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 months ended March 31, 2023. The financial information as of March 31, 2023, should be read in conjunction with the consolidated financial statements for the year ended December 31, 2022, contained in our Annual Report on Form 10-K for the year ended December 31, 2022, and the Condensed Consolidated Financial Statements included in this Quarterly Report. 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 within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended ( the “Exchange Act”), which are intended to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and include this statement for purposes of complying with these safe harbor provisions. 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 the Company, 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 pandemics, epidemics, disease outbreaks and other public health crises, including 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; our ability to hire or retain key personnel; 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; and cyber liability or potential liability for breaches of our or our service providers’ information technology systems or business operations disruptions. Any forward-looking statement speaks only as of the date of this Quarterly Report, and the Company undertakes no obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise, except as required by law. New risks and uncertainties may emerge from time to time, and it is not possible for the Company to predict their occurrence or how they will affect the Company. The Company qualifies all forward-looking statements by these cautionary statements. For additional information concerning such risk factors and cautionary statements, please see the sections titled “Item 1A. Risk Factors” in the 2022 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, 2023, 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 ongoing Russia-Ukraine conflict, inflationary cost pressures, rising interest rates, supply chain disruptions, and labor shortages. The COVID-19 pandemic and governmental responses thereto, including 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 17 Table of Contents levels continue to create supply chain disruptions and inflationary cost pressures within our end-markets. We anticipate that supply chain constraints and the inflationary environment, as impacted by the COVID-19 pandemic, will continue throughout 2023. The Russia-Ukraine conflict also continues to create volatility in global financial and energy markets, creating energy and supply chain shortages, which has added to the inflationary pressures experienced by 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, we cannot reasonably predict the extent to which our operations, or those of our customers or suppliers, will be impacted in the future, 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 materials, services, and labor due to economic policy, the COVID-19 pandemic and, more recently, the Russia-Ukraine conflict. These impacts are likely to persist in 2023 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. Footprint Optimization In 2022, we took specific steps to consolidate our footprint by exiting less profitable end markets and focusing our strategic growth initiatives in markets where we believe we will be able to maximize profitability. We made the decision to close our Taunton and Irvine sites, effectively exiting the Aerospace and Defense business for precision machined components, with both sites expected to close in the first half of 2023. We also expect to close three Mobile Solutions sites in 2023, which will further reduce operating costs in future years. Additionally, we plan to reduce indirect labor costs to decrease fixed manufacturing costs. Three Months Ended March 31, 2023 compared to the Three Months Ended March 31, 2022 Consolidated Results Three Months Ended March 31, 2023 2022 $ Change Net sales $ 127,088 $ 128,067 $ (979) Cost of sales (exclusive of depreciation and amortization shown separately below) 108,421 104,578 $ 3,843 Selling, general, and administrative expense 13,165 13,454 (289) Depreciation and amortization 11,516 11,429 87 Other operating expense, net 1,061 2,026 (965) Loss from operations (7,075) (3,420) (3,655) Interest expense 4,288 3,439 849 Other income, net (2,208) (2,996) 788 Loss before provision for income taxes and share of net income from joint venture (9,155) (3,863) (5,292) Provision for income taxes (1,301) (1,531) 230 Share of net income from joint venture 281 2,092 (1,811) Net loss $ (10,175) $ (3,302) $ (6,873) Net Sales . Net sales decreased by $1.0 million, or (0.8)%, during the three months ended March 31, 2023, compared to the three months ended March 31, 2022, primarily due to reduced volume and unfavorable foreign exchange effects of $1.4 million, partially offset by higher customer pricing and premium pricing on a certain customer project. Cost of Sales. Cost of sales increased by $3.8 million, or 3.7%, during the three months ended March 31, 2023, compared to the three months ended March 31, 2022, primarily due to higher material and labor costs due to inefficient manufacturing processes associated with product launches, partially offset by lower sales volume and favorable foreign exchange effects. In addition, the prior year cost of sales benefited from favorable overhead absorption. Selling, General, and Administrative Expense. Selling, general, and administrative expense decreased by $0.3 million during the three months ended March 31, 2023, compared to the three months ended March 31, 2022, primarily due to lower stock compensation expense partially offset by higher professional fees. 18 Table of Contents Other Operating Expense, Net. Other operating expense, net decreased by $1.0 million during the three months ended March 31, 2023, compared to the three months ended March 31, 2022, primarily due to a legal settlement reached during the first quarter of 2022, partially offset by losses on sales of machinery and equipment during the first quarter of 2023. Interest Expense. Interest expense increased by $0.8 million during the three months ended March 31, 2023, compared to the three months ended March 31, 2022, 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 first quarter of 2022. Three Months Ended March 31, 2023 2022 Interest on debt $ 4,619 $ 3,071 Interest rate swap settlements (468) 44 Amortization of debt issuance costs and discount 353 332 Capitalized interest (330) (125) Other 114 117 Total interest expense $ 4,288 $ 3,439 Other Income, Net. Other income, net decreased by $0.8 million during the three months ended March 31, 2023, compared to the three months ended March 31, 2022, due to lower noncash derivative mark-to-market gains recognized during the current quarter compared with the first quarter of 2022. Benefit (Provision) For Income Taxes . Our effective tax rate was (14.2)% for the three months ended March 31, 2023, compared to (39.6)% for the three months ended March 31, 2022. The rate for the three months ended March 31, 2023 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 unfavorably impacted by the U.S. tax on the earnings of foreign subsidiaries under the global intangible low-taxed income regime. Share of Net Income from Joint Venture. Share of net income from the JV decreased during the three months ended March 31, 2023, compared to the three months ended March 31, 2022, primarily due to lower sales and higher operating costs in the current quarter. The JV, in which we own a 49% investment, recognized net sales of $20.6 million and $26.5 million for the three months ended March 31, 2023 and 2022, respectively. Results by Segment MOBILE SOLUTIONS Three Months Ended March 31, 2023 2022 $ Change Net sales $ 78,018 $ 76,070 $ 1,948 Income (loss) from operations $ (3,319) $ 1,969 $ (5,288) Net sales increased by $1.9 million, or 2.6%, during the three months ended March 31, 2023, compared to the three months ended March 31, 2022, primarily due to higher customer pricing, partially offset by lower volume and unfavorable foreign exchange effects of $1.7 million. Income (loss) from operations changed unfavorably by $5.3 million during the three months ended March 31, 2023, compared to the same period in the prior year, primarily due to lower sales volume, production challenges in two facilities associated with new business launches, and inflationary costs not fully recovered in customer pricing. POWER SOLUTIONS Three Months Ended March 31, 2023 2022 $ Change Net sales $ 49,072 $ 52,011 $ (2,939) Income from operations $ 1,747 $ 364 $ 1,383 Net sales decreased by $2.9 million, or (5.7)%, during the three months ended March 31, 2023 compared to the three months ended March 31, 2022. The decrease in sales was primarily due to lower volume, partially offset by premium pricing on a certain customer project, and favorable foreign exchange effects of $0.2 million. 19 Table of Contents Income from operations increased by $1.4 million during the three months ended March 31, 2023 compared to the same period in the prior year, primarily due to premium pricing on a certain customer project in the first quarter of 2023 and a legal settlement reached during the first quarter of 2022. These increases were partially offset by lower sales volume and an unfavorable change in overhead absorption during the first quarter of 2023 compared to the first quarter of 2022. Changes in Financial Condition from December 31, 2022 to March 31, 2023 Overview From December 31, 2022 to March 31, 2023, total assets increased by $1.1 million primarily due to increases in accounts receivable, inventory and prepaid assets, partially offset by normal depreciation and amortization of fixed assets and intangible assets. 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 2022. From December 31, 2022 to March 31, 2023, total liabilities increased by $9.9 million, primarily due to increases in accounts payable, accrued salaries and benefits and other current liabilities. Working capital, which consists of current assets less current liabilities, was $109.2 million as of March 31, 2023, compared to $112.9 million as of December 31, 2022. The decrease in working capital was primarily due to increases in accounts payable and other current liabilities, partially offset by an increase in accounts receivable. Cash Flows Cash provided by operations was $0.2 million for the three months ended March 31, 2023, compared with cash used by operations of $5.2 million for the three months ended March 31, 2022. 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 2022. Cash used in investing activities decreased by $0.2 million primarily due to higher expenditures for property, plant and equipment in the first quarter of 2023, partially offset by the proceeds from the sale of equipment at the Irvine facility. Cash provided by financing activities was $1.3 million for the three months ended March 31, 2023, compared with cash used by financing activities of $1.5 million for the three months ended March 31, 2022. The difference was primarily due to proceeds from new international loans for working capital needs in the first quarter of 2023. Liquidity and Capital Resources Credit Facilities The principal amount outstanding under our Term Loan Facility as of March 31, 2023, was $147.0 million, without regard to unamortized debt issuance costs and discount. As of March 31, 2023, we had $32.5 million available for future borrowings under the ABL Facility. This amount of borrowing capacity is net of $1.0 million of outstanding borrowings and $10.9 million of outstanding letters of credit at March 31, 2023, 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. Effective March 31, 2023, outstanding borrowings under the Term Loan Facility bear interest at either 1) one-month, three-month, or six-month Adjusted SOFR, 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%. Beginning with the second quarter of 2023, interest is increased on a paid-in-kind basis at a rate between 0.50% and 2.00%, dependent on the Company’s leverage ratio and whether the Company completes a qualifying junior equity raise by June 30, 2023. Based on the interest rate in effect at March 31, 2023, annual cash interest payments would be approximately $17.2 million. The ABL Facility bears interest on a variable borrowing rate based on either 1) Adjusted SOFR 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 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 March 31, 2023. 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. 20 Table of Contents 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 2022 Annual Report, including those policies as discussed in Note 1 to the Notes to Consolidated Financial Statements included in the 2022 Annual Report. There have been no material changes to these policies during the three months ended March 31, 2023.