NN, Inc. — Q1 2020 Form 10-Q
Business and period: NN, Inc. designs and manufactures precision components for medical, aerospace and defense, electrical, automotive, and industrial markets. This unaudited report covers the three months ended March 31, 2020; amounts below are in millions of U.S. dollars unless noted.
Financial performance and liquidity
| Metric | Q1 2020 | Q1 2019 |
|---|---|---|
| Net sales | $199.7 | $213.3 |
| Gross profit / margin | $47.5 / 23.8% | $51.1 / 24.0% |
| Operating loss | $(245.3) | $(0.3) |
| Net loss | $(248.2) | $(19.5) |
| Net loss per diluted share | $(5.96) | $(0.47) |
| Operating cash flow | $10.2 | $(2.7) |
| Capital expenditures | $11.3 | $14.1 |
Revenue fell 6%, comprising an $11.4 million organic decline and $2.1 million unfavorable foreign-exchange impact. Cost of sales and SG&A decreased, reflecting lower volumes and cost reductions. Interest expense rose $3.3 million to $17.1 million, primarily due to higher borrowing costs and debt amendment-cost amortization. Q1 2020 results include a $239.7 million noncash goodwill impairment charge; absent this charge, the reported operating loss would have been substantially lower, but the filing does not provide an adjusted earnings measure.
Sales by segment were Life Sciences $84.0 million, Mobile Solutions $69.9 million, and Power Solutions $46.4 million, before intersegment eliminations. Each segment’s sales declined year over year; Mobile Solutions was down $8.2 million, largely reflecting weaker automotive demand. Life Sciences and Power Solutions recorded goodwill impairments of $146.8 million and $92.9 million, respectively. No impairment was recorded for finite-lived intangible assets or the joint venture in the quarter.
Cash and equivalents were $79.2 million at March 31, versus $31.7 million at year-end, after a $60 million revolver draw. Principal debt was $850.2 million, compared with $793.2 million at year-end; long-term debt, net of current maturities and issuance costs, was $815.0 million. The company reported $3.4 million of remaining revolver availability after borrowings and letters of credit. Current assets were $363.0 million and current liabilities $152.5 million; reported working capital was $210.4 million. Operating cash flow less capital spending was approximately negative $1.0 million.
At March 31, the company was in compliance with its credit covenants, but stated it may not remain compliant over the next 12 months as leverage tests tighten. It was negotiating with lenders to amend the leverage covenant and disclosed substantial doubt about its ability to continue as a going concern for the year following the report date. A $700 million interest-rate swap hedged a portion of variable-rate debt through 2022; the swap liability was $25.5 million at quarter-end.
Changes, outlook, and significant matters
- COVID-19: Facility closures, customer shutdowns, disrupted supply chains, reduced vehicle production, and deferred elective surgeries affected demand and operations. Management said the second quarter was more challenging than the first and expected full-year 2020 results to be adversely affected. On April 6, the company withdrew its previously issued 2020 financial guidance; no replacement numerical guidance was provided.
- Response and strategic review: Actions included salary reductions, furloughs, reduced discretionary spending and capital expenditures, rent deferrals, and use of CARES Act tax provisions. A strategic review begun in November 2019 includes cost and cash initiatives, capital deployment and financing options, and possible sale of part or all of the company.
- Capital and potential dilution: Series B preferred stock had a $95.7 million carrying value at quarter-end and accrues cumulative dividends at 10.625% annually. The rate can rise to 11.625% if specified common-stockholder approval is not obtained. Preferred shares have conversion and redemption features. In April, the board adopted preferred share purchase rights with a 15% ownership trigger, expiring March 31, 2021.
- Unusual operating item: Headquarters lease changes and vacated space contributed to $5.1 million of other operating expense, including a $4.4 million termination charge, $2.9 million leasehold-improvement impairment, and a $3.0 million lease remeasurement gain. The company also commenced a 15-year manufacturing-facility lease with approximately $27.5 million in base rent.
- Reporting and controls: The Q1 2019 comparative figures were revised for previously identified misstatements, including a $0.9 million increase in the prior-period net loss. The company disclosed unremediated material weaknesses in internal controls, including financial-reporting staffing, Paragon Medical revenue/receivables and IT controls, and inventory controls at a foreign subsidiary; disclosure controls were deemed ineffective.
- Contingencies: A Brazilian tax-credit dispute has an estimated possible loss range of $0–$6.0 million, with no accrual recorded; management believes indemnification may apply. Securities-offering litigation seeks unspecified damages, and the company could not assess whether the outcome would be material.
Key facts investors should verify
- Whether NN obtained covenant relief or refinancing, and whether it can maintain liquidity and covenant compliance as tests tighten.
- Cash generation, revolver availability, debt balances and interest costs amid COVID-related disruption.
- Actual demand recovery by end market and the company’s ability to restart production safely; management withdrew full-year guidance.
- Goodwill impairment assumptions and whether further impairment of goodwill, intangibles, or the joint venture becomes necessary.
- Progress remediating material weaknesses and the reliability of subsequent reported financial statements.
- Preferred-stock dividend accruals, approval requirements, potential conversion dilution, and the outcomes of disclosed legal contingencies.