NN, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; unaudited. NN, Inc. designs and manufactures precision components and assemblies for medical, aerospace and defense, electrical, automotive, and industrial markets. It reported three operating segments: Mobile Solutions, Power Solutions, and Life Sciences.
Financial performance and liquidity
- Revenue: $213.3 million, up $44.1 million (26%) from $169.1 million. Acquisitions contributed $55.2 million; lower volume reduced sales by $8.0 million and foreign exchange reduced them by $2.8 million.
- Profitability: Operating income was $0.6 million versus $3.7 million; operating margin was approximately 0.3% versus 2.2%. Net loss widened to $18.6 million from $6.0 million, and diluted loss per share was $0.44 versus $0.22.
- Cash flow: Operating cash use was $2.7 million versus $1.0 million. Investing cash use was $3.7 million versus $32.8 million; capital expenditures were $14.1 million. Financing provided $8.9 million versus cash use of $6.3 million. Cash ended the quarter at $20.3 million.
- Debt and liquidity: Total debt principal was $873.4 million, up from $859.6 million at December 31, 2018. Revolver borrowings were $56.2 million; unused borrowing capacity was $56.7 million, net of letters of credit. The company reported covenant compliance. Quarterly interest expense was $13.8 million.
- Other balance-sheet items: Working capital was $149.3 million, down from $151.8 million. Adoption of the lease standard added $68.5 million of operating lease assets and $74.6 million of operating lease liabilities. Dividends declared were $0.07 per share.
Material changes versus Q1 2018
- Reported revenue growth was driven by the 2018 acquisitions, particularly Paragon Medical and Bridgemedica in Life Sciences. For context, the filing gives 2018 pro forma revenue of $209.8 million and net loss of $8.1 million as if Paragon Medical had been acquired earlier; this is not directly equivalent to reported results.
- Mobile Solutions sales fell $11.7 million and operating income fell $5.7 million, reflecting weaker North American and Chinese automotive demand, foreign exchange, and end-of-life programs.
- Power Solutions sales increased $1.0 million, but operating income fell $1.4 million, including higher segment selling and administrative costs. Life Sciences sales rose $54.8 million, largely from acquisitions; operating income declined $0.4 million amid integration, production-transfer, and staffing costs.
- Higher acquisition-related depreciation and amortization, interest expense, and a $2.7 million debt-issuance-cost write-off weighed on results. A $6.0 million discrete tax charge contributed to the reported tax provision despite the pretax loss.
Outlook, risks, and unusual items
- Management expected positive operating cash flow over the next 12 months and capital expenditure plus finance-lease asset spending to remain relatively consistent with 2018 levels. It believed cash generation and revolver borrowing capacity would fund operations, capital needs, debt service, and dividends. No specific revenue or earnings guidance was provided.
- In February 2019, NN entered a $700 million interest-rate swap, fixing the LIBOR component at 2.4575% on a declining notional through October 2022. The company recorded a $4.0 million fair-value liability and a $3.9 million after-tax loss in accumulated other comprehensive income.
- Goodwill was $440.2 million. NN disclosed that its March 31 market capitalization was below book equity, a potential impairment indicator; it reported no Q1 impairment and said its subsequent market-capitalization increase, with a reasonable control premium, did not indicate additional impairment. Power Solutions had previously recorded a $109.1 million goodwill impairment in 2018, and further impairment could result if performance misses expectations.
- A Brazilian ICMS tax-credit dispute carries an estimated possible loss range of $0–$6.0 million; no amount was accrued because management considered a loss not probable. NN said it believed it was entitled to indemnification from former Autocam shareholders.
- Disclosure controls were deemed ineffective due to an unremediated material weakness in the finance control environment and staffing. Management nevertheless concluded the financial statements were fairly stated in all material respects. Remediation efforts included hiring qualified finance personnel.
- Other cited risks include automotive demand, acquisition integration, foreign exchange, interest rates, customer concentration, and Brexit uncertainty. One customer represented 10.9% of quarterly sales. NN announced the planned closure of its Tennessee shared service center, effective end-June 2019, and expected no material financial impact.
Important facts for investors to verify
- Whether acquisitions and weaker automotive demand continue to drive the divergence between reported sales growth and segment operating performance.
- Operating cash generation, working-capital needs, capital spending, and revolver availability relative to substantial debt and required interest payments.
- Compliance with leverage covenants as they become more restrictive, and progress in remediating the material weakness in internal controls.
- Developments in Power Solutions goodwill impairment indicators and the Brazilian tax dispute, including the stated indemnification provisions.
- Integration costs and expected contribution from acquired businesses, as well as customer concentration and exposure to foreign exchange and variable-rate debt.