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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, 2018
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
 
 
 
 nnlogoa06.jpg
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)
6210 Ardrey Kell Road
Charlotte, North Carolina 28277
(Address of principal executive offices, including zip code)
(980) 264-4300
(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 1, 2018, there were 42,104,207 shares of the registrant’s common stock, par value $0.01 per share, outstanding.
 
 

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NN, Inc.
INDEX
 
 
 
 
Item 1.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.


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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,
 
 
2018
 
2017
 
2018
 
2017
Net sales
 
$
205,683

 
$
148,156

 
$
571,180

 
$
463,658

Cost of sales (exclusive of depreciation and amortization shown separately below)
 
156,408

 
111,272

 
431,492

 
340,266

Selling, general and administrative expense
 
22,480

 
16,985

 
71,298

 
51,630

Acquisition related costs excluded from selling, general and administrative expense
 
597

 
619

 
5,810

 
619

Depreciation and amortization
 
21,259

 
13,384

 
51,798

 
39,006

Other operating income, net
 
(733
)
 

 
(638
)
 
(270
)
Restructuring and integration expense (adjustments), net
 
(209
)
 
345

 
2,137

 
362

Income from operations
 
5,881

 
5,551

 
9,283

 
32,045

Interest expense
 
18,608

 
12,739

 
46,592

 
39,916

Loss on extinguishment of debt and write-off of debt issuance costs
 
6,624

 

 
19,562

 
39,639

Derivative gain on change in interest rate swap fair value
 

 
(27
)
 

 
(14
)
Other (income) expense, net
 
308

 
(755
)
 
1,882

 
(1,192
)
Loss from continuing operations before benefit for income taxes and share of net income from joint venture
 
(19,659
)
 
(6,406
)
 
(58,753
)
 
(46,304
)
Benefit for income taxes
 
5,609

 
1,724

 
12,732

 
14,204

Share of net income from joint venture
 
266

 
1,202

 
1,744

 
4,139

Loss from continuing operations
 
(13,784
)
 
(3,480
)
 
(44,277
)
 
(27,961
)
Income from discontinued operations, net of tax (Note 2)
 

 
129,441

 

 
140,195

Net income (loss)
 
$
(13,784
)
 
$
125,961

 
$
(44,277
)
 
$
112,234

Other comprehensive income (loss):
 
 
 
 
 

 

Reclassification adjustment for discontinued operations
 
$

 
$
(9,243
)
 
$

 
$
(9,243
)
Foreign currency translation gain (loss)
 
(4,193
)
 
6,411

 
(14,509
)
 
21,027

Other comprehensive income (loss)
 
$
(4,193
)
 
$
(2,832
)
 
$
(14,509
)
 
$
11,784

Comprehensive income (loss)
 
$
(17,977
)
 
$
123,129

 
$
(58,786
)
 
$
124,018

Basic net loss per share:
 
 
 
 
 

 

Loss from continuing operations per share
 
$
(0.48
)
 
$
(0.13
)
 
$
(1.59
)
 
$
(1.02
)
Income from discontinued operations per share
 

 
4.70

 

 
5.12

Net income (loss) per share
 
$
(0.48
)
 
$
4.57

 
$
(1.59
)
 
$
4.10

Weighted average shares outstanding
 
28,688

 
27,544

 
27,784

 
27,403

Diluted net loss per share:
 
 
 
 
 

 

Loss from continuing operations per share
 
$
(0.48
)
 
$
(0.13
)
 
$
(1.59
)
 
$
(1.02
)
Income from discontinued operations per share
 

 
4.70

 

 
5.12

Net income (loss) per share
 
$
(0.48
)
 
$
4.57

 
$
(1.59
)
 
$
4.10

Weighted average shares outstanding
 
28,688

 
27,544

 
27,784

 
27,403

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

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NN, Inc.
Condensed Consolidated Balance Sheets
(Unaudited)
Amounts in thousands of dollars
 
 
 
September 30, 2018
 
December 31, 2017
Assets
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
17,789

 
$
224,446

Accounts receivable, net
 
149,982

 
108,446

Inventories
 
124,109

 
82,617

Income tax receivable
 
39,357

 
43,253

Other current assets
 
22,735

 
18,518

Total current assets
 
353,972

 
477,280

Property, plant and equipment, net
 
352,138

 
259,280

Goodwill
 
624,455

 
454,612

Intangible assets, net
 
384,683

 
237,702

Investment in joint venture
 
39,324

 
39,822

Other non-current assets
 
8,750

 
6,307

Total assets
 
$
1,763,322

 
$
1,475,003

Liabilities and Stockholders’ Equity
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
66,302

 
$
52,990

Accrued salaries, wages and benefits
 
27,921

 
21,145

Current maturities of long-term debt
 
31,726

 
17,283

Other current liabilities
 
23,854

 
17,003

Total current liabilities
 
149,803

 
108,421

Deferred tax liabilities
 
102,195

 
71,564

Non-current income tax payable
 

 
5,593

Long-term debt, net of current portion
 
843,520

 
790,805

Other non-current liabilities
 
26,770

 
12,516

Total liabilities
 
1,122,288

 
988,899

Commitments and contingencies (Note 12)
 

 

Total stockholders’ equity
 
641,034

 
486,104

Total liabilities and stockholders’ equity
 
$
1,763,322

 
$
1,475,003

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
 
 
 
Number
of
shares
 
Par
value
 
Additional
paid in
capital
 
Retained
earnings
 
Accumulated other comprehensive loss
 
Total
Balance, December 31, 2017
 
27,572

 
$
275

 
$
292,494

 
$
211,080

 
$
(17,745
)
 
$
486,104

Net loss
 

 

 

 
(44,277
)
 

 
(44,277
)
Cash dividends declared
 

 

 

 
(5,835
)
 

 
(5,835
)
Shares issued
 
14,375


144


217,168






217,312

Share-based compensation expense
 
165

 
2

 
3,423

 

 

 
3,425

Shares issued for option exercises
 
27

 

 
274

 

 

 
274

Restricted shares and performance shares forgiven for taxes and forfeited
 
(35
)
 

 
(723
)
 

 

 
(723
)
Change in estimate of performance share vesting
 

 

 
(802
)
 
49

 

 
(753
)
Foreign currency translation loss
 

 

 

 

 
(14,509
)
 
(14,509
)
Adoption of new accounting standard (Note 1)
 

 

 

 
16

 

 
16

Balance, September 30, 2018
 
42,104

 
$
421

 
$
511,834

 
$
161,033

 
$
(32,254
)
 
$
641,034

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,
 
 
 
2018
 
2017
 
Cash flows from operating activities
 
 
 
 
 
Net income (loss)
 
$
(44,277
)
 
$
112,234

 
Adjustments to reconcile net income (loss) to net cash provided by (used by) operating activities:
 
 
 
 
 
Depreciation and amortization of continuing operations
 
51,798

 
39,006

 
Depreciation and amortization of discontinued operations
 

 
7,722

 
Amortization of debt issuance costs
 
3,631

 
3,237

 
Loss on extinguishment of debt and write-off of debt issuance costs
 
19,562

 
39,639

 
Share of net income from joint venture, net of cash dividends received
 
(1,744
)
 
17

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

 
(123,010
)
 
Compensation expense from issuance of share-based awards
 
2,623

 
3,220

 
Deferred income taxes
 
(14,737
)
 
70

 
Other
 
255

 
(123
)
 
Changes in operating assets and liabilities, net of acquisitions:
 
 
 
 
 
Accounts receivable
 
(19,656
)
 
(14,867
)
 
Inventories
 
(18,207
)
 
(10,328
)
 
Accounts payable
 
3,733

 
(3,317
)
 
Income taxes receivable and payable, net
 
(1,681
)
 
(19,409
)
 
Other
 
5,485

 
(2,765
)
 
Net cash provided by (used by) operating activities
 
(13,215
)
 
31,326

 
Cash flows from investing activities
 
 
 
 
 
Acquisition of property, plant and equipment
 
(46,998
)
 
(31,674
)
 
Cash paid to acquire businesses, net of cash received
 
(399,011
)
 

 
Short term investment
 

 
(8,000
)
 
Proceeds from sale of business, net of cash sold
 

 
371,436

 
Other
 
650

 
1,184

 
Net cash provided by (used by) investing activities
 
(445,359
)
 
332,946

 
Cash flows from financing activities
 
 
 
 
 
Cash paid for debt issuance or prepayment costs
 
(20,703
)
 
(38,130
)
 
Dividends paid
 
(5,812
)
 
(5,764
)
 
Proceeds from issuance of common shares
 
217,435

 

 
Proceeds from long-term debt
 
288,594

 
317,000

 
Repayment of long-term debt
 
(234,000
)
 
(301,313
)
 
Proceeds from (repayments of) short-term debt, net
 
10,474

 
(3,968
)
 
Other
 
(3,161
)
 
(490
)
 
Net cash provided by (used by) financing activities
 
252,827

 
(32,665
)
 
Effect of exchange rate changes on cash flows
 
(910
)
 
1,368

 
Net change in cash and cash equivalents
 
(206,657
)
 
332,975

 
Cash and cash equivalents at beginning of period
 
224,446

 
14,405

(1)
Cash and cash equivalents at end of period
 
$
17,789

 
$
347,380

 
(1)
Cash and cash equivalents as of December 31, 2016, includes $8.1 million of cash and cash equivalents that were included in current assets of discontinued operations.

During the nine months ended September 30, 2018, we had noncash additions to property, plant and equipment of approximately $15.6 million.
The accompanying notes are an integral part of the Condensed Consolidated Financial Statements.

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NN, Inc.
Notes to Condensed Consolidated Financial Statements
September 30, 2018
(Unaudited)
Amounts in thousands of dollars and shares, except per share data
Note 1. Interim Financial Statements
Nature of Business
NN, Inc., is a global diversified industrial company that combines advanced engineering and production capabilities with in-depth materials science expertise to design and manufacture high-precision components and assemblies for the medical, aerospace and defense, electrical, automotive and general industrial markets. 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. As of September 30, 2018, we had 51 facilities in North America, Europe, South America and China.
In January 2018, we implemented a new enterprise and management structure designed to accelerate growth and further balance our portfolio by aligning our strategic assets and businesses. Our businesses were reorganized into the Mobile Solutions, Power Solutions, and Life Sciences groups and are based principally on the end markets they serve. The Autocam Precision Components Group reported in our historical financial statements was renamed as Mobile Solutions. The Mobile Solutions group is focused on growth in the general industrial and automotive end markets. The Precision Engineered Products Group reported in our historical financial statements was bifurcated into two new groups – Power Solutions and Life Sciences. The Power Solutions group is focused on growth in the electrical and aerospace and defense end markets. The Life Sciences group is focused on growth in the medical end market.
Basis of Presentation
The accompanying condensed consolidated financial statements have not been audited, except that the Condensed Consolidated Balance Sheet as of December 31, 2017, was derived from the audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2017 (the “2017 Annual Report”), which we filed with the U.S. Securities and Exchange Commission (the “SEC”), on April 2, 2018. Certain prior period amounts have been reclassified to conform to the current period’s presentation. Historical periods presented reflect reclassifications to reflect discontinued operations (see Note 2). Historical periods also reflect revisions that we disclosed in our 2017 Annual Report (see Note 17). 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 months and nine months ended September 30, 2018 and 2017; financial position as of September 30, 2018, and December 31, 2017; and cash flows for the nine months ended September 30, 2018 and 2017, on a basis consistent with our audited consolidated financial statements other than the adoption of new accounting standards, such as revenue recognition. 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 (“U.S. GAAP”) 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 2017 Annual Report. The results for the three months and nine months ended September 30, 2018, are not necessarily indicative of results for the year ending December 31, 2018, or any other future periods.
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
As disclosed in our 2017 Annual Report, we identified various misstatements in our previously issued 2016 and 2015 annual financial statements and interim periods in 2016 and 2017. These prior period errors related primarily to (i) accounting for income and franchise taxes, (ii) accounting for the gain on the disposition of a business, (iii) accounting for indemnification assets related to a prior acquisition, (iv) accounting for foreign currency transactions, (v) accounting for the translation of foreign subsidiary assets and joint venture, and (vi) other immaterial errors, including errors that had previously been adjusted for as out of period corrections in the periods identified. 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 Accounting

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Standards Codification (“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 revised our previously issued 2016 and 2015 annual financial statements in our 2017 Annual Report. Accordingly, in connection with this Quarterly Report, we are revising our Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) and our Condensed Consolidated Statement of Cash Flows, the related notes, and other financial information for the three months and nine months ended September 30, 2017, to correct for those misstatements that impacted such period. Refer to Note 17 for reconciliations between as originally reported and as revised quarterly amounts.
Accounting Standards Recently Adopted
Revenue Recognition. On January 1, 2018, we adopted ASC Topic 606, Revenue from Contracts with Customers, (“ASC 606”). We adopted ASC 606 utilizing the modified retrospective transition method. Under this transition method, we recognized 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 applied the new standard beginning with the most current period presented to contracts that were not completed at the date of initial application. The adoption adjustment, which was less than $0.1 million, represents the net profit on certain contracts that were accounted for on a consignment basis under ASC Topic 605, Revenue Recognition, (“ASC 605”) Under ASC 605, a sale was not recognized under these consignment contracts until the inventory was used by our customers. Under the new standard, revenue is recognized earlier since the transfer of control to our customers occurs upon shipment from our facilities as our customers have obtained the ability to direct the use of, and obtain substantially all the remaining benefits from, the asset. Comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods. We expect the impact of the adoption of the new standard to be immaterial to our results of operations on an ongoing basis. See Note 13 for the required disclosures related to the impact of adopting ASC 606 and a discussion of our updated policies related to revenue recognition and accounting for costs to obtain and fulfill a customer contract.
Definition of a Business. In January 2017, the Financial Accounting Standards Board (“FASB”) issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, which changes the definition of a business. The new guidance requires an entity to first evaluate whether substantially all the fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets. If that threshold is met, the set of assets and activities is not a business. If the threshold is not met, the entity evaluates whether the set meets the definition of a business. The new definition requires a business to include at least one substantive process and narrows the definition of outputs by more closely aligning it with how outputs are described in the new revenue recognition guidance. The new guidance was effective for us beginning on January 1, 2018. We have applied the new definition of a business prospectively to all business combination transactions that occurred in 2018. The new guidance will have no effect on our historical financial statements.
Statement of Cash Flows. In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Issues Task Force). This guidance provides clarification on how certain cash receipts and cash payments are presented and classified on the statement of cash flows, with focus on eight specific areas in which cash flows have, in practice, been presented inconsistently. The guidance was effective for NN beginning January 1, 2018, and is required to be adopted using a retrospective approach if practicable.
The new cash flow guidance requires that cash payments for debt prepayment costs be classified as cash outflows for financing activities. We paid $31.6 million for debt prepayment costs in April 2017. These debt prepayment costs were previously classified as cash used by operating activities in 2017. Under the new guidance, these costs are reclassified to cash used by financing activities when these comparable periods are presented in future filings.
The new guidance also requires entities to make an accounting policy election regarding classification of distributions received from equity method investees. Existing guidance does not currently address how an entity should determine which distributions represent returns on versus returns of investment. The lack of specific guidance has resulted in diversity in practice. The two allowable approaches are the “cumulative earnings” approach and the “nature of the distribution” approach, as defined by ASU 2016-15. Upon adoption of the new guidance on January 1, 2018, we utilized the cumulative earnings approach for classifying distributions received from our joint venture investment (see Note 8). This policy election is consistent with our historical accounting.

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Accounting Standards Not Yet Adopted
Leases. In February 2016, the FASB issued ASU 2016-02, Leases. ASU 2016-02 creates Topic 842, Leases, (“ASC 842”) 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. We intend to utilize the practical expedient to recognize a cumulative-effect adoption adjustment to retained earnings as of January 1, 2019, and not adjust comparative periods. The adoption of ASC 842 is expected to impact our balance sheet by adding lease-related assets and liabilities. The loan covenants in our credit facility provide for the continuation of covenant computations in accordance with GAAP prior to changes in accounting principles. Therefore, we do not expect the adoption of ASC 842 to affect our compliance. We have performed inquiries within each of our business groups and compiled information on operating and capital leases. We are using the results of these inquiries and compiled information to evaluate the impacts of the lease accounting standard on our financial position, results of operations, and related disclosures. Upon adoption, we expect to recognize a right-of-use asset and a lease liability for nearly all our leases that are currently classified as operating leases and are therefore not recorded on the balance sheet. We are implementing an enterprise-wide lease accounting system and are in the process of loading and verifying data in the system that will enable us to estimate the amounts of those assets and liabilities. We have reviewed all leases and are in the process of reviewing our documentation and conclusions to generate the initial accounting entries upon adoption of the standard. We expect the right-of-use asset and lease liability to exceed $50 million each.
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 us 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.
Effects of Tax Reform in Other Comprehensive Income. In February 2018, the FASB issued guidance related to the impacts of the Tax Cuts and Jobs Act of 2017 (“Tax Act”). Under existing U.S. GAAP, the effects of changes in tax rates and laws on deferred tax balances are recorded as a component of income tax expense in the period in which the law was enacted. When deferred tax balances related to items originally recorded in accumulated other comprehensive income (“AOCI”) are adjusted, certain tax effects become stranded in AOCI. The FASB issued ASU 2018-02, Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, that permits reclassification of certain income tax effects of the Act from AOCI to retained earnings. The guidance also requires certain disclosures about stranded tax effects. ASU 2018-02 is effective for us on January 1, 2019, with early adoption in any period permitted. Entities may adopt the guidance using either at the beginning of the period of adoption or retrospectively to each period in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Act is recognized. We are in the process of evaluating adoption method and the effects of this new guidance on our financial statements.
Fair Value Disclosures. In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement, that modifies fair value disclosure requirements. The new guidance could impact us by streamlining disclosures of Level 3 fair value measurements. The modified disclosures are effective for NN beginning in the first quarter of 2020, with early adoption allowed. ASU 2018-13 changes only disclosures and does not impact our financial condition, results of operations, or cash flows. We are in the process of evaluating the effects of this guidance on our fair value disclosures.
Internal-Use Software. In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software: Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (a consensus of the FASB Emerging Issues Task Force), that provides guidance on a customer’s accounting for implementation, set-up, and other upfront costs incurred in a cloud computing arrangement that is hosted by the vendor. Under the new guidance, customers will apply the same criteria for capitalizing implementation costs as they would for an arrangement that has a software license. ASU 2018-15 is effective for us on January 1, 2020, using either a prospective or retrospective approach and with early adoption permitted. We are in the process of evaluating the effects of this guidance on our financial statements and on cloud computing arrangements that we may enter before the required effective date.

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Note 2. Discontinued Operations
On August 17, 2017, we completed the sale of our global precision bearing components business (the “PBC Business”). 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 Precision Bearing Components Group reportable segment disclosed in our historical financial statements.
In accordance with ASC 205-20, Presentation of Financial Statements – Discontinued Operations, the operating results of the PBC Business for the three and nine months ended September 30, 2017, are classified as discontinued operations. The presentation of discontinued operations includes revenues and expenses of the discontinued operations, net of tax, as one line item on the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss). All historical Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) presented have been revised to reflect this presentation. Accordingly, results of the PBC Business have been excluded from continuing operations and group results for all periods presented in the condensed consolidated financial statements and the accompanying notes unless otherwise stated. The Condensed Consolidated Statement of Cash Flows for the nine months ended September 30, 2017, includes cash flows of the PBC Business in each line item unless otherwise stated.
The following table summarizes the major line items included in the results of operations of the discontinued operations.
 
Three Months Ended September 30, 2017
 
Nine Months Ended
September 30, 2017
Net sales
$
31,600

 
$
168,287

Cost of sales (exclusive of depreciation and amortization shown separately below)
26,070

 
130,555

Selling, general and administrative expense
2,466

 
11,587

Depreciation and amortization
1,611

 
7,722

Restructuring and integration expense

 
429

Income from operations
1,453

 
17,994

Interest income (expense)
7

 
(181
)
Other income (expense)
(66
)
 
(84
)
Income from discontinued operations before gain on disposal and provision for income taxes
1,394

 
17,729

Provision for income taxes
5,362

 
(219
)
Income (loss) from discontinued operations before gain on disposal
6,756

 
17,510

Gain on disposal of discontinued operations
208,896

 
208,896

Provision for income taxes on gain on disposal
(86,211
)
 
(86,211
)
Income from discontinued operations, net of tax
$
129,441

 
$
140,195

The following table presents the significant noncash items and cash paid for capital expenditures of discontinued operations.
 
 
Nine Months Ended
September 30, 2017
Depreciation and amortization
$
7,722

Acquisition of property, plant and equipment
$
7,316


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Note 3. Acquisitions
Paragon Medical, Inc.
On May 7, 2018, we acquired 100% of the stock of PMG Intermediate Holding Corporation, the parent company of Paragon Medical, Inc. (“Paragon Medical”) for a base purchase price of $375.0 million in cash, subject to certain adjustments. After working capital and other closing adjustments, the cash purchase price was approximately $390.9 million which included $13.6 million in cash acquired. During the three months ended September 30, 2018, we received $1.4 million additional cash from the seller to settle working capital adjustments. For accounting purposes, Paragon Medical meets the definition of a business and has been accounted for as a business combination. Paragon Medical is a medical device manufacturer which focuses on the orthopedic, case and tray, implant and instrument markets. This acquisition continues our strategic focus to expand our Life Sciences portfolio as well as create a balanced business by diversifying our products and finished device offerings. Operating results of Paragon Medical are reported prospectively from the date of acquisition in our Life Sciences group. We have performed an assessment of the opening balance sheet which is subject to completion of our internal review procedures over fair value estimates. Opening balance sheet deferred taxes have been recorded based on estimates made as of the acquisition date as well as information currently available to management. As estimates are refined and additional information is received throughout the measurement period, adjustments to opening deferred taxes may be recorded with an offsetting adjustment to goodwill. We incurred new debt in connection with the Paragon Medical acquisition and subsequently repaid the new debt in full with the proceeds from the sale of shares of our common stock as described in Note 10.
The following table summarizes the preliminary purchase price allocation for the Paragon Medical acquisition.
Fair value of assets acquired and liabilities assumed
As Reported on June 30, 2018
 
Subsequent Adjustments
 
September 30, 2018
Cash and cash equivalents
$
13,418

 
$
134

 
$
13,552

Accounts receivable
22,853

 
(721
)
 
22,132

Inventories
23,606

 
(98
)
 
23,508

Other current assets
937

 
734

 
1,671

Property, plant and equipment
69,322

 
(5,625
)
 
63,697

Intangible assets subject to amortization
164,200

 
(700
)
 
163,500

Other non-current assets
3,304

 
(129
)
 
3,175

Goodwill
157,421

 
5,017

 
162,438

Total assets acquired
$
455,061

 
$
(1,388
)
 
$
453,673

Current liabilities
$
16,767

 
$
119

 
$
16,886

Deferred tax liability
46,713

 
(1,407
)
 
45,306

Other non-current liabilities
620

 

 
620

Total liabilities assumed
$
64,100

 
$
(1,288
)
 
$
62,812

          Net assets acquired
$
390,961

 
$
(100
)
 
$
390,861

A combination of income, market, and cost approaches were used for the valuation where appropriate, depending on the asset or liability being valued. Valuation inputs in these models and analyses considered market participant assumptions. Acquired intangible assets are primarily customer relationships. As of September 30, 2018, intangible assets in connection with Paragon Medical were $157.6 million after post-acquisition amortization.
In connection with the Paragon Medical acquisition, we recorded goodwill, which represents the excess of the purchase price over the estimated fair value of tangible and intangible assets acquired, net of liabilities assumed. As of September 30, 2018, goodwill in connection with Paragon Medical was approximately $159.4 million after post-acquisition currency impacts. The goodwill is attributed primarily to Paragon Medical as a going concern, the assembled workforce, the fair value of expected cost synergies, and revenue growth expected from the ability to go to market as a combined life sciences business. The going concern element represents the ability to earn a higher return on the combined assembled collection of assets and businesses of Paragon Medical than if those assets and businesses were to be acquired and managed separately. Approximately $2.8 million of the goodwill relates to prior asset acquisitions by Paragon Medical and is expected to be deducted for tax purposes.

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Property, plant and equipment acquired primarily included machinery and equipment for use in manufacturing operations. Additionally, manufacturing sites and related facilities, including leasehold improvements, were acquired. We have performed a preliminary assessment of the fair value of property, plant and equipment using both the cost approach and the market approach. The preliminary assessment was supported where available by observable market data which includes consideration of obsolescence. We have performed a preliminary assessment of the fair value of intangible assets using the income approach, supported by market data, by using the relief from royalty and multi-period excess earnings methods.
We incurred approximately $5.3 million in acquisition related costs with respect to the Paragon Medical acquisition during the nine months ended September 30, 2018. Transaction costs were expensed as incurred and are included in the “Acquisition related costs excluded from selling, general and administrative expense” line item in the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss). We expensed $12.9 million of financing costs related to the Paragon Medical acquisition during the nine months ended September 30, 2018, which are included in the “Loss on extinguishment of debt and write-off of debt issuance costs” line item in the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss). As required by the acquisition method of accounting, acquired inventories were recorded at their estimated fair value. Beginning May 7, 2018, our consolidated results of operations include the results of Paragon Medical. Since the date of the acquisition, net sales of $70.0 million and income from operations of $2.2 million have been included in our condensed consolidated financial statements.
The unaudited pro forma financial results shown in the table below for the three and nine months ended September 30, 2018 and 2017, combine the consolidated results of NN and Paragon Medical giving effect to the Paragon Medical acquisition as if it had been completed on January 1, 2017, the beginning of the comparable prior annual reporting period presented. The unaudited pro forma financial results do not give effect to any of our other acquisitions that occurred after January 1, 2017, and do not include any anticipated synergies or other assumed benefits of the Paragon Medical acquisition. This unaudited pro forma financial information is presented for informational purposes only and is not indicative of future operations or results had the Paragon Medical acquisition been completed as of January 1, 2017.
The unaudited pro forma financial results include certain adjustments for debt service costs and additional depreciation and amortization expense based upon the fair value step-up and estimated useful lives of Paragon Medical depreciable fixed assets and definite-life amortizable assets acquired. Adjustments for the three and nine months ended September 30, 2018, include a reduction of the prepayment penalty incurred upon the extinguishment of debt (see Note 10) as if the debt had been outstanding since January 1, 2017. The provision for income taxes has also been adjusted for all periods, based upon the foregoing adjustments to historical results. The impact of adopting ASC 606 has been included based on an adoption date of January 1, 2018.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Pro forma net sales
$
205,683

 
$
183,424

 
$
626,414

 
$
568,270

Pro forma income (loss) from continuing operations
$
(11,830
)
 
$
(8,436
)
 
$
(31,909
)
 
$
(52,840
)
Pro forma net income (loss)
$
(11,830
)
 
$
121,005

 
$
(31,909
)
 
$
87,355

Basic income (loss) from continuing operations per share
$
(0.41
)
 
$
(0.31
)
 
$
(1.15
)
 
$
(1.93
)
Diluted income (loss) from continuing operations per share
$
(0.41
)
 
$
(0.31
)
 
$
(1.15
)
 
$
(1.93
)
Unaudited pro forma results for the nine months ended September 30, 2017, include $15.0 million of inventory fair value adjustments, financing, integration, and transaction costs, net of tax, directly attributable to the acquisition which will not have an ongoing impact. No such costs are present in the unaudited pro forma results for the three months ended September 30, 2017.
Other Acquisitions
We made other acquisitions during the nine months ended September 30, 2018, with an aggregate cash purchase price of $22.0 million. Amounts recorded for preliminary goodwill and intangible assets are disclosed in Note 6 and Note 7, respectively, and are subject to completion of our integration procedures. We incurred approximately $0.5 million in acquisition related costs with respect to other acquisitions during the nine months ended September 30, 2018. Transaction costs were expensed as incurred and are included in the “Acquisition related costs excluded from selling, general and administrative expense” line item in the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss).

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Bridgemedica, LLC. On February 22, 2018, we completed the acquisition of 100% of the assets of Bridgemedica, LLC (“Bridgemedica”). For accounting purposes, Bridgemedica meets the definition of a business and has been accounted for as a business combination. Bridgemedica is a medical device company that provides concept to supply solutions through design, development engineering and manufacturing. Operating results of Bridgemedica are reported prospectively in our Life Sciences group after the acquisition date. We have finalized certain working capital adjustments and are in the process of completing the integration of the Bridgemedica business into our operations.
Southern California Technical Arts, Inc. On August 9, 2018, we completed the acquisition of 100% of the capital stock of Southern California Technical Arts, Inc. (“Technical Arts”). For accounting purposes, Technical Arts meets the definition of a business and has been accounted for as a business combination. Technical Arts is an industrial machining company that manufactures tight tolerance metal components and assemblies. The acquisition of Technical Arts expands the NN presence in the aerospace and defense end market. Operating results of Technical Arts are reported prospectively in our Power Solutions group after the acquisition date. We have completed a preliminary purchase price allocation and are in the process of finalizing the fair value of assets acquired and liabilities assumed.

Note 4. Segment Information
We determined our reportable segments under the provisions of U.S. GAAP related to disclosures about segments of an enterprise. Management has concluded that Mobile Solutions, Power Solutions, and Life Sciences each constitutes an operating segment as each engages in business activities for which it earns revenues and incurs expenses for which separate financial information is available, and this is the level at which the Chief Operating Decision Maker (“CODM”) reviews discrete financial information for purposes of allocating resources and assessing performance. In making this determination, management considered the form and content of the financial information that is regularly reviewed by the CODM. As described in Note 1, in January 2018, we implemented a new enterprise and management structure and reorganized our businesses into the Mobile Solutions, Power Solutions and Life Sciences groups based principally on the end markets they serve. In the first quarter of 2018, we began reporting our financial results based on these new reportable segments. Prior year amounts have been restated to conform to the current year presentation.
Mobile Solutions
Mobile Solutions is focused on growth in the general industrial and automotive end markets. We have developed an expertise in manufacturing highly complex, system critical components for fuel systems, engines and transmissions, power steering systems and electromechanical motors on a high-volume basis. This expertise has been gained through investment in technical capabilities, processes and systems, and skilled program management and product launch capabilities.
Power Solutions
Power Solutions is focused on growth in the electrical, and aerospace and defense end markets. Within this group 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 used in applications ranging from power control to flight control and for military devices.
We manufacture a variety of products including electrical contacts, connectors, contact assemblies and precision stampings for the electrical end market and high precision products for the aerospace and defense end markets utilizing our extensive process technologies for optical grade plastics, thermally conductive plastics, titanium, Inconel, magnesium and electroplating.
Life Sciences
Life Sciences is focused on growth in the medical end market. Within this group we combine advanced engineering and production capabilities to design and manufacture a broad range of high-precision metal and plastic components, assemblies and finished devices.
We manufacture a variety of components, assemblies and instruments, such as surgical knives, bioresorbable implants, surgical staples, cases and trays, orthopedic implants and tools, laparoscopic devices, and drug delivery devices for the medical and life sciences end market.

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Segment Results
The following table presents results of continuing operations for each reportable segment.
 
 
Mobile
Solutions
 
Power
Solutions
 
Life
Sciences
 
Corporate
and
Consolidations
 
 
 
Total
Continuing
Operations
Three Months Ended September 30, 2018
 
 
 
 
 
 
 
 
 
 
 
 
Net sales
 
$
81,805

 
$
46,082

 
$
78,363

 
$
(567
)
 
(a)
 
$
205,683

Income (loss) from operations
 
$
4,657

 
$
2,706

 
$
6,717

 
$
(8,199
)
 
 
 
$
5,881

Interest expense
 
 
 
 
 
 
 
 
 
 
 
(18,608
)
Other
 
 
 
 
 
 
 
 
 
 
 
(6,932
)
Loss from continuing operations before benefit for income taxes and share of net income from joint venture
 
$
(19,659
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2018
 

 

 

 

 

 

Net sales
 
$
259,678

 
$
144,584

 
$
168,716

 
$
(1,798
)
 
(a)
 
$
571,180

Income (loss) from operations
 
$
21,822

 
$
13,939

 
$
12,962

 
$
(39,440
)
 

 
$
9,283

Interest expense
 

 

 

 

 

 
(46,592
)
Other
 

 

 

 

 

 
(21,444
)
Loss from continuing operations before benefit for income taxes and share of net income from joint venture
 
$
(58,753
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
Net sales
 
$
81,664

 
$
44,824

 
$
22,154

 
$
(486
)
 
(a)
 
$
148,156

Income (loss) from operations
 
$
6,799

 
$
4,166

 
$
3,011

 
$
(8,425
)
 
 
 
$
5,551

Interest expense
 
 
 
 
 
 
 
 
 
 
 
(12,739
)
Other
 
 
 
 
 
 
 
 
 
 
 
782

Loss from continuing operations before benefit for income taxes and share of net income from joint venture
 
$
(6,406
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2017
 

 

 

 

 

 

Net sales
 
$
254,768

 
$
141,982

 
$
68,397

 
$
(1,489
)
 
(a)
 
$
463,658

Income (loss) from operations
 
$
28,088

 
$
17,780

 
$
10,431

 
$
(24,254
)
 

 
$
32,045

Interest expense
 

 

 

 

 

 
(39,916
)
Other
 

 

 

 

 

 
(38,433
)
Loss from continuing operations before benefit for income taxes and share of net income from joint venture
 
$
(46,304
)
 
(a)
Includes eliminations of intersegment transactions occurring during the ordinary course of business.

 
 
Total Assets as of
 
 
September 30, 2018
 
December 31, 2017
Mobile Solutions
 
$
446,830

 
$
428,321

Power Solutions
 
404,701

 
383,063

Life Sciences
 
806,828

 
355,703

Corporate and Consolidations
 
104,963

 
307,916

Total
 
$
1,763,322

 
$
1,475,003

The Paragon Medical business acquired on May 7, 2018, contributed $70.0 million to net sales and $2.2 million to income from operations in the Life Sciences group after the acquisition date through September 30, 2018. Other businesses acquired in 2018 contributed $7.3 million to net sales and $0.2 million to income from operations in the Life Sciences and Power Solutions groups after each acquisition date through September 30, 2018.

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Note 5. Inventories
Inventories are comprised of the following amounts:
 
 
September 30, 2018
 
December 31, 2017
Raw materials
 
$
54,439

 
$
37,337

Work in process
 
45,801

 
27,669

Finished goods
 
23,869

 
17,611

Inventories
 
$
124,109

 
$
82,617


Note 6. Goodwill
The following table shows changes in the carrying amount of goodwill.
 
 
Mobile
Solutions
 
Power
Solutions
 
Life
Sciences
 
Total
Balance as of December 31, 2017
 
$
74,147

 
$
201,881

 
$
178,584

 
$
454,612

Currency impacts
 
(705
)
 
27

 
(3,037
)
 
(3,715
)
Goodwill acquired in acquisitions
 

 
2,657

 
165,454

 
168,111

Measurement period adjustments
 

 

 
5,447

 
5,447

Balance as of September 30, 2018
 
$
73,442

 
$
204,565

 
$
346,448

 
$
624,455

The goodwill acquired in 2018 is related to the Paragon Medical, Bridgemedica, and Technical Arts acquisitions as described in Note 3 and is derived from the value of the businesses acquired. We recorded $162.4 million of goodwill related to the Paragon Medical acquisition, $8.0 million related to the Bridgemedica acquisition, and $2.7 million related to the Technical Arts acquisition during the nine months ended September 30, 2018. We have completed a preliminary purchase price allocation and are in the process of finalizing the fair value of assets acquired and liabilities assumed. The preliminary fair value of the businesses acquired was based on management business plans and future performance estimates which are subject to a high degree of management judgment and complexity. Actual results may differ from these projections and the differences may be material.
In the first quarter of 2018, as a result of the changes in our organizational and management structure, goodwill was reassigned to operating segments using a relative fair value allocation. For further information on the organizational changes, see Note 1.
Based on the closing sales price of a share of our common stock as of September 30, 2018, our market capitalization exceeded the $641.0 million net book value of our stockholders’ equity. Subsequent to September 30, 2018, our market capitalization declined to a level that is less than the net book value of our stockholders’ equity. A prolonged or significant decline in market capitalization could be an indicator of possible goodwill impairment. We will perform our annual goodwill impairment test during the fourth quarter to determine whether any impairment charge is required. We will continue to monitor the market capitalization relative to net book value throughout the fourth quarter and subsequent periods.
Note 7. Intangible Assets, Net
The following table shows changes in the carrying amount of intangible assets, net.
 
 
Mobile
Solutions
 
Power
Solutions
 
Life
Sciences
 
Total
Balance as of December 31, 2017
 
$
39,446

 
$
105,030

 
$
93,226

 
$
237,702

Amortization
 
(2,655
)
 
(8,746
)
 
(12,713
)
 
(24,114
)
Currency impacts
 
(22
)
 

 

 
(22
)
Intangible assets acquired in acquisitions
 

 
1,900

 
169,917

 
171,817

Measurement period adjustments
 

 

 
(700
)
 
(700
)
Balance as of September 30, 2018
 
$
36,769

 
$
98,184

 
$
249,730

 
$
384,683


The intangible assets acquired in 2018 are related to the Paragon Medical, Bridgemedica, and Technical Arts acquisitions as described in Note 3 and primarily represent customer relationships and trade names. We recorded $163.5 million of intangible

15

Table of Contents

assets related to the Paragon Medical acquisition, $5.7 million related to the Bridgemedica acquisition, and $1.9 million related to the Technical Arts acquisition during the nine months ended September 30, 2018.
The following table shows the nature and preliminary weighted average estimated useful lives of intangible assets acquired during the nine months ended September 30, 2018. Actual results may differ from these projections and the differences may be material.
 
 
Gross Carrying Value as of Acquisition Date
 
Weighted Average Estimated Useful Life in Years
Customer relationships
 
$
146,800

 
20
Trademark and trade name
 
14,700

 
29
Other
 
9,617

 
1
Total intangible assets acquired in current year
 
$
171,117

 
19
As of January 1, 2018, as a result of the changes in our organizational and management structure, intangible assets were reassigned to operating segments using a relative fair value allocation. For further information on the organizational changes, see Note 1.
Note 8. Investment in Joint Venture
We own a 49% investment in Wuxi Weifu Autocam Precision Machinery Company, Ltd. (the “JV”), a joint venture located in Wuxi, China. 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.
Balance as of December 31, 2017
$
39,822

Share of earnings
2,087

Accretion of basis difference from purchase accounting
(343
)
Foreign currency translation loss
(2,242
)
 
 
Balance as of September 30, 2018
$
39,324

We recognized sales to the JV of approximately $0.2 million and approximately $0.2 million during the nine months ended September 30, 2018 and 2017, respectively.
The following tables show selected financial data of the JV.
 
 
September 30, 2018
 
December 31, 2017
Current assets
 
$
43,351

 
$
47,600

Non-current assets
 
32,352

 
24,763

Total assets
 
$
75,703

 
$
72,363

Current liabilities
 
$
27,982

 
$
26,165

Non-current liabilities
 
5

 
22

Total liabilities
 
$
27,987

 
$
26,187

 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Net sales
 
$
16,026

 
$
18,582

 
$
52,140

 
$
55,166

Cost of sales
 
$
14,442

 
$
15,156

 
$
45,126

 
$
43,316

Income from operations
 
$
1,207

 
$
3,204

 
$
5,872

 
$
11,000

Net income
 
$
753

 
$
2,685

 
$
4,257

 
$
9,144



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Table of Contents

Note 9. Income Taxes
On December 22, 2017, the U. S. government enacted comprehensive tax legislation. The Tax Act reduces the maximum U.S. federal corporate income tax rate from 35% to 21% and creates new taxes on certain foreign sourced earnings. In response to the Tax Act, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 118 (“SAB 118”) which allows issuers to recognize provisional estimates of the impact of the Tax Act in their financial statements, or in circumstances where estimates cannot be made, to disclose and recognize at a later date.
For the year ended December 31, 2017, we included in our financial statements provisional charges for the revaluation of our net domestic deferred tax assets and a one-time charge for the deemed repatriation of historic unremitted earnings. During the nine months ended September 30, 2018, there were no additional changes to the provisional amounts recorded as of December 31, 2017. The accounting is expected to be completed and disclosed within the one-year measurement period as allowed by SAB 118.
Our effective tax rate from continuing operations was 28.4% and 21.7% for the three months and nine months ended September 30, 2018, respectively, and 26.9% and 30.5% for the three months and nine months ended September 30, 2017, respectively. Our 2018 effective tax rates differ from the U.S. federal statutory tax rate of 21% due to permanent differences including certain provisions of the Tax Act, specifically the base-broadening provision which imposed a new minimum tax on global intangible low-tax income (“GILTI”). Our 2017 effective tax rates differ from the U.S. federal statutory tax rate of 34% due primarily to earnings outside the U.S. which were taxed at rates lower than the U.S. federal statutory rate.
During the nine months ended September 30, 2018, we finalized our accounting policy decision with respect to the new GILTI tax rules and have concluded that GILTI will be treated as a periodic charge in the year in which it arises. Therefore, we will not record deferred taxes for the basis associated with GILTI earnings.
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 Holdings, LLC, our wholly-owned subsidiary. The examination is ongoing as of September 30, 2018.
Note 10. Debt
The following table presents debt balances as of September 30, 2018, and December 31, 2017.
 
 
September 30, 2018
 
December 31, 2017
$545.0 million Senior Secured Term Loan B (“Senior Secured Term Loan”) bearing interest at the greater of 0.75% or one-month LIBOR (2.26% at September 30, 2018), plus an applicable margin of 3.75% at September 30, 2018, expiring October 19, 2022
 
$
534,250

 
$
534,250

$300.0 million Incremental Term Loan (“Incremental Term Loan”) bearing interest at one-month LIBOR (2.26% at September 30, 2018), plus an applicable margin of 3.25% at September 30, 2018, expiring April 3, 2021
 
282,000

 
291,000

$143.0 million Senior Secured Revolver (“Senior Secured Revolver”) bearing interest at one-month LIBOR (2.26% at September 30, 2018), plus an applicable margin of 3.5% at September 30, 2018, expiring October 19, 2020
 
69,401

 

International lines of credit and other loans
 
7,584

 
3,315

Total
 
893,235

 
828,565

Less current maturities of long-term debt
 
31,726

 
17,283

Principal, net of current portion
 
861,509

 
811,282

Less unamortized debt issuance costs
 
17,989

 
20,477

Long-term debt, net of current portion
 
$
843,520

 
$
790,805

We capitalized interest costs amounting to $0.3 million and $0.2 million in the three months ended September 30, 2018 and 2017, respectively, and $0.8 million and $0.9 million in the nine months ended September 30, 2018 and 2017, respectively, related to construction in progress.
Collectively, our Senior Secured Term Loan, Incremental Term Loan, and Senior Secured Revolver comprise our credit facility. Principal available under the Senior Secured Revolver was $100.0 million as of September 30, 2018. Available principal may be restored to $143.0 million upon the achievement of certain requirements. Our credit facility is subject to certain financial covenants based on a consolidated net leverage ratio, as defined in the credit facility agreement. The financial covenants are

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Table of Contents

effective when we have outstanding amounts drawn on our Senior Secured Revolver on the last day of any fiscal quarter and become more restrictive over time. We had a $69.4 million outstanding balance on the Senior Secured Revolver as of September 30, 2018, and we were in compliance with all covenants under our credit facility.
Second Lien Credit Agreement
In connection with the Paragon Medical acquisition, we, certain of our subsidiaries named therein, SunTrust Bank, as Administrative Agent, SunTrust Robinson Humphrey, Inc. as Lead Arranger and Bookrunner, and the lenders named therein entered into a Second Lien Credit Agreement (the “Second Lien Credit Agreement”) pursuant to which SunTrust and the other lenders extended to us a $200.0 million secured second lien term loan facility (the “Second Lien Facility”). We utilized the net proceeds from the Second Lien Facility, together with cash on hand, to pay the Paragon Medical purchase price and fees and expenses related to the acquisition. The Second Lien Facility was collateralized by all of our assets. The Second Lien Facility had an original maturity date of April 19, 2023, and bore interest at either (i) a base rate, plus an applicable margin, or (ii) the greater of the London Interbank Offered Rate (“LIBOR”) or 1.00%, plus an applicable margin. The initial applicable margin for all borrowings under the Second Lien Facility was 7.00% per annum with respect to base rate borrowings and 8.00% per annum with respect to LIBOR borrowings. We voluntarily prepaid in full the $200.0 million outstanding principal balance with proceeds from the sale of common shares on September 18, 2018. We paid a prepayment penalty of two percent, or $4.0 million, and wrote off $2.6 million of unamortized debt issuance costs.
On September 18, 2018, we issued 14.4 million common shares in a registered public offering. Net proceeds of approximately $217.3 million were used to repay the Second Lien Facility and a portion of the Senior Secured Revolver.
Amendment to Credit Facility
On May 7, 2018, we entered into an amendment to our existing credit facility to permit the Paragon Medical acquisition, to permit the Second Lien Credit Agreement, and to amend certain covenants. We paid $16.7 million of debt issuance costs related to the amendment. A total of $12.9 million is included in the “Loss on extinguishment of debt and write-off of debt issuance costs” line on the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss). The remaining $3.8 million is capitalized as a reduction of long-term debt.

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Note 11. Restructuring and Integration
The following table summarizes restructuring and integration charges incurred for the three months and nine months ended September 30, 2018 and 2017.
 
 
Three Months Ended September 30, 2018
 
 
Mobile
Solutions
 
Power
Solutions
 
Life
Sciences
 
Corporate and
Consolidations
 
Total
Severance and other employee costs
 
$

 
$

 
$
(260
)
 
$

 
$
(260
)
Site closure and other associated costs
 
51

 

 

 

 
51

Total
 
$
51

 
$

 
$
(260
)
 
$

 
$
(209
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2018
 
 
Mobile
Solutions
 
Power
Solutions
 
Life
Sciences
 
Corporate and
Consolidations
 
Total
Severance and other employee costs
 
$

 
$

 
$
1,336

 
$
728

 
$
2,064

Site closure and other associated costs
 
73

 

 

 

 
73

Total
 
$
73

 
$

 
$
1,336

 
$
728

 
$
2,137

 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended September 30, 2017
 
 
Mobile
Solutions
 
Power
Solutions
 
Life
Sciences
 
Corporate and
Consolidations
 
Total
Severance and other employee costs
 
$

 
$

 
$

 
$

 
$

Site closure and other associated costs
 
345

 

 

 

 
345

Total
 
$
345

 
$

 
$

 
$

 
$
345

 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2017
 
 
Mobile
Solutions
 
Power
Solutions
 
Life
Sciences
 
Corporate and
Consolidations
 
Total
Severance and other employee costs
 
$
17

 
$

 
$

 
$

 
$
17

Site closure and other associated costs
 
345

 

 

 

 
345

Total
 
$
362

 
$

 
$

 
$

 
$
362


The following table summarizes restructuring and integration reserve activity for the nine months ended September 30, 2018.
 
 
Reserve
Balance as of
December 31, 2017
 
Charges
 
Non-cash
Adjustments
 
Cash
Reductions
 
Reserve
Balance as of
September 30, 2018
Severance and other employee costs
 
$

 
$
2,064

 
$

 
$
(683
)
 
$
1,381

Site closure and other associated costs
 
1,099

 
73

 
(61
)
 
(902
)
 
209

Total
 
$
1,099

 
$
2,137

 
$
(61
)
 
$
(1,585
)
 
$
1,590

We recognized severance costs of $0.7 million in the nine months ended September 30, 2018, at corporate headquarters related to the restructuring of our former Precision Engineered Products Group to form the Power Solutions and Life Sciences groups effective January 2, 2018.
We recognized severance costs of $1.3 million in the nine months ended September 30, 2018, in our Life Sciences group related to the integration of Paragon Medical into our existing business after the acquisition.
The amount accrued for restructuring and integration costs represents what we expect to pay over the next 2.4 years. We expect to pay $0.8 million within the next twelve months.

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Note 12. Commitments and Contingencies
Brazil ICMS Tax Matter
Prior to the acquisition of Autocam Corporation in 2014 (“Autocam”), 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, 2018, for this matter.
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 13. Revenue from Contracts with Customers
We adopted ASC 606 on January 1, 2018, using the modified retrospective transition method for all contracts not completed as of the date of adoption. The reported results for 2018 reflect the application of ASC 606 while the reported results for 2017 were prepared under the guidance of ASC 605. The adoption of ASC 606 represents a change in accounting principle that will more closely align revenue recognition with the delivery of our goods and will provide financial statement readers with enhanced disclosures. In accordance with ASC 606, revenue is recognized when a customer obtains control of promised goods in an amount that reflects the consideration we expect to be entitled to receive in exchange for those goods. To the extent that transaction price includes variable consideration, we estimate the amount of variable consideration that should be included in the transaction price utilizing the expected value method or the most likely amount method depending on the nature of the variable consideration. Variable consideration is included in the transaction price if, in management’s judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur.
Revenue is recognized when control of the good or service is transferred to the customer either at a point in time or, in limited circumstances, as our services are rendered over time. Revenue is measured as the amount of consideration we expect to receive in exchange for transferring goods or services.

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The following tables summarize sales to external customers by major source.
 
 
Nine Months Ended September 30, 2018
 
 
Mobile
Solutions
 
Power
Solutions
 
Life
Sciences
 
Intersegment
Sales
Eliminations
 
Total
United States
 
$
144,138

 
$
120,189

 
$
142,863

 
$
(1,798
)
 
$
405,392

China
 
34,273

 
4,140

 
3,843

 

 
42,256

Mexico
 
21,042

 
8,799

 
429

 

 
30,270

Brazil
 
27,722

 
157

 
29

 

 
27,908

Germany
 
4,500

 
24

 
11,138

 

 
15,662

Switzerland
 
3,915

 
35

 
3,827

 

 
7,777

Poland
 
5,485

 
23

 
1

 

 
5,509

Italy
 
4,424

 
214

 
243

 

 
4,881

Czech Republic
 
4,791

 
47

 

 

 
4,838

Netherlands
 

 
2,556

 

 

 
2,556

Other
 
9,388

 
8,400

 
6,343

 

 
24,131

Total net sales
 
$
259,678

 
$
144,584

 
$
168,716

 
$
(1,798
)
 
$
571,180

 
 
 
Three Months Ended September 30, 2018
 
 
Mobile
Solutions
 
Power
Solutions
 
Life
Sciences
 
Intersegment
Sales
Eliminations
 
Total
United States
 
$
46,341

 
$
38,137

 
$
63,869

 
$
(567
)
 
$
147,780

China
 
11,111

 
1,696

 
2,405

 

 
15,212

Mexico
 
6,570

 
2,254

 
90

 

 
8,914

Germany
 
1,415

 
17

 
7,321

 

 
8,753

Brazil
 
8,200

 
107

 

 

 
8,307

Poland
 
1,215

 
6

 
2,107

 

 
3,328

Italy
 
1,514

 
5

 

 

 
1,519

Czech Republic
 
1,285

 
105

 
106

 

 
1,496

Switzerland
 
1,420

 
47

 

 

 
1,467

Netherlands
 

 
649

 

 

 
649

Other
 
2,734

 
3,059

 
2,465

 

 
8,258

Total net sales
 
$
81,805

 
$
46,082

 
$
78,363

 
$
(567
)
 
$
205,683

Product Sales
We generally transfer control and recognize a sale when we ship the product from our manufacturing facility to our customer, at a point in time, as this is when our customer obtains the ability to direct use of, and obtain substantially all of the remaining benefits from, the goods. We have elected to recognize the cost for freight and shipping when control over products has transferred to the customer as a component of cost of sales.
We use an observable price to determine the stand-alone selling price for separate performance obligations or a cost-plus-margin approach when an observable price is not available. The expected duration of our contracts is one year or less, and we have elected to apply the practical expedient that allows entities to disregard the effects of financing when the contract length is less than one year. The amount of consideration we receive and the revenue we recognize varies with volume rebates and incentives we offer to our customers. We estimate the amount of variable consideration that should be included in the transaction price utilizing the expected value method or the most likely amount method depending on the nature of the variable consideration. Variable consideration is included in the transaction price if, in our judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur.

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We have utilized certain practical expedients allowed by the new standard. We utilize the portfolio approach practical expedient to evaluate sales-related discounts on a portfolio basis to contracts with similar characteristics. The effect on our financial statements of applying the portfolio approach would not differ materially from applying the new standard to individual contracts.
We give our customers the right to return only defective products in exchange for functioning products or rework of the product. These transactions are evaluated and accounted for under ASC Topic 460, Guarantees, and we estimate the impact to the transaction price based on an analysis of historical experience.
Other Sources of Revenue
We provide pre-production activities related to engineering efforts to develop molds, dies and machines that are owned by our customers. We may receive advance payments from customers which are deferred until satisfying our performance obligations by compliance with customer-specified milestones, recognizing revenue at a point in time. These contracts generally have an original expected duration of less than one year.
The following table provides information about contract liabilities from contracts with customers.
 
 
Deferred
Revenue
Balance at January 1, 2018
$
2,124

Balance at September 30, 2018
$
3,216

The timing of revenue recognition, billings and cash collections results in billed accounts receivable and customer advances and deposits (contract liability) on the Condensed Consolidated Balance Sheet. These contract liabilities are reported on the Condensed Consolidated Balance Sheet on a contract-by-contract basis at the end of each reporting period as deferred revenue. Deferred revenue relates to payments received in advance of performance under the contract and recognized as revenue as (or when) we perform under the contract. Changes in the contract liability balances during the three months and nine months ended September 30, 2018, were not materially impacted by any other factors. Revenue recognized during the three months and nine months ended September 30, 2018, from amounts included in deferred revenue at the beginning of the period for performance obligations satisfied or partially satisfied during the three months and nine months ended September 30, 2018, was approximately $0.5 million and $1.2 million, respectively.
Transaction Price Allocated to Future Performance Obligations
ASC 606 requires that we disclose the aggregate amount of transaction price that is allocated to performance obligations that have not yet been satisfied as of September 30, 2018. The guidance provides certain practical expedients that limit this requirement. Our contracts meet the following practical expedient provided by ASC 606:
 
The performance obligation is part of a contract that has an original expected duration of one year or less.
Costs to Obtain and Fulfill a Contract
Prior to the adoption of ASC 606, we expensed commissions paid to internal sales representatives for obtaining contracts. Under ASC 606, we adopted the practical expedient to recognize commissions paid to internal sales personnel that are incremental to obtaining customer contracts as an expense when incurred since the amortization period is less than one year. The judgments made in determining the amount of costs incurred include whether the commissions are in fact incremental and would not have occurred absent the customer contract. Costs to obtain a contract are expensed as selling, general and administrative expense.
Sales, value add, and other taxes we collect concurrent with revenue-producing activities are excluded from revenue. Incidental items that are immaterial in the context of the contract are recognized as expense.
Financial Statement Impact of Adopting ASC 606
The following table presents the impact of adoption of ASC 606 on our Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) and our Condensed Consolidated Balance Sheet. Differences are due to the acceleration in the recognition of revenue to the point of shipment or delivery for contracts where an unconditional obligation to purchase is present for inventory that was considered in consignment under ASC 605.

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Table of Contents

 
 
Three Months Ended September 30, 2018
 
Nine Months Ended September 30, 2018
 
 
As Reported
 
Balances
Without
Adoption of
ASC 606
 
Effect of
Change
 
As Reported
 
Balances
Without
Adoption of
ASC 606
 
Effect of
Change
Net sales
 
$
205,683

 
$
205,691

 
$
(8
)
 
$
571,180

 
$
571,260

 
$
(80
)
Cost of sales
 
156,408

 
156,424

 
(16
)
 
431,492

 
431,544

 
(52
)
Income (loss) from operations
 
5,881

 
5,873

 
8

 
9,283

 
9,311

 
(28
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
As of September 30, 2018
 
 
 
 
 
 
 
 
As Reported
 
Balances
Without
Adoption of
ASC 606
 
Effect of
Change
 
 
 
 
 
 
Accounts receivable, net
 
$
149,982

 
$
149,454

 
$
528

 
 
 
 
 
 
Inventories
 
124,109

 
124,427

 
(318
)
 
 
 
 
 
 
Note 14. Shared-Based Compensation
The following table lists the components of share-based compensation expense by type of award.
 
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
2018
 
2017
 
2018
 
2017
Stock options
 
$
173

 
$
527

 
$
531

 
$
1,102

Restricted stock
 
388

 
773

 
1,244

 
1,628

Performance share units
 
530

 
467

 
1,650

 
1,255

Change in estimate of performance share vesting (1)
 
(802
)
 
$

 
(802
)
 

Share-based compensation expense
 
$
289

 
$
1,767

 
$
2,623

 
$
3,985


(1)
Reflects decrease in share-based compensation expense of $0.8 million to reflect the change in estimate of the probability of vesting of performance share units as described in the “Performance Share Units” section of this Note.
Stock Options
During the nine months ended September 30, 2018, we granted options to purchase 57,800 shares to certain key employees. The weighted average grant date fair value of the options granted during the nine months ended September 30, 2018, was $10.60 per share. The fair value of our options cannot be determined by market value because they 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 stock options granted in 2018.
 
2018
Stock Option
Awards
Expected term
6 years

Risk free interest rate
2.66
%
Dividend yield
1.15
%
Expected volatility
47.69
%
Expected forfeiture rate
4.00
%
The expected term is derived from using the simplified method of determining stock option terms as described under the Securities and Exchange Commission’s Staff Accounting Bulletin Topic 14, Share-based payment. The simplified method was used because sufficient historical stock option exercise experience was not available.
The average risk-free interest rate is derived from United States Department of Treasury published interest rates of daily yield curves for the same time period as the expected term.

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The expected dividend yield is derived by a mathematical formula which uses the expected annual dividends over the expected term divided by the fair market value of our common stock at the grant date.
The expected volatility rate is derived from our actual common stock historical volatility over the same time period as the expected term. The volatility rate is derived by mathematical formula utilizing daily closing price data.
The forfeiture rate is determined from examining the historical pre-vesting forfeiture patterns of past option issuances to key employees. While the forfeiture rate is not an input of the Black Scholes model for determining the fair value of the options, it is an important determinant of stock option compensation expense to be recorded.
The following table summarizes option activity for the nine months ended September 30, 2018.
 
Options
 
Shares
(in thousands)
 
Weighted-
Average
Exercise
Price
(per share)
 
Weighted-
Average
Remaining
Contractual
Term (years)
 
Aggregate
Intrinsic
Value
 
 
Outstanding at January 1, 2018
 
746

 
$
14.33

 
 
 
 
 
 
Granted
 
58

 
24.41

 
 
 
 
 
 
Exercised
 
(27
)
 
10.15

 
 
 
$
477

 
 
Forfeited or expired
 
(4
)

23.51





 
 
Outstanding at September 30, 2018
 
773

 
$
15.19

 
5.9
 
$
319

 
(1)
Exercisable at September 30, 2018
 
626

 
$
13.63

 
5.2
 
$
1,232

 
(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, 2018.
Restricted Stock
During the nine months ended September 30, 2018, we granted 86,516 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, 2018, 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 awarded 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, 2018, was $24.55 per share. Total grant-date fair value of restricted stock that vested in the nine months ended September 30, 2018, was $1.8 million.
The following table summarizes the status of unvested restricted stock awards as of September 30, 2018, and changes during the nine months then ended.