NN(NNBR) - 2019 Q4 - Annual Report

Part I Business NN, Inc. is a global diversified industrial company manufacturing high-precision components across three segments: Life Sciences, Mobile Solutions, and Power Solutions Business Segments Overview | Segment | Focus End Markets | Key Products | | :--- | :--- | :--- | | Life Sciences | Medical (Orthopaedics, Medical/Surgical) | Surgical knives, bioresorbable implants, orthopaedic implants and tools, drug delivery devices | | Mobile Solutions | General Industrial, Automotive | Components for fuel systems, engines, transmissions, power steering, and electromechanical motors | | Power Solutions | Electrical, Aerospace & Defense | Electrical contacts, connectors, precision stampings, and high-precision products for flight control and military devices | - The company's competitive strengths are rooted in its ability to produce high-precision parts with tolerances of less than one micron, its focus on system-critical components with high costs of failure, and its engagement with customers throughout the entire product lifecycle, from design to post-production[21][22][24] - In 2019, the top ten customers accounted for approximately 52% of net sales. Sales to affiliates of Johnson & Johnson were $93.1 million, representing 11.0% of consolidated net sales, primarily within the Life Sciences and Power Solutions segments[30] - As of December 31, 2019, the company employed 5,418 full and part-time employees and 369 temporary workers. A minority of employees in France, Brazil, Mexico, and one U.S. plant are unionized[33] Executive Officers | Name | Age | Position | | :--- | :--- | :--- | | Warren A. Veltman | 58 | President and Chief Executive Officer | | Thomas D. DeByle | 60 | Senior Vice President and Chief Financial Officer | | John R. Buchan | 58 | Executive Vice President – Mobile Solutions and Power Solutions | | Christopher J. Qualters | 52 | Executive Vice President – Life Sciences | | Matthew S. Heiter | 59 | Senior Vice President and General Counsel | | D. Gail Nixon | 49 | Senior Vice President and Chief Human Resources Officer | Risk Factors The company faces significant operational, legal, financial, and internal control risks, including customer concentration, pandemic disruptions, substantial debt, and material weaknesses in financial reporting - The company is heavily dependent on a few major customers, with the ten largest accounting for about 52% of consolidated net sales in 2019. The loss of a major customer would materially harm revenue and profitability[56] - Operations are exposed to disruptions from health pandemics, such as the coronavirus, which has impacted facilities in China and suppliers in Italy, potentially harming the global economy and demand for the company's products[58][59] - The company's strategic review, initiated in November 2019 to evaluate options for reducing leverage, carries risks such as management distraction, difficulty retaining key employees, and potential negative market reactions[69] - Management identified material weaknesses in internal control over financial reporting as of December 31, 2019. If not remediated, these weaknesses could lead to future material misstatements in financial statements[76] - As of December 31, 2019, the company had approximately $793.2 million of indebtedness outstanding. This high degree of leverage increases vulnerability to adverse economic conditions and restricts financial flexibility[79] Unresolved Staff Comments The company reports no unresolved staff comments from the Securities and Exchange Commission - There are no unresolved staff comments[105] Properties As of December 31, 2019, the company operated 50 owned or leased facilities across seven countries, segmented by business group - The company operates 50 owned or leased facilities in seven countries as of December 31, 2019[106] Facility Count by Segment | Segment | Number of Facilities | | :--- | :--- | | Life Sciences Group | 17 | | Mobile Solutions Group | 17 | | Power Solutions Group | 15 | | Joint Venture | 1 | Legal Proceedings The company is involved in a pre-acquisition tax dispute in Brazil and a class-action lawsuit related to a 2018 stock offering, both of which it intends to vigorously defend - A pre-acquisition tax matter in Brazil regarding ICMS (VAT) tax credits has a potential loss range of $0 to $6.0 million. The company believes a loss is not probable and is entitled to indemnification from the former shareholders of Autocam[110][112][113] - A class-action complaint was filed in November 2019 alleging violations of the Securities Act of 1933 related to the company's September 2018 public stock offering. The company believes the allegations are without merit and intends to defend itself vigorously[114] Mine Safety Disclosures This item is not applicable to the company - Not applicable[116] Part II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities NN, Inc.'s common stock trades on Nasdaq under "NNBR", with its five-year cumulative total return significantly underperforming both the S&P SmallCap 600 and a peer group - The company's common stock is traded on the Nasdaq Stock Market under the symbol "NNBR"[118] Five-Year Cumulative Total Shareholder Return Comparison | Year | NN, Inc. | Peer Group | S&P SmallCap 600 | | :--- | :--- | :--- | :--- | | 2014 | $100.00 | $100.00 | $100.00 | | 2015 | $78.47 | $84.96 | $98.03 | | 2016 | $95.48 | $99.66 | $124.07 | | 2017 | $139.88 | $125.83 | $140.48 | | 2018 | $34.67 | $103.12 | $128.57 | | 2019 | $48.99 | $147.11 | $157.86 | Selected Financial Data This section provides a five-year financial summary (2015-2019) highlighting net sales growth, significant losses from continuing operations due to goodwill impairment, and changes in assets and long-term obligations Selected Financial Data (Years Ended December 31, in thousands) | Metric | 2019 | 2018 | 2017 | 2016 | 2015 | | :--- | :--- | :--- | :--- | :--- | :--- | | Net sales | $847,451 | $770,657 | $619,793 | $584,954 | $405,443 | | Goodwill impairment | $— | $182,542 | $— | $— | $— | | Income (loss) from operations | $9,889 | $(179,864) | $31,780 | $34,779 | $58 | | Income (loss) from continuing operations | $(46,741) | $(262,987) | $24,549 | $(9,490) | $(24,375) | | Total assets | $1,541,984 | $1,500,902 | $1,473,709 | $1,358,274 | $1,388,337 | | Long-term obligations | $769,477 | $817,549 | $792,499 | $788,953 | $802,011 | - In 2018, the company recognized goodwill impairment charges of $182.5 million[126] - In 2017, the company completed the sale of its global precision bearing components (PBC) business, recording an after-tax gain of $127.7 million, which is reflected in income from discontinued operations[127] Management's Discussion and Analysis of Financial Condition and Results of Operations This section discusses 2019 financial performance, including sales growth driven by acquisitions, a reduced net loss, strategic focus on growth and debt reduction, and liquidity management efforts amid restrictive debt covenants and potential coronavirus impacts - Management's long-term objectives include organic growth, improved operating margins, cost reduction, efficient capital deployment, and debt reduction[131] - In December 2019, the company issued $100 million of Series B convertible preferred stock and warrants, receiving net proceeds of $95.7 million used for debt repayment and general corporate purposes[150][151] - The coronavirus outbreak led to temporary closures of production facilities in China in early 2020. While most employees have returned, the company warns that a worsening situation could have a material adverse effect on results[152] - In November 2019, the company initiated a strategic review to evaluate options to reduce leverage and enhance shareholder value, including the potential sale of part or all of the company[184] Results of Operations In 2019, net sales increased by $76.8 million (10.0%) to $847.5 million, driven by acquisitions and Life Sciences growth, resulting in a net loss of $46.7 million, a significant improvement from the $263.0 million loss in 2018 Consolidated Results of Operations Comparison (2019 vs. 2018, in thousands) | Line Item | 2019 | 2018 | $ Change | | :--- | :--- | :--- | :--- | | Net sales | $847,451 | $770,657 | $76,794 | | Cost of sales | $641,639 | $589,181 | $52,458 | | Goodwill impairment | $— | $182,542 | $(182,542) | | Income (loss) from operations | $9,889 | $(179,864) | $189,753 | | Net loss | $(46,741) | $(262,987) | $216,246 | Segment Performance (2019 vs. 2018, in thousands) | Segment | 2019 Net Sales | 2018 Net Sales | 2019 Income from Ops | 2018 Income (Loss) from Ops | | :--- | :--- | :--- | :--- | :--- | | Life Sciences | $359,732 | $248,173 | $28,157 | $19,136 | | Mobile Solutions | $297,749 | $335,037 | $9,553 | $(55,079) | | Power Solutions | $192,100 | $189,778 | $13,881 | $(95,115) | - The Life Sciences segment's net sales increased by $111.6 million, driven by $71.4 million from acquisitions (Paragon Medical and Bridgemedica) and a $41.4 million increase in organic growth[170] - The Mobile Solutions segment's net sales decreased by $37.3 million due to lower demand in North American and European automotive markets and unfavorable foreign exchange effects[173] Liquidity and Capital Resources The company manages liquidity through cash from operations and its Senior Secured Revolver, having amended its credit facility with more restrictive covenants, and implemented a mitigation plan including expense reductions and preferred stock issuance to manage debt - Cash provided by operations was $49.2 million in 2019, compared to $40.9 million in 2018, primarily due to improved gross margin[180] - The company amended its Credit Agreement in December 2019, extending the revolver maturity to July 2022 and the Incremental Term Loan to October 2022, but also establishing more restrictive leverage ratio covenants[185] - Management has a plan to mitigate the risk of noncompliance with financial covenants, which includes cost reductions, repatriating cash from overseas, managing working capital, and selling underutilized properties[186] Contractual Obligations as of December 31, 2019 (in thousands) | Obligation | Total | Less than 1 year | 1-3 years | 3-5 years | After 5 years | | :--- | :--- | :--- | :--- | :--- | :--- | | Long-term debt | $793,247 | $19,160 | $767,939 | $2,347 | $3,801 | | Expected interest payments | $162,496 | $60,639 | $101,447 | $195 | $215 | | Operating leases | $109,212 | $12,229 | $22,174 | $18,535 | $56,274 | | Total | $1,083,198 | $96,335 | $900,110 | $26,191 | $60,562 | Quantitative and Qualitative Disclosures About Market Risk The company is exposed to interest rate and foreign currency risks, having hedged $700.0 million of variable-rate debt with a fixed-rate swap, while holding no currency derivatives as of December 31, 2019 - In February 2019, the company entered into a $700.0 million fixed-rate interest rate swap agreement to convert a portion of its variable-rate debt to a fixed rate of 2.4575% through October 19, 2022[202] - As of December 31, 2019, $700.0 million of the company's outstanding principal was hedged. A one-percent increase in the interest rate on the remaining unhedged variable rate borrowings would increase annualized interest expense by $0.8 million[204] - The company is exposed to foreign currency transaction and translation risk due to its international operations. As of December 31, 2019, no currency derivatives were in place to hedge this exposure[205] Financial Statements and Supplementary Data This section presents audited consolidated financial statements for 2017-2019, noting the auditor's adverse opinion on internal controls due to material weaknesses, despite an unqualified opinion on the financial statements, which show significant net losses in 2018 and 2019 - The independent auditor, PricewaterhouseCoopers LLP, issued an opinion that the company did not maintain effective internal control over financial reporting as of December 31, 2019, due to multiple material weaknesses[212][213] - The material weaknesses identified by the auditor relate to an ineffective control environment, inadequate monitoring controls over the Paragon Medical business, deficiencies in IT general controls, and intentional override of inventory controls at a foreign subsidiary[212] Consolidated Statement of Operations Highlights (in thousands) | Line Item | 2019 | 2018 | 2017 | | :--- | :--- | :--- | :--- | | Net sales | $847,451 | $770,657 | $619,793 | | Income (loss) from operations | $9,889 | $(179,864) | $31,780 | | Income (loss) from continuing operations | $(46,741) | $(262,987) | $24,549 | | Net income (loss) | $(46,741) | $(262,987) | $162,237 | Consolidated Balance Sheet Highlights (in thousands) | Line Item | Dec 31, 2019 | Dec 31, 2018 | | :--- | :--- | :--- | | Total current assets | $302,980 | $296,203 | | Total assets | $1,541,984 | $1,500,902 | | Total current liabilities | $139,481 | $145,030 | | Long-term debt, net of current portion | $757,440 | $811,471 | | Total liabilities | $1,095,695 | $1,081,631 | | Total stockholders' equity | $353,277 | $419,271 | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure The company reports no changes in or disagreements with its accountants on accounting and financial disclosure - None[466] Controls and Procedures Management concluded that disclosure controls and procedures were ineffective as of December 31, 2019, due to material weaknesses in internal control over financial reporting, for which remediation plans are underway - The CEO and CFO concluded that disclosure controls and procedures were not effective as of December 31, 2019, due to material weaknesses in internal control over financial reporting[467] - Material weaknesses identified include: an ineffective control environment (lack of sufficient qualified personnel), ineffective monitoring controls over the Paragon Medical business, and ineffective IT general controls at Paragon Medical[471][472] - A material weakness was identified at a smaller foreign subsidiary where employees intentionally circumvented inventory controls, resulting in unsupported inventory counts and adjustments, which led to a revision of prior period financial statements[473] - Management has begun remediation efforts, which include hiring qualified finance professionals, reorganizing teams at Paragon Medical, and providing enhanced training on inventory procedures[477][478] Other Information The company reports no other information under this item - None[481] Part III Directors, Executive Officers and Corporate Governance Information on directors, executive officers, and corporate governance is incorporated by reference from the company's definitive proxy statement - Information required by this item is incorporated by reference from the company's definitive proxy statement[483] Executive Compensation Information regarding executive compensation is incorporated by reference from the company's definitive proxy statement - Information required by this item is incorporated by reference from the company's definitive proxy statement[486] Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Information on security ownership is incorporated by reference from the company's definitive proxy statement, detailing outstanding equity compensation and securities available for future issuance - Information on security ownership is incorporated by reference from the company's definitive proxy statement[487] Equity Compensation Plan Information (in thousands) | Plan Category | Securities to be issued upon exercise | Weighted-average exercise price | Securities remaining available for future issuance | | :--- | :--- | :--- | :--- | | Approved by security holders | 775 | $13.24 | 3,635 | | Not approved by security holders | — | — | — | | Total | 775 | $13.24 | 3,635 | Certain Relationships and Related Transactions, and Director Independence Information regarding related party transactions and director independence is incorporated by reference from the company's definitive proxy statement - Information required by this item is incorporated by reference from the company's definitive proxy statement[489][490] Principal Accountant Fees and Services Information regarding principal accountant fees and services is incorporated by reference from the company's definitive proxy statement - Information required by this item is incorporated by reference from the company's definitive proxy statement[491] Part IV Exhibits, Financial Statement Schedules This section lists the financial statements and exhibits filed as part of the Form 10-K, with schedules included in the Notes to Consolidated Financial Statements - This section lists the financial statements and exhibits filed with the report[493] Form 10-K Summary No Form 10-K summary is provided - None[494]