Tennant Company — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014; comparisons are with the corresponding 2013 periods unless otherwise noted. Tennant designs, manufactures and sells equipment and other solutions for maintaining and protecting nonresidential surfaces. Amounts below are in U.S. dollars; financial statement amounts are in millions unless specified.
Financial performance
| Metric | Q3 2014 | Q3 2013 | First 9 months 2014 | First 9 months 2013 |
|---|---|---|---|---|
| Net sales | $202.6 | $188.5 | $605.7 | $556.9 |
| Gross profit / margin | $87.2 / 43.0% | $81.9 / 43.4% | $259.3 / 42.8% | $242.1 / 43.5% |
| Operating profit / margin | $17.1 / 8.4% | $16.2 / 8.6% | $49.5 / 8.2% | $44.7 / 8.0% |
| Net earnings | $11.8 | $10.6 | $33.1 | $29.9 |
| Diluted EPS | $0.63 | $0.56 | $1.77 | $1.59 |
- Sales rose 7.5% in Q3 and 8.8% year to date, entirely from organic growth as reported; volume contributed 6.5% and 7.8%, respectively, and price contributed 1.0% in both periods. Management attributed volume growth to strategic accounts, distribution, new products and equipment gains.
- Q3 gross margin fell 40 basis points, mainly from hiring and training costs to support higher production. Year-to-date margin fell 70 basis points, also reflecting a greater mix of lower-margin distribution and strategic-account sales. Operating profit dollars increased, but Q3 operating margin declined 20 basis points.
- R&D expense declined; selling and administrative expense increased as Tennant invested in direct sales, distribution and marketing. Year-to-date net earnings benefited from higher sales and improved operating profit; the 2013 comparison included a $0.6 million tax benefit from retroactive reinstatement of the federal R&D credit.
Cash, liquidity and debt
- Nine-month operating cash flow was $36.8 million, nearly unchanged from 2013. Higher earnings were substantially offset by a $21.7 million inventory increase and a $6.1 million receivables increase.
- Investing used $11.8 million, including $13.2 million of net capital expenditures, partly offset by $1.4 million in proceeds from a previously completed business sale. Financing used $24.7 million, including $13.6 million in share repurchases, $10.9 million in dividends and $2.0 million in long-term debt payments.
- Cash was $79.8 million at September 30, 2014, versus $81.0 million at December 31, 2013. Current ratio was 2.4 and working capital was $189.7 million, compared with $183.8 million at year-end.
- Total debt was $28.2 million, down from $31.8 million at year-end; debt-to-capital was 9.3%, versus 10.8%. Credit facilities included $125.0 million in committed and $87.5 million in uncommitted lines. Tennant reported compliance with covenants; leverage was 0.35x against a maximum 3.00x, and EBITDA-to-interest was 50.81x against a minimum 3.50x.
- Inventory days on hand increased to 90 from 82 a year earlier; management cited higher sales support and new-product launches. Days sales outstanding was 65, unchanged year over year.
Outlook, risks and contingencies
- Management expected 2014 selling-price increases to add approximately 1%–2% to full-year sales, with minimal gross-margin impact because increases were intended to offset inflation. It planned six additional product introductions in Q4; no full-year earnings or revenue guidance is provided in the filing text.
- Q3 Asia Pacific sales declined 5.6%, with management citing economic uncertainty in Australia, Japan and China, longer sales cycles and delayed order and shipment timing. This followed year-to-date regional growth of 8.7%.
- Risks identified include global economic and geopolitical uncertainty, competition, personnel retention, IT-system changes, product development and commercialization, regulatory compliance, raw-material availability and cost, product liability or quality issues, business interruptions, and currency movements. Management reported no material change in market risks or risk factors from the 2013 Form 10-K.
- Unrecognized tax benefits were $3.5 million, with approximately $0.6 million of accrued interest and penalties. Tax examinations were ongoing in certain state and foreign jurisdictions; management said reserves were adequate, but final outcomes were uncertain.
- Vehicle lease residual-value guarantees totaled $9.7 million of guaranteed residuals; a $0.3 million estimated-loss liability was recorded. A three-year software license agreement added a $1.2 million commitment. The filing reported no material pending legal proceedings apart from routine business litigation.
- Foreign-currency translation reduced Q3 comprehensive income: the quarter recorded a $6.9 million total other comprehensive loss, primarily from translation adjustments. The nine-month total other comprehensive loss was $5.0 million.
Important facts for investors to verify
- Whether inventory growth and increased inventory days convert to sales without additional working-capital pressure or obsolescence.
- Whether sales growth sustains, particularly in Asia Pacific, and whether the expected price increases offset cost inflation.
- Whether manufacturing ramp-up costs and sales-and-marketing investment affect future margins and profitability.
- Whether cash generation supports capital spending, dividends and repurchases while maintaining low leverage and covenant headroom.
- Developments in tax examinations, lease guarantees and other commitments, and the implementation effects of the new revenue-recognition standard.