NNBR: NN Inc. reports 2nd quarter 2023 results which showed a difficult demand environment but improved core profitability and free cash flow generation.
NASDAQ:NNBR
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NN Inc. (NASDAQ:NNBR) reported 2nd quarter 2023 financial results on August 3rd, 2023 which showed improved profitability and free cash flow generation. However, sales growth was relatively flat compared to the prior year period.
Total sales were essentially flat in the 2nd quarter at $125.2 million primarily due to reduced volumes and unfavorable foreign exchange effects which were partially offset by higher customer pricing.
Price increases contributed $9.0 million and were offset by $7.0 million in volume declines. Operating loss was ($4.0) million and adjusted operating income loss was $1.3 million, an improvement from adjusted operating income of $0.1 million the 2nd quarter of 2022 and an adjusted operating loss of $0.35 million in the 1st quarter of 2023. The Non-GAAP operating income eliminates amortization expense and one-time unusual items. Adjusted EBITDA was $10.5 million. Free cash flow generated in the quarter was $3.0 million.
In the 2nd quarter, sales in the Power Solution segment decreased 7.7% to $48.1 million compared to the prior year, primarily due to slower residential and commercial construction markets and customer inventory reductions. The company also closed two unprofitable plants, Irvine and Tauton. Adjusted operating income was $5.6 million compared to adjusted operating income of $4.6 million in the 2nd quarter of 2022. The increase was primarily due to the facility closure savings and was partially offset by lower volumes. Adjusted EBITDA increased to $6.5 million.
In the Mobile Solutions segment, net sales for the 2nd quarter of 2023 were $77.2 million, an increase of 5.2% compared to the 2nd quarter of 2022. The increase was primarily due to higher customer pricing actions, partially offset by lower volumes and unfavorable foreign exchange effects. Adjusted operating income was $0.2 million compared to adjusted operating income of $2.6 million in the prior year period.
The decrease in adjusted operating income was primarily driven by volume reductions and a favorable customer settlement in the prior year. Adjusted EBITDA was $7.5 million. The company noted improved operations in the China JV. Demand for Mobile Solutions end markets should be steady in the 2nd half of 2023, however demand growth is not expected given the macro environment and commentary made by other competitors and customers.
Global liquidity remains strong at $44.0 million, which is comprised of $14.3 million in cash and $29.7 million in availability under its credit line. The company indicated the potential preferred equity raise is no longer under consideration. Working capital was $106.4 million. The company’s leverage ratio increased slightly to 3.87x but is expected to trend down going forward if the company continues to generate free cash flow.
New CEO Harold Bevis stated, “Our team has embraced the need for meaningful change and is taking aggressive action to transform the company. Multiple transformation initiatives are underway and are being led by an experienced NN team which has been supplemented by additional talent. The goal is to improve performance faster in both the short-term and long-term. Over the second half of 2023 we are focused on the following:
1) delivering higher rates of new business wins by leveraging existing open capacity and targeted new capacity;
2) containing and eliminating operating losses at a few select plants and within certain customer agreements;
3) installing an evergreen cost productivity and margin expansion regimen; and, lastly
4) investing into the business and delivering net free cash flow.”
Transformation Initiatives
Incoming CEO Harold Bevis has outlined a transformation plan that increases the entire organization’s commitment to boost sales, operating profit and free cash flow. These include hiring new executives and personnel as well as flattening the organizational charge to expand the number of direct reports to the CEO. This includes a Chief Procurement Officer, a soon to be announced Chief Operating Officer, and other certain specialists. New executives include those who have transformed companies as well as those who have worked with Mr. Bevis before at prior roles. The funding for these new personnel additions will be achieved through other cost reduction initiatives.
The company plans to increase its focus on cost reduction and plans to implement a steady-state cost productivity regiment. This involves moving certain manufacturing footprints to low-cost countries as well as minimize skill redundancies at the company. Also included is an increased focus on unprofitable parts of the company, both plants and customer contracts. This alone could improve profitability by over $10 million on an annual basis. The company also plans to increase its focus on free cash flow generation by proactively managing account receivables, accounts payables, inventory and capital spending. The company also plans to significantly increase new business wins through a holistic approach utilizing sales, marketing and engineering resources. In the first half of 2023, electric power steering components for electric vehicles have become the largest component of new business wins. The company plans to expand product concentration in key profitable areas such as electronic power steering for electric vehicles, connector, shielding, and braking system components.
Management Transition
A new CEO hire was announced on May 9th with an effective start date of May 22nd. Harold Bevis has more than 25 years of business leadership experience, including more than 20 years’ experience in the CEO role at various companies. He was previously President and CEO of Commercial Vehicle Group, Inc. (NASDAQ:CVGI), a publicly traded manufacturer of electrical, mechanical and seating systems for electric and internal combustion engine commercial vehicles, as well as industrial automation and robotic systems to retailers and ecommerce shippers. At CVGI, Mr. Bevis demonstrated a track record of driving automation and connectivity. Prior to his experience at CVGI, Mr. Bevis was Chairman and CEO of Boxlight, a startup company focused on education technology solutions. Previously, Mr. Bevis led a number of companies in the packaging industry, including as President and CEO of Xerium Technologies, Inc., Chairman and CEO of Prolamina, and President and CEO of Pliant Corporation. Mr. Bevis has a bachelor’s degree in industrial engineering from Iowa State University, and an MBA in marketing from Columbia Business School.
2023 Outlook
The company updated its 2023 outlook which calls for total revenues in the range of $485-$505 million and adjusted EBITDA in the range of $40-$46 million. Free cash flow is expected to be positive and be between $7 and $13 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.
The company mentioned that there are approximately $10 million in potential cost savings from underperforming plants and customer contracts. This equates to approximately $70-$80 million in revenues that are operating at a loss and that are expected to be recaptured at a profitable level in the future. The company also indicated it plans to slowly reenter the medical markets as its non-compete expires which was part of previously divested business.
Valuation & Estimate Changes
We are adjusting our EPS estimates slightly for 2023 to account for a difficult 1st half. We lower our 2023 revenue estimates to approximately $498 million and our 2023 adjusted EPS estimate is now ($0.34). Our adjusted EBITDA estimate is approximately $43.0 million, which is the mid-point of the company’s guidance.
We are maintaining our DCF derived valuation target of $5.00. In addition, the stock is below book value per share. We estimate NNBR stock is selling at approximately 82.0% of book value.
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 and 2024. As inflationary and other cost pressures recede, NN should be able to produce strong double-digit cash flow growth.
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