Business Context and Reporting Period
Company: NN, Inc.
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2006
Business Overview: NN, Inc. is a leading independent manufacturer of high-precision bearing components (balls, rollers, retainers, seals) and precision plastic and metal parts. The company operates globally with facilities in the U.S., Europe, and China. In 2006, the company executed a strategic shift to diversify beyond metal bearing components by acquiring Whirlaway Corporation, entering the precision metal components market.
Key Financial Metrics
| Metric | 2006 | 2005 | Change |
|---|---|---|---|
| Net Sales | $330.3 million | $321.4 million | +2.8% |
| Net Income | $14.4 million | $15.0 million | -3.9% |
| Diluted EPS | $0.83 | $0.87 | -4.6% |
| Operating Income | $25.9 million | $27.9 million | -7.2% |
| Operating Margin | 7.8% | 8.7% | -0.9 pts |
| Cash Flow from Operations | $33.0 million | $30.0 million | +10.0% |
| Total Assets | $342.7 million | $269.7 million | +27.1% |
| Long-Term Debt | $80.7 million | $57.9 million | +39.4% |
| Working Capital | $51.0 million | $41.1 million | +24.1% |
Material Changes vs. Prior Period
- Acquisition of Whirlaway: On November 30, 2006, NN acquired Whirlaway Corporation for approximately $45.6 million ($24.3M cash, $21.3M note). This created a new "Precision Metal Components" segment. Whirlaway contributed $4.7 million in sales and a $0.6 million loss for the single month of December 2006.
- Revenue Growth Drivers: Sales increased primarily due to price increases passed through to customers to offset raw material (steel) inflation and favorable foreign currency translation (Euro appreciation). These gains were partially offset by volume losses from two major customers.
- Profitability Pressure: Despite revenue growth, net income declined slightly. This was driven by higher selling, general, and administrative (SG&A) expenses (due to the adoption of SFAS 123(R) for stock-based compensation), increased depreciation from new facilities in China and Slovakia, and the initial loss from the Whirlaway acquisition.
- Customer Concentration: Sales to the top 10 customers accounted for 81% of total revenue. Specifically, SKF accounted for 46% and Schaeffler Group (INA) for 11% of 2006 sales.
Guidance, Outlook, and Risks
- Strategic Outlook: Management is executing a five-year plan to diversify end markets and customers. The Whirlaway acquisition is the first step in building a precision metal components platform. The company plans to spend approximately $19.0 million on capital expenditures in 2007, focusing on equipment upgrades and geographic expansion.
- Customer Contract Status:
- SKF: The primary supply agreement expired in July 2006 and was informally extended through 2006. Formal negotiations for a multi-year agreement were ongoing, with a target signing in the first half of 2007.
- Schaeffler Group (INA): A new two-year agreement was signed in January 2007, effective retroactively to July 1, 2006, reflecting a permanent reduction in volume due to INA's decision to in-source some production.
- Key Risks:
- Customer Concentration: Loss of SKF or INA would have a material adverse effect on revenue and margins.
- Raw Material Costs: Dependence on limited sources for 52100 steel. While price increases are generally passed to customers, there is a lag in European operations (typically adjusted in January of the following year).
- Foreign Exchange: Significant exposure to the Euro and other foreign currencies. A strengthening U.S. dollar could negatively impact consolidated results.
- Integration Risk: Challenges in integrating Whirlaway and managing the transition of production at the Eltmann, Germany facility (where wage negotiations were ongoing).
Investor Verification Checklist
- SKF Contract Renewal: Verify the terms and duration of the new supply agreement with SKF, which represents nearly half of the company's revenue.
- Whirlaway Integration: Monitor the performance of the new Precision Metal Components segment in 2007 to ensure it meets pro-forma revenue expectations ($77.7 million annualized) and achieves profitability.
- Steel Pricing Lag: Assess the impact of raw material cost inflation on margins during the lag period before price adjustments are passed to European customers.
- Debt Covenants: Review compliance with the new $90 million revolving credit facility and $40 million senior notes, particularly regarding liquidity measures and restrictions on dividends/repurchases.
- European Restructuring: Track the outcome of labor negotiations at the Eltmann, Germany facility, as failure to reach an agreement could lead to significant restructuring costs or facility closure.