NN, Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. NN manufactured precision components for industrial, automotive, electrical, aerospace and defense markets. The Life Sciences business is presented as discontinued operations for all periods shown.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Continuing-operations net sales | $113.8m | $120.5m | $308.5m | $378.8m |
| Operating income (loss) | ($1.5m) | ($1.8m) | ($116.5m) | ($7.5m) |
| Continuing-operations income (loss) | $1.6m | ($4.8m) | ($124.0m) | ($20.8m) |
| Net income (loss), including discontinued operations | $22.0m | ($5.9m) | ($248.0m) | ($32.7m) |
| Operating cash flow | Not provided for quarter | $19.3m | $33.6m |
- Q3 continuing sales declined 5.6%; management attributed the decrease to lower COVID-19-affected demand and unfavorable foreign exchange. Nine-month continuing sales fell 18.6%.
- Q3 gross profit before depreciation and amortization was $23.7m, or 20.8% of sales, versus $23.8m, or 19.8%, a year earlier. Q3 operating margin was approximately negative 1.3%, versus negative 1.5%.
- Q3 reported net income included $20.3m income from discontinued operations, net of tax; continuing operations generated a $1.6m accounting profit, but preferred dividends meant a $0.04 loss per common share from continuing operations. Nine-month results included $92.9m continuing-operations goodwill impairment and $146.8m discontinued-operations goodwill impairment.
- Nine-month operating cash flow of $19.3m was down from $33.6m. Capital expenditures were $20.5m, compared with $40.7m. Cash-flow figures include discontinued operations.
Financial position, debt and liquidity
- At September 30, cash and cash equivalents were $56.1m on the balance sheet, plus $16.0m classified in assets held for sale; the cash-flow statement reports $72.1m total cash including held-for-sale cash. Total debt principal was $842.2m, including $59.0m drawn on the revolver. Only $1.4m of revolver capacity was available after letters of credit and borrowings.
- Current maturities included $700.0m of term-loan principal expected to be repaid using Life Sciences sale proceeds. Reported working capital was negative $573.7m, largely because of this debt classification.
- The Life Sciences sale closed October 6, 2020, for $757.2m cash proceeds at closing. NN prepaid $700.0m on its term loans and repaid the revolver in full. The company expected to recognize a gain on sale exceeding $100m, net of tax, in Q4; purchase-price adjustments remained subject to finalization.
- Management said the sale-related debt reduction, available revolver capacity and expected operating cash flows resolved the previously disclosed going-concern substantial doubt, and expected liquidity and covenant compliance to be sufficient for the following 12 months. This is management’s assessment, not a guarantee.
Changes, outlook and notable matters
- Mobile Solutions Q3 sales were $70.4m, down $2.7m year over year, while operating income rose to $5.0m from $3.4m. Power Solutions sales were $43.4m, down $4.0m, and operating income fell to $1.1m from $3.4m, reflecting volume pressure and higher precious-metals costs.
- Management expected full-year 2020 results to be adversely affected by COVID-19, citing uncertain demand, possible renewed shutdowns, and customer and supply-chain disruption. No numerical earnings or revenue guidance was provided.
- The July credit amendment waived leverage-ratio covenant compliance for Q2 and Q3, subject to minimum-liquidity and other requirements. NN reported compliance with credit-facility requirements at September 30; leverage-ratio testing resumed in Q4 under amended terms.
- Following the debt prepayment, part of the interest-rate swap no longer qualified for hedge accounting. NN expected to reclassify related accumulated losses to earnings in Q4 and recognize subsequent fair-value changes in earnings for that portion.
- Disclosure controls were deemed ineffective at September 30 because material weaknesses in internal control over financial reporting remained unremediated. The filing cited deficiencies in staffing and oversight, revenue and receivables controls, IT controls, and inventory controls. Weaknesses associated with the sold Life Sciences business ceased to apply after the sale.
- Pending matters include a securities-offering class action and a post-sale complaint by preferred-stock investors alleging the Life Sciences sale breached preferred-stock terms. NN said it considered the allegations without merit; it could not assess potential material financial impact. Remaining Brazilian tax cases had potential exposure below $5m, with management expecting indemnification from former owners.
Key facts for investors to verify
- Final Life Sciences sale-price adjustments, any earnout (up to $70m subject to 2022 performance), and the actual Q4 gain on sale.
- Post-sale debt, interest expense, swap-related earnings charges, revolver availability and compliance with the resumed leverage covenant.
- Continuing-business demand, margins and cash generation as COVID-19 and market conditions evolve.
- Progress in remediating material weaknesses and the potential outcomes of the preferred-stock and securities litigation.
- How much of Q3 and year-to-date reported net income or loss reflects continuing operations versus discontinued operations, impairments and tax effects.