NN, Inc. — 2018 Form 10-K Summary
Business context and reporting period
NN, Inc. designs and manufactures precision components, assemblies, and finished devices for automotive and general industrial, electrical, aerospace and defense, and medical markets. This filing reports the fiscal year ended December 31, 2018; fourth-quarter figures are identified where relevant. In 2018, the company reorganized into Mobile Solutions, Power Solutions, and Life Sciences. It acquired Paragon Medical, Bridgemedica, and Technical Arts, while 2017 results include the discontinued PBC business sale.
Financial results and liquidity
| Metric | 2018 | 2017 |
|---|---|---|
| Net sales | $770.7 million | $619.8 million |
| Income (loss) from operations | $(178.9) million | $33.1 million |
| Income (loss) from continuing operations | $(264.5) million | $25.4 million |
| Net income (loss) | $(264.5) million | $163.1 million |
| Cash provided by (used in) operations | $40.9 million | $(28.2) million |
| Capital expenditures | $64.0 million | $43.7 million |
- Sales increased 24%, primarily from acquisitions; organic volume added $7.3 million, while price/mix and foreign exchange partly offset growth. Cost of sales excluding depreciation and amortization was 76.3% of sales, versus 74.1% in 2017.
- The $182.5 million goodwill impairment drove the operating loss. The company also recorded $5.2 million of fixed-asset impairment and a $16.6 million impairment of its Chinese joint-venture investment.
- 2018 net loss per share was $8.35. Fourth-quarter net loss was $220.2 million, including the year’s goodwill impairment charges.
- Gross principal debt was $859.6 million at year-end; cash was $18.0 million and unused revolver capacity was $76.6 million. Long-term debt, net of current maturities and issuance costs, was $811.5 million. Interest expense was $61.2 million.
- Working capital was $151.8 million, down from $368.9 million. Total assets were $1.50 billion and stockholders’ equity was $418.3 million.
Material changes versus the prior comparable period
- Reported sales growth largely reflected acquisitions: acquisitions contributed about $153.0 million. Life Sciences sales rose to $248.2 million from $98.3 million; Mobile Solutions sales edged down to $335.0 million from $336.9 million; Power Solutions sales increased to $189.8 million from $186.6 million.
- Segment operating results were $19.1 million for Life Sciences, a loss of $54.1 million for Mobile Solutions, and a loss of $95.1 million for Power Solutions. The latter two included goodwill impairments of $73.4 million and $109.1 million, respectively.
- 2017 net income included $137.7 million from discontinued operations, primarily the after-tax gain on the PBC sale. Thus, the year-over-year net-income comparison is not a like-for-like measure of continuing performance.
- Operating cash flow improved from an outflow to an inflow, helped by a refund of taxes overpaid in connection with the PBC sale; higher inventory partly offset the improvement. Investing used $461.3 million, mainly for acquisitions.
- The company issued 14.4 million shares in September 2018, raising approximately $217.3 million net. Proceeds repaid the $200 million acquisition-related second-lien loan and part of the revolver; shares outstanding increased from 27.6 million at year-end 2017 to 42.1 million at year-end 2018.
Outlook, commentary, risks, and unusual items
- Management expected positive cash flow from continuing operations over the next 12 months and believed cash generation plus revolver availability would fund operations, debt service, working capital, and capital expenditures. Capital spending was expected to remain broadly consistent with 2018. This is management’s stated expectation, not quantified earnings guidance.
- After year-end, NN entered a $700 million notional fixed-rate interest-rate swap on February 8, 2019 to reduce exposure to variable-rate debt. The filing notes that a 1% rate increase on the year-end variable-rate borrowings would add approximately $8.5 million in annual interest expense.
- Life Sciences goodwill had only about 3.7% valuation headroom; Mobile Solutions goodwill was fully impaired, and Power Solutions’ reporting-unit carrying value equaled fair value after impairment. Further underperformance could trigger additional goodwill or intangible-asset impairment.
- Leverage, variable interest rates, customer concentration (top ten customers represented about 49% of sales), competitive pricing, acquisition integration, raw-material costs and tariffs, foreign exchange, and exposure to automotive and industrial demand are material risks. The company had no currency derivatives at year-end.
- Management and the auditor concluded internal control over financial reporting was ineffective at December 31, 2018 because of a material weakness: insufficient finance personnel with appropriate knowledge, experience, and training. Three previously identified weaknesses were remediated; remediation of the remaining weakness was underway. The auditor’s opinion on the financial statements was unqualified.
- A Brazilian ICMS tax-credit dispute had a possible loss range of $0–$6.0 million; no amount was accrued because management considered a loss not probable. The company reported a favorable decision in one action and believed it had indemnification rights from former Autocam shareholders.
- Adoption of lease accounting in 2019 was expected to add $65–$95 million each in right-of-use assets and lease liabilities. The filing also anticipated approximately $6 million of additional 2019 tax expense from final transition-tax regulations.
Important facts for investors to verify
- Whether operating cash flow and acquisition integration progress support debt service and the stated liquidity outlook.
- Performance and valuation assumptions underlying goodwill, particularly the limited Life Sciences headroom and remaining Power Solutions goodwill.
- Remediation and independent testing of the remaining material weakness in financial reporting controls.
- Organic sales, pricing, margins, and customer demand by segment, separating acquisition contributions from underlying trends.
- Interest-rate exposure, covenant compliance, refinancing needs, and the actual effect of the February 2019 swap.
- Final acquisition purchase-price allocations, the Brazilian tax matter, and the financial effects of lease-accounting adoption and tax regulations.