NNBR: The company released 1st quarter 2023 results which were below company expectations due to an ongoing difficult operating environment in certain markets and industries.
NASDAQ:NNBR
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Financial Review
NN Inc. (NASDAQ:NNBR) reported 1st quarter 2023 financial results on May 5th, 2023. The company’s profitability levels continued to be hampered by inflationary pressures, lower production volumes, difficult end markets, and customer reduction of inventory levels.
Total sales decreased 0.8% in the 1st quarter and were flat on a constant currency basis. Price increases totaled $13.0 and were offset by $13 million in volume declines. Operating loss was ($7.1) million and adjusted operating loss was ($0.4) million. The Non-GAAP operating loss eliminates amortization expense and one-time unusual items totaling $3.2 which was largely related to facility closure expenses.
Macro-economic issues and Inflation continues to negatively impact the company’s operating results. The company has held proactive pricing discussions with many of its customers in 2022 and these actions will continue into 2023.
In the 1st quarter, sales in the Power Solution segment decreased 5.7% compared to the prior year period primarily due to decreased electrical and general industrial component sales as a result of lower housing starts and customer inventory reductions. U.S. housing starts in the 1st quarter decreased approximately 18.9% compared to the 1st quarter of 2022. Adjusted operating income increased 6.9% to $5.5 million from $5.2 million in the prior year period, largely due to premium pricing at its Irvine facility as well as the company’s ability to rationalize unprofitable business at its Taunton facility. The Irvine and Taunton facilities are still on track for closure in the 2nd quarter of 2023 and have the potential to substantially increase operating margins in this segment.
In the Mobile Solutions segment, net sales for the 1st quarter of 2023 increased 2.6% to $78.0 million compared to $76.1 million in the prior year period. The increase in sales was primarily due to pricing actions which offset reduced volume demand. Adjusted loss from operations was ($0.8) million compared to adjusted income from operations of $3.0 million in the 1st quarter of 2022. The decrease in adjusted income from operations was primarily driven by volume reductions, the impact of reduced income from the China joint venture due to lower volumes, unrecovered inflation and inefficiencies at the Wellington and Juarez facilities.
CEO Warren Veltman stated, “Our first quarter results were adversely impacted by reduced production volumes resulting from decreases in residential and commercial construction and the end of COVID-19 restrictions in China. Customers have also reduced inventory levels to buffer against future volume uncertainty further impacting volumes. From an operational perspective, we continued to experience product launch inefficiencies within our Mobile Solutions group. While we are disappointed with our financial results at the start of the year, we significantly improved free cash flow performance in comparison to a year ago, and our liquidity position remains solid. We remain on plan with cost improvements associated with our facility closures and have taken action to further improve our cost structure through a 10% global reduction of indirect labor that will begin to benefit our results in the second quarter.”
Global liquidity remains strong at $43.0 million, which is comprised of $10.5 million in cash and $32.5 million in availability under its credit line. The preferred equity raise is still under consideration, although not required, and would occur before June 30, 2023. The targeted size if it were to occur would be $10 million and would improve domestic liquidity as the substantial majority of cash balances reside in international markets. It would also reduce the liquidity covenant by $5 million to $15 million. This would also provide approximately $3 million in term loan cost reduction through the 2nd quarter of 2025 due to lower paid-in-kind interest and less penny warrants being issued.
Loan Amendment
On March 3rd, 2023, the company amended its ABL and term loan to create additional flexibility to manage its business operations through an uncertain economic environment. The amendments increase maximum total leverage ratio covenants for the duration of the term loan beginning in 2023 which starts at 4.50x currently and drops to 3.00x in 2025. In addition, the existing cap on customer receivable financing programs has been increased from $20 million to $30 million. The amendments also introduced a quarterly domestic liquidity covenant which is a $20 million minimum. Interest under the term loan amendment is increased on a paid-in-kind basis at a rate dependent on the outstanding leverage ratio at period end or whether the company completes a qualifying preferred equity raise by June 30, 2023. The company also issued penny warrants to satisfy the lender fee associated with the term loan amendment.
Growth Initiatives
The company also provided updates on certain growth initiatives to drive profitable sales going forward. These include implementing a sales compensation program where account managers are incentivized based on individual performance with a higher variable component which increases total earnings opportunities. There are also strategic incentives tied to electric and hybrid vehicles. Overall sales capacity is to be increased by approximately 20%.
Other efforts are being made to increase market awareness and support sales efforts. These include increased participation in industry associations, forums and tradeshows. Customer engagement is also expected to be improved through press releases, social media, and target advertising. The company has also revised its website, updated the investor presentation, and added specific vertical presentations.
The company believes it has created a higher quality and healthier future pipeline of business going forward. The new mix of business proposals aligns with the company’s strategic focus into power and eMobility segments. The new pipeline is a reduction from past levels as the company purposely eliminated new business proposals that don’t meet strategic growth objectives as well as proposals that were too capital intensive and had unattractive free cash flow characteristics. The closures of the Irvine and Taunton facilities also reduced active proposals in certain verticals such as aerospace and defense. The company indicated there are potentially $546 million in peak annualized sales from current outstanding proposals. This could translate into over $2 billion in sales over the lives of these contracts.
Business and Market Updates
The slowdown in residential and commercial construction in 2023 has affected near-term operating results for the company. However, the long-term outlook for the Power Solutions segment remains strong as residential and commercial construction is expected to grow by the end of 2023 or early 2024. Demand for electric control panels and solar related equipment is expected to regain its strong growth trends in 2023 from end customers that are involved in upgrading the national electric grid. The global market size for grid battery electric storage is also expected to be a strong growth driver and is estimated to reach $6.6 billion in value by 2030. The direct addressable market opportunity for NN is estimated to be in the range of $300 to $500 million by 2030.
Commercial, private, and industrial sectors are expected to yield the highest demand for battery energy storage systems. The rising penetration of lithium-ion batteries will also create growth opportunities. In addition, expansion of infrastructure projects, along with the growth in the transportation sector, will encourage leading companies to tap into those markets. Around the world, many countries are driving progress in grid interconnection gaps, clearing the way for source to load across wide geographies.
The outlook for Mobile Solutions segment is turning positive with light vehicle production forecasted to improve throughout 2023 which reflects recovering markets in China and South Asia. This forecast is somewhat tempered by ongoing supply chain issues and Covid-19 issues in early 2023. Production of global light vehicles is expected to increase approximately 5.0% in 2023. Zero Emission and Hybrid vehicles are expected to take a larger share of vehicle production in coming years.
The company’s sales pipeline is developing as planned with business development teams focusing on key target markets with the expansion of products into the Electric Vehicle (EV) and Electric Grid markets remaining a priority. Another positive sign is the company’s average deal size is increasing in value which can be attributed to high volume sales activity in Grid Storage and EV battery systems.
The company has been proactive in taking pricing initiatives in many areas of its business. The company has secured full material pass-through pricing on substantially all Mobile Solutions customers. In addition, discussions are ongoing with a focus on eliminating the negative pass-through lag that often occurs in an inflationary environment. New customer contracts are also being structured to provide additional inflation protection. The benefits of these pricing actions are expected to be fully realized in 2023.
NN has implemented a series of cost reduction initiatives which primarily focus on closing certain aerospace, defense and medical facilities. Facilities in Taunton, Massachusetts and Irvine, California are expected to be closed in the 1st half of 2023 which combined had annual operating losses of approximately $10 million. Three additional facilities are expected to be closed in the Mobile Solutions segment which may bring $3.9 million in benefits through cost savings and EBITDA improvement.
Management Transition
On November 1st, the company announced they have implemented a management transition plan to address the planned retirements of CEO, Warren Veltman and Executive Vice President, Mobile Solutions and Power Solutions, John Buchan. NN anticipates that Mr. Veltman and Mr. Buchan will remain in their current positions until the end of the 1st quarter of 2023, which may be extended in order to facilitate an orderly transition. Following their retirement, the company expects that Mr. Veltman and Mr. Buchan will remain available on a consulting basis to assist with the management transition as needed.
The Board of Directors has engaged Korn Ferry, a global organizational consulting and recruiting firm, to assist in identifying candidates for the President and Chief Executive Officer position, with expertise in the electrical and electric vehicle industries to further NN’s focus on these rapidly growing markets. The company stated during the recent earnings call that the company is close to selecting a candidate.
2023 Outlook
The company updated its 2023 outlook which calls for total revenues in the range of $515-$545 million and adjusted EBITDA in the range of $47-$57 million. Free cash flow is expected to be positive and be between $7 and $17 million. The free cash flow guidance does not include the CARES Act tax refund of approximately $11 million due to uncertain timing on when that may be received.
Valuation & Estimate Changes
We are adjusting our EPS estimates slightly for 2023 to account for a difficult 1st quarter. We lower our 2023 revenue estimates to $528.4 million and our 2023 EPS estimate is now ($0.05). Our adjusted EBITDA estimate is $51.9 million.
We are maintaining our DCF derived valuation target of $5.00. In addition, the stock is selling below both book value per share and tangible book value per share. We estimate NNBR stock is selling at approximately 26.0% of book value per share.
The markets that NN is focusing on are expected to produce above average growth rates. According to an IHS Market study, products used to expand and modernize the electric grid are expected to grow at an average annual rate of between 6%-10% from 2022 to 2027. The next generation mobility market, which are components used in the manufacturing of electric vehicles, is also a high-growth market. Electric vehicle production is expected to grow at an average annualized rate of between 16%-20% between 2023 and 2028.
We do not believe the recent operating environment reflects the true earnings power of NN going forward. The company’s primary focus on growing end markets such as electric vehicles and electric grid upgrades should provide growth tailwinds for the foreseeable future. The company is already seeing results from recent sales efforts where there has been a significant pipeline expansion in these target growth markets. The company has a focused plan for cost reduction and margin improvement that should start to take hold in 2023. As inflationary and other cost pressures recede, NN should be able to produce strong double-digit cash flow growth.
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