NNBR

Business Context and Reporting Period

Company: NN, Inc.
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2007
Business Overview: NN, Inc. operates three segments: Metal Bearing Components (72% of sales), Plastic and Rubber Components (12% of sales), and Precision Metal Components (16% of sales). The company manufactures precision bearing components, seals, retainers, and metal parts for global bearing manufacturers and industrial markets. In November 2006, the company acquired Whirlaway Corporation to establish the Precision Metal Components segment.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased by $91.0 million (27.5%) primarily due to the full-year inclusion of the Whirlaway acquisition ($62.7 million) and a favorable Euro-to-U.S. Dollar exchange rate ($19.6 million).
• Profitability Decline: The company reported a net loss of $1.2 million in 2007 compared to a net income of $14.4 million in 2006. This reversal was driven by a $13.6 million restructuring and impairment charge.
• Impairment Charges: In Q2 2007, the company recorded $13.3 million in non-cash impairment costs related to the Metal Bearing Components Segment. This included a $10.0 million goodwill write-down and a $3.3 million write-down of excess production equipment in European operations.
• Effective Tax Rate: The effective tax rate spiked to 122% in 2007 (vs. 37% in 2006) due to valuation allowances against tax benefits associated with the impairment charges. Excluding these impacts, the rate would have been approximately 38%.
• Debt Levels: Long-term debt increased by $19.5 million, largely due to debt assumed in the Whirlaway acquisition and increased usage of the revolving credit facility.

Guidance, Outlook, and Risks

• Restructuring: Management is aligning global capacity by shifting production to lower-cost facilities in China and Slovakia. A planned downsizing at the Eltmann Plant (Germany) was postponed in February 2008 after a new agreement with the union regarding wages and hours.
• Capital Expenditures: The company plans to spend approximately $18.5 million on capital expenditures in 2008, focused on geographic expansion and cost improvement initiatives.
• Customer Concentration: Sales to SKF accounted for approximately 40% of total net sales in 2007. The top 10 customers accounted for 75% of sales. Loss of a major customer would have a material adverse effect.
• Raw Materials: The company relies on foreign sources for 52100 steel. While contracts allow for passing price increases to customers, supply shortages or currency fluctuations pose risks.
• Internal Control Weakness: The company identified a material weakness in internal controls regarding the accounting for impairment of long-lived assets, which led to a restatement of interim 2007 financial statements. Management states this has been remediated.

Investor Verification Checklist

• Impairment Validity: Verify the assumptions used for the $13.3 million impairment charge and the projected cash flows supporting the remaining goodwill balances.
• Customer Dependency: Monitor the status of supply agreements with SKF (40% of sales) and Schaeffler Group (11% of sales).
• European Restructuring: Track the execution of the capacity shift to China and Slovakia and the financial impact of the revised labor agreement at the Eltmann Plant.
• Currency Exposure: Assess the impact of future Euro fluctuations on consolidated results, as the company has no hedging program in place.
• Internal Controls: Confirm the effectiveness of remediation efforts regarding the accounting for intangible asset impairments.