NN, Inc. — Q2 2017 Form 10-Q
Business context and reporting period. NN, Inc. is a global manufacturer of precision bearing components, industrial plastic products and precision metal components, with three reportable segments: Precision Bearing Components (PBC), Autocam Precision Components (APC) and Precision Engineered Products (PEP). This unaudited quarterly report covers the three and six months ended June 30, 2017; comparisons are to the same periods in 2016. Unless stated otherwise, amounts below are in millions of dollars.
Financial performance and position
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $225.9 | $214.3 | $452.2 | $426.5 |
| Income from operations | $20.6 | $17.3 | $42.8 | $29.1 |
| Operating margin | 9.1% | 8.1% | 9.5% | 6.8% |
| Net income (loss) | $(21.5) | $2.1 | $(14.1) | $0.8 |
| Diluted earnings (loss) per share | $(0.78) | $0.08 | $(0.52) | $0.03 |
| Interest expense | $12.4 | $16.6 | $27.4 | $33.1 |
Q2 and first-half sales rose about 5% and 6%, respectively, primarily on higher volumes across automotive, industrial and medical markets. Foreign-exchange effects partly offset growth. First-half operating income increased 47%, with lower restructuring costs and cost-reduction projects also contributing. The PEP segment had higher Q2 sales but slightly lower operating income, principally due to product mix.
Net losses reflected a $39.6 million debt-extinguishment and debt-issuance-cost charge associated with the April refinancing. This included a $31.6 million cash call premium and noncash write-offs; it more than offset improved operating income, lower interest expense and lower income tax expense.
- Cash flow, six months: operating cash used was $15.6 million, versus $11.8 million provided in 2016; investing cash used was $20.3 million, including $20.7 million of capital expenditures; financing cash provided was $39.8 million. Cash ended at $19.2 million.
- Liquidity: working capital was $180.6 million, up from $141.9 million at year-end 2016, mainly reflecting higher receivables and inventories. The company reported $56.2 million available under its revolving facility, net of letters of credit.
- Debt: total debt was $852.1 million at June 30, compared with $798.5 million at December 31, 2016. The company redeemed $250 million face value of 10.25% Senior Notes for $281.6 million, funded principally by a new $300 million term loan at LIBOR plus 3.75%. The revolver was temporarily reduced from $143 million to $100 million, subject to restoration after meeting a leverage covenant threshold.
- Balance sheet: total assets were $1.406 billion and stockholders’ equity was $311.8 million at June 30, 2017.
Material developments, outlook and risks
- Proposed PBC sale: On July 10, 2017, NN agreed to sell PBC to TSUBAKI NAKASHIMA for $375 million cash, subject to adjustments and closing conditions. Closing was expected in the second half of 2017; estimated net proceeds were approximately $270 million. Management said proceeds were intended for higher-growth, higher-margin markets and debt reduction. PBC would be reported as discontinued operations after closing.
- Liquidity outlook: Management expected operating cash flow and available borrowings to fund capital expenditures and working-capital needs over the next 12 months, and forecast positive operating cash flow. Capital expenditures were expected to remain relatively consistent, mostly for new or expanded business. No earnings or revenue guidance was provided.
- Financial reporting controls: Management concluded disclosure controls were ineffective at June 30 due to previously identified material weaknesses in the control environment and in accounting for business combinations and income taxes. Remediation efforts included additional finance and tax personnel, automated tax software, training and enhanced procedures; management said remediation was not complete.
- Prior-period revisions: The company revised prior-period statements for errors in accounting for foreign currency translation of its 49% China joint-venture investment and other related items, which it deemed immaterial to prior periods. Revisions affected reported earnings and other comprehensive income; the company did not revise prior cash-flow statements.
- Contingency: A Brazilian ICMS tax-credit dispute had a possible loss range of $0–$6 million. No accrual was recorded because management considered a loss not probable; the company cited indemnification rights from former Autocam shareholders.
- Other risks: Sale completion, timing and terms were uncertain; a failed or delayed sale could disrupt operations and relationships, and the post-sale company would be smaller and less diversified. NN also cited customer concentration, competition, capacity utilization, raw-material availability, foreign-exchange exposure and acquisition integration risks. No foreign-currency hedges were in place at quarter-end.
- Accounting changes: The company was assessing the effects of forthcoming revenue-recognition and lease standards; it expected to complete its revenue-standard impact evaluation during 2017.
Important facts for investors to verify
- Whether the PBC sale closed on the expected terms and how net proceeds were applied, particularly to debt reduction.
- Debt balances, borrowing availability, covenant compliance and the realized interest savings from refinancing.
- Whether operating cash flow improves after the first-half cash use and elevated working-capital investment.
- Progress in remediating the material weaknesses and whether subsequent filings report effective controls.
- Any developments in the Brazilian tax dispute, associated indemnification and potential cash exposure.
- How the reported prior-period revisions affect comparisons, and the eventual revenue-standard implementation impact.