NN, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017. NN is a diversified global manufacturer of precision bearing components, engineered products and precision metal components, operating through three reportable segments. Financial statements are unaudited.
Financial performance
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Net sales | $226.3 million | $212.2 million |
| Income from operations | $22.2 million | $11.9 million |
| Operating margin | 9.8% | 5.6% |
| Net income (loss) | $7.4 million | $(1.3) million |
| Diluted earnings (loss) per share | $0.27 | $(0.05) |
| Operating cash flow | $5.2 million | $3.5 million |
| Capital expenditures | $8.6 million | $8.0 million |
Sales rose 6.6%. Cost of products sold, excluding separately reported depreciation and amortization, was $167.0 million; the resulting gross margin was approximately 26.2%, versus 24.7% a year earlier. Interest expense was $15.0 million, down from $16.4 million. The income tax provision was $2.3 million; the effective tax rate was 29%, compared with 21% in Q1 2016. NN also reported $1.7 million of equity-method income from its joint venture.
Operating cash flow exceeded the prior-year period, but cash flow less capital expenditures was negative $3.3 million. Cash and cash equivalents were $19.6 million at quarter-end, up from $14.4 million at December 31, 2016. Total debt was $810.2 million, including $10.8 million of current maturities; total debt excludes capital lease obligations. The company reported $92.0 million of revolver availability, net of letters of credit, subject to limitations. Working capital was $160.2 million, versus $141.9 million at year-end.
Changes versus Q1 2016
- Revenue increased $14.1 million, driven mainly by volume (+$14.1 million) and price/material-inflation pass-through/mix (+$2.0 million), partly offset by foreign exchange (−$2.0 million). Management cited improved industrial and medical demand.
- Operating income improved $10.3 million. Management attributed the change to higher sales, cost-reduction projects, lower amortization of acquisition-related backlog and unfavorable leasehold intangibles, and substantially lower restructuring costs ($0.1 million versus $2.5 million).
- Sales increased in all segments: Precision Bearing Components to $68.8 million, Autocam Precision Components to $86.4 million, and Precision Engineered Products to $71.1 million. Segment operating income increased to $8.4 million, $10.6 million and $10.9 million, respectively.
- Receivables rose to $159.6 million from $139.5 million at year-end; inventory was relatively stable at $116.6 million. Management reported inventory days down approximately five days.
Liquidity, outlook and material matters
- Management said operating cash generation and available credit were expected to fund capital expenditures and working-capital needs for the next 12 months; it expected capital expenditures to remain relatively consistent. No numerical earnings or revenue guidance was provided.
- After quarter-end, NN redeemed $250 million face value of 10.25% Senior Notes for $281.6 million, funded by a new $300 million incremental term loan priced at LIBOR plus 3.75%, maturing April 3, 2021. The redemption resulted in a $36.3 million debt-extinguishment loss. This subsequent event is not included in Q1 results.
- At March 31, reported debt included a $545 million Senior Secured Term Loan B and $143 million Senior Secured Revolver facility; the term loan bore interest at LIBOR plus 4.25%, subject to a 0.75% floor. The filing notes variable-rate exposure and an interest-rate swap. A 1% rate increase was estimated to raise annual interest expense by approximately $5.4 million on the term loan and $0.4 million on revolver borrowings.
- Foreign-currency movements reduced reported sales; no currency hedges were in place at quarter-end. Management cited currency, customer concentration, capacity utilization, quality, raw-material availability, competition, acquisition integration and economic conditions among forward-looking risks.
- A Brazilian ICMS tax-credit dispute had a possible loss range of $0–$6.0 million; management said a loss was not probable, recorded no accrual, and noted potential indemnification from former Autocam shareholders. Other legal proceedings were described as routine and not expected to be material.
- Disclosure controls were concluded to be ineffective at quarter-end because previously reported material weaknesses remained in the control environment, business-combination accounting and income-tax accounting. Management described remediation efforts, including additional hiring, training and process improvements; remediation was not yet complete.
- Adoption of the new revenue-recognition standard was planned for January 1, 2018 using a full retrospective method; the company was still evaluating impacts, including possible changes in timing for customer incentives. Lease-standard impacts were also under evaluation.
Important facts for investors to verify
- Whether stronger demand and segment operating improvement persist, and how cost reductions compare with inflation, mix and staffing costs.
- The actual financing costs, debt balances and covenant headroom following the April note redemption and incremental term loan.
- Whether operating cash flow improves enough to cover capital spending, dividends and debt service, given receivables growth.
- Progress and testing of remediation for the disclosed material weaknesses and the resulting effectiveness of financial reporting controls.
- Developments in the Brazilian tax matter and the scope and enforceability of the stated indemnification.