NN INC 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Overview NN, Inc. is a global diversified industrial company that combines advanced engineering and production capabilities with in-depth materials science expertise to design and manufacture high-precision components and assemblies primarily for the electrical, automotive, general industrial, aerospace and defense, and medical markets. As used in this Quarterly Report, the terms “NN,” the “Company,” “we,” “our,” or “us” refer to NN, Inc. and its subsidiaries. Forward-Looking Statements This Quarterly Report contains forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements may discuss goals, intentions and expectations as to future trends, plans, events, results of operations or financial condition, or state other information relating to NN, Inc., based on current beliefs of management as well as assumptions made by, and information currently available to, management. Forward-looking statements generally will be accompanied by words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “forecast,” “guidance,” “intend,” “may,” “possible,” “potential,” “predict,” “project” or other similar words, phrases or expressions. Forward-looking statements involve a number of risks and uncertainties that are outside of management’s control and that may cause actual results to be materially different from such forward-looking statements. Such factors include, among others, general economic conditions and economic conditions in the industrial sector; the impacts of the COVID-19 pandemic on the Company’s financial condition, business operations and liquidity; competitive influences; risks that current customers will commence or increase captive production; risks of capacity underutilization; quality issues; availability of raw materials; currency and other risks associated with international trade; our dependence on certain major customers; the impact of acquisitions and divestitures; the level of our indebtedness; the restrictions contained in our debt agreements; our ability to obtain financing at favorable rates, if at all, and to refinance existing debt as it matures; unanticipated difficulties integrating acquisitions; new laws and governmental regulations; and other risk factors and cautionary statements listed from time-to-time in our periodic reports filed with the Securities and Exchange Commission. We disclaim any obligation to update any such factors or to publicly announce the result of any revisions to any of the forward-looking statements included herein or therein to reflect future events or developments. For additional information concerning such risk factors and cautionary statements, please see the sections titled “Item 1A. Risk Factors” in the 2020 Annual Report and this Quarterly Report. Results of Operations Factors That May Influence Results of Operations The following paragraphs describe factors that have influenced results of operations for the three months ended March 31, 2021, that management believes are important to provide an understanding of the business and results of operations or that may influence operations in the future. Global COVID-19 Pandemic The COVID-19 pandemic continues to disrupt the United States and global economy, and we cannot predict when a full economic recovery will occur, but product volumes are beginning to return to more normalized levels. Our operating results in the first quarter reflect momentum in the recovery of our business from the effects of COVID-19. Although vaccinations are in process and economies across the globe have reopened, many public health experts warn there may be additional COVID-19 surges in 2021. Further surges in the COVID-19 infection rates could result in the reinstatement of directives and mandates requiring businesses to again curtail or cease normal operations. Thus, the spread of COVID-19 and the responses thereto have created a disruption in the manufacturing, delivery, and overall supply chain of automobile manufacturers and suppliers, as well as disruption within the power industry. Global vehicle production decreased significantly in 2020, but production has since been ramping back up. Disruptions of normal supply chains have caused challenges in obtaining raw materials we use in the manufacture of some of our products. We have been increasing our inventories in the first quarter to mitigate the risk of supply chain disruption for our customers. A worldwide semiconductor chip shortage is beginning to affect original equipment manufacturers, causing unpredictable volumes. The rapid development and fluidity of the situation precludes any prediction as to the ultimate impact COVID-19 will have on our business, financial condition, results of operations, and cash flows, which will depend largely on future developments directly or indirectly relating to the duration and scope of the COVID-19 pandemic. While managing decreased demand in many regions across the globe, we are now operating at all of our business locations. We have implemented training and recruiting programs to address labor shortages. We are focused on the safety of our employees, customers and suppliers. We have developed and implemented processes to ensure a safe environment for our employees and 25 Table of Contents any visitors to our facilities, including providing personal protective equipment to our employees and establishing social distancing protocols and temperature checks. We are actively promoting vaccination among our employees. These processes include recommendations based on guidelines from the Centers for Disease Control and Prevention and the World Health Organization. The health and safety of our employees remains our top priority. We have undertaken a number of permanent and temporary actions to manage the evolving situation, as described in our 2020 Annual Report.. We continue to streamline facilities and implement cost savings initiatives. Capital expenditures and travel costs remain at relatively low levels. We refinanced our credit facility and preferred stock in the first quarter as discussed above. Credit Facilities On March 22, 2021, we entered into a new $150.0 million term loan facility (the “Term Loan Facility”) and a new $50.0 million asset backed credit facility (the “ABL Facility”). The proceeds from the Term Loan Facility were used to prepay the amounts outstanding on our previous term loans. The previous credit facility was terminated and consisted of a Senior Secured Term Loan, Incremental Term Loan, and Senior Secured Revolver. No amounts were outstanding on the Senior Secured Revolver at the time of termination. Outstanding borrowings under the Term Loan Facility bear interest at either 1) one-month LIBOR (subject to a 1.000% floor) plus an applicable margin of 6.875% or 2) the greater of various benchmark rates plus an applicable margin of 5.875%. At March 31, 2021, the Term Loan Facility bore interest based on one-month LIBOR at 7.875%. The Term Loan Facility requires quarterly principal payments of $0.4 million with the remaining unpaid principal amount due on the final maturity date of September 22, 2026. The Term Loan Facility is collateralized by all of our assets. The Term Loan Facility has a first lien on all assets other than accounts receivable and inventory and has a second lien on accounts receivable and inventory. We were in compliance with all requirements under the Term Loan Facility as of March 31, 2021. The ABL Facility provides for a senior secured revolving credit facility in the amount of $50.0 million, of which $30.0 million is available in the form of letters of credit and $5.0 million is available for the issuance of short-term swingline loans. The availability of credit under the ABL Facility is limited by a borrowing base calculation derived from accounts receivable and inventory held in the United States. Outstanding borrowings under the ABL Facility bear interest on a variable rate structure plus an interest rate spread that is based on the average amount of aggregate revolving commitment available. The variable borrowing rate is either 1) LIBOR plus an applicable margin of 1.75% or 2.00%, depending on availability, or 2) the greater of the federal funds rate or prime, plus an applicable margin of 0.75% or 1.00%, depending on availability. We may elect whether to use one-month, three-month, or six-month LIBOR, subject to a 0.50% floor. Interest payments are due monthly on borrowings that utilize one-month LIBOR and quarterly on borrowings that utilize three-month or six-month LIBOR. At March 31, 2021, using one-month LIBOR plus a 1.75% spread, the weighted average interest rate on outstanding borrowings under the ABL Facility would have been 2.25% if there had been any balance outstanding. We pay a commitment fee of 0.375% for unused capacity under the ABL Facility and a 0.125% fee on the amount of letters of credit outstanding. The final maturity date of the ABL Facility is March 22, 2026. We had no outstanding borrowings under the ABL Facility at March 31, 2021. Total capacity under the ABL Facility was $47.3 million as of March 31, 2021, with $32.9 million available for future borrowings after reductions for outstanding letters of credit as of March 31, 2021. The ABL Facility has a first lien on accounts receivable and inventory. We were in compliance with all requirements under the ABL Facility as of March 31, 2021. Preferred Stock On March 22, 2021, we completed a private placement of 65 thousand shares of newly designated Series D Perpetual Preferred Stock, with a par value of $0.01 per share (the “Series D Preferred Stock”) at a price of $1,000 per share, together with detachable warrants (the “2021 Warrants”) to purchase up to 1.9 million shares of our common stock at an exercise price of $0.01 per share. The Series D Preferred Stock has a liquidation preference of $1,000 per share and is redeemable at our option in cash, subject to the applicable redemption premium. Series D Preferred Stock shares earn cash dividends at a rate of 10.0% per year, payable quarterly in arrears, accruing whether or not earned or declared. If no cash dividend is paid, then the liquidation preference per share effective on the dividend date increases by 12.0% per year. On March 22, 2026, the cash dividend rate and in-kind dividend rate increase by 2.5% per year. Cash dividends are required beginning on September 30, 2027. Net cash proceeds of $61.8 million from the issuance of the Series D Preferred Stock, along with part of the proceeds from the Term Loan Credit Facility, were used to redeem all of the outstanding shares of the Company’s Series B Convertible Preferred Stock (the “Series B Preferred Stock”). The total redemption cash payment was $118.4 million. 26 Table of Contents Sales Concentration We recognized sales from a single customer of $13.1 million, or 10% of consolidated net sales, during the three months ended March 31, 2021. We recognized sales from another customer of $11.1 million, or 10% of consolidated net sales, during the three months ended March 31, 2020. Revenues from these customers are primarily in our Mobile Solutions segment. Three Months Ended March 31, 2021, compared to the Three Months Ended March 31, 2020 Three Months Ended March 31, 2021 2020 $ Change Net sales $ 126,804 $ 116,213 $ 10,591 Organic growth $ 11,248 Foreign exchange effects (657) Cost of sales (exclusive of depreciation and amortization shown separately below) 99,688 94,478 5,210 Selling, general, and administrative expense 14,575 16,160 (1,585) Depreciation and amortization 11,568 11,357 211 Goodwill impairment — 92,942 (92,942) Other operating expense (income), net (5) 5,126 (5,131) Income (loss) from operations 978 (103,850) 104,828 Interest expense 2,024 3,807 (1,783) Loss on extinguishment of debt and write-off of debt issuance costs 2,390 — 2,390 Derivative payments on interest rate swap 1,717 — 1,717 Loss on interest rate swap 2,033 — 2,033 Other expense (income), net (122) 1,544 (1,666) Loss from continuing operations before benefit for income taxes and share of net income (loss) from joint venture (7,064) (109,201) 102,137 Benefit for income taxes 756 1,395 (639) Share of net income (loss) from joint venture 1,395 (271) 1,666 Loss from continuing operations (4,913) (108,077) 103,164 Income (loss) from discontinued operations, net of tax — (140,114) 140,114 Net loss $ (4,913) $ (248,191) $ 243,278 Net Sales . Net sales increased by $10.6 million, or 9%, during the three months ended March 31, 2021, compared to the three months ended March 31, 2020, primarily due to an increase in organic volume of $11.2 million, as a result of increased demand in the automotive industry as the economy begins to recover from the impact of the COVID-19 pandemic. Sales were positively impacted by increased selling prices for precious metals allowed under customer contracts due to the sharp rise in underlying commodities costs since the second half of 2020. These increases were partially offset by decreased demand for smart meter components due to inventory adjustments at a key customer. Sales of components to the medical industry were also negatively impacted by delays in elective surgeries caused by the COVID-19 pandemic. We also realized unfavorable foreign exchange effects of $0.7 million. Cost of Sales. Cost of sales increased by $5.2 million, or 6%, during the three months ended March 31, 2021, compared to the three months ended March 31, 2020, primarily due to variable costs associated with the above-referenced sales volume increase, partially offset by variable and fixed cost reduction initiatives. Selling, General and Administrative Expense. Selling, general and administrative expense decreased by $1.6 million during the three months ended March 31, 2021, compared to the three months ended March 31, 2020, primarily due to cost reduction initiatives that drove decreases in personnel and travel costs. Goodwill Impairment. We recognized goodwill impairment of $92.9 million at Power Solutions during the three months ended March 31, 2020, which resulted in no remaining goodwill balance. Other Operating Expense (Income), Net. Other operating expense (income), net, changed favorably by $5.1 million primarily due to charges and costs associated with asset disposals and elimination of a portion of lease obligations as a result of vacating a portion of our corporate headquarters building during the three months ended March 31, 2020. 27 Table of Contents Interest Expense. Interest expense decreased by $1.8 million during the three months ended March 31, 2021, compared to the three months ended March 31, 2020, primarily due to settlements on the interest rate swap in the prior year that were recognized in interest expense while the hedge was effective. Commitment fees on our Senior Secured Revolver decreased due to a lower available capacity after the sale of our Life Sciences business in October 2020. Three Months Ended March 31, 2021 2020 Interest on debt $ 1,439 $ 1,851 Interest rate swap settlements — 1,370 Amortization of debt issuance costs 405 426 Capitalized interest (31) (89) Other 211 249 Total interest expense $ 2,024 $ 3,807 Loss on Extinguishment of Debt and Write-off of Debt Issuance Costs. Loss on extinguishment of debt and write-off of debt issuance costs represents unamortized debt issuance costs that were associated with the credit facility that was terminated in March 2021. Derivative Payments on Interest Rate Swap. Derivative payments on interest rate swap represent cash settlements of the interest rate swap after hedge accounting was discontinued in October 2020. Prior to October 2020, interest rate swap settlements were recognized in interest expense. Loss on Interest Rate Swap . Loss on interest rate swap represents mark-to-market adjustments on the interest rate swap after hedge accounting was discontinued in October 2020 as well as amortization of the residual loss in accumulated other comprehensive income as monthly settlements occur. Prior to October 2020, mark-to-market adjustments on the interest rate swap were recognized in accumulated other comprehensive income. Upon termination of the interest rate swap in March 2021, we recognized in earnings the remaining $3.3 million loss that had been deferred in accumulated other comprehensive income. Benefit For Income Taxes. Our effective tax rate was 10.7% for the three months ended March 31, 2021, compared to 1.3% for the three months ended March 31, 2020. The difference in rates is primarily due to the impact of the impairment of nondeductible goodwill in 2020, and the estimated impacts of GILTI and the CARES Act. Note 8 in the Notes to Condensed Consolidated Financial Statements describes the effective income tax rate for each period presented. Share of Net Income from Joint Venture. Our share of net income from the joint venture increased during the three months ended March 31, 2021, compared to the three months ended March 31, 2020, primarily due to improved profits resulting from higher sales volumes, expanding variable margins as a result of successful process improvement initiatives and improved product mix, and fixed cost reduction actions. Results by Segment MOBILE SOLUTIONS Three Months Ended March 31, 2021 2020 $ Change Net sales $ 77,776 $ 69,884 $ 7,892 Organic growth $ 8,576 Foreign exchange effects (684) Income from operations $ 6,090 $ 264 $ 5,826 Net sales increased by $7.9 million during the three months ended March 31, 2021, compared to the three months ended March 31, 2020, primarily due to higher demand within all markets which were negatively impacted by the COVID-19 pandemic in the prior year and new business in the general industrial market. The increase in volume was partially offset by unfavorable foreign exchange effects of $0.7 million. Income from operations increased by $5.8 million during the three months ended March 31, 2021, compared to the same period in the prior year primarily due to the above-noted increase in revenue and variable and fixed cost reduction initiatives. Moreover, we built inventory in the three months ended March 31, 2021, which resulted in favorable overhead absorption during the quarter. 28 Table of Contents POWER SOLUTIONS Three Months Ended March 31, 2021 2020 $ Change Net sales $ 49,075 $ 46,401 $ 2,674 Organic growth $ 2,647 Foreign exchange effects 27 Goodwill impairment $ — $ (92,942) $ 92,942 Income (loss) from operations $ 2,432 $ (90,334) $ 92,766 Net sales increased by $2.7 million during the three months ended March 31, 2021, compared to the three months ended March 31, 2020. Sales were positively impacted by increased selling prices for precious metals allowed under customer contracts due to the sharp rise in underlying commodities costs since the second half of 2020. Furthermore, demand in the automotive market rebounded to more normalized levels after COVID-19. These increases were partially offset by decreased demand for smart meter components due to inventory adjustments at a key customer. Sales of components to the medical industry were also negatively impacted by delays in elective surgeries caused by the COVID-19 pandemic. The Power Solutions group generally began experiencing the impact of the COVID-19 pandemic on its operating results during the second quarter of 2020. Income from operations increased by $92.8 million compared to the same period in the prior year primarily due to the $92.9 million goodwill impairment lost recognized in the first quarter of 2020. Because increased pricing for precious metals was offset by equivalent increased raw materials cost based on commodity pricing, the increase in sales did not have a proportionate effect on income from operations. Changes in Financial Condition from December 31, 2020, to March 31, 2021 Overview From December 31, 2020, to March 31, 2021, total assets decreased by $2.6 million primarily due to normal depreciation and amortization of fixed assets, lease right-of-use assets, and intangible assets. These decreases were offset by increases in accounts receivable and inventories during the three months ended March 31, 2021. Accounts receivable increased as a result of increasing sales, and inventories increased as a result of a strategic decision to mitigate potential supply chain issues for our customers. From December 31, 2020, to March 31, 2021, total liabilities increased by $75.0 million, primarily due to the refinancing of our credit facilities and Series B Preferred Stock. Working capital, which consists of current assets less current liabilities, was $124.4 million as of March 31, 2021, compared to $112.0 million as of December 31, 2020. The increase in working capital was primarily due to the increases in accounts receivable and inventories discussed above. Cash Flows Cash provided by operations was $7.9 million for the three months ended March 31, 2021, compared with cash provided by operations of $10.2 million for the three months ended March 31, 2020. The difference was primarily due to building inventory levels during the three months ended March 31, 2021, to mitigate potential supply chain issues for our customers. Cash used in investing activities was $20.9 million for the three months ended March 31, 2021, compared with cash used in investing activities of $11.2 million for the three months ended March 31, 2020. The decrease was primarily due to cash settlement of the interest rate swap, partially offset by lower capital expenditures in the current year. Cash provided by financing activities was $9.6 million for the three months ended March 31, 2021, compared with cash provided by financing activities of $53.9 million for the three months ended March 31, 2020. The difference was primarily due to $11.9 million net inflow from the debt and preferred stock refinancing in the current year compared to the $60.0 million draw on the Senior Secured Revolver in the prior year. 29 Table of Contents Liquidity and Capital Resources Credit Facilities The principal amount outstanding under our Term Loan Facility as of March 31, 2021, was $150.0 million, without regard to unamortized debt issuance costs. As of March 31, 2021, we had unused borrowing capacity of $32.9 million under the ABL Facility, subject to certain limitations. This amount of borrowing capacity is net of $14.5 million of outstanding letters of credit at March 31, 2021, which are considered as usage of the ABL Facility. The Term Loan Facility requires quarterly principal payments of $0.4 million with the remaining unpaid principal amount due on the final maturity date of September 22, 2026. If one-month LIBOR is less than 1.00%, then we pay 7.875% per annum in interest. If one-month LIBOR exceeds 1.000%, then we pay the variable one-month LIBOR plus an applicable margin of 6.875%. Based on the interest rate in effect at March 31, 2021, annual interest payments would be approximately $11.8 million. The ABL Facility bears interest on a variable rate structure with borrowings bearing interest at one-month LIBOR plus an applicable margin of 1.75%. The interest rate in effect at March 31, 2021, was 2.25%. We pay a commitment fee of 0.375% for unused capacity under the ABL Facility. We were in compliance as of March 31, 2021, with all requirements under our Term Loan Facility and ABL Facility. Both credit facilities allow for optional expansion of available borrowings, subject to certain terms and conditions. Seasonality and Fluctuation in Quarterly Results General economic conditions impact our business and financial results, and certain businesses experience seasonal and other trends related to the industries and end markets that they serve. For example, European sales are often weaker in the summer months as customers slow production and sales to original equipment manufacturers are often stronger immediately preceding and following the launch of new products. However, as a whole, we are not materially impacted by seasonality. Off-Balance Sheet Arrangements We are not a party to any off-balance sheet arrangements that have, or are reasonably likely to have, a material current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources. Critical Accounting Policies Our critical accounting policies, including the assumptions and judgments underlying them, are disclosed in the 2020 Annual Report, including those policies as discussed in Note 1 to the Notes to Consolidated Financial Statements included in the 2020 Annual Report. There have been no changes to these policies during the three months ended March 31, 2021, except as discussed in Note 1 to the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report. Recent Accounting Pronouncements See Note 1 in the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report.