and we continue to be good operators and we take cost out of the business and we continue to enhance margin. This is exactly how the business is operating today. Irrespective of the prices in the market at the end of the quarter, we were still able to do and operate the business appropriately and bring to bear a 13% operating margin number and low to mid-single digit top line growth number.

With that in mind as you look at the outlook for fourth quarter, on the top line, we're calling for $200 million to $205 million, largely on the back of the second half softness of the automotive market in general, but primarily China as well as the impact of trade and tariff issues that are going on. Not to be lost in this equation, because I don't know that it -- that everyone is usually sensitized to this, not to be lost in this equation we have less manufacturing days inside the fourth quarter or less selling days inside the fourth quarter. So, please don't feel -- the fall off may look like it's bigger than it is, it's to calculate some days and I think we have this discussion almost every fourth quarter of the year.

Operating margin between 12% and 12.5% and so that would be in line with the selling days, with the fall-off in the Asian market. And so we're seeing 12% to 12.5%, EBITDA margins, again 18% to 18.5%, in line with our expectations and adjusted diluted EPS of $0.25 to $0.30. This takes into account the dilution created -- the full quarter dilution created by the secondary offering, the increased tax on foreign earnings as well. And so, that's what we're looking out for Q4.

As we move over to Page 15 and you look at full year, we have adjusted guidance to take that second half softness in China as well as the trade and tariff issues into account, our new guidance is -- on the low end has come down some $5 million and so we are at $770 million to $775 million. Operating margin is impacted by about 0.5 point. We are -- it's in line with what we expect, but nonetheless we're still working pretty hard to offset that line a little bit more. EBITDA margins about what we figured, they would be again 18% to 18.25% which has tightened that line a little bit. EPS of $1.25 to $1.30 again takes into account the dilution of the shares, the higher taxes as well as the loss fall through on the lower sales. CapEx is at $50 million to $53 million. We have spent some more CapEx than planned on the back of the wins -- the continued wins of the Life Sciences program. Unlike our -- some of our other programs, keep in mind that our Life Sciences programs typically go from CapEx spend to full production rates between 6 and 9 months. And so, we will bear significant fruit from these increased investments within 2019, unlike some of our other businesses that typically have a 12 to 18-month cycle. On a cash flow perspective, $35 million to $40 million and that's directly related to the increased investment that we had related to some of the newer Life Sciences program.

As you move over to Page 16. Just on the summary basis again, I'm sorry if I sound like a beating a dead horse, but the business continues to grow organically, right? That was the construct. The construct was to keep the corporation growing, keep the corporation getting more profitable and manage within the business segments. I know there is a propensity to deep dive on to one segment and call the entire corporation based on a single segment, but that is not the way the corporation is constructed. It is constructed for the early cycle businesses to go in and the late cycle businesses to come out and the entire corporation continues to grow and continues to enhance profitability and continues to enhance cash flow, and that's exactly what's happening.

Our margins overall are in line with expectations. The Paragon integration is on track with growth that is outpacing our projections. We are completing the spend on these multi-year programs that we've been talking to you about and production shipments begin towards the latter half of 2019 and in large part at least for five of those programs. Those programs will be key to keeping us to a flat to probably 1% to 2% upmarket -- rather growth in the Mobile Solutions segment. Again, the countercyclical performance is as expected, early is going in and mid cycles are coming out and so it is as we think.

So before I open the line for questions, I guess, I'll put it this way. I would just encourage everyone to keep their eye on the donut rather than the hole. The business is growing in a down-turning global automotive environment. The business is increasing in profitability. The business will generate substantially more cash going forward, as we continue to pull back on our CapEx or the need to spend as much CapEx. We are on track to continue to pay down our debt as expected. And this is a good and solid business.

With that, I will open the line for questioning.

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Questions and Answers

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Operator [1]

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Ladies and gentlemen, at this time, we will open the floor for questions. (Operator Instruction] We will take our first question from Rob Brown with Lake Street Capital Markets.

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Robert Duncan Brown, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [2]

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In terms of the mobile and automotive market, how would you characterize the visibility at this point? You talked about flat and I understand that there's new programs helping, but is there visibility in the market were flat, what's your confidence level there?

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Richard D. Holder, NN, Inc. - President, CEO & Director [3]

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Yes. So what we've done? Robert, we've gone out and we pulled the bulk of our customers to get sort of their view of it. We think that in -- certainly in North America, this thing is rapidly moving to more of a [16.6%, 16.7%] run rate number. We have looked at it as more of a [16.5%] number. We think as we look out globally, that this is more than [$93.5 million] kind of SAAR rate number. We've adjusted appropriately and we're flexing the operations in concert with that. I think we have a good sort of 60-day outlook in all the regions of the world with the exception of China right now. What's going on in China is being heavily influenced by day-to-day trade activity and discussion. We've actually never seen this sort of behavior before, but what we are assuming is that we have a light behavior going forward until this thing is resolved. And so, we've kind of built that into our foresight.

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Robert Duncan Brown, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [4]

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Okay. And then you talked about the supply chain retooling going on kind of globally, how does that sort of play out for 2019? Do you see similar growth rates in 2019 you just talked about in Q4 or what's sort of the 2019 view given the trade activity?

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Richard D. Holder, NN, Inc. - President, CEO & Director [5]

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So I -- largely for us, I think on 2019 -- and I'm not giving 2019 guidance, I will tell you a couple of things that from a supply chain perspective that are definitely happening. You are seeing a lot more discussions about restoring activity and we are part of that discussion. And it is directly attributed to the fact that the more folks feel that the tariff will be a systemic long-term issue, the more -- it's probably a bad word, excited, they become about the re-storing effort around a number of things. Most like -- most notably, high-precision motor staff and a few other things that remains in the general industrial market. From a supply chain retooling perspective, we are in this road and we are beginning to quote more and more product in the Mobile Solutions space that is out two years, right? That is kind of the window for these products. We have to assume and other manufacturers have to assume that the tariff in this case is going to be systemic. And so when you do that, you have to quote the product from a different parts of the world, essentially than the U.S., right? Our competitors are primarily European competitors. And so, they are not subject to the raw material tariffs that we are seeing. And so in order for us to be even with them, we essentially need to quote the product out of Poland, out of a France, something like that. And in order to facilitate that, we have to build the line over there. And so when I talk about supply chain retooling taking place, we are seeing, we are being a part of, we are getting much more inquiries on moving lines to different places in the world because I think this thing has now been in place long enough that people are believing that it's potentially a long-term issue that they need to solve for and the solution is move the line from the U.S. to Europe where you're not subject to the tariff.

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Operator [6]

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[Operator Instruction] We'll take our next question from Charley Brady with SunTrust Robinson Humphrey.

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Charles Damien Brady, SunTrust Robinson Humphrey, Inc., Research Division - MD [7]

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Hedged on the last point on moving the production out of U.S. into other European markets like Poland and other areas. I mean is that -- can you give us a sense as to if you quantify, what would be a timing on that, what would be a cost impact from a CapEx perspective, how do you mitigate the disruption in moving those lines across continents?

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Richard D. Holder, NN, Inc. - President, CEO & Director [8]

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Candidly, I'll tell you us. Let me be clear, when I talk about the supply chain retooling, I'm talking more about my customer than me. We do not have in our plan any intent to move our lines in '19. What we will do is, as we bid our new programs going forward, we will construct the new lines in Europe instead of constructing the new lines in the U.S. That is how we're going to do it. And so if you project that over the long term, we're not going to spend the CapEx, we're not going to spend the additional resources to fundamentally move a line on a program that's coming to an end in the next two -- probably three years. So, we will be focused on the new programs and the geography of the new programs rather than actually moving the line. Now in full transparency, what that could mean is we could find ourselves in towards the end of '19, 2020 under a little bit more pressure from the customer if these tariffs don't go away to be more productive and to find more and more cost out, we are prepared to do that and drive more and more business excellence activity and lean activity into the business to try and facilitate and offset as much as possible. But on the new programs, we just unable to do that.

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Charles Damien Brady, SunTrust Robinson Humphrey, Inc., Research Division - MD [9]

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Okay. That's helpful. Can you remind us how much of the CAFE business is directly China, it's a majority and is it not?

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Richard D. Holder, NN, Inc. - President, CEO & Director [10]

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No, it's not the majority. It's about half when you roll in -- [perhaps] about a third when you roll in the JV and the like. Now I'll point this out. Most of the new generation stuff is in China. And so what has happened over the course of the last year and a half. I think you've heard me say it before, where the traditional path was we launched product in the West, whether it be Europe or the U.S. and migrated to the East. The last two new generation products have been launched in China and will migrate to -- or the assumption is it will migrate to Western Europe and the U.S. So the newer technology fuel system activity is definitely in China.

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Charles Damien Brady, SunTrust Robinson Humphrey, Inc., Research Division - MD [11]

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So that percentage as we look out to '19 and '20 should go -- should increase from a third of that business, is that fair?

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Richard D. Holder, NN, Inc. - President, CEO & Director [12]

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I'm not sure if I understand the question.

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Charles Damien Brady, SunTrust Robinson Humphrey, Inc., Research Division - MD [13]

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If it's a third of -- the third is China today and the new programs are largely China going forward that 1/3 percentage should -- could move higher to some higher number?

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Richard D. Holder, NN, Inc. - President, CEO & Director [14]

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Yes, that's correct. That's correct.

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Charles Damien Brady, SunTrust Robinson Humphrey, Inc., Research Division - MD [15]

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And just one more from...

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Richard D. Holder, NN, Inc. - President, CEO & Director [16]

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The new programs are kind of split between China and Europe.

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Charles Damien Brady, SunTrust Robinson Humphrey, Inc., Research Division - MD [17]

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Okay.

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Richard D. Holder, NN, Inc. - President, CEO & Director [18]

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Just keep that in mind.

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Charles Damien Brady, SunTrust Robinson Humphrey, Inc., Research Division - MD [19]

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That's helpful. One more from me. On the Power Systems business, you talked about seeing a shift resi to non-resi, but no real revenue impact and from a margin perspective, is there any impact on that -- the shift of resi to non-resi?

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Richard D. Holder, NN, Inc. - President, CEO & Director [20]

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Yes. We generally get a little margin improvement in the non-res part of the market, typically because products are a little bit bigger, it's a little bit less volume. We can drive a little bit more efficiency across the line. I don't know that it's appreciable, right? But it's probably kind of a quarter point kind of movement in the business. The issue is going to be as we're in this -- as we are in the transition heavy. So we're actually in both spaces right now, as the transition goes kind of one way to the next.

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Operator [21]

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We'll take our next question from Steve Barger with KeyBanc Capital Markets.

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Robert Stephen Barger, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [22]

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Rich, I hear you when you say the organization is working as designed and I know you don't want to talk a lot about 2019, but stock is down a lot right now. I think it's important to help people think about the bridge to next year. On Slide 57, from the Analyst Day, you showed the NN [next 5, which included 6% to 8%] organic growth and 20% EBITDA growth. Are those ranges a reasonable way to think about what next year can look like or do we need to temper expectations on the front end, given some of the macro issues we're seeing?

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Richard D. Holder, NN, Inc. - President, CEO & Director [23]

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No, I think those ranges continue to be reasonable. Those ranges are heavily dependent on the growth of our late-cycle business, which is Life Sciences. And as Life Sciences obviously become a greater part of the organization as we go through the cycle, to some degree, we just get the natural uplift from that and then inclusive of that is the synergy movements and a lot of new programs that are out there. So I think that is still a good number. I think the numbers we talked about for cash generation and debt paydown in 2019 are still good numbers. I think it's fair to assume that our CapEx spend is substantively less in 2019. I think that's an appropriate way to look at it. And candidly just overall in 2019, we just have less moving pieces in the (inaudible).

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Robert Stephen Barger, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [24]

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So I'm glad you brought up free cash flow, a big part has obviously been having a higher margin, lower CapEx model. You did just reduced free cash flow for the current program spending. Can you just talk about the decision process for spending versus harvesting in the context of how focused investors are on free cash flow generation?

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Richard D. Holder, NN, Inc. - President, CEO & Director [25]

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And again, I've got to take us back to and point to the Life Sciences business. We are outpacing the demand in that business and we have to put to continue with the growth path that we're on. We needed to put some capital to use and within that business to more often than not just simply expand capacity as this is not even a brand spanking new program. This is really an adjunct to a program that's already running that we're seeing demand on. So just to give you some high-level numbers, we are building a backlog in that business that is significant. It is plus a $100 million backlog in that business, and it continues to grow and so lead times are moving out. And so, we have the ability with some CapEx input to pull that backlog down to turn that into nearer term sales and that is kind of the thought process around the investment.

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Robert Stephen Barger, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [26]

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Understood. Given the free cash flow is such a key focus here, will that metric be a part of senior management compensation targets in 2019?

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Richard D. Holder, NN, Inc. - President, CEO & Director [27]

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Free cash, it is a part of the senior metric compensation today. So the answer is yes.

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Operator [28]

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We'll take our next question from Stanley Elliott with Stifel.

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Stanley Stoker Elliott, Stifel, Nicolaus & Company, Incorporated, Research Division - VP & Analyst [29]

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On the Life Sciences business kind of looking at the guide, I mean, is it reasonable to think that this business is doing something like $130 million plus or minus in terms of revenue for the year?

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Richard D. Holder, NN, Inc. - President, CEO & Director [30]

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No, it's doing -- I'm not going to give you a number on it, but I'll tell you that is a low number. That's not -- more than that.

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Stanley Stoker Elliott, Stifel, Nicolaus & Company, Incorporated, Research Division - VP & Analyst [31]

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And then, when thinking about kind of the Paragon slide deck, you had $8 million of kind of day one synergies and $16 million of kind of full year numbers, where are we in realizing those values?

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Richard D. Holder, NN, Inc. - President, CEO & Director [32]

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Obviously, we've taken the day 1. We are, I would say, roughly 3/4 of the way through the balance of the year synergies. We will continue to drive that. I will tell you that part of what's happening is in some cases, we're making the decision to facilitate the growth in the business and the margin and such that comes with it rather than executing on some of the synergy actions, but growing again a lot faster than we had certainly in the model and sometimes -- some of these moves require us to do some things on the factory floor that certainly in the fourth quarter we probably will not want to shut down the line to do. And so, we continue to work at it. We think optimally we'll get it on both ends, the synergy and the growth, but we're certainly leaning towards the growth.

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Stanley Stoker Elliott, Stifel, Nicolaus & Company, Incorporated, Research Division - VP & Analyst [33]

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Perfect. And then, just make sure I heard correctly. Talking about CapEx into next year, even with some of the retooling that it was going to taking place, you expect that to be lower on a run rate from where we are today?

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Richard D. Holder, NN, Inc. - President, CEO & Director [34]

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That's correct.

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Operator [35]

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We'll take our next question from Daniel Moore with CJS Securities.

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Daniel Joseph Moore, CJS Securities, Inc. - Director of Research [36]

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Mobile Solutions, given the context of the outlook for, let's assume that flat is correct for the next few quarters, how do we think about margins and your ability to hold the line or drive margins in that kind of demand environment?

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Thomas C. Burwell, NN, Inc. - Senior VP, CFO & Assistant Secretary [37]

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Well, I think the right way to think about it is that the margins will be coming back, right? The margins have been under pressure because of the spend on starting up these new programs. And so, even if these new programs are not at an expected volume, we still get the margin uplift within the business and should get back into our 11% to 12% range as these programs -- as they launch.

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Daniel Joseph Moore, CJS Securities, Inc. - Director of Research [38]

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Got it. And on the tax rate, just trying to understand, it doesn't seem like just the slowdown in China would be enough to explain that the full delta between the prior guide and where we are ending up in the sort of low to mid-20s -- or low-20s, anything else change on the tax front other than just the geographic mix?

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Richard D. Holder, NN, Inc. - President, CEO & Director [39]

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Yes, it's primarily geographic mix by including Paragon. They have operations in Poland. They have operations in China also. It's just we are having higher earnings in those geographies than we originally expected when we put the ETR together in Q2.

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Daniel Joseph Moore, CJS Securities, Inc. - Director of Research [40]

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Okay, and then just housekeeping, Tom, do you have where cash flow from ops and CapEx were in the quarter?

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Thomas C. Burwell, NN, Inc. - Senior VP, CFO & Assistant Secretary [41]

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Yes. That will be in the 10-Q that's being filed I think early this afternoon.

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Operator [42]

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(Operator Instructions) We'll take our next question from Charley Brady with SunTrust Robinson Humphrey.

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Charles Damien Brady, SunTrust Robinson Humphrey, Inc., Research Division - MD [43]

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(inaudible) on a follow-up here. I think it'll be very helpful for everyone if we can better understand all these programs that are coming those are ramping and hitting in '19. I know you don't want to give '19 guidance, but I think there's a lot of moving parts here with costs coming out, revenues going up across the segments, can you give us some sense and frame the ramp speed or timing on that and how that would impact margins on a go forward basis, again you don't want to give specifics, but I think we have to have some framework from a modeling perspective to understand when does the ramp time when these programs start hitting and what is the margin impact across the three businesses, primarily the power and (inaudible) mobile?

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Richard D. Holder, NN, Inc. - President, CEO & Director [44]

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I guess, I'll -- let me frame it that way. I think it's a fair question. I don't have -- I won't lay out the detailed numbers for '19 there again, because we'll give '19 guidance next time around. But I think the way to think about it is the bulk of these programs will be at production run levels towards the end of the second quarter. And so they are on or in most cases, a little bit better than the normal run rate contribution margins for the mobile business. And so on an operating basis, that's kind of somewhere between 10% and 13%. For the power business, the program is coming through. They are actually a little bit better. And so on an operating basis, they are closer to 18%, 19%. The power businesses will come online towards the end of the first quarter. Again the mobile stuff will come full production towards the end of the second quarter. And as we look at the forecast right now, what we think will happen is really those programs coming on -- in large part offset what's going to be a falling market and keep us flat as we think about '19 and then of course the fact that we are no longer spending on these programs and comes right back to the margin line.

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Charles Damien Brady, SunTrust Robinson Humphrey, Inc., Research Division - MD [45]

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Is that -- when you talk about the margins on these new programs 10% to 13% for mobile and 18% and 19% on power, is that including the drop-off in the costs being spent or is the cost drop-off incremental to that?

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Richard D. Holder, NN, Inc. - President, CEO & Director [46]

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The cost drop-off would be incremental to that.

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Operator [47]

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Thank you. Once again, ladies and gentlemen -- go ahead sir.

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Richard D. Holder, NN, Inc. - President, CEO & Director [48]

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Looks like we don't have any more questions in the queue. So I will thank everybody for joining us. I absolutely understand that it's been a challenging quarter. I think again -- I'll say it again, I think the business is operating through the challenges the way we had expected. And we'll continue to drive and go from there. So, thanks for joining us and we will see you next quarter.

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Operator [49]

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Thank you. Ladies and gentlemen, this concludes today's teleconference. You may now disconnect.