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10-Q
NN INC filed this Form 10-Q on 11/09/2017
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10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2017

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File Number 000-23486

 

 

 

LOGO

NN, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   62-1096725

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

207 Mockingbird Lane

Johnson City, Tennessee 37604

(Address of principal executive offices, including zip code)

(423) 434-8300

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer      Accelerated filer  
Non-accelerated filer   ☐  (Do not check if a smaller reporting company)    Smaller reporting company  
     Emerging growth company  

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act    ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

As of November 7, 2017, there were 27,573,397 shares of the registrant’s common stock, par value $0.01 per share, outstanding.

 

 

 


Table of Contents

NN, Inc.

INDEX

 

PART I. FINANCIAL INFORMATION

     3  

Item 1.

   Financial Statements      3  

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      26  

Item 3.

   Quantitative and Qualitative Disclosures About Market Risk      35  

Item 4.

   Controls and Procedures      36  

PART II. OTHER INFORMATION

     37  

Item 1.

   Legal Proceedings      37  

Item 1A.

   Risk Factors      38  

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds      38  

Item 3.

   Defaults upon Senior Securities      38  

Item 4.

   Mine Safety Disclosures      38  

Item 5.

   Other Information      38  

Item 6.

   Exhibits      39  

SIGNATURES

     40  

 

2


Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

NN, Inc.

Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)

(Unaudited)

Amounts in thousands of dollars, except per share data

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2017     2016(1)     2017     2016(1)  

Net sales

   $ 148,156     $ 146,714     $ 463,658     $ 443,310  

Cost of products sold (exclusive of depreciation and amortization shown separately below)

     110,836       107,185       339,345       323,660  

Selling, general and administrative expense

     16,985       14,201       52,606       46,931  

Acquisition related costs excluded from selling, general and administrative expense

     619       —         619       —    

Depreciation and amortization

     13,075       11,737       38,432       38,411  

Restructuring and integration expense

     345       606       362       4,851  
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     6,296       12,985       32,294       29,457  

Interest expense

     12,739       15,801       39,916       48,708  

Loss on extinguishment of debt and write-off of unamortized debt issuance costs

     —         2,589       39,639       2,589  

Derivative payments on interest rate swap

     —         609       —         609  

Derivative loss (gain) on change in interest rate swap fair value

     (27     3,130       (14     3,130  

Other (income) expense, net

     (848     (263     (945     (2,297
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from continuing operations before benefit for income taxes and share of net income from joint venture

     (5,568     (8,881     (46,302     (23,282

Benefit for income taxes

     1,436       8,246       14,145       11,763  

Share of net income from joint venture

     1,202       1,427       4,139       4,170  
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations

     (2,930     792       (28,018     (7,349

Income from discontinued operations, net of tax (Note 2)

     135,825       3,663       146,579       12,564  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 132,895     $ 4,455     $ 118,561     $ 5,215  
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss):

        

Change in fair value of interest rate swap

   $ —       $ 2,244     $ —       $ 2,025  

Reclassification adjustment for discontinued operations

     (9,243     —         (9,243     —    

Foreign currency translation gain (loss)

     6,083       (378     20,327       1,774  
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss):

   $ (3,160   $ 1,866     $ 11,084     $ 3,799  
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

   $ 129,735     $ 6,321     $ 129,645     $ 9,014  
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic net income (loss) per share:

        

Income (loss) from continuing operations per share

   $ (0.11   $ 0.03     $ (1.02   $ (0.27

Income from discontinued operations per share

     4.93       0.13       5.35       0.47  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income per share

   $ 4.82     $ 0.16     $ 4.33     $ 0.19  
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding

     27,544       27,159       27,403       26,973  
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted net income (loss) per share:

        

Income (loss) from continuing operations per share

   $ (0.11   $ 0.03     $ (1.02   $ (0.27

Income from discontinued operations per share

     4.93       0.13       5.35       0.47  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income per share

   $ 4.82     $ 0.16     $ 4.33     $ 0.19  
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding

     27,544       27,322       27,403       26,973  
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash dividends per common share

   $ 0.07     $ 0.07     $ 0.21     $ 0.21  
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Includes the effects of discontinued operations (Note 2) and prior periods’ revisions (Note 1 and Note 15)

The accompanying notes are an integral part of the Condensed Consolidated Financial Statements.

 

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Table of Contents

NN, Inc.

Condensed Consolidated Balance Sheets

(Unaudited)

Amounts in thousands of dollars, except share data

 

     September 30,
2017
     December 31,
2016(1)
 

Assets

     

Current assets:

     

Cash and cash equivalents

   $ 347,380      $ 6,271  

Accounts receivable, net

     108,220        93,433  

Inventories

     76,641        67,137  

Income tax receivable

     —          872  

Current assets of discontinued operations

     —          106,717  

Other current assets

     20,194        6,997  
  

 

 

    

 

 

 

Total current assets

     552,435        281,427  

Property, plant and equipment, net

     238,809        230,580  

Goodwill, net

     443,496        441,402  

Intangible assets, net

     236,752        254,263  

Investment in joint venture

     37,739        36,008  

Non-current assets of discontinued operations

     —          103,290  

Other non-current assets

     8,279        9,602  
  

 

 

    

 

 

 

Total assets

   $ 1,517,510      $ 1,356,572  
  

 

 

    

 

 

 

Liabilities and Stockholders’ Equity

     

Current liabilities:

     

Accounts payable

   $ 48,330      $ 44,705  

Accrued salaries, wages and benefits

     17,362        15,762  

Income taxes payable

     65,989        —    

Current maturities of long-term debt

     21,090        12,751  

Current liabilities of discontinued operations

     —          45,421  

Other current liabilities

     22,233        20,849  
  

 

 

    

 

 

 

Total current liabilities

     175,004        139,488  

Deferred tax liabilities

     96,316        96,069  

Long-term debt, net of current portion

     793,999        785,713  

Non-current liabilities of discontinued operations

     —          11,960  

Other non-current liabilities

     10,887        12,829  
  

 

 

    

 

 

 

Total liabilities

     1,076,206        1,046,059  
  

 

 

    

 

 

 

Total stockholders’ equity

     441,304        310,513  
  

 

 

    

 

 

 

Total liabilities and stockholders’ equity

   $ 1,517,510      $ 1,356,572  
  

 

 

    

 

 

 

 

(1) Includes the effects of discontinued operations (Note 2) and prior periods’ revisions (Note 1 and Note 15)

The accompanying notes are an integral part of the Condensed Consolidated Financial Statements.

 

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NN, Inc.

Condensed Consolidated Statement of Changes in Stockholders’ Equity

(Unaudited)

Amounts in thousands of dollars and shares

 

     Common Stock                  Accumulated              
     Number            Additional           other     Non-        
     of     Par      paid in     Retained     comprehensive     controlling        
     shares     value      capital     earnings     income (loss)     interest     Total  

Balance, December 31, 2016(1)

     27,249     $ 272      $ 284,508     $ 55,509     $ (29,808   $ 32     $ 310,513  

Net income

     —         —          —         118,561       —         —         118,561  

Dividends paid

     —         —          —         (5,913     —         —         (5,913

Share-based compensation expense

     86       1        3,985       —         —         —         3,986  

Shares issued for option exercises

     250       2        2,943       —         —         —         2,945  

Sale of PBC business (Note 2)

     —         —          —         —         (9,243     (32     (9,275

Restricted shares forgiven for taxes
and forfeited

     (24     —          (580     —         —         —         (580

Foreign currency translation gain (loss)

     —         —          —         —         20,327       —         20,327  

Adoption of new accounting standard (Note 1)

     —         —          —         740       —         —         740  
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, September 30, 2017

     27,561     $ 275      $ 290,856       168,897     $ (18,724   $ —       $ 441,304  
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Includes the effects of prior periods’ revisions (Note 1 and Note 15)

The accompanying notes are an integral part of the Condensed Consolidated Financial Statements.

 

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NN, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

Amounts in thousands of dollars

 

     Nine Months Ended  
     September 30,  
     2017     2016  

Cash flows from operating activities:

    

Net income (loss)

   $ 118,561     $ 5,215  

Adjustments to reconcile net income to net cash provided by (used by) operating activities:

    

Depreciation and amortization

     38,432       38,411  

Depreciation and amortization of discontinued operations

     7,723       8,766  

Amortization of debt issuance costs

     3,237       3,048  

Write-off of debt issuance costs

     8,054       2,589  

Gain on disposal of discontinued operations, net of tax and cost to sell

     (129,353     —    

Compensation expense from issuance of share-based awards

     3,220       3,051  

Other

     439       421  

Changes in operating assets and liabilities:

    

Accounts receivable

     (15,094     (24,422

Inventories

     (10,764     1,663  

Accounts payable

     (3,317     629  

Income taxes payable

     (19,178     (2,153

Other

     (1,674     9,073  
  

 

 

   

 

 

 

Net cash provided by operating activities

     286       46,291  
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Acquisition of property, plant and equipment

     (31,674     (32,166

Proceeds from measurement period adjustments to previous acquisition

     —         1,635  

Proceeds from disposals of property, plant and equipment

     639       366  

Short term investment

     (8,000     —    

Proceeds from sale of business, net of cash sold

     371,436       —    
  

 

 

   

 

 

 

Net cash provided by (used by) investing activities

     332,401       (30,165
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Debt issue costs paid

     (6,545     (3,692

Dividends paid

     (5,764     (5,677

Proceeds from long-term debt

     317,000       39,000  

Repayment of long-term debt

     (301,313     (39,562

Proceeds from (repayment of) short-term debt, net

     (3,968     (4,101

Proceeds from issuance of stock and exercise of stock options

     2,945       2,553  

Shares withheld to satisfy income tax withholding

     (580     (159

Principal payments on capital leases

     (2,855     (3,465
  

 

 

   

 

 

 

Net cash used by financing activities

     (1,080     (15,103
  

 

 

   

 

 

 

Effect of exchange rate changes on cash flows

     1,368       (1,322

Net change in cash and cash equivalents

     332,975       (299

Cash and cash equivalents at beginning of period(1)

     14,405       15,087  
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

     347,380     $ 14,788  
  

 

 

   

 

 

 

 

(1) Beginning balance for the nine-month period ended September 30, 2017, includes $8.1 million of cash that was included in current assets of discontinued operations.

The accompanying notes are an integral part of the Condensed Consolidated Financial Statements.

 

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Table of Contents

NN, Inc.

Notes to Condensed Consolidated Financial Statements

September 30, 2017

(Unaudited)

Amounts in thousands of dollars and shares, except per share data

Note 1. Interim Financial Statements

Nature of Business

NN, Inc., a diversified industrial company, combines advanced engineering and production capabilities with in-depth materials science expertise to design and manufacture high-precision components and assemblies for a variety of markets on a global basis. As used in this Quarterly Report on Form 10-Q, the terms “NN,” the “Company,” “we,” “our,” or “us” refer to NN, Inc., and its subsidiaries. We have historically reported results of operations in three reportable segments: the Precision Bearing Components Group (“PBC”), the Precision Engineered Products Group (“PEP”), and the Autocam Precision Components Group (“APC”). On August 17, 2017, we sold our PBC business. Note 2 in these Notes to Condensed Consolidated Financial Statements provides further information on the sale of the PBC business. After the sale of the PBC business, we had 33 manufacturing facilities in North America, Europe, South America and China. We added three more North American manufacturing facilities in October 2017 (see Note 16 for information about our acquisition subsequent to September 30, 2017).

Basis of Presentation

The accompanying condensed consolidated financial statements have not been audited, except that the Condensed Consolidated Balance Sheet as of December 31, 2016, was derived from the audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2016 (the “2016 Annual Report”), which we filed with the U.S. Securities and Exchange Commission (the “SEC”), on March 16, 2017. Historical periods presented reflect reclassifications to reflect discontinued operations (see Note 2). Historical periods also reflect revisions that we disclosed in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2017 (see Note 15). In management’s opinion, the accompanying unaudited condensed consolidated financial statements reflect all adjustments necessary to fairly state our results of operations for the three-month and nine-month periods ended September 30, 2017 and 2016; financial position as of September 30, 2017, and December 31, 2016; and cash flows for the nine months ended September 30, 2017 and 2016, on a basis consistent with our audited consolidated financial statements. These adjustments are of a normal recurring nature and are, in the opinion of management, necessary to present fairly the Company’s financial position and operating results for the interim periods.

Certain information and footnote disclosures normally included in the consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted from the interim financial statements presented in this Quarterly Report on Form 10-Q. These unaudited condensed consolidated financial statements should be read in conjunction with our audited consolidated financial statements and accompanying notes included in the 2016 Annual Report. The results for the nine months ended September 30, 2017, are not necessarily indicative of results for the year ending December 31, 2017, or any other future periods. Certain prior year amounts have been reclassified to conform to the current year’s presentation.

Except for per share data or as otherwise indicated, all dollar amounts presented in the tables in these Notes to Condensed Consolidated Financial Statements are in thousands.

Prior Periods’ Financial Statement Revision

In connection with the preparation of condensed consolidated financial statements as of and for the three-month and six-month periods ended June 30, 2017, we identified misstatements in our previously issued financial statements related to the foreign currency translation of our investment in a China joint venture. We acquired a 49% investment in the joint venture as part of the acquisition of Autocam Corporation (“Autocam”) on August 29, 2014. We remeasured the investment in the joint venture to fair value at the time of the acquisition, and we have accounted for the investment under the equity method of accounting. Following the completion of the Autocam acquisition, we accounted for the investment in the joint venture in U.S. dollars whereas it should have been accounted for in the joint venture’s functional currency of the Chinese Renminbi in accordance with Accounting Standards Codification (“ASC”) Topic 830, Foreign Currency Matters. As a result, we did not correctly account for the investment in the joint venture and the related currency translation adjustment impacts.

We previously corrected as out-of-period adjustments certain immaterial misstatements and reflected them in the prior period financial statements, where applicable. These immaterial previously recorded out-of-period adjustments were primarily due to misstatements related to the initial recording of deferred tax assets and liabilities and corresponding adjustments to goodwill as part of the purchase price allocations of the Autocam and PEP acquisitions in 2014 and 2015, the accounting for the goodwill balances from those acquisitions for multi-currency reporting through other comprehensive income, and the mark-to-market adjustments on our interest rate hedge, net of tax, through other comprehensive income.

 

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We assessed the materiality of the misstatements on prior periods’ financial statements in accordance with SEC Staff Accounting Bulletin (“SAB”) Topic 1.M, Materiality, codified in ASC Topic 250, Accounting Changes and Error Corrections, (“ASC 250”) and concluded that the misstatements were not material to any prior annual or interim periods. In accordance with ASC 250 (SAB Topic 1.N, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements), we have corrected these misstatements for all prior periods presented by revising the condensed consolidated financial statements and other consolidated financial information included herein. We have revised, and will revise for annual and interim periods in future filings, certain amounts in the consolidated financial statements to correct these misstatements. See Note 15 for additional information on the revision.

Newly Adopted Accounting Standards

In March 2016, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) 2016-09, Improvements to Employee Share-Based Payment Accounting. The new standard changes how companies account for certain aspects of share-based payments to employees. Entities must recognize the income tax effects of awards in the statement of operations when the awards vest or are settled (i.e., additional paid-in capital pools were eliminated). The guidance changed regarding employers’ accounting for an employee’s use of shares to satisfy the employer’s statutory income tax withholding obligation and for forfeitures. The guidance was effective for public business entities for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. As of January 1, 2017, we adopted ASU 2016-09, and the effects of the standard are reflected in the three-month and nine-month periods ended September 30, 2017, balances. Upon adoption, we reclassified $0.7 million in historical tax benefits from deferred taxes to retained earnings. We will recognize prospective tax benefits in income tax expense. Tax payments in respect of shares withheld for taxes are now classified in the financing section of the statement of cash flows. The calculation of diluted earnings per share now excludes tax benefits that would have generated more dilutive shares. The effects of the adoption were not material to the financial statements.

Issuance of New Accounting Standards

Revenue Recognition. In May 2014, the FASB issued a new standard that provides a single, comprehensive revenue recognition model for all contracts with customers and supersedes most of the existing revenue recognition requirements. Under the new guidance, revenue is recognized when a customer obtains control of promised goods or services in an amount that reflects the consideration the entity expects to receive in exchange for those goods or services. The standard also requires disclosure of the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. Factors that will affect pre-and post-implementation include, but are not limited to, identifying all the contracts that exist and whether incidental obligations or marketing incentives included in some of those contracts are performance obligations. Additionally, we are evaluating the transfer of control of certain consignment contracts which may impact the timing of revenue recognition under the new standard.

The standard will be effective for us beginning January 1, 2018. We intend to adopt the standard utilizing the modified retrospective transition method. Under this transition method, we will recognize the cumulative effect of initially applying the new standard as an adjustment to the opening balance of retained earnings as of January 1, 2018, and will apply the new standard beginning with the most current period presented to contracts that are not completed at the date of initial application. We continue to evaluate the adoption method throughout each phase of implementation.

While our ability to adopt the standard using the modified retrospective method depends on system readiness and completing our analysis of information necessary to present required footnote disclosures in the consolidated financial statements, the implementation project remains on schedule. We have completed a diagnostic accounting assessment, including an analysis of a representative sample of contracts, to identify areas that will be most significantly impacted by implementation of the new standard. We have also completed initial training to educate contract managers of the technical aspects of the new standard. We are in the process of concluding on and documenting our assessments related to the standard as well as potential system and procedural changes. We are evaluating the impact the new standard will have on our financial condition, results of operations and cash flows. We expect to complete our final evaluation of the impact of adopting the new standard during 2017.

Leases. In February 2016, the FASB issued ASU 2016-02, Leases. ASU 2016-02 creates Topic 842, Leases, in the ASC and supersedes ASC 840, Leases. Entities that hold numerous equipment and real estate leases, in particular those with numerous operating leases, will be most affected by the new guidance. The lease accounting standard is effective for NN beginning January 1, 2019, with modified retrospective adoption required and early adoption permitted. The amendments in ASU 2016-02 are expected to impact balance sheets at many companies by adding lease-related assets and liabilities. This may affect compliance with contractual agreements and loan covenants. We have performed inquiries within segment locations and compiled information on operating and capital leases. We are currently evaluating the impacts of the lease accounting standard on our financial position, results of operations, and related disclosures.

 

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Statement of Cash Flows. In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments. This standard provides clarification on how certain cash receipts and cash payments are presented and classified on the statement of cash flows. The standard is effective for NN beginning January 1, 2018, and is required to be adopted using a retrospective approach if practicable, with early adoption permitted. We are in the process of assessing the effects of the standard on prior periods. We expect to complete our final evaluation of the impact of adopting the new standard during 2017. Although our analysis of the effects on prior periods is not yet complete, we have identified $31.6 million of cash paid for debt prepayment in April 2017 that is currently classified as an operating cash outflow. Under the new guidance, this $31.6 million will be classified as a financing cash outflow.

Goodwill. In January 2017, the FASB issued ASU 2017-04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, that eliminates the requirement to calculate the implied fair value of goodwill (i.e., Step 2 of the current goodwill impairment test) to measure a goodwill impairment charge. Instead, entities will record an impairment charge based on the excess of a reporting unit’s carrying amount over its fair value (i.e., measure the charge based on the current Step 1 test). The standard is effective for NN beginning with impairment tests performed on or after January 1, 2020, with early adoption permitted. We are currently evaluating the impact this new guidance is expected to have on our financial position or results of operations and related disclosures.

Note 2. Discontinued Operations

On August 17, 2017, we completed the sale of our PBC business to Tsubaki Nakashima, Co, Ltd. for a base purchase price of $375.0 million in cash, subject to certain adjustments. We expect to finalize purchase price adjustments in accordance with the purchase agreement. The PBC business included all our facilities that were engaged in the production of precision steel balls, steel rollers, and metal retainers and automotive specialty products used primarily in the bearing industry. The sale of the PBC business furthers management’s long-term strategy to build a diversified industrial business with a comprehensive geographic footprint in attractive high-growth market segments. The PBC business represented all of the PBC reportable segment disclosed in our historical financial statements. Under the terms of a transition services agreement, we will provide certain support services for twelve months from the closing date of the sale.

We received cash proceeds of $387.6 million and recorded an estimated after-tax gain on sale of $129.4 million, which is included in the “Income from discontinued operations, net of tax” line on the Condensed Consolidated Statements of Operations and Comprehensive Income for the three-month and nine-month periods ended September 30, 2017. The net amount of cash proceeds and gain are subject to change due to the finalization of working capital adjustments. The gain includes the effects of $9.3 million in cumulative foreign currency translation gain and non-controlling interest attributable to the PBC business as of August 17, 2017.

In accordance with ASC 205-20, Presentation of Financial Statements – Discontinued Operations, the operating results of PBC are classified as discontinued operations. The presentation of discontinued operations includes revenues and expenses of the discontinued operations and gain on the disposition of the business, net of tax, as one line item on the Condensed Consolidated Statements of Operations and Comprehensive Income. All Condensed Consolidated Statements of Operations and Comprehensive Income presented have been revised to reflect this presentation. Accordingly, results of the PBC business have been excluded from continuing operations and segment results for all periods presented in the condensed consolidated financial statements and the accompanying notes unless otherwise stated.

 

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Table of Contents

The following table summarizes the major line items included in the results of operations of the discontinued operations.

 

     Three Months Ended      Nine Months Ended  
     September 30,      September 30,  
     2017      2016      2017      2016  

Net sales

   $ 31,600      $ 58,247      $ 168,287      $ 188,149  

Cost of products sold (exclusive of depreciation and amortization shown separately below)

     26,070        45,353        130,554        145,426  

Selling, general and administrative expense

     2,466        4,146        11,589        13,211  

Depreciation and amortization

     1,611        2,956        7,723        8,766  

Restructuring and integration expense

     —          50        427        2,390  
  

 

 

    

 

 

    

 

 

    

 

 

 

Income from operations

     1,453        5,742        17,994        18,356  

Gain on disposal of discontinued operations

     215,280        —          215,280        —    

Other income (expense)

     (59      (98      (265      (325
  

 

 

    

 

 

    

 

 

    

 

 

 

Income (loss) from discontinued operations before provision (benefit) for income taxes

     216,674        5,644        233,009        18,031  

Provision for income taxes

     (80,849      (1,981      (86,430      (5,467
  

 

 

    

 

 

    

 

 

    

 

 

 

Income (loss) from discontinued operations, net of tax

     135,825        3,663        146,579        12,564  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

The following table summarizes the carrying amounts of major classes of assets and liabilities of discontinued operations for each of the periods presented.

 

     September 30,      December 31,  
     2017      2016  

Cash

   $ —        $ 8,134  

Accounts receivable, net

     —          46,114  

Inventories

     —          47,714  

Other current assets

     —          4,755  
  

 

 

    

 

 

 

Total current assets of discontinued operations

     —          106,717  
  

 

 

    

 

 

 

Property, plant and equipment, net

     —          92,373  

Goodwill, net

     —          8,909  

Intangible assets, net

     —          1,718  

Other non-current assets

     —          290  
  

 

 

    

 

 

 

Total non-current assets of discontinued operations

     —          103,290  
  

 

 

    

 

 

 

Total assets of discontinued operations

   $ —        $ 210,007  
  

 

 

    

 

 

 

Accounts payable

   $ —        $ 31,014  

Accrued salaries, wages and benefits

     —          9,234  

Income taxes payable

     —          2,997  

Other current liabilities

     —          2,176  
  

 

 

    

 

 

 

Total current liabilities of discontinued operations

     —          45,421  
  

 

 

    

 

 

 

Deferred tax liabilities

     —          3,522  

Accrued post-employment benefits

     —          4,707  

Other non-current liabilities

     —          3,731  
  

 

 

    

 

 

 

Total non-current liabilities of discontinued operations

     —          11,960  
  

 

 

    

 

 

 

Total liabilities of discontinued operations

   $ —        $ 57,381  
  

 

 

    

 

 

 

The following table presents the significant noncash items and cash paid for capital expenditures of discontinued operations for each period presented.

 

     Nine Months Ended  
     September 30,  
     2017      2016  

Depreciation and amortization

   $ 7,723      $ 8,766  

Acquisition of property, plant and equipment

   $ 10,024      $ 14,015  

 

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Note 3. Inventories

Inventories are comprised of the following amounts:

 

     September 30,      December 31,  
     2017      2016  

Raw materials

   $ 35,253      $ 36,081  

Work in process

     24,535        22,644  

Finished goods

     16,853        8,412  
  

 

 

    

 

 

 

Inventories

   $ 76,641      $ 67,137  
  

 

 

    

 

 

 

Inventories are stated at the lower of cost or net realizable value. Cost is determined using the average cost method. The inventory valuations above were developed using normalized production capacities for each manufacturing location. Any costs from abnormal excess capacity or underutilization of fixed production overheads are expensed in the period incurred and are not included as a component of inventory valuation.

Note 4. Net Income (Loss) Per Share

 

     Three Months Ended      Nine Months Ended  
     September 30,      September 30,  
     2017      2016      2017      2016  

Income (loss) from continuing operations

   $ (2,930    $ 792      $ (28,018    $ (7,349

Income from discontinued operations, net of tax

     135,825        3,663        146,579        12,564  
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income

   $ 132,895      $ 4,455      $ 118,561      $ 5,215  
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average shares outstanding

     27,544        27,159        27,403        26,973  

Effect of dilutive stock options

     —          163        —          —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted shares outstanding

     27,544        27,322        27,403        26,973  
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic income (loss) from continuing operations per share

   $ (0.11    $ 0.03      $ (1.02    $ (0.27

Basic income from discontinued operations per share

     4.93        0.13        5.35        0.47  
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic net income per share

   $ 4.82      $ 0.16      $ 4.33      $ 0.19  
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted income (loss) from continuing operations per share

   $ (0.11    $ 0.03      $ (1.02    $ (0.27

Diluted income from discontinued operations per share

     4.93        0.13        5.35        0.47  
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted net income per share

   $ 4.82      $ 0.16      $ 4.33      $ 0.19  
  

 

 

    

 

 

    

 

 

    

 

 

 

The calculations of diluted income from continuing operations per share for the three-month periods ended September 30, 2017 and 2016, exclude 0.8 million and 0.6 million potentially dilutive stock options, which had the effect of being anti-dilutive. The calculations of diluted income from continuing operations per share for the nine-month periods ended September 30, 2017 and 2016, exclude 0.8 million and 0.8 million potentially dilutive stock options, which had the effect of being anti-dilutive. Given the loss from continuing operations for the three-month and nine-month periods ended September 30, 2017, and for the nine-month period ended September 30, 2016, all options are considered anti-dilutive and were excluded from the calculation of diluted loss from continuing operations per share.

Note 5. Segment Information

The segment information and the accounting policies of each segment are the same as those described in the Notes to Consolidated Financial Statements entitled “Segment Information” and “Summary of Significant Accounting Policies and Practices,” respectively, included in our 2016 Annual Report. Our business has historically been aggregated into three reportable segments: PBC, APC, and PEP. See Note 2 for information regarding the sale of the PBC business on August 17, 2017. The results of the PBC business are classified as discontinued operations for all periods in the condensed consolidated financial statements and accompanying notes unless otherwise stated. Accordingly, results of the PBC business are not included in the tabular presentation below.

Within our APC segment, we manufacture highly engineered, difficult-to-manufacture precision metal components and sub-assemblies for the automotive and industrial end markets.

 

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Within our PEP segment, we combine materials science expertise with advanced engineering and production capabilities to design and manufacture a broad range of high-precision metal and plastic components, assemblies, and finished devices for the medical, electrical, automotive and aerospace end markets.

The following table presents results of continuing operations for each reportable segment. There were no significant inter-segment transactions during the three-month and nine-month periods ended September 30, 2017 and 2016.

 

     Autocam
Precision
Components
Group
     Precision
Engineered
Products
Group
     Corporate
and
Consolidations
     Total
Continuing
Operations
 

Three Months Ended September 30, 2017

           

Revenues from external customers

   $ 81,664      $ 66,492      $ —        $ 148,156  

Income (loss) from operations

   $ 6,799      $ 7,922      $ (8,425    $ 6,296  

Nine Months Ended September 30, 2017

           

Revenues from external customers

   $ 254,768      $ 208,890      $ —        $ 463,658  

Income (loss) from operations

   $ 28,088      $ 29,436      $ (25,230    $ 32,294  

Three Months Ended September 30, 2016

           

Revenues from external customers

   $ 80,492      $ 66,222      $ —        $ 146,714  

Income (loss) from operations

   $ 8,464      $ 9,913      $ (5,392    $ 12,985  

Nine Months Ended September 30, 2016

           

Revenues from external customers

   $ 247,473      $ 195,837      $ —        $ 443,310  

Income (loss) from operations

   $ 22,761      $ 26,116      $ (19,420    $ 29,457  

 

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Note 6. Debt

The following table presents debt balances as of September 30, 2017, and December 31, 2016.

 

     September 30,
2017
     December 31,
2016
 

$545.0 million Senior Secured Term Loan B (“Senior Secured Term Loan”) bearing interest at the greater of 0.75% or one-month LIBOR (1.23% at September 30, 2017), plus an applicable margin of 4.25% at September 30, 2017, expiring October 19, 2022

   $ 539,250      $ 543,563  

$300.0 million Incremental Term Loan (“Incremental Term Loan”) bearing interest at the greater of 0.75% or one-month LIBOR (1.23% at September 30, 2017), plus an applicable margin of 3.75% at September 30, 2017, expiring April 3, 2021

     294,000        —    

$143.0 million Senior Secured Revolver (“Senior Secured Revolver”) bearing interest at one-month LIBOR (1.23% at September 30, 2017) plus an applicable margin of 3.5% at September 30, 2017, expiring October 19, 2020

     —          27,977  

$250.0 million Senior Notes (“Senior Notes”) bearing interest at 10.25%

     —          250,000  

French Safeguard Obligations

     401        358  

Brazilian lines of credit and equipment notes

     327        573  

Chinese line of credit, bearing interest

     3,014        2,619  
  

 

 

    

 

 

 

Total

     836,992        825,090  

Less current maturities of long-term debt

     21,090        12,751  
  

 

 

    

 

 

 

Principal, net of current portion

     815,902        812,339  

Less unamortized debt issuance costs

     21,903        26,626  
  

 

 

    

 

 

 

Long-term debt, net of current portion

   $ 793,999      $ 785,713  
  

 

 

    

 

 

 

On April 3, 2017, we redeemed the Senior Notes for $281.6 million resulting in a loss on debt extinguishment of $36.3 million, including $31.6 million cash paid for the call premium and a $4.7 million non-cash write-off of unamortized debt issuance costs. The Senior Notes were redeemed and the call premium was paid with the proceeds of a new $300.0 million Incremental Term Loan that was added by amendment to the existing credit facility. The Incremental Term Loan bears interest at the lower of 0.75% or the one-month London Interbank Offered Rate (“LIBOR”), plus 3.75%, and matures on April 3, 2021, with payments of $3.0 million due quarterly. The amendment also reduced the Senior Secured Revolver from $143.0 million to $100.0 million until such time as a leverage ratio covenant threshold has been met for four consecutive fiscal quarters. Upon satisfaction of the ratio threshold, the Senior Secured Revolver may be restored to $143.0 million. In connection with the amendment, we paid $6.5 million in debt issuance costs of which we recorded $4.0 million as a direct reduction to the carrying amount of the associated debt and $2.5 million as a loss on modification of the Senior Secured Term Loan. Debt issuance costs related to the amendment were paid with proceeds from the Incremental Term Loan. Also in connection with the amendment, we wrote off $0.8 million of unamortized debt issuance costs related to the modification of the Senior Secured Revolver.

We used cash generated from operations and a portion of the cash proceeds from the sale of the PBC business to pay down the Senior Secured Revolver on August 17, 2017, which had a $33.2 million outstanding balance at that time. We continue to utilize the Senior Secured Revolver for daily working capital needs.

We assumed certain foreign credit facilities as part of the Autocam acquisition. These facilities relate to local borrowings in France, Brazil, and China. These facilities are with financial institutions in the countries in which foreign plants operate and are used to fund working capital and equipment purchases in those countries. Our 2016 Annual Report includes descriptions of these foreign credit facilities.

 

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Table of Contents

Note 7. Goodwill, Net

The following table shows changes in the carrying amount of goodwill, net, for the nine months ended September 30, 2017.

 

     Autocam
Precision
Components
Group
     Precision
Engineered
Products
Group
     Total  

Balance as of December 31, 2016

   $ 70,717      $ 370,685      $ 441,402  

Currency impacts

     736        1,358        2,094  
  

 

 

    

 

 

    

 

 

 

Balance as of September 30, 2017

   $ 71,453      $ 372,043      $ 443,496  
  

 

 

    

 

 

    

 

 

 

Goodwill is tested for impairment on an annual basis during the fourth quarter and more often if a triggering event occurs. As of September 30, 2017, there were no indications of impairment at the reporting units with goodwill balances.

Note 8. Intangible Assets, Net

The following table shows changes in the carrying amount of intangible assets, net, for the nine months ended September 30, 2017.

 

     Autocam
Precision
Components
Group
     Precision
Engineered
Products
Group
     Total  

Balance as of December 31, 2016

   $ 42,928      $ 211,335      $ 254,263  

Amortization

     (2,616      (14,900      (17,516

Currency impacts

     5        —          5  
  

 

 

    

 

 

    

 

 

 

Balance as of September 30, 2017

   $ 40,317      $ 196,435      $ 236,752  
  

 

 

    

 

 

    

 

 

 

Intangible assets are tested for impairment when changes in circumstances indicate the carrying value of those assets may not be recoverable. As of September 30, 2017, there were no indications of impairment at the reporting units with intangible asset balances.

Note 9. Shared-Based Compensation

The following table lists the components of share-based compensation expense for the three-month and nine-month periods ended September 30, 2017 and 2016, by type of award.

 

     Three Months Ended      Nine Months Ended  
     September 30,      September 30,  
     2017      2016      2017      2016  

Stock options

   $ 527      $ 185      $ 1,102      $ 679  

Restricted stock

     773        425        1,628        2,120  

Performance share units

     467        294        1,255        760  
  

 

 

    

 

 

    

 

 

    

 

 

 

Share-based compensation

   $ 1,767      $ 904      $ 3,985      $ 3,559  
  

 

 

    

 

 

    

 

 

    

 

 

 

Prior to the sale of the PBC business, our board of directors approved the acceleration of vesting of share-based awards to 19 members of PBC executive management in recognition of their service to the Company. The vesting date was accelerated to August 17, 2017, and the term was changed to two years for 58,094 option awards. The vesting date for 25,564 restricted stock awards was accelerated to August 17, 2017. We accounted for the acceleration of vesting as a modification of share-based awards. Accordingly, we recognized in discontinued operations approximately $0.8 million of incremental share-based compensation expense.

 

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Table of Contents

Stock Options

During the nine months ended September 30, 2017, we granted 125,700 option awards to officers and certain other key employees. The weighted average grant date fair value of options granted during the nine months ended September 30, 2017, was $11.84 per share. The fair value of these options cannot be determined by market value because the options are not traded in an open market. Accordingly, we utilized the Black Scholes financial pricing model to estimate the fair value. The following table shows the weighted average assumptions relevant to determining the fair value of the 2017 stock option grants.

 

     2017
Stock Option
Awards
 

Expected term

     6 years  

Risk free interest rate

     2.03

Dividend yield

     1.16

Expected volatility

     56.56

Expected forfeiture rate

     3.00

The following table provides a reconciliation of option activity for the nine months ended September 30, 2017.

 

            Weighted-      Weighted-         
            Average      Average         
            Exercise      Remaining      Aggregate  
            Price      Contractual      Intrinsic  

Options

   Shares (000)      (per share)      Term (years)      Value  

Outstanding at January 1, 2017

     897      $ 12.22        

Granted

     126        24.20        

Exercised

     (250      11.79        

Forfeited or expired

     (6      7.72        
  

 

 

    

 

 

       

Outstanding at September 30, 2017

     767      $ 14.32        6.5      $ 11,246 (1) 
  

 

 

    

 

 

    

 

 

    

 

 

 

Exercisable at September 30, 2017

     583      $ 12.71        5.7      $ 9,500 (1) 
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) The intrinsic value is the amount by which the market price of our stock was greater than the exercise price of any individual option grant at September 30, 2017.

Restricted Stock

During the nine months ended September 30, 2017, we granted 85,393 restricted stock awards to non-executive directors, officers and certain other key employees. The shares of restricted stock granted during the nine months ended September 30, 2017, vest pro-rata over three years for officers and certain other key employees and over one year for non-executive directors. We determined the fair value of the shares issued by using the closing price of our common stock as of the date of grant. The weighted average grant date value of restricted stock granted in the nine months ended September 30, 2017, was $24.29 per share.

Performance Share Units

During the nine months ended September 30, 2017, we granted 98,618 performance share units to officers and certain other key employees. The performance share units granted will be satisfied in the form of shares of common stock during 2020 if certain performance and/or market conditions are met. We recognize the compensation expense over the three-year period in which the performance and market conditions are measured. We determined the fair value per share of the performance share units issued by using the grant date closing price of our common stock for the units with a performance condition, or $24.20, and a Monte Carlo valuation model for the units that have a market condition, or $29.84.

 

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Table of Contents

Note 10. Income Taxes

Our effective tax rate from continuing operations was 26% and 31% for the three-month and nine-month periods ended September 30, 2017, respectively, and 93% and 51% for the three-month and nine-month periods ended September 30, 2016, respectively. The loss on extinguishment of Senior Notes impacted the 2017 tax rate and was treated as a discrete item during the second quarter of 2017. The 2016 effective rate was impacted by changes in forecasted income and loss and driven by the application of the three- and nine-month results against the permanent book to tax differences. The effective tax rates for 2017 and 2016 differ from the U.S. federal statutory tax rate of 35% due primarily to earnings outside the United States that are indefinitely reinvested and taxed at rates lower than the U.S. federal statutory rate.

Management believes that it is reasonably possible that the amount of unrecognized income tax benefits and interest may decrease during the next 12 months by approximately $0.6 million related to the expiration of the statutes of limitations, of which $0.5 million would reduce income tax expense.

During the third quarter of 2017, the Internal Revenue Service commenced an examination of the federal tax return for the pre-acquisition period of January 1, 2015 through October 19, 2015 for Precision Engineered Products.

Note 11. Commitments and Contingencies

Brazil ICMS Tax Matter

Prior to the Autocam acquisition, Autocam’s Brazilian subsidiary received notification from the Brazilian tax authorities regarding ICMS (state value added tax or VAT) tax credits claimed on intermediary materials (tooling and perishable items) used in the manufacturing process. The Brazilian tax authority notification disallowed state ICMS credits claimed on intermediary materials based on the argument that these items are not intrinsically related to the manufacturing processes. Autocam Brazil filed an administrative defense with the Brazilian tax authority arguing, among other matters, that it should qualify for an ICMS tax credit, contending that the intermediary materials are directly related to the manufacturing process.

We believe that we have substantial legal and factual defenses, and we plan to defend our interests in this matter vigorously. While we believe a loss is not probable, we estimate the range of possible losses related to this assessment is from $0 to $6.0 million. No amount was accrued at September 30, 2017, for this matter. There was no material change in the status of this matter from December 31, 2016 to September 30, 2017.

We are entitled to indemnification from the former shareholders of Autocam, subject to the limitations and procedures set forth in the agreement and plan of merger relating to the Autocam acquisition. Management believes the indemnification would include amounts owed for the tax, interest and penalties related to this matter.

All Other Legal Matters

All other legal proceedings are of an ordinary and routine nature and are incidental to our operations. Management believes that such proceedings should not, individually or in the aggregate, have a material adverse effect on our business, financial condition, results of operations or cash flows. In making that determination, we analyze the facts and circumstances of each case at least quarterly in consultation with our attorneys and determine a range of reasonably possible outcomes.

Note 12. Investment in Joint Venture

We own a 49% investment in a joint venture located in Wuxi, China, with an unrelated entity called Wuxi Weifu Autocam Precision Machinery Company, Ltd. (the “JV”). The JV is jointly controlled and managed, and we account for it under the equity method.

The following table summarizes activity related to our investment in the JV for the nine months ended September 30, 2017.

 

Balance as of December 31, 2016

   $ 36,008  

Our share of cumulative earnings

     4,481  

Dividends declared and paid by joint venture

     (4,156

Accretion of basis difference from purchase accounting

     (342

Foreign currency translation gain

     1,748  
  

 

 

 

Balance as of September 30, 2017

   $ 37,739  
  

 

 

 

 

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Table of Contents

The following table summarizes balance sheet information of the JV itself.

 

     September 30,
2017
     December 31,
2016
 

Current assets

   $ 41,367      $ 31,295  

Non-current assets

     29,176        22,522  
  

 

 

    

 

 

 

Total assets

   $ 70,543      $ 53,817  
  

 

 

    

 

 

 

Current liabilities

   $ 26,746      $ 13,549  
  

 

 

    

 

 

 

Total liabilities

   $ 26,746      $ 13,549  
  

 

 

    

 

 

 

We recognized sales to the JV of less than $0.1 million and approximately $0.2 million during the three-month and nine-month periods ended September 30, 2017. Amounts due to us from the JV were less than $0.1 million as of September 30, 2017, and are included in accounts receivable.

Note 13. Fair Value Measurements

Fair value is an exit price representing the expected amount that an entity would receive to sell an asset or pay to transfer a liability in an orderly transaction with market participants at the measurement date. We followed consistent methods and assumptions to estimate fair values as more fully described in the 2016 Annual Report.

Our financial instruments that are subject to fair value disclosure consist of cash and cash equivalents, accounts receivable, accounts payable, derivatives and long-term debt. As of September 30, 2017, the carrying values of these financial instruments approximated fair value. The fair value of floating-rate debt approximates the carrying amount because the interest rates paid are based on short-term maturities. As of September 30, 2017, we had no fixed-rate debt outstanding.

Fair value principles prioritize valuation inputs across three broad levels. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument. Level 3 inputs are unobservable inputs based on the assumptions used to measure assets and liabilities at fair value. An asset or liability’s classification within the various levels is determined based on the lowest level input that is significant to the fair value measurement.

The following table summarizes assets and liabilities measured at fair value on a recurring basis for the interest rate swap derivative financial instrument:

 

            Fair Value Measurements at September 30, 2017  

Description

   September 30,
2017
     Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable
Inputs (Level 3)
 

Derivative asset - current

   $ 10        —        $ 10        —    

Derivative asset - noncurrent

     —          —          —          —    

Derivative liability - current

     (1,479      —          (1,479      —    

Derivative liability - noncurrent

     —          —          —          —    
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ (1,469      —        $ (1,469      —    
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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            Fair Value Measurements at December 31, 2016  

Description

   December 31,
2016
     Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable
Inputs (Level 3)
 

Derivative asset - current

   $ 69      $ —        $ 69      $ —    

Derivative asset - noncurrent

     6        —          6        —    

Derivative liability - current

     (1,903      —          (1,903      —    

Derivative liability - noncurrent

     (1,028      —          (1,028      —    
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ (2,856    $ —        $ (2,856    $ —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Our policy is to manage interest expense using a mix of fixed and variable rate debt. To manage this mix effectively, we may enter into interest rate swaps to exchange the difference between fixed and variable interest amounts.

The inputs for determining fair value of the interest rate swap are classified as Level 2 inputs. Level 2 fair value is based on estimates using standard pricing models. These standard pricing models use inputs which are derived from or corroborated by observable market data such as interest rate yield curves, index forward curves, discount curves, and volatility surfaces. Counterparties to these derivative contracts are highly rated financial institutions which management believes carry only a minimal risk of nonperformance.

We have elected to present the derivative contracts on a gross basis in the Condensed Consolidated Balance Sheets included within other current assets, other non-current assets, other current liabilities and other non-current liabilities. If the derivative contract were presented on a net basis, the derivative would reflect in a net liability position of $1.5 million as of September 30, 2017. We do not have any cash collateral due under such agreements.

As of September 30, 2017, we had no gains or losses in accumulated other comprehensive income related to the interest rate swap. Additionally, during the nine months ended September 30, 2016, when the interest rate swap was accounted for in accordance with hedge accounting, the periodic settlements and related reclassification of other comprehensive income was $1.4 million of net hedging losses on the interest rate swap in the interest expense line on the Condensed Consolidated Statements of Operations and Comprehensive Income. The “Derivative loss (gain) on change in interest rate swap fair value” line on the Condensed Consolidated Statements of Operations and Comprehensive Income includes interest rate swap settlements of $0.3 million and $1.3 million for the three-month and nine-month periods ended September 30, 2017, and $0.6 million for the three-month and nine-month periods ended September 30, 2016. Effective October 27, 2017, we terminated our interest rate swap with a cash payment of $1.3 million. Therefore, we classified all amounts related to the interest rate swap as current assets and current liabilities on our balance sheet as of September 30, 2017.

Note 14. Restructuring and Integration

We recognized restructuring and integration costs totaling $0.3 million and $0.4 million in the three-month and nine-month periods ended September 30, 2017. We recognized restructuring and integration costs totaling $0.6 million and $4.9 million in the three-month and nine-month periods ended September 30, 2016.

Within APC, certain restructuring programs that included the closure of one facility, the Wheeling Plant, resulted in a charge of $0.3 million and $0.4 million for the three-month and nine-month periods ended September 30, 2017, and $0.3 million and $3.9 million for the three-month and nine-month periods ended September 30, 2016.

Within PEP, initiatives resulted in integration, site closure and employee costs of $0.3 million and $1.0 million for the three-month and nine-month periods ended September 30, 2016. There were no charges in the three-month and nine-month periods ended September 30, 2017.

 

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The following table summarizes restructuring and integration activity related to actions incurred for the three-month and nine-month periods ended September 30, 2017 and 2016.

 

     Three Months Ended      Nine Months Ended  
     September 30,      September 30,  
     2017      2016      2017      2016  

Severance and other costs

   $ —        $ 228      $ 17      $ 1,535  

Site closure and other associated costs

   $ 345      $ 378      $ 345      $ 3,316  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 345      $ 606      $ 362      $ 4,851  
  

 

 

    

 

 

    

 

 

    

 

 

 
     Reserve
Balance at
December 31, 2016
     Charges      Paid in
2017
     Reserve
Balance at
September 30, 2017
 

Severance and other costs

   $ 1,000      $ 17      $ (1,017    $ —    

Site closure and other associated costs

     1,625        345        (730      1,240  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,625      $ 362      $ (1,747    $ 1,240  
  

 

 

    

 

 

    

 

 

    

 

 

 

We are still identifying restructuring and impairment costs at our segments; therefore, we are not able to estimate the ultimate costs at this time. Future filings will include updates to these activities along with a reconciliation of beginning and ending liabilities. We expect to pay $1.0 million of the reserve balance remaining at September 30, 2017, within the next twelve months. The remaining reserve of $0.2 million is expected to be paid in 2018 and 2019.

Note 15. Prior Periods’ Financial Statement Revision

As described in Note 1 in these Notes to Condensed Consolidated Financial Statements, we corrected misstatements for all prior periods presented by revising the Condensed Consolidated Financial Statements and other financial information included herein. We have not revised Consolidated Statements of Cash Flows for any periods. The amounts presented below for prior periods were reported before the PBC business qualified as discontinued operations and therefore include the results of the PBC business.

The following tables present the effect of the revision on the Condensed Consolidated Statements of Operations.

 

     Year Ended December 31, 2016  
     As Previously
Reported
     Adjustment      As Revised  

Selling, general and administrative expense

   $ 80,266      $ (37    $ 80,229  

Income from operations

     59,400        37        59,437  

Write-off of unamortized debt issuance costs

     3,089        (500      2,589  

Income (loss) before provision (benefit) for income
taxes and share of net income from joint venture

     (7,309      537        (6,772

Provision (benefit) for income taxes

     (9,313      1,180        (8,133

Net income (loss)

     7,942        (643      7,299  

Basic net income (loss) per share

   $ 0.29      $ (0.02    $ 0.27  

Diluted net income (loss) per share

   $ 0.29      $ (0.02    $ 0.27  

 

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Table of Contents
     Three Months Ended     Nine Months Ended  
     September 30, 2016     September 30, 2016  
     As Previously
Reported
    Adjustment     As Revised     As Previously
Reported
    Adjustment     As Revised  

Selling, general and administrative expense

   $ 18,347     $ —         18,347     $ 60,651     $ (509   $ 60,142  

Income from operations

     18,727       —         18,727       47,304       509       47,813  

Interest expense

     16,337       (466     15,871       48,924       —         48,924  

Income (loss) before provision (benefit) for income taxes and share of net income from joint venture

     (3,703     466       (3,237     (5,760     509       (5,251

Provision (benefit) for income taxes

     (6,423     158       (6,265     (6,469     173       (6,296

Net income

     4,147       308       4,455       4,879       336       5,215  

Basic net income per share

   $ 0.15     $ 0.01     $ 0.16     $ 0.18     $ 0.01     $ 0.19  

Diluted net income per share

   $ 0.15     $ 0.01     $ 0.16     $ 0.18     $ 0.01     $ 0.19  

 

     Three Months Ended  
     March 31, 2016  
     As Previously
Reported
     Adjustment      As Revised  

Selling, general and administrative expense

   $ 20,712      $ 90      $ 20,802  

Income (loss) from operations

     11,874        (90      11,784  

Loss before benefit for income taxes and share of net income from joint venture

     (3,419      (90      (3,509

Benefit for income taxes

     (720      (31      (751

Net loss

     (1,299      (59      (1,358

Basic net loss per share

   $ (0.05    $ —        $ (0.05

Diluted net loss per share

   $ (0.05    $ —        $ (0.05
     Year Ended December 31, 2015  
     As Previously
Reported
     Adjustment      As Revised  

Selling, general and administrative expense

   $ 51,745      $ 37      $ 51,782  

Income (loss) from operations

     26,797        (37      26,760  

Write-off of unamortized debt issuance costs

     18,673        500        19,173  

Income (loss) before provision (benefit) for income taxes and share of net income from joint venture

     (22,950      (537      (23,487

Provision (benefit) for income taxes

     (10,518      (1,180      (11,698

Net income (loss)

     (7,431      643        (6,788

Basic net income (loss) per share

   $ (0.35    $ 0.03      $ (0.32

Diluted net income (loss) per share

   $ (0.35    $ 0.03      $ (0.32

 

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The following tables present the effect of the revision on the Condensed Consolidated Statements of Comprehensive Income (Loss).

 

     Three Months Ended  
     March 31, 2017  
     As Previously
Reported
     Adjustment      As Revised  

Net income

   $ 7,407      $ —        $ 7,407  

Foreign currency translation gain

     4,706        298        5,004  
  

 

 

    

 

 

    

 

 

 

Other comprehensive income

     4,706        298        5,004  
  

 

 

    

 

 

    

 

 

 

Comprehensive income

   $ 12,113      $ 298      $ 12,411  
  

 

 

    

 

 

    

 

 

 
     Year Ended December 31, 2016  
     As Previously
Reported
     Adjustment      As Revised  

Net income (loss)

   $ 7,942      $ (643    $ 7,299  

Change in fair value of interest rate hedge

     3,015        (1,105      1,910  

Foreign currency translation loss

     (8,984      (743      (9,727
  

 

 

    

 

 

    

 

 

 

Other comprehensive loss

     (5,969      (1,848      (7,817
  

 

 

    

 

 

    

 

 

 

Comprehensive income (loss)

   $ 1,973      $ (2,491    $ (518
  

 

 

    

 

 

    

 

 

 

 

     Three Months Ended     Nine Months Ended  
     September 30, 2016     September 30, 2016  
     As Previously
Reported
     Adjustment     As Revised     As Previously
Reported
     Adjustment     As Revised  

Net income

   $ 4,147      $ 308     $ 4,455     $ 4,879      $ 336     $ 5,215  

Change in fair value of interest rate hedge

     4,211        (1,967     2,244       3,130        (1,105     2,025  

Foreign currency translation gain (loss)

     382        (760     (378     4,176        (2,402     1,774  
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Other comprehensive income (loss)

     4,593        (2,727     1,866       7,306        (3,507     3,799  
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Comprehensive income (loss)

   $ 8,740      $ (2,419   $ 6,321     $ 12,185      $ (3,171   $ 9,014  
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

 

     Three Months Ended  
     March 31, 2016  
     As Previously
Reported
     Adjustment      As Revised  

Net income

   $ (1,299    $ (59    $ (1,358

Change in fair value of interest rate hedge

     (1,002      367        (635

Foreign currency translation gain

     6,719        504        7,223  
  

 

 

    

 

 

    

 

 

 

Other comprehensive income

     5,717        871        6,588  
  

 

 

    

 

 

    

 

 

 

Comprehensive income

   $ 4,418      $ 812      $ 5,230  
  

 

 

    

 

 

    

 

 

 

 

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Table of Contents
     Year Ended December 31, 2015  
     As Previously
Reported
     Adjustment      As Revised  

Net income (loss)

   $ (7,431    $ 643      $ (6,788

Change in fair value of interest rate hedge

     (2,584      947        (1,637

Foreign currency translation loss

     (21,936      (3,075      (25,011
  

 

 

    

 

 

    

 

 

 

Other comprehensive loss

     (24,520      (2,128      (26,648
  

 

 

    

 

 

    

 

 

 

Comprehensive loss

   $ (31,951    $ (1,485    $ (33,436
  

 

 

    

 

 

    

 

 

 
     Year Ended December 31, 2014  
     As Previously
Reported
     Adjustment      As Revised  

Net income

   $ 8,217      $ —        $ 8,217  

Change in fair value of interest rate hedge

     (431      158        (273

Foreign currency translation loss

     (17,731      (868      (18,599
  

 

 

    

 

 

    

 

 

 

Other comprehensive loss

     (18,162      (710      (18,872
  

 

 

    

 

 

    

 

 

 

Comprehensive loss

   $ (9,945    $ (710    $ (10,655
  

 

 

    

 

 

    

 

 

 

The following tables present the effect of the revision on the Condensed Consolidated Balance Sheets.

 

     As of March 31, 2017  
     As Previously
Reported
     Adjustment      As Revised  

Investment in joint venture

   $ 42,387      $ (4,388    $ 37,999  

Total assets

     1,391,043        (4,388      1,386,655  

Accumulated other comprehensive loss

     (20,416      (4,388      (24,804

Total stockholders’ equity

     327,879        (4,388      323,491  

Total liabilities and stockholders’ equity

     1,391,043        (4,388      1,386,655  
     As of December 31, 2016  
     As Previously
Reported
     Adjustment      As Revised  

Investment in joint venture

   $ 40,694      $ (4,686    $ 36,008  

Total assets

     1,360,386        (4,686      1,355,700  

Accumulated other comprehensive income

     (25,122      (4,686      (29,808

Total stockholders’ equity

     315,199        (4,686      310,513  

Total liabilities and stockholders’ equity

     1,360,386        (4,686      1,355,700  

 

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Table of Contents
     As of December 31, 2015  
     As Previously
Reported
     Adjustment      As Revised  

Current deferred tax assets

   $ 6,696      $ 3,707      $ 10,403  

Total current assets

     280,181        3,707        283,888  

Property, plant and equipment, net

     318,968        (329      318,639  

Goodwill, net

     449,898        5,072        454,970  

Investment in joint venture

     38,462        (2,212      36,250  

Total assets

     1,380,567        6,238        1,386,805  

Accrued salaries, wages and benefits

     21,125        (300      20,825  

Income taxes payable

     5,350        44        5,394  

Total current liabilities

     133,351        (256      133,095  

Non-current deferred tax liabilities

     117,459        8,176        125,635  

Other liabilities

     4,746        178        4,924  

Total liabilities

     1,066,686        8,098        1,074,784  

Additional paid-in capital

     277,582        335        277,917  

Retained earnings

     55,151        643        55,794  

Accumulated other comprehensive income

     (19,153      (2,839      (21,992

Total stockholders’ equity

     313,881        (1,861      312,020  

Total liabilities and stockholders’ equity

     1,380,567        6,238        1,386,805  

The following tables present the effect of the revision on our Condensed Consolidated Statements of Changes in Stockholders’ Equity.

 

     As Previously
Reported
     Adjustment      As Revised  

As of and for the year ended December 31, 2014

        

Change in fair value of interest rate hedge

   $ (431    $ 158      $ (273

Foreign currency translation loss

     (17,731      (868      (18,599

Accumulated other comprehensive income (loss)

     5,367        (710      4,657  

Total stockholders’ equity

     173,699        (710      172,989  

As of and for the year ended December 31, 2015

        

Net income (loss)

   $ (7,431    $ 643      $ (6,788

Change in fair value of interest rate hedge

     (2,584      947        (1,637

Foreign currency translation loss

     (21,936      (3,075      (25,011

Accumulated other comprehensive loss

     (19,153      (2,839      (21,992

Additional paid-in capital

     277,582        335        277,917  

Total stockholders’ equity

     313,881        (1,861      312,020  

As of and for the year ended December 31, 2016

        

Net income (loss)

   $ 7,942      $ (643    $ 7,299  

Change in fair value of interest rate hedge

     3,015        (1,105      1,910  

Foreign currency translation loss

     (8,984      (743      (9,727

Accumulated other comprehensive loss

     (25,122      (4,686      (29,808

Total stockholders’ equity

     315,199        (4,686      310,513  

As of and for the three months ended March 31, 2017

 

     

Foreign currency translation gain

   $ 4,706        298      $ 5,004  

Accumulated other comprehensive loss

     (20,416      (4,388      (24,804

Total stockholders’ equity

     327,879        (4,388      323,491  

 

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Note 16. Subsequent Events

DRT Medical Acquisition

On October 2, 2017, we acquired 100% of the membership interests of DRT Medical, LLC, (“DRT Medical”) for $38.6 million in cash, subject to certain post-closing adjustments. DRT Medical is a supplier of precision manufactured medical instruments and orthopedic implants with locations in Ohio and Pennsylvania. Operating results of DRT Medical will be reported prospectively in our PEP segment. The effects of this acquisition are not reflected in the condensed consolidated financial statements presented in this Quarterly Report on Form 10-Q because the acquisition occurred subsequent to September 30, 2017. We are in the process of analyzing the opening balance sheet and purchase price allocation. We incurred approximately $0.6 million in acquisition related costs, primarily with respect to DRT Medical, during the three-month and nine-month periods ended September 30, 2017.

Interest Rate Swap

Effective October 27, 2017, we terminated our interest rate swap with a cash payment of $1.3 million.

 

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Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

NN, Inc., a diversified industrial company, combines advanced engineering and production capabilities with in-depth materials science expertise to design and manufacture high-precision components and assemblies for a variety of markets on a global basis. As used in this Quarterly Report on Form 10-Q, the terms “NN,” the “Company,” “we,” “our,” or “us” refer to NN, Inc., and its subsidiaries. We have historically reported results of operations in three reportable segments: the Precision Bearing Components Group (“PBC”), the Precision Engineered Products Group (“PEP”), and the Autocam Precision Components Group (“APC”). On August 17, 2017, we sold our PBC business. The Results of Operations section below and Note 2 in these Notes to Condensed Consolidated Financial Statements provide further information on the sale of the PBC business. After the sale, we had 33 manufacturing facilities in North America, Europe, South America and China. We added three more North American manufacturing facilities in October 2017 (see the subsequent event described in the “Results of Operations” section below for more information about our acquisition subsequent to September 30, 2017).

Forward-Looking Statements

This Quarterly Report on Form 10-Q 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, competitive influences, risks that current customers will commence or increase captive production, risks of capacity underutilization, quality issues, availability of raw materials, currency and other risks associated with international trade, our dependence on certain major customers, the impact of acquisitions and divestitures, unanticipated difficulties integrating acquisitions, new laws and governmental regulations, 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 section titled “Item 1A. Risk Factors” in our 2016 Annual Report on Form 10-K for the fiscal year ended December 31, 2016, which we filed with the SEC on March 16, 2017 (the “2016 Annual 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-month and nine-month periods ended September 30, 2017, that management believes are important to provide an understanding of the business and results of operations.

Discontinued Operations

On August 17, 2017, we completed the sale of our PBC business to Tsubaki Nakashima, Co, Ltd. for a base purchase price of $375.0 million in cash, subject to certain adjustments. We expect to finalize purchase price adjustments in accordance with the purchase agreement. The PBC business included all our facilities that were engaged in the production of precision steel balls, steel rollers, and metal retainers and automotive specialty products used primarily in the bearing industry. The PBC business represented all of the PBC reportable segment disclosed in our historical financial statements.

The sale of the PBC business furthers management’s long-term strategy to build a diversified industrial business with a comprehensive geographic footprint in attractive high-growth market segments. We intend to deploy the proceeds into higher-growth, higher-margin end markets, while also accelerating our focus on paying down debt.

We received cash proceeds of $387.6 million and recorded an estimated after-tax gain on sale of $129.4 million, which is included in the “Income from discontinued operations, net of tax” line on the Condensed Consolidated Statements of Operations and Comprehensive Income for the three-month and nine-month periods ended September 30, 2017. The net amount of cash proceeds and gain are subject to change due to the finalization of working capital adjustments.

 

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In accordance with ASC 205-20, Presentation of Financial Statements – Discontinued Operations, the operating results of PBC are classified as discontinued operations. The presentation of discontinued operations includes revenues and expenses of the discontinued operations and gain on the disposition of the business, net of tax, as one line item on the Condensed Consolidated Statements of Operations and Comprehensive Income. All Condensed Consolidated Statements of Operations and Comprehensive Income presented have been revised to reflect this presentation. Accordingly, results of the PBC business have been excluded from continuing operations and segment results for all periods presented in the condensed consolidated financial statements and the accompanying notes unless otherwise stated. Refer to Note 2 in the Notes to Condensed Consolidated Financial Statements for more information.

Debt Refinancing

On April 3, 2017, we redeemed the Senior Notes for $281.6 million resulting in a loss on debt extinguishment of $36.3 million, including $31.6 million cash paid for the call premium and a $4.7 million non-cash write-off of unamortized debt issuance costs. The Senior Notes were redeemed and the call premium was paid with the proceeds of a new $300.0 million Incremental Term Loan that was added by amendment to the existing credit facility. The Incremental Term Loan bears interest at the lower of 0.75% or one-month LIBOR, plus 3.75%, and matures on April 3, 2021, with payments of $3.0 million due quarterly. The amendment also reduced the Senior Secured Revolver from $143.0 million to $100.0 million until such time as a leverage ratio covenant threshold has been met for four consecutive fiscal quarters. Upon satisfaction of the ratio threshold, the Senior Secured Revolver may be restored to $143.0 million. In connection with the amendment, we paid $6.5 million in debt issuance costs of which we recorded $4.0 million as a direct reduction to the carrying amount of the associated debt and $2.5 million as a loss on modification of the Senior Secured Term Loan. Debt issuance costs related to the amendment were paid with proceeds from the Incremental Term Loan. Also in connection with the amendment, we wrote off $0.8 million of unamortized debt issuance costs related to the modification of the Senior Secured Revolver.

Prior Periods’ Financial Statement Revision

Certain prior period amounts have been revised to reflect the impact of adjustments made to our joint venture investment and to correct the timing of previously recorded out-of-period adjustments. Refer to Note 1 and Note 15 in the Notes to Condensed Consolidated Financial Statements for more information.

Subsequent Events

DRT Medical Acquisition. On October 2, 2017, we acquired 100% of the membership interests of DRT Medical, LLC, (“DRT Medical”) for $38.6 million in cash, subject to certain post-closing adjustments. DRT Medical is a supplier of precision manufactured medical instruments and orthopedic implants with locations in Ohio and Pennsylvania. Operating results of DRT Medical will be reported prospectively in our PEP segment. The effects of this acquisition are not reflected in the condensed consolidated financial statements presented in this Quarterly Report on Form 10-Q because the acquisition occurred subsequent to September 30, 2017. We are in the process of analyzing the opening balance sheet and purchase price allocation. We incurred approximately $0.6 million in acquisition related costs, primarily with respect to DRT Medical, during the three-month and nine-month periods ended September 30, 2017.

Interest Rate Swap. Effective October 27, 2017, we terminated our interest rate swap with a cash payment of $1.3 million.

 

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Three Months Ended September 30, 2017, Compared to the Three Months Ended September 30, 2016

Overall Consolidated Results

 

     Three Months Ended September 30,  
     2017      2016      $ Change  

Net sales

   $ 148,156      $ 146,714      $ 1,442     

Volume

            $ 314  

Foreign exchange effects

              745  

Price/material inflation pass-through/mix

              383  

Cost of products sold (exclusive of depreciation and amortization shown separately below)

     110,836        107,185        3,651     

Volume

              480  

Foreign exchange effects

              604  

Mix

              2,309  

Inflation

              522  

Cost reduction projects/other

              (264

Selling, general and administrative expense

     16,985        14,201        2,784     

Acquisition related costs excluded from selling, general and administrative expense

     619        —          619     

Depreciation and amortization

     13,075        11,737        1,338     

Restructuring and integration expense

     345        606        (261   
  

 

 

    

 

 

    

 

 

    

Income from operations

     6,296        12,985        (6,689   

Interest expense

     12,739        15,801        (3,062   

Loss on extinguishment of debt and write-off of unamortized debt issuance costs

     —          2,589        (2,589   

Derivative payments (receipts) on interest rate swap

     —          609        (609   

Derivative loss (gain) on change in interest rate swap fair value

     (27      3,130        (3,157   

Other (income) expense, net

     (848      (263      (585   
  

 

 

    

 

 

    

 

 

    

Loss from continuing operations before benefit for income taxes and share of net income from joint venture

     (5,568      (8,881      3,313     

Benefit for income taxes

     1,436        8,246        (6,810   

Share of net income from joint venture

     1,202        1,427        (225   
  

 

 

    

 

 

    

 

 

    

Income (loss) from continuing operations

     (2,930      792        (3,722   

Income from discontinued operations, net of tax

     135,825        3,663        132,162     
  

 

 

    

 

 

    

 

 

    

Net income

   $ 132,895      $ 4,455      $ 128,440     
  

 

 

    

 

 

    

 

 

    

Net Sales. Net sales increased during the third quarter of 2017 from the third quarter of 2016, principally due to foreign exchange effects of the Brazilian real and the euro, each of which appreciated compared to the dollar. Overall, sales were ahead of the prior year by $1.2 million for APC and $0.3 million for PEP as demand for automotive products related to Corporate Average Fuel Economy (“CAFE”) efforts continued to rise.

Cost of Products Sold. The increase in cost of products sold was primarily due to a shift in product mix toward products using higher cost raw materials. An increase in demand for CAFE products and start-up costs for certain new products also contributed to the increase in cost of products sold. Additionally, increases were partially offset by cost savings from production process improvement projects.

Selling, General and Administrative Expense. The majority of the increase for the third quarter of 2017 from the third quarter of 2016 was due to infrastructure and staffing costs incurred related to our strategic initiatives, including a global implementation of an enterprise resource planning (“ERP”) system.

Acquisition Related Costs Excluded from Selling, General and Administrative Expense. Acquisition related costs are primarily third party legal, accounting, valuation consulting and investment banking advisory fees incurred related to the DRT Medical acquisition.

Interest Expense. Interest expense decreased by $3.1 million primarily due to the redemption of the Senior Notes at the beginning of the second quarter of 2017 with the proceeds of the Incremental Term Loan, which bears a lower interest rate based on LIBOR.

 

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     Three Months Ended
September 30,
 
     2017      2016  

Interest on debt

   $ 11,591      $ 14,477  

Interest rate swaps settlements

     —          466  

Amortization of debt issuance costs

     1,084        1,062  

Capital lease interest

     286        213  

Capitalized interest (1)

     (222      (417
  

 

 

    

 

 

 

Total interest expense

   $ 12,739      $ 15,801  
  

 

 

    

 

 

 

Debt issuance costs write-off

     —          2,589  
  

 

 

    

 

 

 

 

(1) Capitalized interest primarily relates to equipment construction efforts at various plants.

Loss on Extinguishment of Debt and Write-off of Unamortized Debt Issuance Costs. In September 2016, we amended and restated our credit facility, and consequently we wrote off a total of $2.6 million in debt issuance costs related to the modification and extinguishment of debt.

Derivative Loss (Gain) on Change in Interest Rate Swap Fair Value. During the third quarter of 2016, we chose to discontinue hedge accounting. As a result, all amounts of accumulated other comprehensive income were reclassified to earnings.

Benefit for Income Taxes. Our effective tax rate from continuing operations was 26% in the third quarter of 2017 compared to 93% in the third quarter of 2016. Note 10 in the Notes to Condensed Consolidated Financial Statements describes effective tax rates for each period presented.

Income (Loss) from Continuing Operations. The $6.7 million decrease in income from operations was the primary reason for the $3.7 million decrease in income from continuing operations in the third quarter of 2017. In addition, the increase in net sales was offset by increases in cost of products sold and selling, general and administrative expense as described above. Also, acquisition related costs, primarily with respect to DRT Medical, accounted for $0.6 million of the decrease in income from operations compared to the third quarter of 2016. This decrease in income from operations was partially offset by a $3.1 million reduction in interest expense.

Income from Discontinued Operations, Net of Tax. The largest component of income from discontinued operations in the third quarter of 2017 was the $129.4 million gain on sale of our PBC business, net of tax. Note 2 in the Notes to Condensed Consolidated Financial Statements provides details of the results of discontinued operations.

Results by Segment

AUTOCAM PRECISION COMPONENTS GROUP

Within our APC segment, we manufacture highly engineered, difficult-to-manufacture precision metal components and sub-assemblies for the automotive, and industrial end markets.

 

     Three Months Ended September 30,  
     2017      2016      $ Change  

Net sales

   $ 81,664      $ 80,492      $ 1,172     

Volume

            $ 1,049  

Foreign exchange effects

              652  

Price/material inflation pass-through/mix

              (529

Income from operations

   $ 6,799      $ 8,464      $ (1,665   

Net sales increased during the third quarter of 2017 from the third quarter of 2016 due to industrial market demand improvements in the US and China and new automotive program launches in the US, China and Brazil. We are realizing the indirect benefits of our customers taking an increasing portion of market share in a key general industrial market. Also, as the Brazilian economy rebounds, demand for automotive products is increasing. During the third quarter of 2017, 63% of APC sales were in the US, 12% of APC sales were in China, and 11% of APC sales were in Brazil.

 

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Income from operations decreased due to various factors including an increase in cost of products sold of $1.2 million, consistent with the increase in sales and due to a shift in product mix toward products using higher cost raw materials. We incurred start-up costs related to new product launches during the third quarter of 2017.

PRECISION ENGINEERED PRODUCTS GROUP

Within our PEP segment, we combine materials science expertise with advanced engineering and production capabilities to design and manufacture a broad range of high-precision metal and plastic components, assemblies, and finished devices for the medical, electrical, automotive and aerospace end markets.

 

     Three Months Ended September 30,  
     2017      2016      $ Change  

Net sales

   $ 66,492      $ 66,222      $ 270     

Volume

            $ (735

Foreign exchange effects

              93  

Price/material inflation pass-through/mix

              912  

Income from operations

   $ 7,922      $ 9,913      $ (1,991   

Net sales increased during the third quarter of 2017 from the third quarter of 2016 primarily due to the overall improvement in demand across the medical end market, which resulted in a favorable sales mix.

The decrease in income from operations was primarily due to a shift in product mix toward higher cost raw materials and new program setup costs for certain products sold into the aerospace end market.

 

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Nine Months Ended September 30, 2017, Compared to the Nine Months Ended September 30, 2016

Overall Consolidated Results

 

     Nine Months Ended September 30,  
     2017      2016      $ Change  

Net sales

   $ 463,658      $ 443,310      $ 20,348     

Volume

            $ 20,520  

Foreign exchange effects

              425  

Price/material inflation pass-through/mix

              (597

Cost of products sold (exclusive of depreciation and amortization
shown separately below)

     339,345        323,660        15,685     

Volume

              13,145  

Foreign exchange effects

              639  

Mix

              4,987  

Inflation

              2,009  

Cost reduction projects/other

              (5,095

Selling, general and administrative expense

     52,606        46,931        5,675     

Acquisition related costs excluded from selling, general and
administrative expense

     619        —          619     

Depreciation and amortization

     38,432        38,411        21     

Restructuring and integration expense

     362        4,851        (4,489   
  

 

 

    

 

 

    

 

 

    

Income from operations

     32,294        29,457        2,837     

Interest expense

     39,916        48,708        (8,792   

Loss on extinguishment of debt and write-off of unamortized
debt issuance costs

     39,639        2,589        37,050     

Derivative payments (receipts) on interest rate swap

     —          609        (609   

Derivative loss (gain) on change in interest rate swap fair value

     (14      3,130        (3,144   

Other (income) expense, net

     (945      (2,297      1,352     
  

 

 

    

 

 

    

 

 

    

Loss from continuing operations before benefit for income
taxes and share of net income from joint venture

     (46,302      (23,282      (23,020   

Benefit for income taxes

     14,145        11,763        2,382     

Share of net income from joint venture

     4,139        4,170        (31   
  

 

 

    

 

 

    

 

 

    

Loss from continuing operations

     (28,018      (7,349      (20,669   

Income from discontinued operations, net of tax

     146,579        12,564        134,015     
  

 

 

    

 

 

    

 

 

    

Net income

   $ 118,561      $ 5,215      $ 113,346     
  

 

 

    

 

 

    

 

 

    

Net Sales. Net sales increased during the first nine months of 2017 from the first nine months of 2016, principally due to higher volumes. The higher volumes were primarily due to demand improvements within the medical end market, the automotive end market and the industrial end market. Overall, sales were ahead of the prior year by $7.3 million for APC and $13.1 million for PEP.

Cost of Products Sold. The increase in cost of products sold was primarily due to the increase in demand and production volumes as well as changes in product mix and start-up costs for certain new products. Increases were partially offset by cost savings from production process improvement projects.

Selling, General and Administrative Expense. The majority of the increase during the first nine months of 2017 from the first nine months of 2016 was due to infrastructure and staffing costs incurred related to our strategic initiatives, including a global implementation of an enterprise resource planning (“ERP”) system.

Acquisition Related Costs Excluded from Selling, General and Administrative Expense. Acquisition related costs are primarily third party legal, accounting, valuation consulting and investment banking advisory fees incurred related to the DRT Medical acquisition.

Depreciation and Amortization. The slight increase in depreciation and amortization during the first nine months of 2017 from the first nine months of 2016 was consistent with additions to property, plant and equipment. The expected increase was partially offset by the absence in 2017 of $2.5 million of amortization of backlog and unfavorable leasehold intangibles which became fully amortized during the first quarter of 2016.

 

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Restructuring and Integration Expense. The decrease in restructuring and integration expense was primarily due to limited spending on site closure costs in the first nine months of 2017 compared to the first nine months of 2016. The first nine months of 2016 included $3.9 million of cost incurred to close the Wheeling Plant.

Interest Expense. Interest expense decreased by $8.8 million due to the redemption of the Senior Notes at the beginning of the second quarter of 2017 with the proceeds of the Incremental Term Loan, which bears a lower interest rate based on LIBOR. Further interest savings resulted from the refinancing of the Senior Secured Term Loan and Senior Secured Revolver in the third quarter of 2016.

 

     Nine Months Ended September 30,  
     2017      2016  

Interest on debt

   $ 36,689      $ 44,824  

Interest rate swaps settlements

     —          1,393  

Amortization of debt issuance costs

     3,237        3,048  

Capital lease interest

     856        628  

Capitalized interest (1)

     (866      (1,185
  

 

 

    

 

 

 

Total interest expense

   $ 39,916      $ 48,708  
  

 

 

    

 

 

 

 

(1) Capitalized interest primarily relates to the equipment construction efforts at the various plants.

Loss on Extinguishment of Debt and Write-off of Unamortized Debt Issuance Costs. We wrote off $39.6 million in 2017 as a result of the extinguishment of the Senior Notes and modification of the credit facility.

Derivative Loss (Gain) on Change in Interest Rate Swap Fair Value. During the third quarter of 2016, we chose to discontinue hedge accounting. As a result, all amounts of accumulated other comprehensive income were reclassified to earnings.

Benefit for Income Taxes. Our effective tax rate from continuing operations was 31% for the nine-month period ended September 30, 2017, compared to 51% for the nine-month period ended September 30, 2016. Note 10 in the Notes to Condensed Consolidated Financial Statements describes effective tax rates for each period presented.

Loss from Continuing Operations. Income from operations of $32.3 million for the first nine months of 2017 was more than offset by the loss on extinguishment of debt and write-off of unamortized debt issuance cost and interest expense. In addition, the increase in net sales was offset by increases in cost of products sold and selling, general and administrative expense as described above. Also, acquisition related costs accounted for a $0.6 million reduction in income from operations compared to 2016. The loss was partially offset by an $8.8 million reduction in interest expense. Significant components of the changes in income from operations and interest expense were presented in the preceding paragraphs.

Income from Discontinued Operations, Net of Tax. The largest component of income from discontinued operations in the first nine months of 2017 was the $129.4 million gain on sale of our PBC business, net of tax. Note 2 in the Notes to Condensed Consolidated Financial Statements provides details of the results of discontinued operations.

Results by Segment

AUTOCAM PRECISION COMPONENTS GROUP

 

     Nine Months Ended September 30,  
     2017      2016      $ Change  

Net sales

   $ 254,768      $ 247,473      $ 7,295     

Volume

            $ 7,727  

Foreign exchange effects

              1,066  

Price/material inflation pass-through/mix

              (1,498

Income from operations

   $ 28,088      $ 22,761      $ 5,327     

Net sales increased during the first nine months of 2017 from the first nine months of 2016 due to industrial market demand improvements in the US and China and new automotive program launches in the US, China and Brazil. We are realizing the indirect benefits of our customers taking an increasing portion of market share. Also, as the Brazilian economy rebounds, demand for automotive products is increasing.

 

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The increase in net sales contributed to the increase in income from operations. Cost reduction projects resulted in savings in cost of products sold of approximately $1.2 million over the first nine months of 2017 compared to the same period in 2016. Overall, cost of products sold increased by $3.2 million. Restructuring costs decreased by $3.6 million compared to the first nine months of 2016, primarily related to the closure of the Wheeling Plant in the prior year. These factors that increased income from operations were slightly offset by start-up costs for new products and a $1.7 million increase in depreciation and amortization consistent with recent capital expenditure activity.

PRECISION ENGINEERED PRODUCTS GROUP

 

     Nine Months Ended September 30,  
     2017      2016      $ Change  

Net sales

   $ 208,890      $ 195,837      $ 13,053     

Volume

            $ 12,793  

Foreign exchange effects

              (641

Price/material inflation pass-through/mix

              901  

Income from operations

   $ 29,436      $ 26,116      $ 3,320     

Net sales increased during the first nine months of 2017 from the first nine months of 2016 primarily due to the overall improvement in demand across the medical end market and sales to new customers within the aerospace market. In addition to overall medical market improvement, we have achieved increases in market share for certain medical devices. We have also benefited from the introduction of new products for the aerospace end market.

The increase in net sales contributed to the increase in income from operations. Cost of products sold increased at a rate consistent with net sales. We also experienced a shift in product mix toward higher cost raw materials and incurred new program setup costs for certain products sold into the aerospace end market. Additionally, during the first quarter of 2016 we recognized $2.5 million of amortization expense related to backlog and unfavorable leasehold intangibles which was fully amortized in 2016 and therefore did not impact 2017. Likewise, $0.9 million of restructuring cost was incurred in 2016 related to restructuring after the 2015 acquisition of PEP.

Changes in Financial Condition from December 31, 2016 to September 30, 2017

From December 31, 2016 to September 30, 2017, total assets increased by $160.9 million. Cash proceeds of $387.6 million from the sale of the PBC business was the primary contributor to the increase in assets. We also experienced increases in accounts receivable at APC and PEP as sales grew. Days inventory outstanding increased slightly by approximately four days due to normal seasonal inventory building activity as we prepare for fourth quarter sales. The increases in cash, accounts receivable, and inventory were partially offset by the carrying value of current assets of discontinued operations and noncurrent assets of discontinued operations as of December 31, 2016, which were sold in the sale of the PBC business and are therefore no longer a component of total assets as of September 30, 2017. Accordingly, current assets decreased by $106.7 million and noncurrent assets decreased by $103.3 million compared to December 31, 2016, due to the sale of the PBC business. Also offsetting the increase in cash was a $17.5 million decrease in intangible assets due to normal amortization. Foreign exchange translation impacted total assets in comparing changes in account balances from December 31, 2016, to September 30, 2017, by increasing total assets by $7.0 million, of which $2.5 million related to current assets.

From December 31, 2016 to September 30, 2017, total liabilities increased by $30.1 million. Total debt increased by $16.6 million as a result of the redemption of our Senior Notes with the proceeds of a new $300.0 million Incremental Term Loan in April 2017, net of the effect of paying down the Senior Secured Revolver using cash generated from operations and a portion of the cash proceeds from the sale of the PBC business. Income taxes payable increased by $66.0 million, primarily due to taxes on the gain on sale of the PBC business. We also experienced increases in accounts payable at APC and PEP as sales grow. The increases in debt, income taxes payable, and accounts payable were partially offset by the carrying value of current liabilities of discontinued operations and noncurrent liabilities of discontinued operations as of December 31, 2016, which were assumed by the acquirer in the sale of the PBC business and are therefore no longer a component of total liabilities as of September 30, 2017. Accordingly, current liabilities decreased by $45.4 million and noncurrent liabilities decreased by $12.0 million compared to December 31, 2016, due to the sale of the PBC business. Foreign exchange translation impacted total liabilities in comparing changes in account balances from December 31, 2016, to September 30, 2017, by increasing total liabilities by $3.0 million, of which $1.3 million related to current liabilities.

 

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Working capital, which consists principally of cash, accounts receivable, inventories and other current assets offset by accounts payable, accrued payroll costs, income taxes payable current maturities of long-term debt and other current liabilities, was $377.4 million as of September 30, 2017, compared to $141.9 million as of December 31, 2016. The increase in working capital was due primarily to $387.6 million of cash proceeds from the sale of the PBC business and increases in accounts receivable and inventories, as discussed above, slightly offset by increases in accounts payable and taxes payable, also discussed above. The repayment of approximately $33.2 million of principal outstanding on our Senior Secured Revolver in August 2017 resulted in a reduction of working capital. Current assets of discontinued operations of $106.7 as of December 31, 2016, have the effect of decreasing working capital at September 30, 2017, compared to December 31, 2016, because they were sold in the sale of the PBC business and are no longer a component of our current assets. Current liabilities of discontinued operations of $45.4 as of December 30, 2016, have the effect of increasing working capital at September 30, 2017, compared to December 31, 2016, because they were assumed by the acquirer in the sale of the PBC business and are no longer a component of our current liabilities.

Cash provided by operations was $0.3 million for the nine months ended September 30, 2017, compared with cash provided by operations of $46.3 million for the nine months ended September 30, 2016. The difference was primarily due to $31.6 million paid for the call premium on the redemption of the Senior Notes in April 2017, partially offset by increased operating income. Cash provided by operating activities for discontinued operations was $17.1 million and $14.4 million for the nine-month periods ended September 30, 2017 and 2016, respectively.

Cash provided by investing activities was $332.4 million for the nine months ended September 30, 2017, compared with cash used by investing activities of $30.2 million for the nine months ended September 30, 2016. The difference was primarily due to proceeds from the sale of the PBC business in August 2017. Cash used by investing activities for discontinued operations was $9.8 million and $14.0 million for the nine-month periods ended September 30, 2017 and 2016, respectively.

Cash used by financing activities was $1.1 million for the nine months ended September 30, 2017, compared with cash used by financing activities of $15.1 million for the nine months ended September 30, 2016. The difference was primarily due to net proceeds of debt to fund the Senior Notes call premium in 2017.

Liquidity and Capital Resources

Aggregate principal amounts outstanding under the Senior Secured Term Loan and Incremental Term Loan as of September 30, 2017, were $833.3 million (without regard to debt issuance costs). We had no amounts outstanding on the Senior Secured Revolver at that time. As of September 30, 2017, we could borrow up to $89.7 million under the Senior Secured Revolver, subject to certain limitations. This amount of availability is net of $10.3 million of outstanding letters of credit at September 30, 2017, which are considered as usage of the Senior Secured Revolver.

The Senior Secured Term Loan requires quarterly principal payments of $1.4 million through September 30, 2022, with the remaining principal amount due on the maturity date. If one-month LIBOR is less than 0.75%, then we pay 5.00% per annum in interest. If one-month LIBOR exceeds 0.75%, then we pay the variable one-month LIBOR rate plus an applicable margin of 4.25%. Based on the outstanding balance at September 30, 2017, annual interest payments would have been $29.6 million.

The Incremental Term Loan requires quarterly principal payments of $3.0 million through March 31, 2021, with the remaining principal amount due on the maturity date. If one-month LIBOR is less than 0.75%, then we pay 4.50% per annum in interest. If one-month LIBOR exceeds 0.75%, then we pay the variable one-month LIBOR rate plus an applicable margin of 3.75%. Based on the outstanding balance at September 30, 2017, annual interest payments would have been $14.6 million.

The Senior Secured Revolver bears interest at a rate of one-month LIBOR plus an applicable margin of 3.50%. We had no outstanding balance at September 30, 2017.

The Senior Notes bore interest at 10.25% payable semi-annually in arrears on May 1 and November 1 of each year. Upon redemption of the Senior Notes, we paid interest of $10.8 million for the period November 1, 2016 through April 3, 2017.

We believe that funds generated from our consolidated continuing operations and existing cash will provide sufficient cash flow to service the required debt and interest payments under these facilities. The absence of cash flows from discontinued operations is not expected to significantly affect our ability to service our debt.

Our arrangements with customers typically provide that payments are due within 30 to 60 days following the date of shipment. We invoice and receive payment from many of our customers in euros as well as other currencies. Additionally, we are party to various third party and intercompany loans, payables and receivables denominated in currencies other than the U.S. dollar. As a result of these sales, loans, payables and receivables, our foreign exchange transaction and translation risk has increased. Various strategies to manage this risk are available to management, including producing and selling in local currencies and hedging programs. As of September 30, 2017, no currency hedges were in place. In addition, a strengthening of the U.S. dollar and/or euro against foreign currencies could impair our ability to compete with international competitors for foreign as well as domestic sales.

 

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For the next twelve months, we expect capital expenditures to remain relatively consistent, the majority of which relate to new or expanded business or continuous improvement programs. We believe that funds generated from continuing operations and borrowings from the credit facilities will be sufficient to finance capital expenditures and working capital needs through this period. The absence of cash flows from discontinued operations is not expected to significantly affect our ability to finance capital expenditures or working capital needs. We base these assertions on current availability for borrowing of up to $89.7 million, existing cash of $347.4 million and forecasted positive cash flow from continuing operations for the next twelve months.

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, medical device sales are often stronger in the fourth calendar quarter, 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 subject to material seasonality.

Off-Balance Sheet Arrangements

We are not a party to any off-balance sheet arrangements that have, or are reasonably likely to have, a material current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Critical Accounting Policies

Our critical accounting policies, including the assumptions and judgments underlying them, are disclosed in the 2016 Annual Report, including those policies as discussed in Note 1 to the Notes to Consolidated Financial Statements included in the 2016 Annual Report. There have been no changes to these policies during the nine months ended September 30, 2017, except as discussed in Note 1 to the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.

Recent Accounting Pronouncements

See Note 1 in the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to changes in financial market conditions in the normal course of business due to use of certain financial instruments as well as transacting business in various foreign currencies. To mitigate the exposure to these market risks, we have established policies, procedures and internal processes governing the management of financial market risks. We are exposed to changes in interest rates primarily as a result of borrowing activities.

At September 30, 2017, we had $539.3 million of principal outstanding under the variable rate Senior Secured Term Loan, without regard to debt issuance costs. At September 30, 2017, a one-percent increase in the interest rate charged on outstanding variable rate borrowings under the Senior Secured Term Loan would result in interest expense increasing annually by approximately $5.4 million.

At September 30, 2017, we had $294.0 million of principal outstanding under the Incremental Term Loan, without regard to debt issuance costs. At September 30, 2017, a one-percent increase in the interest rate charged on outstanding variable rate borrowings under the Incremental Term Loan would result in interest expense increasing annually by approximately $2.9 million.

At September 30, 2017, we did not have any debt outstanding under the Senior Secured Revolver.

Our policy is to manage interest expense using a mix of fixed and variable rate debt. To manage this mix effectively, we may enter into interest rate swaps to exchange the difference between fixed and variable interest amounts. The nature and amount of borrowings may vary as a result of future business requirements, market conditions and other factors.

Translation of our operating cash flows denominated in foreign currencies is impacted by changes in foreign exchange rates. We participate in various third party and intercompany loans, payables and receivables denominated in currencies other than the U.S. dollar. To help reduce exposure to foreign currency fluctuation, we have incurred debt in euros in the past. From time to time, we may use foreign currency hedges to hedge currency exposures when these exposures meet certain discretionary levels. We did not hold a position in any foreign currency hedging instruments as of September 30, 2017.

 

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Item 4. Controls and Procedures

Under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Based upon that evaluation, as a result of the material weaknesses in internal control over financial reporting described below, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of September 30, 2017, to ensure that information required to be disclosed in the reports that we file under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure.

Previously Identified Material Weaknesses in Internal Control Over Financial Reporting

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of annual or interim financial statements would not be prevented or detected on a timely basis.

We previously disclosed in the 2016 Annual Report the following material weaknesses, which still existed as of September 30, 2017. We did not maintain an effective control environment due to a lack of a sufficient complement of personnel with an appropriate level of knowledge, experience and training commensurate with our financial reporting requirements. This material weakness in the control environment contributed to the following material weaknesses: we did not design and maintain effective internal control over: (i) the accounting for business combinations, which specifically included not designing and maintaining controls over the (a) accuracy, valuation and presentation and disclosure for allocating goodwill to our international businesses and (b) completeness, accuracy and valuation of deferred income taxes recorded in connection with business combinations; and (ii) the accounting for income taxes, which specifically included not designing and maintaining controls over the completeness, accuracy, valuation and presentation and disclosure of deferred income tax accounts, income tax provision and related disclosures.

These material weaknesses resulted in immaterial errors to property, plant and equipment, net; goodwill, net; investment in joint venture; accrued salaries, wages and benefits; other liabilities; deferred tax assets and liabilities; provision for income taxes; and other comprehensive income in our consolidated financial statements for the years ended December 31, 2016, 2015 and 2014. These immaterial errors resulted in a revision to previously issued financial statements as discussed in Note 1 and Note 15 in the Notes to Condensed Consolidated Financial Statements presented in this Quarterly Report. Management has determined that the revision was an additional effect of the material weaknesses described above. Additionally, these control deficiencies could result in a misstatement of substantially all account balances or disclosures that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected. Notwithstanding such material weaknesses, our Chief Executive Officer and Chief Financial Officer have concluded that our condensed consolidated financial statements in this Quarterly Report on Form 10-Q present fairly, and in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with U.S. generally accepted accounting principles.

Remediation Plan for Material Weaknesses

Building on our efforts during 2016, with the oversight of the Audit Committee of our board of directors, we have continued throughout 2017 to dedicate significant resources and efforts to improve our control environment and to take steps to remediate the material weaknesses identified above. Our internal audit organization, which reports directly to our audit committee, has played an integral role in providing direction to achieve a stronger control environment. While certain remedial actions have been completed, we continue to actively plan for and implement additional control procedures.

Actions Taken During the Current Quarter

The following remediation efforts were completed in the current quarter.

 

    Utilized automated tax software for current quarter calculations;

 

    Designed and implemented new business combination controls and enhanced existing business combination controls to specifically address 1) accuracy, valuation and presentation and disclosure for allocating goodwill to newly acquired international businesses and 2) completeness, accuracy and valuation of deferred income taxes recorded in connection with business combinations; and

 

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Ongoing Remediation Efforts

The remediation efforts outlined in the following list address the identified material weaknesses and enhance our overall financial control environment.

 

    Enhanced our tax department by hiring two additional tax personnel and implementing automated tax software;

 

    Conducted a gap analysis to identify where new tax controls are needed and to enhance existing tax controls to specifically address completeness, accuracy, valuation and presentation and disclosure of deferred income tax accounts, income tax provision and related disclosures.

 

    Instituted, and will continue to provide, additional training programs for our finance and accounting personnel;

 

    Augmented the personnel within our finance and accounting organization by adding two experienced personnel to address SEC technical accounting and reporting; and

 

    Strengthened our business combination and income tax control process with improved accounting policies, documentation standards, technical oversight and training, as well as the recent hires noted above.

Status of Remediation Efforts

We believe the measures described above will remediate the control deficiencies we have identified and strengthen our internal control over financial reporting. We are committed to continuing to improve our internal control processes and will continue to review, optimize and enhance our financial reporting controls and procedures. As we continue to evaluate and work to improve our internal control over financial reporting, we may take additional measures to address control deficiencies, or we may modify, or in appropriate circumstances not complete, certain of the remediation measures described above. These material weaknesses will not be considered remediated until the applicable remedial controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively.

Changes in Internal Control Over Financial Reporting

As described above in the “Remediation Plan for Material Weaknesses” section, there were changes during the fiscal quarter ended September 30, 2017, in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Brazil ICMS Tax Matter

Prior to the Autocam acquisition, Autocam’s Brazilian subsidiary received notification from the Brazilian tax authorities regarding ICMS (state value added tax or VAT) tax credits claimed on intermediary materials (tooling and perishable items) used in the manufacturing process. The Brazilian tax authority notification disallowed state ICMS credits claimed on intermediary materials based on the argument that these items are not intrinsically related to the manufacturing processes. Autocam Brazil filed an administrative defense with the Brazilian tax authority arguing, among other matters, that it should qualify for an ICMS tax credit, contending that the intermediary materials are directly related to the manufacturing process.

We believe that we have substantial legal and factual defenses, and we plan to defend our interests in this matter vigorously. While we believe a loss is not probable, we estimate the range of possible losses related to this assessment is from $0 to $6.0 million. No amount was accrued at September 30, 2017 for this matter. There was no material change in the status of this matter from December 31, 2016 to September 30, 2017.

We are entitled to indemnification from the former shareholders of Autocam, subject to the limitations and procedures set forth in the agreement and plan of merger relating to the Autocam acquisition. Management believes the indemnification would include amounts owed for the tax, interest and penalties related to this matter.

 

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All Other Legal Matters

All other legal proceedings are of an ordinary and routine nature and are incidental to our operations. Management believes that such proceedings should not, individually or in the aggregate, have a material adverse effect on our business, financial condition, results of operations or cash flows. In making that determination, we analyze the facts and circumstances of each case at least quarterly in consultation with our attorneys and determine a range of reasonably possible outcomes.

Item 1A. Risk Factors

There have been no material changes to the risk factors disclosed in our 2016 Annual Report on Form 10-K for the fiscal year ended December 31, 2016, which was filed with the SEC on March 16, 2017 under Item 1A. “Risk Factors.”

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

Period

   Total Number of Shares
Purchased(1)
     Average Price Paid Per
Share
     Total Number of Shares
Purchased as Part of
Publicly Announced
Plans or Programs(1)
     Maximum Number (or
Approximate Dollar
Value) of Shares That
May Yet Be Purchased
Under the Plan or
Programs(1)
 

July 2017

     —        $ —          —          —    

August 2017

     6,388      $ 25.85        —          —    

September 2017

     63      $ 25.60        —          —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     6,451      $ 25.83        —          —    

 

(1) Shares were withheld to pay for tax obligations due upon the vesting of restricted stock held by certain employees granted under the NN, Inc. Amended and Restated 2011 Stock Incentive Plan (the “Plan”). The Plan provides for the withholding of shares to satisfy tax obligations. It does not specify a maximum number of shares that can be withheld for this purpose. These shares may be deemed to be “issuer purchases” of shares that are required to be disclosed pursuant to this Item.

Item 3. Defaults upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.

 

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Item 6. Exhibits

 

Exhibit
No.
  

Description

    2.1    Purchase Agreement, dated as of July  10, 2017, by and between NN, Inc. and TSUBAKI NAKASHIMA Co., Ltd. (incorporated by reference to Exhibit 2.1 to NN, Inc.’s Current Report on Form 8-K filed on July 10, 2017)
  10.1    Amendment No. 2 to Amended and Restated Credit Agreement, dated as of August  15, 2017, by and among NN, Inc., certain NN, Inc. subsidiaries named therein, and SunTrust Bank, Regions Bank, JPMorgan Chase Bank, N.A., HomeTrust Bank and Key Bank National Association, collectively, the Revolving Credit Lenders, and SunTrust Bank, as the Administrative Agent (incorporated by reference to Exhibit 10.1 to NN, Inc.’s Current Report on Form 8-K filed on August 18, 2017)
  31.1    Certification of Principal Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as amended.
  31.2    Certification of Principal Financial Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as amended.
  32.1    Certification of Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  32.2    Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS    XBRL Instance Document
101.SCH    XBRL Taxonomy Extension Service
101.CAL    Taxonomy Calculation Linkbase
101.LAB    XBRL Taxonomy Label Linkbase
101.PRE    XBRL Presentation Linkbase Document
101.DEF    XBRL Definition Linkbase Document

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

     

NN, Inc.

      (Registrant)
Date: November 9, 2017      

/s/ Richard D. Holder

      Richard D. Holder,
      President, Chief Executive Officer and Director
     

(Principal Executive Officer)

(Duly Authorized Officer)

Date: November 9, 2017      

/s/ Thomas C. Burwell, Jr.

      Thomas C. Burwell, Jr.
      Senior Vice President— Chief Financial Officer
      (Principal Financial and Accounting Officer)
      (Duly Authorized Officer)

 

 

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