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, 2023. The financial information as of September 30, 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, military conflict (including the Russia/Ukraine conflict, the conflict in Israel and surrounding areas, the possible expansion of such conflicts and the geopolitical and economic consequences associated therewith), 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, the availability of labor and labor disruptions along the supply chain; 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, as well as expansion of end markets and product offerings; 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; 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 nine months ended September 30, 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 global conflicts, inflationary cost pressures, rising interest rates, supply chain disruptions, and labor shortages and disruptions. 20 Table of Contents The COVID-19 pandemic and governmental responses thereto, including COVID-19 lockdowns in China, has impacted our business operations and our customers' and suppliers' ability to operate at normal levels. Disruptions in normal operating levels created supply chain disruptions and inflationary cost pressures within our end-markets. As of the date of this filing, we cannot 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 COVID-19 may impact our business, financial condition, results of operations and cash flow. The ongoing global conflicts continue 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 global conflicts 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 inflationary increases and rising interest rates, as well as supply issues in materials, services, and labor due to economic policy, the COVID-19 pandemic and global conflicts. These impacts are likely to persist into 2024. We cannot predict the impact on our end-markets or input costs nor our ability to recover cost increases through pricing. In September 2023, the United Auto Workers (the “UAW”) initiated a strike at certain U.S. facilities of General Motors, Ford and Stellantis North America (the “Detroit Three Automakers”) following the expiration of the collective bargaining agreement between the UAW and the Detroit Three Automakers. Certain of our customers in the automotive end market are suppliers to the Detroit Three Automakers. While the duration and scope of the initial and any future UAW strikes against the Detroit Three Automakers, as well as the corresponding impact on the business of suppliers to the Detroit Three Automakers and the impact on our own business, financial position, results of operations and cash flow, are impossible to predict at this time, the prolonged idling of our customers’ production facilities in response to the strikes could have a material adverse impact on us. Footprint Optimization In 2022, we took specific steps to consolidate our footprint by identifying less profitable end markets and focusing our strategic growth initiatives in markets where we believe we will be able to maximize profitability. During the first half of 2023, we closed our Taunton and Irvine sites from the Power Solutions group and three underutilized Mobile Solutions sites to reduce operating costs. Additionally, we continue to evaluate our global footprint, which may result in further consolidation or expansion actions to further improve our overall cost structure. Three Months Ended September 30, 2023 compared to the Three Months Ended September 30, 2022 Consolidated Results Three Months Ended September 30, 2023 2022 $ Change Net sales $ 124,443 $ 127,297 $ (2,854) Cost of sales (exclusive of depreciation and amortization shown separately below) 104,543 108,033 $ (3,490) Selling, general, and administrative expense 11,693 10,205 1,488 Depreciation and amortization 11,577 11,193 384 Other operating income, net (631) (17) (614) Loss from operations (2,739) (2,117) (622) Interest expense 5,739 3,746 1,993 Other income, net (1,463) (1,156) (307) Loss before benefit for income taxes and share of net income from joint venture (7,015) (4,707) (2,308) Benefit for income taxes 245 1,068 (823) Share of net income from joint venture 1,713 1,424 289 Net loss $ (5,057) $ (2,215) $ (2,842) Net Sales . Net sales decreased by $2.9 million, or 2.2%, during the three months ended September 30, 2023, compared to the three months ended September 30, 2022, primarily due to reduced volume, partially offset by higher customer pricing and favorable foreign exchange effects of $0.8 million. The closure of the Taunton and Irvine facilities contributed to the lower sales volume during the three months ended September 30, 2023. Cost of Sales. Cost of sales decreased by $3.5 million, or 3.2%, during the three months ended September 30, 2023, compared to the three months ended September 30, 2022, primarily due to lower sales volume and lower costs associated with facility 21 Table of Contents closures in the third quarter. These decreases were partially offset by higher material and labor costs and unfavorable foreign exchange effects. Selling, General, and Administrative Expense. Selling, general, and administrative expense increased by $1.5 million during the three months ended September 30, 2023, compared to the three months ended September 30, 2022, primarily due to increased wages and higher stock compensation expense, partially offset by lower travel and professional fees. Other Operating Income, Net. Other operating income, net increased by $0.6 million during the three months ended September 30, 2023, compared to the three months ended September 30, 2022, primarily due to sublease income related to the facilities that closed during the second quarter of 2023. Interest Expense. Interest expense increased by $2.0 million during the three months ended September 30, 2023, compared to the three months ended September 30, 2022, primarily due to higher interest rates and the addition of a 2.00% PIK interest rate in connection with the Term Loan Amendment. Three Months Ended September 30, 2023 2022 Interest on debt $ 5,779 $ 3,639 Gain recognized on interest rate swap (449) (146) Amortization of debt issuance costs and discount 529 359 Capitalized interest (350) (272) Other 230 166 Total interest expense $ 5,739 $ 3,746 Other Income, Net. Other income, net increased by $0.3 million during the three months ended September 30, 2023, compared to the three months ended September 30, 2022, due to higher noncash derivative mark-to-market gains recognized during the current quarter compared to the third quarter of 2022. Benefit (Provision) For Income Taxes . Our effective tax rate was 3.5% for the three months ended September 30, 2023, compared to 22.7% for the three months ended September 30, 2022. The rate for the three months ended September 30, 2023 and 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. In addition, the effective tax rate for the three months ended September 30, 2023, was favorably impacted by a net valuation allowance release based on management’s reassessment of the amount of its deferred tax assets that are more likely than not to be realized. Share of Net Income from Joint Venture. Share of net income from the JV increased by $0.3 million during the three months ended September 30, 2023, compared to the three months ended September 30, 2022, primarily due to higher sales partially offset by higher depreciation and interest expense in the current quarter. The JV, in which we own a 49% investment, recognized net sales of $30.3 million and $27.0 million for the three months ended September 30, 2023 and 2022, respectively. Results by Segment MOBILE SOLUTIONS Three Months Ended September 30, 2023 2022 $ Change Net sales $ 78,961 $ 76,122 $ 2,839 Loss from operations $ (1,283) $ (474) $ (809) Net sales increased by $2.8 million, or 3.7%, during the three months ended September 30, 2023, compared to the three months ended September 30, 2022, primarily due to higher customer pricing, a customer settlement in the quarter, and favorable foreign exchange effects of $0.9 million, partially offset by lower volume. Loss from operations changed unfavorably by $0.8 million during the three months ended September 30, 2023, compared to the same period in the prior year, primarily due to lower volume, unfavorable foreign exchange effects on costs, and increased depreciation expense. These were partially offset by the impact of a customer settlement in the quarter. 22 Table of Contents POWER SOLUTIONS Three Months Ended September 30, 2023 2022 $ Change Net sales $ 45,484 $ 51,124 $ (5,640) Income from operations $ 3,936 $ 2,582 $ 1,354 Net sales decreased by $5.6 million, or 11.0%, during the three months ended September 30, 2023 compared to the three months ended September 30, 2022. The decrease in sales was primarily due to lower volume, partially offset by higher pricing. The closure of the Taunton and Irvine sites contributed to the lower sales volume during the three months ended September 30, 2023. Income from operations increased by $1.4 million during the three months ended September 30, 2023 compared to the same period in the prior year, primarily due to lower costs associated with the facilities that closed in the second quarter, higher pricing, and sublease income earned on the closed facilities, partially offset by the impact of lower sales volume. Nine Months Ended September 30, 2023, compared to the Nine Months Ended September 30, 2022 Consolidated Results Nine Months Ended September 30, 2023 2022 $ Change Net sales $ 376,737 $ 380,726 $ (3,989) Cost of sales (exclusive of depreciation and amortization shown separately below) 320,648 316,500 $ 4,148 Selling, general, and administrative expense 35,833 38,453 (2,620) Depreciation and amortization 34,643 33,962 681 Other operating expense (income), net (526) 1,862 (2,388) Loss from operations (13,861) (10,051) (3,810) Interest expense 15,484 10,673 4,811 Other expense (income), net 1,970 (4,219) 6,189 Loss before provision for income taxes and share of net income from joint venture (31,315) (16,505) (14,810) Provision for income taxes (1,381) (1,514) 133 Share of net income from joint venture 3,087 3,935 (848) Net loss $ (29,609) $ (14,084) $ (15,525) Net Sales . Net sales decreased by $4.0 million, or 1.0%, during the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022, primarily due to reduced volume, primarily from the closure of the Taunton and Irvine facilities, lower customer settlements and unfavorable foreign exchange effects of $1.5 million. These decreases were partially offset by higher customer pricing and premium pricing on a certain customer project. Cost of Sales. Cost of sales increased by $4.1 million, or 1.3%, during the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022, primarily due to higher material and labor costs and lower favorable overhead absorption. These increases were partially offset by lower sales volume and lower labor costs associated with facility closures. Selling, General, and Administrative Expense. Selling, general, and administrative expense decreased by $2.6 million during the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022, primarily due to lower stock compensation expense and lower professional fees and travel costs. Other Operating Expense (Income), Net. Other operating expense (income), net changed favorably by $2.4 million primarily due to a legal settlement reached during the first quarter of 2022 and sublease income earned on closed facilities during the nine months ended September 30, 2023. Interest Expense. Interest expense increased by $4.8 million during the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022, primarily due to higher interest rates and the addition of a 2.00% PIK interest rate in connection with the Term Loan Amendment. These increases were partially offset by the recognition of gains from the interest rate swap and a higher amount of interest expense that was capitalized in the current quarter compared with the third 23 Table of Contents quarter of 2022. Nine Months Ended September 30, 2023 2022 Interest on debt $ 16,007 $ 9,819 Gain recognized on interest rate swap (1,366) (64) Amortization of debt issuance costs and discount 1,409 1,021 Capitalized interest (1,060) (572) Other 494 469 Total interest expense $ 15,484 $ 10,673 Other Expense (Income), Net. Other expense (income), net changed unfavorably by $6.2 million during the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022, primarily due to noncash derivative mark-to-market losses recognized during the first three quarters of 2023 compared to gains recognized during the first three quarters of 2022. Benefit (Provision) for Income Taxes. Our effective tax rate was (4.4)% for the nine months ended September 30, 2023, compared to (9.2)% for the nine months ended September 30, 2022. The rate for the nine months ended September 30, 2023 and 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. In addition, the effective rate for the nine months ended September 30, 2023, was favorably impacted by a net valuation allowance release based on management’s reassessment of the amount of its deferred tax assets that are more likely than not to be realized. Share of Net Income from Joint Venture. Share of net income from the JV decreased by $0.8 million during the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022, primarily due to higher manufacturing costs and increased depreciation and interest expense. The JV, in which we own a 49% investment, recognized net sales of $75.9 million and $76.4 million for the nine months ended September 30, 2023 and 2022, respectively. Results by Segment MOBILE SOLUTIONS Nine Months Ended September 30, 2023 2022 $ Change Net sales $ 234,132 $ 225,542 $ 8,590 Income (loss) from operations $ (6,063) $ 3,224 $ (9,287) Net sales increased by $8.6 million, or 3.8%, during the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022, primarily due to higher customer pricing, partially offset by lower volume, lower customer settlements and unfavorable foreign exchange effects of $1.3 million. Income (loss) from operations changed unfavorably by $9.3 million during the nine months ended September 30, 2023 compared to the same period in the prior year, primarily due to higher material and labor costs, lower sales volume, lower customer settlement and unfavorable foreign exchange effects. In addition, costs increased due to production challenges in two facilities associated with new business launches POWER SOLUTIONS Nine Months Ended September 30, 2023 2022 $ Change Net sales $ 142,618 $ 155,184 $ (12,566) Income from operations $ 8,266 $ 4,376 $ 3,890 Net sales decreased by $12.6 million, or 8.1%, during the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022, due to lower volumes, primarily from the closure of the Taunton and Irvine facilities. These decreases were partially offset by higher customer pricing and premium pricing on a certain customer project. Income from operations increased by $3.9 million during the nine months ended September 30, 2023 compared to the same period in the prior year, primarily due to lower costs associated with the facilities that closed in the second quarter of 2023, premium pricing on a certain customer project in the first quarter of 2023, a legal settlement reached during the first quarter of 2022, and sublease income earned on closed facilities. These increases were partially offset by lower sales volume. 24 Table of Contents Changes in Financial Condition from December 31, 2022 to September 30, 2023 Overview From December 31, 2022 to September 30, 2023, total assets decreased by $25.4 million primarily due to decreases in inventory, property, plant and equipment and intangible assets. The closure of two Power Solutions facilities contributed to the decrease in inventory and property, plant and equipment, and the decline in intangible assets is due to amortization. From December 31, 2022 to September 30, 2023, total liabilities increased by $7.5 million, primarily due to increases in accounts payable and other non-current liabilities, partially offset by a decrease in long-term debt. The increase in other non-current liabilities is primarily due to warrants issued in the first two quarters of 2023. Working capital, which consists of current assets less current liabilities, was $104.7 million as of September 30, 2023, compared to $112.9 million as of December 31, 2022. The decrease in working capital was primarily due to a decrease in inventory and increases in accounts payable and current maturities of long-term debt. Cash Flows Cash provided by operations was $23.9 million for the nine months ended September 30, 2023, compared with cash used by operations of $2.7 million for the nine months ended September 30, 2022. The difference was primarily due to decreases in accounts receivable and inventory during the nine months ended 2023 compared to increases in these balance during the corresponding period of 2022. Cash used in investing activities increased by $0.1 million primarily due to higher expenditures for property, plant and equipment during the nine months ended September 30, 2023, partially offset by the proceeds from the sale of equipment at the Taunton and Irvine facilities in the first half of 2023. Cash used in financing activities was $1.2 million for the nine months ended September 30, 2023, compared with cash provided by financing activities of $1.4 million for the nine months ended September 30, 2022. The difference was primarily due to lower borrowings on the ABL Facility during the nine months ended September 30, 2023 compared to the prior year. This was partially offset by proceeds from new international loans for working capital needs during 2023. Liquidity and Capital Resources Credit Facilities The principal amount outstanding under our Term Loan Facility as of September 30, 2023, was $147.7 million, without regard to unamortized debt issuance costs and discount. As of September 30, 2023, we had $28.7 million available for future borrowings under the ABL Facility. This amount of borrowing capacity is net of $10.9 million of outstanding letters of credit at September 30, 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 1.00% and 2.00%, dependent on the Company’s leverage ratio. Based on the interest rate in effect at September 30, 2023, annual cash interest payments would be approximately $18.2 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 September 30, 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. 25 Table of Contents Sale of Business We are in the process of making final determinations in the matter of the sale of our Life Sciences business in October 2020 to American Securities LLC and its associated earnout provision. It has been represented that no earnout is due and we are verifying this matter per the terms of the agreement. Other Receivables In 2021, we filed a refund claim with the IRS as a result of the Coronavirus Aid, Relief, and Economic Security Act. Including interest accrued on the initial refund amount, we have a $11.4 million tax refund receivable at September 30, 2023, which is in the process of IRS review and approval. The timing of the receipt of the refund remains uncertain. 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 nine months ended September 30, 2023.