NN, Inc. — Q2 2013 Form 10-Q
Business context and reporting period. NN, Inc. manufactures metal bearing, precision metal, and plastic and rubber components. This unaudited quarterly report covers the three and six months ended June 30, 2013; financial amounts below are in millions of dollars unless otherwise noted.
Financial performance and position
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net sales | $96.3 | $98.8 | $190.1 | $203.3 |
| Income from operations | $7.9 | $8.3 | $13.6 | $17.3 |
| Net income | $4.8 | $7.0 | $7.6 | $12.9 |
| Diluted EPS | $0.28 | $0.41 | $0.45 | $0.76 |
| Operating margin | 8.2% | 8.4% | 7.1% | 8.5% |
| Net margin | 5.0% | 7.1% | 4.0% | 6.4% |
- Sales declined 2.5% year over year in Q2 and 6.5% for the first half. First-half operating cash flow was $8.8 million, down from $11.6 million. Capital spending was $4.9 million; investing cash outflow was $4.9 million.
- Cash fell to $5.2 million from $19.0 million at year-end 2012, principally as the company used cash and operating cash flow to repay debt. Total debt was $51.7 million, down from $69.5 million. Q2 interest expense decreased to $0.7 million from $1.1 million.
- Current assets were $127.9 million and current liabilities $64.6 million; the current ratio was 1.98, versus 2.17 at December 31, 2012. Working capital was $63.4 million, compared with $68.5 million.
- First-half accounts receivable increased $15.9 million, while inventory was broadly stable. Management attributed the receivables increase to higher Q2 sales relative to Q4 2012; days sales outstanding remained consistent with year-end.
Changes versus the prior comparable period
- Lower volume was the main driver of the sales decline, reflecting weaker European and Asian automotive markets, customer and platform-specific changes, customer inventory adjustments, and reduced exposure to lower-margin programs. Lower material inflation also reduced price and raw-material pass-through revenue.
- Q2 cost of products sold fell by $2.1 million, benefiting from lower volume and continuous-improvement projects. For the first half, SG&A rose $1.1 million, including $0.7 million of severance costs, as well as relocation, professional-fee, and foreign-exchange costs.
- Net income fell by $2.3 million in Q2 and $5.3 million for the first half. Higher U.S. tax expense was a major factor: the effective tax rate was 36% in Q2 and 35% for the first half, versus 16% and 18%, respectively, in 2012. Prior-year U.S. tax benefits reflected use of net operating losses with valuation allowances; those allowances were largely removed at year-end 2012.
- Segment results were mixed: first-half sales and net income declined in all three segments. In Precision Metal, operational improvements offset price/mix and volume pressure before tax effects; Plastic and Rubber earnings were particularly affected by reduced volume and under-absorbed fixed costs.
Outlook, risks, contingencies, and notable items
- Management reported improving European sales momentum in Q2, supported by better customer penetration and stronger European heavy-truck demand; North American automotive demand also improved in certain businesses. It nevertheless cited continuing European automotive weakness and slowing Asian growth.
- The company expected 2013 capital expenditures of up to $17.0 million, with heavier spending in the second half and most investment related to new or expanded business. Management believed operating cash flow and available borrowing would fund capital and working-capital needs through June 2014. No revenue or earnings guidance was provided in the filing text.
- At June 30, $73.3 million was available under the $100 million revolving facility, net of letters of credit and subject to covenant limitations. The company reported compliance with covenants: interest coverage 8.24x, fixed-charge coverage 1.50x, and leverage 1.47x. A 1 percentage-point increase in variable borrowing rates was estimated to add about $0.3 million to annual interest expense.
- Foreign-exchange movements affect results; no currency hedges were in place. The company also noted seasonality in Metal Bearing sales, historically weaker during August due to European customer shutdowns.
- Ordinary legal matters had an estimated aggregate potential liability range of $0–$3.0 million; approximately $0.65 million was accrued. The ultimate responsibility, if any, associated with the bankruptcy liquidation of wholly owned German subsidiary Eltmann remained subject to court proceedings; management did not expect further significant financial-statement impacts.
- Richard D. Holder became President and CEO effective June 3, 2013. Management stated disclosure controls were effective and reported no material changes in internal control over financial reporting. No material changes to the previously reported risk factors were identified.
Important facts for investors to verify
- Whether the Q2 improvement in European sales momentum continued, given ongoing European and Asian demand weakness and the seasonal August slowdown.
- Whether lower cash, higher receivables, and planned second-half capital spending affect liquidity; monitor cash conversion and available revolver capacity.
- Whether cost-reduction and operational-improvement benefits can offset volume declines, fixed-cost under-absorption, and lower-margin program exits.
- The effect of the higher U.S. tax burden on future earnings, and any developments in the Eltmann bankruptcy or other legal contingencies.
- Compliance with debt covenants and the company’s exposure to unhedged foreign-exchange movements and variable interest rates.