Tennant Company — Q3 2016 Form 10-Q
Business context and period. Tennant designs, manufactures and sells commercial cleaning equipment, products and services, including floor coatings. This unaudited filing covers the quarter and nine months ended September 30, 2016; comparisons are to the same 2015 periods unless noted. Amounts below are in U.S. dollars.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $200.1 million | $204.8 million | $596.8 million | $605.9 million |
| Gross profit / margin | $85.3 million / 42.6% | $88.7 million / 43.3% | $258.1 million / 43.2% | $261.8 million / 43.2% |
| Operating profit / margin | $16.3 million / 8.1% | $4.6 million / 2.2% | $45.9 million / 7.7% | $35.4 million / 5.8% |
| Net earnings (loss) | $11.5 million | $(1.0) million | $31.2 million | $18.9 million |
| Diluted EPS | $0.64 | $(0.05) | $1.74 | $1.01 |
Cash flow and liquidity. For the first nine months, operating cash flow was $33.3 million, versus $30.9 million. Capital expenditures were $22.5 million, implying operating cash flow less capital expenditures of approximately $10.8 million; business acquisitions used a further $12.4 million net of cash acquired. Cash declined $9.0 million from year-end 2015 to $42.3 million. At September 30, current assets were $281.6 million and current liabilities $122.9 million; working capital was $158.7 million and the current ratio was 2.3.
Debt and capital returns. Total debt was $36.2 million, up from $24.7 million at December 31, 2015, including $15.0 million of new long-term borrowing during the nine-month period. The company reported covenant compliance, a debt-to-EBITDA ratio of 0.53 and EBITDA-to-interest coverage of 68.37. It paid $10.6 million in dividends and repurchased $12.8 million of common stock during the period. The declared dividend was $0.20 per share in Q3.
Material changes and operating drivers
- Q3 sales fell 2.3%; nine-month sales fell 1.5%. Q3 organic sales declined 2.2%, driven by a 2.2% volume decline, while nine-month organic sales increased 0.1%.
- Regional sales were uneven: Q3 Americas sales grew 2.2%, while EMEA fell 15.1% and Asia Pacific fell 13.1%. Management cited weaker industrial equipment sales, a larger-than-expected U.K. impact associated with Brexit, and APAC declines after strong prior-year growth.
- Q3 gross margin declined 70 basis points, primarily due to North American productivity challenges and skilled-labor shortages. Nine-month gross margin was unchanged year over year.
- Q3 operating profit improved substantially from 2015, chiefly because the prior-year quarter included an $11.2 million non-cash long-lived-asset impairment and a $1.8 million restructuring charge. These items make the year-over-year earnings comparison unusually favorable; they were not recurring 2016 charges.
- Selling and administrative expense fell 6.3% in Q3, reflecting cost controls and operating efficiencies, partly offset by growth investments. New products launched within the prior three years represented 40% of Q3 equipment revenue, compared with 24% a year earlier.
Outlook, commentary and risks
- Management said it did not anticipate significant inflation or material selling-list-price increases in 2016, and expected only an immaterial full-year sales increase from pricing. The filing does not provide a quantified earnings or revenue forecast.
- The company planned at least 10 new products for 2016; eight had been introduced through the first nine months. Management described product innovation as a key growth driver.
- Foreign exchange reduced operating profit by approximately $1.6 million in the first nine months, while strengthening non-U.S. currencies increased Q3 operating profit by approximately $0.5 million. Currency movements remain a risk.
- Tennant acquired Florock, a commercial floor coatings business, and selected assets of Mexican distributor Dofesa in 2016. Combined incremental revenue and earnings were not material; acquisition purchase-price allocations remained preliminary.
- The Green Machines outdoor-cleaning business was sold in January 2016. An October amendment changed the remaining $5.489 million sale consideration to 16 quarterly installments beginning in 2018. Tennant estimated the divestiture would reduce annual revenue by about 1%, with an immaterial earnings impact. The amendment also canceled a $24 million product-purchase commitment and narrowed distribution rights. Separately, Tennant advanced $2 million to an affiliate of the buyer, repayable in 36 equal installments beginning January 2017.
- Other commitments include up to $8 million over four years under a software joint-development agreement, subject to time-and-materials billing and milestones. Vehicle lease residual-value guarantees totaled $11.1 million, with a recorded estimated loss liability of $0.3 million.
- Management identified risks including global economic and geopolitical uncertainty, competition, currency exposure, raw-material availability and cost, hiring and retention, IT systems, product quality and liability, supply-chain disruption, and regulatory compliance. It reported no material changes to previously disclosed risk factors and no material pending legal proceedings outside routine litigation.
Important facts for investors to verify
- Whether North American productivity and labor constraints improve, and whether the order backlog converts to sales.
- Whether weakness in EMEA and Asia Pacific persists, including the effects of Brexit, currency movements and the Green Machines divestiture.
- How much of the reported operating-profit improvement reflects sustainable cost efficiencies versus the absence of 2015 impairment and restructuring charges.
- The final purchase-price allocation and realized contribution from Florock and Dofesa, alongside integration and working-capital effects.
- Execution and cash-flow implications of the deferred Green Machines sale payments, the $2 million affiliate advance, and remaining software-development commitment.
- Cash conversion, inventory and receivables trends, capital spending, and debt levels; inventory days on hand rose to 94 from 89 at year-end 2015, and days sales outstanding rose to 64 from 61.