NN, Inc. — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011; financial statements are unaudited. Dollar figures below are in millions unless noted.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net sales | $101.1 | $91.0 | $328.4 | $269.0 |
| Income from operations | $5.8 | $2.9 | $24.3 | $11.4 |
| Net income (loss) | $4.7 | ($1.0) | $16.0 | $4.3 |
| Diluted EPS | $0.28 | ($0.06) | $0.95 | $0.26 |
| Operating margin | 5.7% | 3.2% | 7.4% | 4.2% |
Sales rose 11% in Q3 and 22% for the nine-month period. Nine-month growth reflected higher volume, foreign-exchange effects, targeted pricing, and material-inflation pass-through. Q3 growth also benefited from currency and price pass-through; European volume declined with more typical summer seasonality.
Cost of products sold was 82.6% of Q3 sales and 81.8% for the nine-month period, which management said was above its historical range. New-program start-up inefficiencies, inflation, compensation, repairs, and manufacturing supplies pressured costs. Nine-month net income benefited from lower interest expense and the absence of 2010 restructuring charges, partly offset by higher operating costs.
Cash flow, liquidity, and debt
- Nine-month operating cash flow was $3.3 million, down from $13.1 million. Working-capital movements, particularly lower accounts payable and higher receivables and inventory, weighed on cash generation.
- Capital expenditures were $14.8 million through September 30. Management expected approximately $24 million for 2011 and said contemplated growth initiatives could add up to $3 million.
- Cash was $12.1 million, versus $5.6 million at December 31, 2010. Current assets were $134.6 million and current liabilities $75.3 million; the current ratio was 1.79, up from 1.38.
- Total debt was $90.4 million, up from $73.4 million at year-end; it comprised $73.2 million of floating-rate revolver borrowings and $17.1 million of fixed-rate senior notes. The revolver rate was LIBOR plus 3.00%; notes bore 6.70% and mature in April 2014.
- Revolver availability was $16.1 million, after letters of credit and the amended requirement to keep borrowings at least $10 million below the $100 million commitment. The company reported compliance with covenants. Fixed-charge coverage was 1.21 against a 1.00 minimum; leverage was 2.00 against a 2.75 maximum.
Management believed operating cash flow and available borrowing would fund capital expenditures and working-capital needs through September 2012, based partly on forecast positive cash flow in the remaining quarter of 2011.
Segments and material developments
- Metal Bearing Components: Q3 sales were $72.5 million and segment net income $6.1 million, versus $67.6 million and $4.9 million. Nine-month sales were $241.1 million and income $24.8 million, versus $196.5 million and $17.5 million.
- Precision Metal Components: Q3 sales increased to $17.9 million from $13.4 million; segment loss narrowed to $0.5 million from $3.5 million. Nine-month sales were $53.8 million and loss $3.8 million, compared with $43.0 million and loss $6.0 million. Four new multi-year programs supported sales but generated start-up inefficiencies and costs.
- Plastic and Rubber Components: Q3 sales increased to $10.8 million from $10.0 million, while segment income fell to $0.1 million from $0.5 million. Nine-month sales were $33.4 million and income $1.9 million, versus $29.5 million and $1.9 million; new-program start-up costs offset volume benefits.
- Eltmann, a wholly owned German subsidiary, entered bankruptcy in January 2011. NN lost control and deconsolidated it, recording a $0.2 million gain; the bankruptcy trustee sold most production assets. NN said it expected no further significant consolidated impact. The company stated it had no remaining pension obligations for the Eltmann plan.
- Other income in Q3 included $1.4 million of foreign-exchange gains on intercompany loans; nine-month other expense included $0.3 million of such losses. The 2011 nine-month tax rate was 23%, including $0.6 million of deferred tax benefits tied to Eltmann. A valuation allowance remained on U.S. net deferred tax assets.
Outlook, risks, and contingencies
- No formal earnings or revenue guidance was provided. Management cited slower, varied end-market growth in Q3 and normal European summer seasonality; it also reported improving start-up costs on major Precision Metal programs.
- Interest-rate and currency exposure remain relevant: $73.2 million of debt was variable rate, and a 1 percentage-point rate increase would add approximately $0.7 million in annual interest expense. No currency hedges were in place.
- Management reported an estimated $0.1 million accrued share of remediation costs at a former waste-recycling vendor site; the overall project was estimated at approximately $10 million. The company believed its share was the maximum liability under the tentatively accepted plan. Other legal matters were described as routine and not expected to be material.
- Management said there were no material changes to the risk factors in the 2010 Form 10-K. Disclosure controls were assessed as effective, with no material change in internal control over financial reporting reported for the quarter.
Important facts for investors to verify
- Whether operating cash flow improves as receivables, inventory, and payable timing normalize, and whether planned capital spending is funded without constraining liquidity.
- Revolver availability and covenant headroom, particularly under the amended borrowing limit and fixed-charge coverage requirement.
- Whether start-up inefficiencies at the four new Precision Metal programs decline as management expects and translate into improved segment profitability.
- The sustainability of sales growth and margins amid European seasonality, raw-material inflation, currency fluctuations, and variable-rate debt exposure.
- Any subsequent developments in the Eltmann liquidation, U.S. deferred-tax valuation allowance, or environmental remediation matter.