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, 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 our financial condition, business operations and liquidity; competitive influences; risks that current customers will commence or increase captive production; risks of capacity underutilization; quality issues; material changes in the costs and availability of raw materials; economic, social, political and geopolitical instability, currency fluctuation, and other risks of doing business outside of the United States; inflationary pressures and changes in the cost or availability of materials, supply chain shortages and disruptions, and the availability of labor; our dependence on certain major customers, some of whom are not parties to long-term agreements (and/or are terminable on short notice); 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; the impact of climate change on our operations; cyber liability or potential liability for breaches of our or our service providers’ information technology systems or business operations disruptions; 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 2021 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 six months ended June 30, 2022, 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 impact our business operations and our customers' and suppliers' ability to operate at normal levels. Disruptions in normal operating levels continue to create supply chain disruptions and inflationary cost pressures within our end-markets. We anticipate supply chain constraints and the inflationary environment will continue during 2022. The spread of COVID-19 and the responses thereto have created, and could continue to create, a disruption in the manufacturing, delivery, and overall supply chain of automobile manufacturers and suppliers, as well as disruption within the power industry. During the first half of 2022, production continued to be impacted by disruptions of global supply chains, which have caused challenges in obtaining raw materials we use in the manufacture of some of our products. In addition, power shortages in China have resulted in widespread blackouts, often without any or little notice. These blackouts caused us and other manufacturers in the region to shut down production until power was restored. Supply chain and COVID-19 related disruptions are expected to continue during 2022. Inflation triggered by the unprecedented economic impact of the COVID-19 pandemic and current geopolitical instability has increased our manufacturing costs, particularly labor and materials, in 2022 and is expected to continue into future periods. 23 Table of Contents We have undertaken a number of permanent and temporary actions to manage the evolving situation. We continue to streamline facilities and implement cost savings initiatives. Capital expenditures and travel costs remain at relatively low levels. We are focused on the health and safety of our employees, customers, and suppliers and have implemented processes to ensure a safe environment for our employees and any visitors to our facilities, including providing personal protective equipment and establishing social distancing protocols. 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. While we are actively promoting vaccination among our employees, vaccination status may affect workforce availability ranging from absences for vaccinations, booster shots, and recovery from side-effects. We have implemented training and recruiting programs to address labor shortages, but, significant workforce availability challenges could have a material effect on our business operations, financial results, liquidity, and financial position. COVID-19 and its impacts are unprecedented and continuously evolving, and the long-term impacts to our business, financial condition, results of operations and cash flows are still uncertain. Three Months Ended June 30, 2022 compared to the Three Months Ended June 30, 2021 Consolidated Results Three Months Ended June 30, 2022 2021 $ Change Net sales $ 125,362 $ 123,157 $ 2,205 Organic growth $ 2,700 Foreign exchange effects $ (495) Cost of sales (exclusive of depreciation and amortization shown separately below) 103,889 99,797 $ 4,092 Selling, general, and administrative expense 14,794 13,585 1,209 Depreciation and amortization 11,340 11,687 (347) Other operating income, net (147) (324) 177 Loss from operations (4,514) (1,588) (2,926) Interest expense 3,488 3,573 (85) Other expense (income), net (67) 1,680 (1,747) Loss before benefit (provision) for income taxes and share of net income from joint venture (7,935) (6,841) (1,094) Benefit (provision) for income taxes (1,051) 231 (1,282) Share of net income from joint venture 419 1,219 (800) Net loss $ (8,567) $ (5,391) $ (3,176) Net Sales . Net sales increased by $2.2 million, or 1.8%, during the three months ended June 30, 2022, compared to the three months ended June 30, 2021, primarily due to increased pricing to recover certain inflationary costs and underutilized fixed costs caused by lower-than-expected customer demand. These increases were partially offset by lower demand in Mobile Solutions which was impacted by the war in Ukraine, COVID disruptions in China, continued supply chain disruptions and unfavorable foreign exchange effects of $0.5 million. Cost of Sales. Cost of sales increased by $4.1 million, or 4.1%, during the three months ended June 30, 2022, compared to the three months ended June 30, 2021, primarily due to inflationary costs, partially offset by lower sales volume. Selling, General, and Administrative Expense. Selling, general, and administrative expense increased by $1.2 million during the three months ended June 30, 2022, compared to the three months ended June 30, 2021, primarily due to legal fees related to litigation, higher stock compensation expense and higher professional fees. These increases were partially offset by the reduction in severance and retention costs incurred in the prior year. 24 Table of Contents Interest Expense. Interest expense decreased by $0.1 million during the three months ended June 30, 2022, compared to the three months ended June 30, 2021, primarily due to a higher amount of interest expense that was capitalized in the current quarter compared with the second quarter of 2021. Three Months Ended June 30, 2022 2021 Interest on debt $ 3,109 $ 3,110 Interest rate swap settlements 38 — Amortization of debt issuance costs and discount 330 313 Capitalized interest (175) (80) Other 186 230 Total interest expense $ 3,488 $ 3,573 Other Expense, Net. Other expense (income), net changed favorably by $1.7 million during the three months ended June 30, 2022, compared to the three months ended June 30, 2021, due to noncash derivative mark-to-market gains during 2022 and the impact of a litigation settlement reached during the second quarter of 2021. These impacts were partially offset by unfavorable foreign exchange effects associated with intercompany borrowings. Benefit (Provision) For Income Taxes . Our effective tax rate was (13.2)% for the three months ended June 30, 2022, compared to 3.4% for the three months ended June 30, 2021. The rate for the three months ended June 30, 2022 was unfavorably impacted due to the accrual of tax on non-permanently reinvested unremitted earnings of foreign subsidiaries and by the limitation on the amount of tax benefit recorded for loss carryforwards in certain jurisdictions where we believe it is more likely than not that a portion of the future tax benefit may not be realized. Share of Net Income from Joint Venture. Share of net income from the JV decreased during the three months ended June 30, 2022, compared to the three months ended June 30, 2021, primarily due to decreased profits resulting from lower sales and inflationary costs in the current quarter. The JV, in which we own a 49% investment, recognized net sales of $22.9 million and $22.3 million for the three months ended June 30, 2022 and 2021, respectively. Results by Segment MOBILE SOLUTIONS Three Months Ended June 30, 2022 2021 $ Change Net sales $ 73,350 $ 73,886 $ (536) Organic decline $ (75) Foreign exchange effects (461) Income from operations $ 1,729 $ 2,509 $ (780) Net sales decreased by $0.5 million, or (0.7)%, during the three months ended June 30, 2022, compared to the three months ended June 30, 2021, primarily due to lower sales of diesel components due to lower European demand which is impacted by the war in Ukraine, pandemic interruptions in China, lost sales associated with certain fuel systems reaching end of production, and unfavorable foreign exchange effects of $0.5 million. These unfavorable impacts were partially offset by increased pricing to recover certain inflationary costs and underutilized fixed costs caused by lower-than-expected customer demand. Income from operations decreased by $0.8 million during the three months ended June 30, 2022, compared to the same period in the prior year, primarily due to inflationary costs not fully recovered in customer pricing and variable cost inefficiencies associated with supply chain interruptions, uneven customer ordering patterns, and labor constraints caused by pandemic interruptions. 25 Table of Contents POWER SOLUTIONS Three Months Ended June 30, 2022 2021 $ Change Net sales $ 52,049 $ 49,271 $ 2,778 Organic growth $ 2,812 Foreign exchange effects (34) Income from operations $ 1,430 $ 2,875 $ (1,445) Net sales increased by $2.8 million, or 5.6%, during the three months ended June 30, 2022 compared to the three months ended June 30, 2021. The increase in sales was the result of increased electric component sales, which were up 15.6% compared with the second quarter of 2021, primarily due to higher customer pricing to recover inflationary costs and improved volume, offset by lower sales to automotive and aerospace and defense customers. Income from operations decreased by $1.4 million during the three months ended June 30, 2022 compared to the same period in the prior year, primarily due to inflationary costs which were not fully recovered from pricing, variable cost inefficiencies associated with supply chain interruptions and uneven customer ordering patterns. Six Months Ended June 30, 2022, compared to the Six Months Ended June 30, 2021 Consolidated Results Six Months Ended June 30, 2022 2021 $ Change Net sales $ 253,429 $ 249,961 $ 3,468 Organic growth $ 3,804 Foreign exchange effects $ (336) Cost of sales (exclusive of depreciation and amortization shown separately below) 208,467 199,485 $ 8,982 Selling, general, and administrative expense 28,248 28,160 88 Depreciation and amortization 22,769 23,255 (486) Other operating expense (income), net 1,879 (329) 2,208 Loss from operations (7,934) (610) (7,324) Interest expense 6,927 5,597 1,330 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 (3,063) 1,558 (4,621) Loss before benefit (provision) for income taxes and share of net income from joint venture (11,798) (13,905) 2,107 Benefit (provision) for income taxes (2,582) 987 (3,569) Share of net income from joint venture 2,511 2,614 (103) Net loss $ (11,869) $ (10,304) $ (1,565) Net Sales . Net sales increased by $3.5 million, or 1.4%, during the six months ended June 30, 2022, compared to the six months ended June 30, 2021, primarily due to increased pricing to recover certain inflationary costs and underutilized fixed costs caused by lower-than-expected customer demand. These increases were partially offset by lower demand in Mobile Solutions which was impacted by the war in Ukraine, COVID disruptions in China, continued supply chain disruptions and unfavorable foreign exchange effects $0.3 million. Cost of Sales. Cost of sales increased by $9.0 million, or 4.5%, during the six months ended June 30, 2022, compared to the six months ended June 30, 2021, primarily due to inflationary costs, partially offset by lower sales volume. Selling, General, and Administrative Expense. Selling, general, and administrative expense increased by $0.1 million during the six months ended June 30, 2022, compared to the six months ended June 30, 2021, primarily due to legal fees related to litigation, higher stock compensation expense and higher professional fees. These increases were partially offset by the reduction in severance and retention costs incurred in the prior year. 26 Table of Contents Other Operating Expense (Income), Net. Other operating expense (income), net changed unfavorably by $2.2 million primarily due to a legal settlement reached during the first quarter of 2022. Interest Expense. Interest expense increased by $1.3 million during the six months ended June 30, 2022, compared to the six months ended June 30, 2021, primarily due to higher interest rates and a larger average debt balance as a result of the credit facility and preferred stock refinance during the first quarter of 2021. Six Months Ended June 30, 2022 2021 Interest on debt $ 6,180 $ 4,549 Interest rate swap settlements 82 — Amortization of debt issuance costs and discount 662 718 Capitalized interest (300) (111) Other 303 441 Total interest expense $ 6,927 $ 5,597 Loss on Extinguishment of Debt and Write-off of Debt Issuance Costs. We recognized $2.4 million in the first quarter of 2021 for the write-off of unamortized debt issuance costs 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 an interest rate swap which was terminated in the first quarter of 2021. We entered into a new interest rate swap in the third quarter of 2021, which is designated as a cash flow hedge with the impact of settlements recognized in interest expense. Loss on Interest Rate Swap . We recognized a $2.0 million loss in the first quarter of 2021 related to the termination of the previous interest rate swap in March 2021. Other Expense (Income), Net. Other expense (income), net changed favorably by $4.6 million during the six months ended June 30, 2022, compared to the six months ended June 30, 2021, due to noncash derivative mark-to-market gains during 2022 and the impact of a litigation settlement reached during the second quarter of 2021. Benefit (Provision) for Income Taxes. Our effective tax rate was (21.9)% for the six months ended June 30, 2022, compared to 7.1% for the six months ended June 30, 2021. The rate for the six months ended June 30, 2022 was unfavorably impacted by the accrual of tax on non-permanently reinvested unremitted earnings of foreign subsidiaries and by the limitation on the amount of tax benefit recorded for loss carryforwards in certain jurisdictions where we believe it is more likely than not that a portion of the future tax benefit may not be realized. The rate for the six months ended June 30, 2021 was favorably impacted by the change in assertion and reduction in the accrual of tax on non-permanently reinvested unremitted earnings of foreign subsidiaries. Share of Net Income from Joint Venture. Share of net income from the JV decreased during the six months ended June 30, 2022, compared to the six months ended June 30, 2021, primarily due to decreased profits resulting from inflationary costs partially offset by higher sales volume. The JV, in which we own a 49% investment, recognized net sales of $49.4 million and $45.7 million for the six months ended June 30, 2022 and 2021, respectively. Results by Segment MOBILE SOLUTIONS Six Months Ended June 30, 2022 2021 $ Change Net sales $ 149,420 $ 151,662 $ (2,242) Organic decline $ (1,940) Foreign exchange effects (302) Income from operations $ 3,698 $ 8,599 $ (4,901) Net sales decreased by $2.2 million, or (1.5)%, during the six months ended June 30, 2022, compared to the six months ended June 30, 2021, primarily due to lower sales of diesel components due to lower European demand which was impacted by the war in Ukraine, pandemic interruptions in China, lost sales associated with certain fuel systems reaching end of production, and unfavorable foreign exchange effects of $0.3 million. These unfavorable impacts were partially offset by increased pricing to recover certain inflationary costs and underutilized fixed costs caused by lower-than-expected customer demand. Income from operations decreased by $4.9 million during the six months ended June 30, 2022 compared to the same period in the prior year, primarily due to inflationary costs not fully recovered in customer pricing and variable cost inefficiencies 27 Table of Contents associated with supply chain interruptions, uneven customer ordering patterns, and labor constraints caused by pandemic interruptions. POWER SOLUTIONS Six Months Ended June 30, 2022 2021 $ Change Net sales $ 104,060 $ 98,346 $ 5,714 Organic growth $ 5,748 Foreign exchange effects (34) Income from operations $ 1,794 $ 5,307 $ (3,513) Net sales increased by $5.7 million, or 5.8%, during the six months ended June 30, 2022, compared to the six months ended June 30, 2021, primarily due to higher customer pricing to recover inflationary costs. Income from operations decreased by $3.5 million during the six months ended June 30, 2022 compared to the same period in the prior year, primarily due to a $1.8 million litigation settlement to settle claims from 2016, inflationary costs which were not fully recovered from pricing, variable cost inefficiencies associated with supply chain interruptions, uneven customer ordering patterns, and labor constraints caused by pandemic interruptions. Changes in Financial Condition from December 31, 2021 to June 30, 2022 Overview From December 31, 2021 to June 30, 2022, total assets decreased by $5.9 million primarily due to normal depreciation and amortization of fixed assets, lease right-of-use assets, and intangible assets. These decreases were partially offset by increases in accounts receivable and inventories during the six months ended June 30, 2022. The increase in accounts receivable is due to higher sales during the end of the current quarter compared with the end of the fourth quarter of 2021. The value of inventory increased due to higher material costs as well as higher quantities to maintain customer safety stock due to ongoing supply chain interruptions, especially in China. From December 31, 2021 to June 30, 2022, total liabilities increased by $6.7 million, primarily due to increases in accounts payable attributed to higher inventory balances at June 30, 2022. Working capital, which consists of current assets less current liabilities, was $122.3 million as of June 30, 2022 and December 31, 2021. The balance of working capital remained constant as an increase in accounts receivable and inventory was offset by an increase in accounts payable and other current liabilities. Cash Flows Cash used in operations was $2.5 million for the six months ended June 30, 2022, compared with cash provided by operations of $5.9 million for the six months ended June 30, 2021. The difference was primarily due to an increase in accounts receivable related to higher sales during the current quarter compared with the fourth quarter of 2021. Cash used in investing activities was $9.3 million for the six months ended June 30, 2022, compared with cash used in investing activities of $30.2 million for the six months ended June 30, 2021. The difference was primarily due to cash paid to settle the interest rate swap in the first quarter of 2021. Cash used in financing activities was $1.0 million for the six months ended June 30, 2022, compared with cash provided by financing activities of $6.9 million for the six months ended June 30, 2021. The difference was primarily due to the debt and preferred stock refinancing in the first quarter of 2021. Liquidity and Capital Resources Credit Facilities The principal amount outstanding under our Term Loan Facility as of June 30, 2022, was $148.1 million, without regard to unamortized debt issuance costs and discount. As of June 30, 2022, we had $36.9 million available for future borrowings under the ABL Facility. This amount of borrowing capacity is net of $2.0 million of outstanding borrowings and $11.1 million of outstanding letters of credit at June 30, 2022, 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. 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 28 Table of Contents rates plus an applicable margin of 5.875%. Based on the interest rate in effect at June 30, 2022, and the fixed rate on the 2021 interest rate swap, annual interest payments would be approximately $12.4 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 June 30, 2022, was 3.00%. We pay a commitment fee of 0.375% for unused capacity under the ABL Facility. We were in compliance with all requirements under our Term Loan Facility and ABL Facility as of June 30, 2022. 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. Critical Accounting Estimates Our critical accounting policies, including the assumptions and judgments underlying them, are disclosed in the 2021 Annual Report, including those policies as discussed in Note 1 to the Notes to Consolidated Financial Statements included in the 2021 Annual Report. There have been no material changes to these policies during the six months ended June 30, 2022.