NN, Inc. — Q2 2018 Form 10-Q
Period: Three and six months ended June 30, 2018. Unaudited results; dollar amounts are in millions except per-share data. NN manufactures precision components for automotive, industrial, electrical, aerospace and medical markets. In 2018 it reorganized into Mobile Solutions, Power Solutions and Life Sciences.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $196.3 | $157.9 | $365.5 | $315.5 |
| Operating income (loss) | $(0.3) | $12.6 | $3.4 | $26.5 |
| Net income (loss) | $(24.5) | $(21.1) | $(30.5) | $(13.7) |
| Operating margin | (0.1)% | 8.0% | 0.9% | 8.4% |
| Net loss per share | $(0.89) | $(0.77) | $(1.10) | $(0.50) |
- Q2 sales rose 24%; six-month sales rose 16%. Acquisitions contributed $37.2 million in Q2 and $46.1 million for six months; volume and foreign exchange also contributed, while price/mix/other reduced sales.
- Q2 gross profit, using reported cost of sales excluding separately presented depreciation and amortization, was $47.7 million, or 24.3% of sales, versus $43.4 million, or 27.5%, a year earlier.
- Operating results included increased SG&A, acquisition and integration costs, and depreciation and amortization. Q2 acquisition-related expense was $3.4 million; the six-month amount was $5.2 million. Paragon inventory fair-value step-up added $3.4 million to cost of sales.
- Interest expense was $16.0 million in Q2 and $28.0 million for six months. A $12.9 million debt-extinguishment/write-off charge was recorded in 2018; the comparable 2017 charge was $39.6 million.
- Cash from operations was $(19.4) million for six months, versus $15.8 million provided in 2017. Capital expenditures were $28.9 million; acquisition cash payments were $393.5 million. Cash ended at $23.2 million, down from $224.4 million at year-end 2017.
- At June 30, current assets were $363.0 million and current liabilities $138.4 million; reported working capital was $224.5 million. Debt principal was $1.087 billion, including a $200 million second-lien facility; cash netted against principal implies approximate net debt of $1.064 billion. Revolver availability was $29.6 million, after letters of credit.
Changes, outlook and risks
- Life Sciences sales increased sharply with Paragon Medical, Bridgemedica and Vandalia acquisitions. Paragon Medical, acquired May 7, contributed $27.1 million of sales and $1.7 million of operating income through June 30. Mobile and Power Solutions sales increased modestly, but operating income declined in both groups; Life Sciences operating income also declined from the prior-year quarter.
- Prior-year quarterly figures were revised for immaterial errors and recast to present the sold precision bearing business as discontinued operations. The 2017 comparison therefore excludes that business from continuing operations; the 2017 cash flow statement includes discontinued-operations cash flows.
- Management said it expects positive cash flow from continuing operations and believes cash, operating funds and available credit will cover debt service, capital spending and working-capital needs over the next 12 months. It expects capital expenditures to remain relatively consistent. No numerical earnings or revenue guidance was provided.
- The company was in compliance with credit-facility covenants and expected compliance through June 30, 2019. The second-lien debt carries an 8% LIBOR-based margin and prepayment penalties before May 2020. Variable-rate exposure is material; management estimated a 1 percentage-point rate increase would add about $10.9 million of annual interest across the listed variable-rate borrowings.
- Management reported material weaknesses in internal control over financial reporting, including business-combination and income-tax accounting controls, and concluded disclosure controls were not effective at June 30. Remediation work and staffing additions were underway; weaknesses are not considered remediated until controls operate effectively and testing supports that conclusion.
- Brazilian ICMS tax-credit proceedings have a possible loss range of $0–$6.0 million; no liability was accrued, and management considers loss not probable. The company believes it has defenses and indemnification rights from former Autocam shareholders.
- Other risks discussed include acquisition integration, customer and market demand, raw-material costs, foreign exchange, and covenant and interest-rate exposure. No currency derivatives or interest-rate swaps were in place at quarter-end.
Key facts for investors to verify
- Whether acquired-business contributions and any organic volume growth translate into sustained operating improvement and cash generation.
- Integration progress, purchase-price allocation adjustments, and goodwill/intangible valuations for recent acquisitions.
- Debt reduction, interest expense, revolver availability, covenant headroom and the company’s ability to meet its positive-cash-flow expectations.
- Progress and testing results for remediation of the disclosed material weaknesses in financial reporting controls.
- Resolution and potential exposure from the Brazilian ICMS matter, and any updates to tax estimates or acquisition-related contingencies.