TENNANT CO quarterly report, Q2 FY2019

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Tennant Company (TNC) — Q2 2019 Form 10-Q

Business context and reporting period

Tennant designs and sells commercial cleaning equipment, parts and consumables, services, and related solutions. This unaudited report covers the three and six months ended June 30, 2019, compared with the corresponding 2018 periods.

Financial performance and liquidity

  • Q2 revenue: $299.7 million, up 2.6% year over year. Organic sales rose 3.8%, acquisition impact was +1.4%, and foreign exchange was -2.6%. For the first half, revenue was $562.1 million, down 0.5%.
  • Regional performance: Q2 Americas sales increased 6.0%, EMEA declined 7.4%, and Asia Pacific increased 12.7%. Management cited market weakness in EMEA and Korea; Asia Pacific’s reported growth included Gaomei.
  • Profit and margins: Q2 gross profit was $120.8 million, with a 40.3% gross margin versus 40.1%; operating profit was $19.9 million, with a 6.6% operating margin versus 6.5%; Tennant-attributable net earnings were $14.8 million versus $12.7 million, and diluted EPS was $0.81 versus $0.69. First-half net earnings were $20.2 million versus $16.0 million, with diluted EPS of $1.10 versus $0.88. First-half gross and operating margins were 40.7% and 5.5%, compared with 40.1% and 5.2%.
  • Cash flow: First-half operating cash flow was $10.9 million, down from $26.0 million. Capital expenditures were $25.4 million; operating cash flow less capital expenditures was negative $14.5 million. Cash, cash equivalents, and restricted cash declined to $55.4 million from $86.1 million at year-end, largely amid increased inventory and receivables.
  • Debt and liquidity: Total debt was $354.4 million versus $355.1 million at year-end; cash was $55.4 million. The company had $56.0 million drawn on its revolving facility and approximately $140.7 million of unused capacity. The current ratio was 1.8 and working capital was $219.7 million. Tennant reported compliance with its debt covenants; an acquisition holiday temporarily raised certain leverage covenant thresholds.
  • Other metrics: Q2 declared dividend was $0.22 per share. Total assets were $1,070.8 million and total equity was $335.2 million at June 30, 2019.

Material changes versus prior comparable periods

  • Q2 sales growth and earnings improvement contrasted with a slight first-half sales decline. First-half organic growth of 1.6% and Gaomei’s 0.9% contribution were more than offset by a 3.0% adverse foreign-exchange impact.
  • Management attributed improved gross margin to pricing, product mix, cost reductions, and manufacturing efficiencies, partly offset by material and tariff costs, acquired-inventory fair-value adjustments, and discontinued product lines.
  • First-half interest expense fell to $10.5 million from $11.8 million, primarily due to lower debt levels during the period. Other income included a $1.8 million acquisition-related indemnification settlement.
  • Tennant adopted the new lease standard on January 1, 2019, recording $44.8 million of operating lease assets and liabilities at adoption; the company said adoption did not affect earnings or cash flows.

Outlook, commentary, risks, and unusual items

  • The filing provides no specific revenue or earnings guidance. Management described ongoing investment in product and technology innovation and expects restructuring savings to offset the related $4.3 million charge approximately one year after the action.
  • In Q1, Tennant recorded a $4.3 million severance restructuring charge related to IPC integration. In Q2, it recorded a $2.7 million write-down of a note receivable related to the Green Machine divestiture and a $2.4 million inventory charge after deciding to discontinue the Green Machine and Orbio product lines. Q2 S&A also included a $2.0 million Gaomei contingent-consideration adjustment and $0.8 million of acquisition and integration costs.
  • Tennant completed its Gaomei acquisition in January for a stated purchase price of $27.1 million, including $11.3 million paid at closing, $11.3 million due in January 2020, and contingent consideration. The contingent amount could range from $0 to $42.4 million; its June 30 fair value was $6.6 million. Certain purchase-allocation values remained subject to finalization.
  • Key risks identified include raw-material cost, availability and tariffs; foreign-exchange and geopolitical conditions; competition and market weakness; acquisition integration; product quality and liability; cybersecurity and business interruption; and the ability to generate cash to meet debt obligations. Management said it did not expect ordinary-course legal matters to materially affect financial position or results. It reported no material change in risk factors since the 2018 Form 10-K.
  • The effective tax rate was 10.8% in Q2 and 12.7% for the first half. Management cited geographic earnings mix and discrete tax items in the year-over-year increase.

Most important facts for investors to verify

  • Whether organic demand and margins can hold up, especially given continuing EMEA weakness, tariffs, and foreign-exchange headwinds.
  • Whether operating cash flow improves as inventory and receivables increase, and whether capital spending remains elevated.
  • Gaomei’s performance and integration, including the final purchase accounting and potential contingent payment.
  • The financial effects of discontinuing Green Machine and Orbio, including any further inventory or asset charges.
  • Debt covenant headroom, revolving-facility capacity, and the timing of debt repayments and acquisition-related payments.
  • The sustainability of reported earnings given restructuring and other unusual charges, the indemnification settlement, and tax-rate variability.