NN, Inc. (NNBR) — Q2 2019 Form 10-Q
Business context and period. NN, Inc. designs and manufactures precision components for medical, aerospace and defense, electrical, automotive, and general industrial markets. This unaudited quarterly report covers the three and six months ended June 30, 2019; comparisons are with the corresponding 2018 periods. Results include acquisitions completed in 2018, notably Paragon Medical.
Financial performance
Amounts below are in millions of dollars, except per-share data and percentages.
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net sales | $221.7 | $196.3 | $434.9 | $365.5 |
| Gross profit | $58.2 | $47.7 | $110.1 | $90.4 |
| Gross margin | 26.2% | 24.3% | 25.3% | 24.7% |
| Operating income (loss) | $8.1 | $(0.3) | $8.7 | $3.4 |
| Operating margin | 3.7% | (0.1)% | 2.0% | 0.9% |
| Net loss | $(6.7) | $(24.5) | $(25.3) | $(30.5) |
| Net loss per diluted share | $(0.16) | $(0.89) | $(0.60) | $(1.10) |
| Operating cash flow | — | $4.4 | $(19.4) | |
| Capital expenditures | — | $29.0 | $28.9 |
- Quarterly changes: Sales rose 13%, primarily from acquisitions ($19.5 million) and higher volume ($7.6 million), partly offset by foreign-exchange effects. Operating income improved by $8.4 million, while net loss narrowed by $17.8 million, helped by the absence of the prior-year $12.9 million debt-extinguishment loss and lower interest expense.
- First-half changes: Sales increased 19%, led by $74.7 million of acquired-business sales; volume declined $1.2 million and foreign exchange reduced sales by $5.2 million. Operating income improved $5.3 million and net loss narrowed $5.2 million. These results include $2.7 million of debt-extinguishment and debt-cost write-offs in 2019, versus $12.9 million in 2018.
- Segment mix: Q2 Life Sciences sales were $91.3 million and operating income $9.3 million, up substantially with acquisitions and core-volume growth. Mobile Solutions sales fell to $79.4 million and operating income to $4.1 million amid weaker automotive demand. Power Solutions sales were $51.4 million and operating income $5.7 million.
- Cash flow and investment: First-half operating cash flow improved to $4.4 million from a $19.4 million use, while investing used $19.8 million, including capital expenditures; financing provided $19.7 million. Approximate first-half free cash flow (operating cash flow less capital expenditures) was negative $24.6 million.
- Liquidity and debt: June 30 cash was $22.1 million; working capital was $169.4 million. Total debt principal was $888.3 million, including $76.4 million drawn on the revolver. Revolver capacity was $100 million, with $11.5 million available after letters of credit and borrowings. The company reported compliance with its covenants at quarter-end.
Outlook, commentary, and notable risks
- Management said cash, operating cash generation, and revolver borrowings should fund operations, capital spending, working capital, debt service, and dividends for the next 12 months. It provided no specific revenue or earnings guidance in the supplied filing text.
- The $700 million interest-rate swap, entered into in February 2019, fixes the LIBOR component on a declining notional balance at 2.4575% through October 2022. The swap had a $13.9 million fair-value liability at June 30 and contributed a $10.8 million after-tax loss in accumulated other comprehensive income.
- The revolver matures October 19, 2020. Management stated that refinancing, extension, or sufficient cash generation will be needed to address amounts outstanding at maturity; limited borrowing availability and increasingly restrictive leverage covenants are key liquidity risks. A 1 percentage-point increase in rates on the reported variable-rate term loans and revolver would increase annual interest expense by approximately $8.8 million, before considering the swap.
- Automotive demand weakened in North America and China, reducing Mobile Solutions sales and the contribution from the Chinese joint venture. Management also cited inflation, foreign-exchange exposure, Brexit uncertainty, customer concentration, and acquisition integration as risks. One customer represented 10.4% of sales in both Q2 and the first half of 2019.
- Power Solutions had $94.7 million of goodwill following a $109.1 million impairment in 2018. No impairment trigger was identified in Q2 2019, but the filing warns that weaker-than-expected performance or a prolonged market-capitalization decline could indicate further impairment risk.
- A Brazilian ICMS tax-credit dispute has an estimated possible loss range of $0 to $6.0 million; no amount was accrued because management considers a loss not probable. The company believes it is entitled to indemnification from former Autocam shareholders, subject to contractual terms.
- Disclosure controls were deemed ineffective due to an unremediated material weakness involving insufficient finance personnel with appropriate knowledge, experience, and training. Management reported that the financial statements nevertheless fairly present the company’s financial position and results in all material respects. The CFO resigned effective July 12, 2019; the CEO was acting principal financial officer.
- Adoption of the new lease standard resulted in $65.3 million of operating lease right-of-use assets and $71.4 million of operating lease liabilities recorded at June 30. The company also disclosed a subsequent agreement to sell its former headquarters for approximately $4 million net proceeds, expected to close in Q3 2019 with no material gain or loss.
Important facts for investors to verify
- Whether automotive and electrical-market demand stabilizes, and whether Life Sciences growth and margins persist after separating acquisition contributions from organic performance.
- Quarterly cash conversion, working-capital needs, capital spending, and the ability to improve free cash flow while servicing nearly $888 million of debt principal.
- Revolver availability, covenant headroom, and the refinancing or repayment plan before the October 2020 revolver maturity.
- Progress remediating the material weakness in internal controls and the effects of the CFO transition on financial reporting oversight.
- Potential goodwill impairment, the Brazilian tax matter and indemnification, and the realized outcome of the headquarters sale.