NN INC 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to help the reader understand the results of operations and financial condition of NN, Inc. and its consolidated subsidiaries for the three and nine months ended September 30, 2022. The financial information as of September 30, 2022, should be read in conjunction with the consolidated financial statements for the year ended December 31, 2021, contained in our Annual Report on Form 10-K for the year ended December 31, 2021, and the Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q. 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 nine months ended September 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. Macroeconomic Conditions We continue to monitor the ongoing impacts of current macroeconomic and geopolitical events, including changing conditions from the COVID-19 pandemic, the on-going Russia-Ukraine conflict, inflationary cost pressures, rising interest rates, supply chain disruptions, and labor shortages. The COVID-19 pandemic and governmental responses thereto, including current COVID-19 lockdowns in China, continue 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 23 Table of Contents anticipate that supply chain constraints and the inflationary environment, as impacted by the COVID-19 pandemic, will continue through 2022 and beyond. The Russia-Ukraine conflict also continues to create volatility in global financial and energy markets, creating energy and supply chain shortages, adding to the inflationary pressures in the global economy. We continue to actively work with our suppliers to minimize impacts of supply shortages on our manufacturing capabilities. Although our business has not been materially impacted by the ongoing Russia-Ukraine conflict as of the date of this filing, it is impossible to predict the extent to which our operations, or those of our customers or suppliers, will be impacted, or the ways in which the conflict may impact our business, financial condition, results of operations and cash flows. The U.S. economy is experiencing broad and rapid inflation and rising interest rates, as well as supply issues in material, services and labor due to economic policy, the COVID-19 pandemic and, more recently, the Russia-Ukraine conflict. These impacts are likely to persist through 2022 and beyond. We cannot predict the impact on the Company’s end-markets or input costs nor the ability of the Company to recover cost increases through pricing. Three Months Ended September 30, 2022 compared to the Three Months Ended September 30, 2021 Consolidated Results Three Months Ended September 30, 2022 2021 $ Change Net sales $ 127,297 $ 117,244 $ 10,053 Organic growth $ 12,226 Foreign exchange effects $ (2,173) Cost of sales (exclusive of depreciation and amortization shown separately below) 108,033 98,642 $ 9,391 Selling, general, and administrative expense 10,205 12,181 (1,976) Depreciation and amortization 11,193 11,605 (412) Other operating income, net (17) (572) 555 Loss from operations (2,117) (4,612) 2,495 Interest expense 3,746 3,578 168 Other income, net (1,156) (4,346) 3,190 Loss before benefit (provision) for income taxes and share of net income from joint venture (4,707) (3,844) (863) Benefit (provision) for income taxes 1,068 (375) 1,443 Share of net income from joint venture 1,424 842 582 Net loss $ (2,215) $ (3,377) $ 1,162 Net Sales . Net sales increased by $10.1 million, or 8.6%, during the three months ended September 30, 2022, compared to the three months ended September 30, 2021, primarily due to increased pricing and higher demand in Mobile Solutions, partially offset by unfavorable foreign exchange effects of $2.2 million. Cost of Sales. Cost of sales increased by $9.4 million, or 9.5%, during the three months ended September 30, 2022, compared to the three months ended September 30, 2021, primarily due to inflationary costs and unfavorable overhead absorption during the quarter, partially offset by favorable foreign exchange effects. Selling, General, and Administrative Expense. Selling, general, and administrative expense decreased by $2.0 million during the three months ended September 30, 2022, compared to the three months ended September 30, 2021, primarily due to lower incentive and stock compensation expense. Other Operating Income, Net. Other operating income, net changed unfavorably by $0.6 million during the three months ended September 30, 2022, compared to the three months ended September 30, 2021, primarily due to a gain on the sale of a facility in the third quarter of 2021. 24 Table of Contents Interest Expense. Interest expense increased by $0.2 million during the three months ended September 30, 2022, compared to the three months ended September 30, 2021, primarily due to higher interest rates, partially offset by favorable interest rate swap settlements and a higher amount of interest expense that was capitalized in the current quarter compared with the third quarter of 2021. Three Months Ended September 30, 2022 2021 Interest on debt $ 3,639 $ 3,146 Interest rate swap settlements (146) 32 Amortization of debt issuance costs and discount 359 331 Capitalized interest (272) (89) Other 166 158 Total interest expense $ 3,746 $ 3,578 Other Income, Net. Other income, net changed unfavorably by $3.2 million during the three months ended September 30, 2022, compared to the three months ended September 30, 2021, due to lower noncash derivative mark-to-market gains recognized during the current quarter compared with the third quarter of 2021. Benefit (Provision) For Income Taxes . Our effective tax rate was 22.7% for the three months ended September 30, 2022, compared to (9.8)% for the three months ended September 30, 2021. The rate for the three months ended September 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. The effective tax rate was favorably impacted by the recording of interest income on the Company’s federal income tax refund requested as a result of the CARES act. Share of Net Income from Joint Venture. Share of net income from the JV increased during the three months ended September 30, 2022, compared to the three months ended September 30, 2021, primarily due to higher sales partially offset by higher operating costs in the current quarter. The JV, in which we own a 49% investment, recognized net sales of $27.0 million and $22.8 million for the three months ended September 30, 2022 and 2021, respectively. Results by Segment MOBILE SOLUTIONS Three Months Ended September 30, 2022 2021 $ Change Net sales $ 76,122 $ 68,586 $ 7,536 Organic growth $ 9,573 Foreign exchange effects (2,037) Loss from operations $ (474) $ (257) $ (217) Net sales increased by $7.5 million, or 11.0%, during the three months ended September 30, 2022, compared to the three months ended September 30, 2021, primarily due to increased pricing and a recovery of sales that were negatively impacted by the global semi-conductor shortage in 2021. These increases were partially offset by unfavorable foreign exchange effects of $2.0 million. Loss from operations increased by $0.2 million during the three months ended September 30, 2022, compared to the same period in the prior year, primarily due to inflationary costs not fully recovered in customer pricing and unfavorable overhead absorption. These decreases were partially offset by higher sales volume and lower incentive compensation expense. 25 Table of Contents POWER SOLUTIONS Three Months Ended September 30, 2022 2021 $ Change Net sales $ 51,124 $ 48,680 $ 2,444 Organic growth $ 2,580 Foreign exchange effects (136) Income from operations $ 2,582 $ 1,252 $ 1,330 Net sales increased by $2.4 million, or 5.0%, during the three months ended September 30, 2022 compared to the three months ended September 30, 2021. The increase in sales was primarily due to higher customer pricing and volume, partially offset by lower precious metals pass-through pricing and unfavorable foreign exchange effects. Income from operations increased by $1.3 million during the three months ended September 30, 2022 compared to the same period in the prior year, primarily due to the increase in sales and lower incentive compensation expense and favorable mix, partially offset by a gain on the sale of a facility in the third quarter of 2021. Nine Months Ended September 30, 2022, compared to the Nine Months Ended September 30, 2021 Consolidated Results Nine Months Ended September 30, 2022 2021 $ Change Net sales $ 380,726 $ 367,205 $ 13,521 Organic growth $ 16,030 Foreign exchange effects $ (2,509) Cost of sales (exclusive of depreciation and amortization shown separately below) 316,500 298,127 $ 18,373 Selling, general, and administrative expense 38,453 40,341 (1,888) Depreciation and amortization 33,962 34,860 (898) Other operating expense (income), net 1,862 (901) 2,763 Loss from operations (10,051) (5,222) (4,829) Interest expense 10,673 9,175 1,498 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 income, net (4,219) (2,788) (1,431) Loss before benefit (provision) for income taxes and share of net income from joint venture (16,505) (17,749) 1,244 Benefit (provision) for income taxes (1,514) 612 (2,126) Share of net income from joint venture 3,935 3,456 479 Net loss $ (14,084) $ (13,681) $ (403) Net Sales . Net sales increased by $13.5 million, or 3.7%, during the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021, primarily due to increased pricing partially offset by lower volume and unfavorable foreign exchange effects $2.5 million. Cost of Sales. Cost of sales increased by $18.4 million, or 6.2%, during the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021, primarily due to inflationary costs and unfavorable overhead absorption, partially offset by lower sales volume and favorable foreign exchange effects. Selling, General, and Administrative Expense. Selling, general, and administrative expense decreased by $1.9 million during the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021, primarily due to lower incentive compensation, severance and retention expense. These decreases were partially offset by higher stock compensation expense, higher professional fees and increased travel costs. 26 Table of Contents Other Operating Expense (Income), Net. Other operating expense (income), net changed unfavorably by $2.8 million primarily due to a legal settlement reached during the first quarter of 2022 and the gain on the sale of a facility in the third quarter of 2021. Interest Expense. Interest expense increased by $1.5 million during the nine months ended September 30, 2022, compared to the nine months ended September 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. These increases were partially offset by a higher amount of interest expense that was capitalized in 2022 compared with the prior year. Nine Months Ended September 30, 2022 2021 Interest on debt $ 9,819 $ 7,695 Interest rate swap settlements (64) 32 Amortization of debt issuance costs and discount 1,021 1,049 Capitalized interest (572) (200) Other 469 599 Total interest expense $ 10,673 $ 9,175 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 Income, Net. Other income, net changed favorably by $1.4 million during the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021, primarily due to the impact of a litigation settlement reached during the second quarter of 2021. Benefit (Provision) for Income Taxes. Our effective tax rate was (9.2)% for the nine months ended September 30, 2022, compared to 3.5% for the nine months ended September 30, 2021. The rate for the nine months ended September 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 effective tax rate for the nine months ended September 30, 2022 was favorably impacted by the recording of interest income on the Company’s federal income tax refund requested as a result of the CARES act. The rate for the nine months ended September 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 increased during the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021, primarily due to higher sales partially offset by higher operating costs in the current quarter. The JV, in which we own a 49% investment, recognized net sales of $76.4 million and $68.4 million for the nine months ended September 30, 2022 and 2021, respectively. Results by Segment MOBILE SOLUTIONS Nine Months Ended September 30, 2022 2021 $ Change Net sales $ 225,542 $ 220,248 $ 5,294 Organic growth $ 7,633 Foreign exchange effects (2,339) Income from operations $ 3,224 $ 8,342 $ (5,118) Net sales increased by $5.3 million, or 2.4%, during the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021, primarily due to increased pricing, partially offset by lower sales of diesel components due to lower European demand which was impacted by the war in Ukraine, COVID-19 interruptions in China, lost sales associated with certain fuel systems reaching end of production, and unfavorable foreign exchange effects of $2.3 million. 27 Table of Contents Income from operations decreased by $5.1 million during the nine months ended September 30, 2022 compared to the same period in the prior year, primarily due to inflationary costs not fully recovered in customer pricing, unfavorable overhead absorption, and variable cost inefficiencies associated with supply chain interruptions, uneven customer ordering patterns, and labor constraints caused by pandemic interruptions. These decreases were partially offset by lower incentive compensation expense. POWER SOLUTIONS Nine Months Ended September 30, 2022 2021 $ Change Net sales $ 155,184 $ 147,026 $ 8,158 Organic growth $ 8,328 Foreign exchange effects (170) Income from operations $ 4,376 $ 6,559 $ (2,183) Net sales increased by $8.2 million, or 5.5%, during the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021, primarily due to higher customer pricing partially offset by lower volume and unfavorable foreign exchange effects. Income from operations decreased by $2.2 million during the nine months ended September 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 and the absence of a gain on the sale of a facility in the third quarter of 2021. These decreases were partially offset by the impact of higher sales and lower incentive compensation expense. Changes in Financial Condition from December 31, 2021 to September 30, 2022 Overview From December 31, 2021 to September 30, 2022, total assets decreased by $21.5 million primarily due to normal depreciation and amortization of fixed assets and intangible assets. These decreases were partially offset by increases in accounts receivable and inventories during the nine months ended September 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. There was no change in total liabilities from December 31, 2021 to September 30, 2022, as lower employee incentive compensation accruals and a decrease in the unrealized losses of certain derivatives were offset by an increase in accounts payable attributed to higher inventory balances at September 30, 2022 and higher borrowings on the ABL Facility. Working capital, which consists of current assets less current liabilities, was $125.5 million as of September 30, 2022, compared to $122.3 million as of December 31, 2021. The increase in working capital was primarily due to increases in accounts receivable and inventory, partially offset by an increase in accounts payable. Cash Flows Cash used in operations was $2.7 million for the nine months ended September 30, 2022, compared with cash provided by operations of $5.7 million for the nine months ended September 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 $13.6 million for the nine months ended September 30, 2022, compared with cash used in investing activities of $32.7 million for the nine months ended September 30, 2021. The difference was primarily due to cash paid to settle the interest rate swap in the first quarter of 2021. Cash provided by financing activities was $1.4 million for the nine months ended September 30, 2022, compared with cash provided by financing activities of $4.5 million for the nine months ended September 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 September 30, 2022, was $147.8 million, without regard to unamortized debt issuance costs and discount. As of September 30, 2022, we had $32.1 million available for future borrowings under the ABL Facility. This amount of borrowing capacity is net of $6.0 million of outstanding borrowings and $11.1 million of outstanding letters of credit at September 30, 2022, which are considered as usage of the ABL Facility. 28 Table of Contents 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 rates plus an applicable margin of 5.875%. Based on the interest rate in effect at September 30, 2022, and the fixed rate on the 2021 interest rate swap, annual interest payments would be approximately $13.7 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 September 30, 2022, was 4.56%. 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 September 30, 2022. Both credit facilities allow for optional expansion of available borrowings, subject to certain terms and conditions. Accounts Receivable Sales Programs We participate in programs established by our customers which allows us to sell certain receivables from that customer on a non-recourse basis to a third-party financial institution. In exchange, we receive payment on the receivables, less a discount, sooner than under the customary credit terms we have extended to that customer. These programs allow us to improve working capital and cash flows. Our access to these programs is dependent on our customers ongoing agreements with the third-parties. Our participation in these programs is based on our specific cash needs throughout the year, the discount charged to receive payment earlier, the length of the payment terms with our customers, as well being subject to limits in our ABL Facility and Term Loan Facility agreements. 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 nine months ended September 30, 2022.