Tennant Company — Q3 2017 Form 10-Q
Business context and period. This unaudited quarterly report covers the three and nine months ended September 30, 2017. Tennant designs, manufactures and sells commercial cleaning equipment and related products and services. Results include IPC Cleaning S.p.A. from its April 6, 2017 acquisition.
Financial performance
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Net sales | $261.9m | $200.1m | $723.8m | $596.8m |
| Gross margin | 39.9% | 42.6% | 39.9% | 43.2% |
| Operating income | $11.0m | $16.3m | $17.6m | $45.9m |
| Net income (loss) attributable to Tennant | $3.6m | $11.5m | $(3.0)m | $31.2m |
| Diluted EPS | $0.20 | $0.64 | $(0.17) | $1.74 |
| Operating cash flow | — | $32.1m | $33.3m |
Q3 sales rose 30.9%; nine-month sales rose 21.3%. Acquisitions contributed 28.4 percentage points of Q3 growth and 20.1 points of nine-month growth. Organic growth was 1.3% and 1.1%, respectively. EMEA growth was particularly acquisition-driven; Americas organic sales were slightly lower in Q3, while APAC organic sales declined.
Gross margin contracted 270 basis points in Q3 and 330 basis points year to date. The filing attributes pressure to IPC acquisition-related inventory step-up and lower acquired-business margins, a higher EMEA sales mix, raw-material inflation, service productivity challenges, and near-term manufacturing automation investments. Operating income and earnings also reflected higher IPC amortization and acquisition expenses and substantially higher interest expense.
Cash, liquidity and debt
- At September 30, cash and cash equivalents were $55.9m; working capital was $220.8m and the current ratio was 2.1.
- Nine-month investing cash outflow was $371.5m, including $354.1m for business acquisitions net of cash acquired. Financing cash inflow was $335.8m. Cash decreased $2.1m over the period.
- Debt outstanding was $395.7m gross, including $300m of 5.625% senior notes due 2025 and $95m borrowed under the secured credit facility. Debt-to-capital rose to 56.9% from 11.5% at year-end 2016. The company reported compliance with its financial covenants at quarter-end.
Outlook, commentary and risks
- Management expected 2017 price increases to add approximately 1%–2% to annual sales, with minimal gross-margin benefit because increases were intended to offset inflation. The filing provides no explicit earnings or revenue forecast.
- A first-quarter restructuring charge was $8.0m; management expected savings to offset the charge in approximately one year and did not expect further costs from that action.
- IPC acquisition accounting remained preliminary. The company reported $115.2m of IPC sales and a $12.0m net loss contribution for the nine months since acquisition; results included purchase-accounting and acquisition-related charges.
- Key risks include substantial debt and debt-service capacity, restrictive covenants, acquisition integration and expected synergies, economic and competitive conditions, raw-material costs, foreign-exchange volatility, and execution of organizational and technology changes.
- Disclosure controls were deemed ineffective at September 30 because of previously identified material weaknesses, including revenue accounting for maintenance and repair services and software-cost capitalization controls. Management was implementing remediation and targeted completion by year-end 2017; the weaknesses were not yet considered remediated.
Important facts for investors to verify
- How much reported growth and future profitability depend on IPC, and whether integration benefits offset acquisition costs and purchase-accounting charges.
- Whether margins recover as inventory step-up charges, service productivity issues and automation investments run their course.
- Debt service, covenant headroom, refinancing or repayment requirements, and the effect of leverage on dividends and repurchases.
- Progress and effectiveness testing of the internal-control remediation plan, and the final IPC purchase-price allocation.
- Whether working-capital metrics improve: DSO increased to 66 days from 59 at year-end, and inventory days rose to 104 from 89.