NN, Inc. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2016. Unaudited interim results; dollar amounts below are in millions unless otherwise noted. NN manufactures precision bearing components, engineered plastic products and precision metal components through three reportable segments. The comparison is materially affected by its 2015 acquisitions, including PEP, acquired in October 2015.
Financial performance and position
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $205.0 | $154.8 | $631.5 | $483.4 |
| Gross profit / margin | $52.4 / 25.6% | $34.6 / 22.4% | $162.4 / 25.7% | $105.2 / 21.8% |
| Operating income / margin | $18.7 / 9.1% | $10.1 / 6.5% | $47.3 / 7.5% | $37.6 / 7.8% |
| Net income | $4.1 | $4.6 | $4.9 | $17.6 |
| Diluted earnings per share | $0.15 | $0.17 | $0.18 | $0.86 |
| Operating cash flow | Not reported by quarter | $46.1 | $13.3 |
- Cash and liquidity: Cash was $14.8 at September 30, 2016, versus $15.1 at year-end 2015. Current assets were $295.5 and current liabilities $136.4; reported working capital was $159.1, compared with $146.8 at year-end.
- Debt: Balance-sheet total debt was $804.3, including $8.6 current maturities; long-term debt was $795.7. Cash-flow and liquidity disclosures identify $828.0 of outstanding borrowings under the Term Loan B, Senior Notes and revolver before debt issuance costs. Revolver availability was $98.2, net of letters of credit, at September 30.
- Capital spending: Property, plant and equipment purchases were $32.2 for the nine months. Operating cash flow less capital expenditures was approximately $14.0.
- Dividends: $0.07 per share in Q3 and $0.21 per share for the nine-month period.
Changes versus comparable periods
- Q3 sales increased $50.1 year over year, primarily reflecting $57.9 of PEP-related acquisition sales; lower volumes, price/product mix, and the sale of the Delta Rubber plant partly offset growth. Nine-month sales rose $148.0, including $174.2 attributed to acquisitions, offset by foreign exchange, the plant sale, volume and price/mix.
- Q3 operating income rose $8.6, while nine-month operating income rose $9.7. Acquired operations and improved gross margin contributed, but nine-month operating margin was slightly lower year over year. The filing cites industrial weakness, declines in heavy truck demand, and lower prices or unfavorable mix in certain segments.
- Net income fell $0.5 in Q3 and $12.7 for the nine months. Higher debt-related expense was a major factor: nine-month interest expense increased $32.4 to $48.9. Results also included a $2.6 debt-cost write-off and $3.1 of derivative fair-value losses in 2016.
- Nine-month cash from operations increased to $46.1 from $13.3; investing used $30.2 versus $34.0, and financing used $14.9 versus providing $23.7 in 2015. Accounts receivable used $24.4 of operating cash in 2016.
Segments, outlook and significant items
- Q3 segment results: Precision Bearing Components sales were $58.2 and operating income $5.8; Autocam sales were $80.5 and operating income $8.5; Precision Engineered Products sales were $66.2 and operating income $9.9. Bearing and Autocam sales and operating income declined year over year; PEP growth primarily reflects its acquisition.
- Debt refinancing: On September 30, the company lowered the Term Loan B margin by 75 basis points to LIBOR (0.75% floor) plus 4.25%, and increased revolver capacity from $100 to $133. The revolver was subsequently increased to $143 after quarter-end. Senior Notes bear 10.25% interest. Management said operating cash flow and available borrowing capacity should fund debt service, capital expenditures and working capital over the next twelve months; it expected capital expenditures to remain relatively consistent. No specific earnings or sales guidance was provided.
- Interest-rate and currency exposure: NN discontinued hedge accounting for its $150 interest-rate swap following changes to the LIBOR floor and expected benchmark usage. It will mark the swap to market, which may increase GAAP earnings volatility; the filing said this change does not affect reported cash flows. The company had no currency hedges at September 30. A 1% rate increase was estimated to raise annual interest expense by about $4.3 on the Term Loan B and $0.3 on revolver borrowings.
- Restructuring: Charges were $0.7 in Q3 and $7.2 for nine months, including $3.9 related to closure of Autocam’s Wheeling plant and $2.4 for Precision Bearing Components restructuring. Remaining restructuring reserves were $3.9 at September 30.
- Tax and accounting items: A $6.4 Q3 tax benefit contributed to reported net income despite a $3.7 pretax loss; the company attributed its unusually high reported effective tax rate to the revised full-year tax-rate estimate and the mix of U.S. losses and foreign earnings. The filing disclosed a $0.4 nine-month out-of-period share-compensation adjustment and a $0.5 swap-related out-of-period adjustment recorded in Q3.
- Contingency: A Brazilian ICMS tax-credit dispute has an estimated possible loss range of $0–$6.0; no amount was accrued because management considered a loss not probable. NN stated it had defenses and potential indemnification from former Autocam shareholders. Other legal matters were described as routine and not expected to be material.
- Principal risks: Global industrial and heavy-truck demand, customer concentration and potential captive production, capacity utilization, raw-material availability, quality, acquisition integration, foreign exchange, and interest-rate exposure. Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of reported sales and operating performance reflects acquired businesses versus organic trends, particularly after PEP’s inclusion in the prior-year comparison.
- Whether cash generation can sustainably cover substantial debt service, capital spending and working-capital needs; monitor receivables and revolver availability.
- Debt terms and refinancing effects, including the 10.25% Senior Notes, variable-rate exposure and the swap’s potential GAAP volatility.
- Whether restructuring actions and the Wheeling closure deliver expected operating benefits, and whether further charges arise.
- Developments in the Brazilian tax matter and any changes to management’s probability assessment, potential loss estimate or indemnification recovery.
- Future earnings comparability given acquisition accounting, restructuring, swap mark-to-market results and the unusually large tax benefit in Q3.