NN, Inc. — 2019 Third-Quarter Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. NN designs and manufactures precision components for medical, aerospace and defense, electrical, automotive, and general industrial markets.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net sales | $213.9 million | $205.7 million | $648.8 million | $571.2 million |
| Income from operations | $7.7 million | $5.9 million | $16.4 million | $9.3 million |
| Operating margin | 3.6% | 2.9% | 2.5% | 1.6% |
| Net loss | $(5.6) million | $(13.8) million | $(30.9) million | $(44.8) million |
| Loss per diluted share | $(0.13) | $(0.48) | $(0.74) | $(1.61) |
| Operating cash flow | Not presented by quarter | $33.6 million | $(13.2) million |
Gross margin, calculated as net sales less cost of sales before separately reported depreciation and amortization, was 24.8% in Q3 2019 versus 24.0% in Q3 2018, and 25.2% for the first nine months versus 24.5%. Nine-month capital expenditures were $40.7 million. Cash increased to $24.4 million from $18.0 million at year-end 2018.
Liquidity, debt and financial position
- At September 30, principal debt was $879.0 million, including $71.3 million drawn on the revolving credit facility; reported long-term debt, net of current maturities and issuance costs, was $841.7 million. Cash was $24.4 million.
- Working capital was $160.3 million, compared with $153.2 million at December 31, 2018. Current assets were $316.3 million and current liabilities $156.0 million.
- Revolver availability was $16.7 million after borrowings and letters of credit. The revolver matures October 19, 2020. NN said it did not expect to repay the outstanding balance at maturity without refinancing or new financing, and disclosed substantial doubt about its ability to continue as a going concern within one year after issuance of the financial statements.
- NN was in compliance with credit-facility covenants at September 30, but stated that covenants become more restrictive over time and future compliance depends on operating and financial performance.
- A $700 million interest-rate swap, entered in February 2019, fixes the LIBOR component on a declining portion of variable-rate debt at 2.4575% through October 2022. The swap liability was $15.2 million at quarter-end.
Comparative changes and operating trends
- Q3 sales rose 4.0%, primarily from $9.0 million of organic growth and $0.6 million from acquisitions, partly offset by $1.4 million of unfavorable currency effects. Nine-month sales rose 13.6%, mainly reflecting $75.3 million from 2018 acquisitions and $9.1 million organic growth, partly offset by $6.8 million of foreign-exchange effects.
- Life Sciences led growth: Q3 sales increased $15.6 million, with higher orthopaedic and medical/surgical volumes; nine-month sales increased $102.6 million, including acquisition contribution. Mobile Solutions weakened: Q3 sales fell $8.7 million and nine-month sales fell $29.1 million, largely because of lower automotive demand, currency effects, and programs nearing end of life. Power Solutions Q3 sales increased $1.3 million; nine-month operating income declined $1.1 million.
- Operating income improved, while net losses continued. Lower interest expense and lower debt-extinguishment charges versus 2018 helped reduce the losses. The 2018 comparison included a $6.6 million Q3 debt-extinguishment loss and $19.6 million for the first nine months.
- Nine-month operating cash flow improved from use of $13.2 million to generation of $33.6 million, which management attributed mainly to improved profitability and working-capital changes. Investing cash outflow was $31.0 million, versus $445.4 million in 2018, when acquisitions were a major use of cash.
Outlook, risks and unusual items
- Financing and going concern: Refinancing is necessary to address the revolver maturity; NN said there is no assurance that financing will be available on commercially reasonable terms, or at all. The filing identifies potential effects on customers, suppliers, employees, and operations if confidence or vendor payment terms deteriorate.
- Cost and cash actions: Announced October 21, 2019, initiatives include facility streamlining, lower SG&A, reduced capital spending, and elimination of quarterly dividends. The company expected the initiatives to be fully realized by Q2 2020. No earnings or revenue guidance is provided in the supplied filing text.
- Management and controls: The company reported departures of its former CEO and CFO during Q3 and appointments of interim officers. Disclosure controls were deemed ineffective because of an unremediated material weakness involving insufficient finance personnel with appropriate knowledge, experience, and training. Management said the financial statements nevertheless fairly presented results in all material respects and described hiring and process improvements as remediation efforts.
- Prior-period revisions: NN revised 2018 comparative information for tax-accounting misstatements it assessed as immaterial to previously issued periods. The revision reduced nine-month 2018 net income by $0.5 million; NN said it did not change net cash flows.
- Impairment and contingencies: NN recorded a $109.1 million Power Solutions goodwill impairment in 2018 and a $16.6 million joint-venture impairment in 2018. It reported no Q3 2019 triggering event, but noted further impairment could result if performance or valuation assumptions weaken. A Brazilian tax matter has an estimated possible loss range of $0–$6.0 million, with no accrual; the company expects indemnification subject to contractual terms. A securities-offering class action filed November 1, 2019 seeks unspecified damages; the company disputes the claims and cannot assess potential material impact.
- Customer and market exposure: One customer represented 11.1% of Q3 sales and 10.6% of nine-month sales. NN also cites automotive demand, foreign exchange, interest rates, acquisition integration, Brexit uncertainty, and dependence on refinancing as risks.
Investor verification priorities
- Track refinancing progress, the October 2020 revolver maturity, borrowing availability, and covenant headroom.
- Assess whether the announced cost reductions, dividend suspension, and lower capital spending improve cash generation and debt reduction as planned.
- Monitor Mobile Solutions demand and margins, Life Sciences growth, and customer concentration.
- Review remediation of the material weakness and the planned corrections to prior annual and interim financial statements.
- Follow impairment indicators, the Brazilian tax assessment, and the securities-offering litigation.