NN, Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. Dollar amounts below are in millions unless noted. The company sold its Precision Bearing Components (PBC) business on August 17, 2017; results are presented as discontinued operations, so continuing-operation comparisons reflect the remaining APC and PEP businesses.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Continuing net sales | $148.2 | $146.7 | $463.7 | $443.3 |
| Income from operations | $6.3 | $13.0 | $32.3 | $29.5 |
| Operating margin | 4.3% | 8.9% | 7.0% | 6.6% |
| Income (loss) from continuing operations | $(2.9) | $0.8 | $(28.0) | $(7.3) |
| Net income | $132.9 | $4.5 | $118.6 | $5.2 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $0.3 | $46.3 |
Q3 continuing sales rose 1.0% year over year, but operating income fell $6.7 million as product mix, raw-material costs, start-up costs, higher SG&A and acquisition costs weighed on results. Lower interest expense partially offset the decline. Nine-month sales increased 4.6%, mainly on higher volume in medical, automotive and industrial markets. Nine-month operating income improved, but the continuing-operations loss widened substantially, primarily because of debt-extinguishment and financing-related charges.
Reported net income was dominated by the PBC disposal: discontinued operations contributed $135.8 million in Q3 and $146.6 million for the nine months, including an estimated $129.4 million after-tax sale gain. Continuing diluted EPS was $(0.11) for Q3 and $(1.02) for nine months; total diluted EPS was $4.82 and $4.33, respectively.
Liquidity, debt and cash flow
- Cash and equivalents were $347.4 million at September 30, up from $6.3 million at year-end. Working capital was $377.4 million versus $141.9 million.
- Total debt was approximately $837.0 million before unamortized issuance costs, including $539.3 million on the senior term loan and $294.0 million on the incremental term loan. No revolver balance was outstanding; stated borrowing availability was $89.7 million, net of $10.3 million in letters of credit. Long-term debt, net of current maturities and issuance costs, was $794.0 million.
- Nine-month investing cash flow was $332.4 million, including $371.4 million of net proceeds reported from the PBC sale; capital expenditures were $31.7 million. Financing cash flow was a $1.1 million outflow. Operating cash flow was just $0.3 million; management attributed the year-over-year decline mainly to the $31.6 million cash call premium paid in the April debt redemption.
- The company said existing cash, continuing-operation cash generation and available borrowing were expected to cover debt service, capital spending and working-capital needs over the next 12 months.
Material changes, outlook and risks
- PBC divestiture: Sold for a stated $375.0 million base price, subject to adjustments; cash proceeds were $387.6 million and the estimated after-tax gain was $129.4 million. Purchase-price adjustments remained to be finalized. Management said proceeds would support investment in higher-growth, higher-margin markets and debt reduction.
- Debt refinancing: In April, redeemed $250 million of 10.25% senior notes for $281.6 million, funded with a new $300 million term loan at a lower floating rate. Nine-month debt-extinguishment and issuance-cost charges totaled $39.6 million. Interest expense declined $8.8 million year over year for the nine months.
- Acquisition after quarter-end: On October 2, NN acquired DRT Medical for $38.6 million cash, subject to adjustments. It will report in PEP; its results are not included in this filing.
- Management outlook: Capital expenditures were expected to remain relatively consistent over the next year, mainly for new or expanded business and continuous improvement. Management forecast positive continuing-operation cash flow and said PBC’s absence was not expected to materially impair debt service or funding needs. No specific earnings or revenue guidance is provided in the supplied filing text.
- Controls and reporting: Disclosure controls were deemed ineffective because material weaknesses persisted in the control environment, business-combination accounting and income-tax accounting. The filing revised prior-period financial statements for errors involving foreign-currency translation of a China joint-venture investment and other items; management said prior errors were not material to any individual prior period. Remediation was underway, but effectiveness had not yet been established.
- Contingencies and exposure: A Brazilian ICMS tax dispute has a possible loss range of $0–$6.0 million; no amount was accrued, and management said loss was not probable and believed indemnification may apply. The company had no currency hedges at quarter-end and had floating-rate debt; a 1 percentage-point rate increase was estimated to add about $8.3 million in annual interest expense on the two term loans.
- Other items: A $1.3 million cash payment terminated the interest-rate swap on October 27. Management reported no goodwill or intangible-asset impairment indicators at September 30. A global ERP implementation and strategic staffing/infrastructure costs contributed to higher SG&A.
Key facts for investors to verify
- Final PBC sale working-capital and purchase-price adjustments, actual net proceeds, and use of the sale cash.
- Post-acquisition DRT Medical purchase-price allocation, integration costs and contribution to PEP.
- Whether operating cash flow improves and whether the company reduces debt while meeting capital and working-capital needs.
- Progress and testing results for remediation of material weaknesses, particularly tax and acquisition accounting controls.
- Continuing-segment margins and whether mix, inflation and new-program start-up costs moderate.
- Outcome and indemnification coverage of the Brazilian tax matter, and the impact of floating rates and foreign-exchange movements.