NN, Inc. — Q2 2012 Form 10-Q
Business context and period. NN manufactures metal bearing, precision metal, and plastic and rubber components. This unaudited report covers the quarter and six months ended June 30, 2012, with comparisons to the same 2011 periods. Amounts below are in millions of dollars unless noted.
Financial performance
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Net sales | $98.8 | $115.9 | $203.3 | $227.2 |
| Operating income | $8.3 | $9.3 | $17.3 | $18.5 |
| Net income | $7.0 | $5.8 | $12.9 | $11.3 |
| Diluted EPS | $0.41 | $0.34 | $0.76 | $0.67 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $11.6 | $(2.0) |
| Capital expenditures | Not provided for quarter | Not provided for quarter | $9.1 | $10.2 |
Q2 sales declined 14.7% year over year, while net income rose 20.8%. For the first half, sales fell 10.5% and net income increased 14.2%. Operating margin, calculated as operating income divided by sales, was 8.4% in Q2 2012 versus 8.0% in Q2 2011, and 8.5% versus 8.1% for the first half. Net margin was 7.1% versus 5.0% in Q2 and 6.4% versus 5.0% for the first half. Gross margin before depreciation and amortization was 21.2% in Q2 versus 18.3%, and 20.9% versus 18.6% for the first half.
Six-month cash flow from operations improved by $13.7 million year over year. Operating cash flow less capital expenditures was approximately $2.5 million, compared with approximately negative $12.2 million in the first half of 2011. Cash was $12.0 million at June 30, 2012, up from $4.5 million at year-end 2011. Total debt was $81.6 million, including $6.7 million in current maturities; it was $78.1 million at year-end. Working capital was $69.1 million, and the current ratio was 2.06, up from 1.70.
Material changes and drivers
- Management attributed the sales decline principally to lower volumes in the Metal Bearing Components segment, reflecting European macroeconomic weakness, lower European automotive demand, customer inventory adjustments, and unfavorable currency translation. Lower volume reduced production efficiency and segment earnings.
- Metal Bearing Components revenue fell to $65.8 million in Q2 from $84.8 million; segment net income fell to $6.3 million from $8.9 million. Precision Metal Components revenue rose to $22.6 million from $19.5 million, and segment income improved to $1.9 million from a $1.1 million loss. Plastic and Rubber Components revenue declined to $10.5 million from $11.6 million; income was $0.8 million versus $0.9 million.
- Precision Metal Components benefited from higher run-rate sales on programs launched in 2011 and the absence of prior-year start-up costs and inefficiencies ($2.0 million in Q2 2011 and $4.5 million in the first half of 2011). Cost-reduction projects also helped offset weaker volume; inflation and higher SG&A, including stock-based compensation, were offsets.
- Q2 other income included approximately $1.1 million of foreign-exchange gains on intercompany loans, versus losses in the prior-year quarter. First-half other income also reflected approximately $0.4 million of such FX gains and a roughly $0.2 million gain related to final settlement of a note receivable. These items supported reported earnings.
- Foreign-currency translation reduced Q2 comprehensive income by $6.6 million; first-half translation loss was $3.2 million. Q2 comprehensive income was $0.5 million, compared with $7.8 million a year earlier.
Liquidity, outlook, risks, and contingencies
- NN reported $38.9 million of additional revolver availability at June 30, net of letters of credit and subject to covenant limitations. It was in compliance with its debt covenants; the reported fixed-charge coverage ratio was 1.31 against a 1.00 minimum. The minimum rises to 1.25 beginning October 1, 2012.
- Management expected 2012 capital expenditures of $15 million to $20 million, primarily for new or expanded business, and believed operating cash flow and available borrowings would fund capital and working-capital needs through June 2013. No specific revenue or earnings guidance was provided.
- The company had $50.1 million outstanding on its floating-rate revolver and $31.4 million of fixed-rate notes. It had no currency hedges; a one-percentage-point increase in rates on variable-rate debt was estimated to increase annual interest expense by about $0.5 million.
- NN maintained an approximately $10.3 million valuation allowance against U.S. net deferred tax assets. Management said continued U.S. profitability could allow a significant portion, excluding approximately $3.25 million related to foreign tax credits, to be reversed, but timing and amount are uncertain. First-half tax expense benefited from use of reserved net operating losses and lower-taxed foreign earnings.
- At a former waste-recycling vendor, NN’s allocated share of a tentatively EPA-approved remediation plan was approximately $132,000 and had been paid; management believed this was the maximum liability, while noting there could be no assurance. The Eltmann subsidiary bankruptcy proceedings were not final, though management did not expect further significant consolidated impact. NN said other legal proceedings were routine and risk factors had not materially changed.
- The Metal Bearing Components business historically experiences seasonality from slower European production in August. Results for the interim periods were not necessarily indicative of full-year results.
Investor verification priorities
- Assess whether European demand, customer inventory adjustments, and currency translation continued to pressure metal-bearing volumes and earnings after June 30.
- Verify covenant headroom and revolver availability, particularly after the fixed-charge coverage minimum increased on October 1, 2012.
- Compare actual capital spending and operating cash flow with management’s $15–$20 million capex plan and liquidity expectations.
- Track whether improved Precision Metal Components sales and U.S. profitability persisted, including any resulting change to the deferred-tax valuation allowance.
- Review the timing and outcome of Eltmann bankruptcy proceedings and any further remediation or other contingent-liability developments.