NN, Inc. — Q1 2018 Form 10-Q
Business context and reporting period. This unaudited filing covers the three months ended March 31, 2018. NN manufactures precision components and assemblies for automotive, industrial, electrical, aerospace and defense, and medical markets. In January 2018, it reorganized into Mobile Solutions, Power Solutions, and Life Sciences. The 2017 comparison is presented on a continuing-operations basis; the precision bearing components business sold in August 2017 is classified as discontinued operations.
Financial performance and liquidity
Amounts below are in U.S. dollars; financial statement figures have been converted from thousands to millions where appropriate.
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Net sales | $169.1 million | $157.6 million |
| Gross profit / margin | $42.7 million / 25.2% | $43.1 million / 27.3% |
| Operating income / margin | $3.7 million / 2.2% | $13.9 million / 8.8% |
| Continuing-operations net income (loss) | $(6.0) million | $1.9 million |
| Net income (loss), including discontinued operations | $(6.0) million | $7.4 million |
| Operating cash flow | $(1.0) million | $4.9 million |
| Interest expense | $12.0 million | $14.8 million |
- Sales rose 7%, with $9.0 million attributed to acquisitions, $1.1 million to volume, and $2.4 million to foreign exchange; price, mix, inflation, and other factors reduced the increase by $0.9 million.
- Q1 segment sales and operating income: Mobile Solutions $89.8 million and $9.8 million; Power Solutions $48.7 million and $5.2 million; Life Sciences $31.2 million and $4.2 million. Corporate and consolidation costs reduced operating income by $15.5 million.
- Cash and cash equivalents were $185.0 million at March 31, down from $224.4 million at year-end. Working capital was $338.8 million, versus $368.9 million at December 31, 2017.
- Capital expenditures were $11.9 million. Investing cash use totaled $32.8 million, including $14.7 million for acquisitions and $6.0 million paid as earnest money toward Paragon Medical.
- Debt principal was $825.6 million, including $822.3 million under the senior secured and incremental term loans. The revolver had no borrowings; reported availability was $97.6 million, net of letters of credit. The company reported covenant compliance at quarter-end.
Material changes and unusual items
- Operating income fell $10.2 million year over year despite higher sales. Management cited acquisition and infrastructure costs, increased depreciation, restructuring, product mix and inflation; cost-reduction projects partly offset higher costs.
- Life Sciences sales benefited from the Bridgemedica and Vandalia acquisitions. Bridgemedica, acquired February 22, contributed $1.3 million in sales and $0.1 million in operating income after acquisition.
- Interest expense declined $2.8 million, primarily following refinancing and replacement of higher-cost notes. The joint venture’s contribution to income also declined, by $0.9 million, amid lower pricing and higher raw-material costs.
- NN adopted ASC 606 on January 1, 2018. The filing says its Q1 effect was immaterial; reported sales were $54,000 lower than they would have been without adoption. The 2017 comparison was not restated for the new standard.
- NN disclosed prior-period financial statement revisions for identified errors it assessed as immaterial to prior periods. It revised the Q1 2017 comparison and noted that further 2017 quarterly revisions would be addressed in later filings.
Outlook, risks, and contingencies
- Management expected positive cash flow from continuing operations over the next 12 months and believed cash, operating cash flow, and available credit would fund debt service, capital expenditures, and working capital. It expected capital expenditures to remain relatively consistent. These are expectations, not a quantified earnings forecast.
- On May 7, 2018, after quarter-end, NN acquired Paragon Medical for $375 million in cash. It funded the purchase with a $200 million second-lien term loan and cash on hand, and amended its existing credit facility. The new loan carries an initial margin of 8% over LIBOR (subject to a 1% LIBOR floor), or 7% over the base rate, and matures in 2023. The acquisition and financing are not reflected in March 31 balances.
- Variable-rate debt exposes NN to interest-rate increases: the filing estimates a one-percentage-point increase would add approximately $5.3 million annually on the senior term loan and $2.9 million on the incremental term loan. No interest-rate swaps or foreign-currency derivatives were in place at quarter-end.
- NN reported ineffective disclosure controls as of March 31 due to previously identified material weaknesses in staffing and financial reporting controls, particularly income taxes and business combinations. Remediation was ongoing; management said the weaknesses were not yet remediated.
- A Brazilian ICMS tax dispute carries an estimated possible loss range of $0 to $6.0 million. No amount was accrued because management believed a loss was not probable; it cited potential indemnification from former Autocam shareholders. Other legal proceedings were described as routine and not expected to have a material adverse effect.
- The filing identifies risks including economic and end-market conditions, customer concentration, competition, raw-material availability, foreign exchange, acquisition integration, capacity utilization, and quality issues. NN also warned that the 2019 lease-accounting standard is expected to add lease assets and liabilities and may affect loan-covenant compliance if not addressed.
Investor facts to verify
- How margins and operating performance develop after the Q1 cost pressures, including the progress and costs of ERP implementation and restructuring.
- The final Paragon Medical purchase-price allocation, integration results, and effect of the second-lien financing on leverage, interest costs, and covenants.
- Whether management’s expected positive operating cash flow and stated liquidity remain adequate after the acquisition and ongoing investment needs.
- Progress in remediating material weaknesses and whether subsequent filings report effective controls or further revisions.
- Developments in the Brazilian ICMS assessment, indemnification coverage, and any change to the unaccrued loss estimate.