NN, Inc. — Q2 2011 Form 10-Q
Business context and period: NN, Inc. manufactures components for automotive and industrial markets. This unaudited filing covers the three and six months ended June 30, 2011, compared with the same periods in 2010. Unless otherwise noted, financial amounts below are in millions of dollars.
Financial performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net sales | $115.9 | $92.7 | $227.2 | $178.0 |
| Income from operations | $9.3 | $6.6 | $18.5 | $8.5 |
| Net income | $5.8 | $5.1 | $11.3 | $5.3 |
| Diluted EPS | $0.34 | $0.31 | $0.67 | $0.32 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $(2.0) | $5.1 |
- Q2 sales increased 25.1%; first-half sales increased 27.6%. Management attributed first-half growth to higher volume ($31.9 million), foreign exchange ($6.4 million), material inflation pass-through ($6.5 million), price ($3.6 million), and mix ($0.7 million).
- Calculated operating margin was approximately 8.0% in Q2 2011 versus 7.1% in Q2 2010, and 8.1% for the first half versus 4.7%. Calculated net margin was about 5.0% in Q2 2011 versus 5.5%, and 5.0% for the first half versus 3.0%.
- Cost of products sold, excluding depreciation and amortization, was 81.7% of Q2 sales and 81.4% of first-half sales. Management said these levels were above its historical range, citing new-program start-up inefficiencies, inflation, compensation, maintenance, and manufacturing-supply costs.
- Interest expense fell to $1.2 million in Q2 from $1.8 million, and to $2.4 million for the first half from $3.5 million, primarily reflecting lower borrowing spreads, partly offset by higher debt.
- Other expense/income was a notable comparison: Q2 2011 included $0.3 million of foreign-exchange losses on intercompany loans, versus $1.7 million of gains in Q2 2010. First-half 2011 included $1.1 million of such losses versus $2.8 million of gains in 2010.
Balance sheet, liquidity and cash flow
- At June 30, 2011, cash was $9.9 million; total assets were $278.7 million; and stockholders’ equity was $100.4 million. Current assets were $139.6 million and current liabilities $83.4 million, for a current ratio of 1.68 versus 1.38 at December 31, 2010.
- Total debt was $86.8 million, up from $73.4 million at year-end 2010: $69.6 million under the revolving facility and $17.1 million of fixed-rate senior notes. The revolving borrowings carried LIBOR plus a 3.25% margin; notes bore 6.70% interest.
- Approximately $29.7 million remained available under the $100 million revolver, net of letters of credit. The company reported compliance with debt covenants. Its fixed-charge coverage ratio was 1.13 against a minimum of 1.10; management said it did not expect a covenant failure in the next 12 months and could adjust capital spending if needed.
- First-half operating cash flow was negative $2.0 million, versus positive $5.1 million in 2010, mainly reflecting working-capital movements, including a decrease in accounts payable. Capital expenditures were $10.2 million; investing cash outflow was $11.0 million. Financing activities provided $15.4 million, and cash increased $4.4 million to $9.9 million.
- Receivables rose with sales growth; management also cited a two-day increase in days sales outstanding, partly due to receipt timing and a higher mix of export customers with longer payment terms. Working capital was $56.3 million, compared with $32.1 million at year-end.
Material developments and segment performance
- Metal Bearing Components: Q2 sales were $84.8 million, up from $66.9 million; segment net income was $8.9 million versus $8.3 million. First-half sales were $168.6 million and segment net income $18.7 million, up from $128.9 million and $13.3 million. Growth and cost-reduction initiatives supported results, though sales volume was flat sequentially in Q2 and management cited lower sales to a Western European customer.
- Precision Metal Components: Q2 sales were $19.5 million, up from $16.0 million, but segment net loss widened to $1.1 million from $0.6 million. First-half sales were $35.9 million and the segment net loss was $3.3 million. Four new multi-year programs drove sales growth but incurred start-up costs and inefficiencies; first-half costs attributed to these programs were $4.5 million.
- Plastic and Rubber Components: Q2 sales were $11.6 million and segment net income $0.9 million, compared with $9.8 million and $0.8 million. First-half sales were $22.7 million and net income $1.7 million, versus $19.5 million and $1.5 million.
- Eltmann, a wholly owned German subsidiary, entered bankruptcy on January 20, 2011. NN lost control and deconsolidated it, recognizing a $0.2 million gain; the deconsolidation also removed $5.6 million of accrued pension liabilities. The trustee sold most production assets in April. NN did not expect further significant consolidated financial-statement effects from liquidation.
Outlook, risks and contingencies
- NN expected 2011 capital expenditures of approximately $23 million, primarily for new or expanded business, with potential growth initiatives possibly increasing spending. Management believed operating cash flow and available borrowings would fund capital and working-capital needs through June 2012. The filing gives no earnings or revenue guidance.
- Management noted Q2 sales volume was relatively flat versus Q1 and August seasonality in European production. New-program start-up costs, material and operating-cost inflation, customer demand, working-capital needs, foreign exchange, and debt-covenant headroom are relevant risks.
- No currency hedges were in place. A one-percentage-point increase in rates on variable-rate debt would increase annual interest expense by approximately $0.7 million.
- The company accrued approximately $143,000 for its estimated share of remediation at a former waste-recycling vendor; the overall remediation was estimated at $10 million. Management believed its accrued amount was the maximum liability under the tentatively accepted plan. Other legal matters were described as routine and not expected to be materially adverse.
- The U.S. deferred-tax-asset valuation allowance remained in place. First-half effective tax rates were 24% in 2011 and 32% in 2010; the 2011 rate benefited from lower-tax foreign earnings and $0.6 million of tax benefits related to Eltmann.
- Management reported effective disclosure controls as of June 30, 2011 and no material changes in internal control over financial reporting. It said there were no material changes to the risk factors in the 2010 Form 10-K.
Important facts for investors to verify
- Whether start-up costs for the four Precision Metal Components programs decline as production ramps, and whether segment profitability improves.
- Whether sales growth converts into operating cash flow, given receivables growth, longer export payment terms, and negative first-half operating cash flow.
- Available revolver capacity, covenant calculations—especially the 1.13 fixed-charge coverage ratio versus the 1.10 minimum—and planned capital spending.
- The sensitivity of results and debt service to foreign-exchange movements and variable interest rates, as the company reported no currency hedges.
- Progress and final financial consequences, if any, from the Eltmann bankruptcy and the former-vendor environmental remediation.