Tennant Company — Q3 2018 Form 10-Q
Business context and reporting period. Tennant designs, manufactures and sells commercial cleaning equipment, parts and consumables, services, and related products. This unaudited report covers the three and nine months ended September 30, 2018; financial amounts below are in millions of dollars unless stated otherwise.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $273.3 | $261.9 | $838.3 | $723.8 |
| Gross profit / margin | $108.1 / 39.6% | $104.6 / 39.9% | $337.5 / 40.3% | $288.9 / 39.9% |
| Operating profit / margin | $15.4 / 5.7% | $11.0 / 4.2% | $44.8 / 5.3% | $17.7 / 2.4% |
| Net earnings (loss) attributable to Tennant | $9.7 | $3.6 | $25.7 | $(3.0) |
| Diluted EPS | $0.52 | $0.20 | $1.40 | $(0.17) |
- Q3 sales increased 4.3%; organic growth was 6.1% (volume +4.6%, price +1.5%), partly offset by a 1.7% unfavorable foreign-exchange impact. Nine-month sales rose 15.8%, including 8.7% from acquisitions and divestitures, primarily IPC, and 5.9% organic growth.
- Q3 gross margin declined 30 basis points year over year; nine-month margin improved 40 basis points. Operating profit grew in both comparison periods, while nine-month earnings turned positive from a prior-year loss.
- Operating cash flow was $43.5 million for the first nine months, versus $32.1 million a year earlier. Inventory growth used $19.6 million of cash. Investing activities used $10.4 million; financing activities used $35.8 million, including $30.2 million of long-term debt payments and $11.4 million of dividends.
- At September 30, cash and cash equivalents were $53.5 million; current assets were $439.1 million and current liabilities $238.7 million. Working capital was $200.4 million and the current ratio was 1.8.
- Debt included $300.0 million of senior notes, $50.0 million of credit-facility borrowings and $3.0 million of capital leases. The company reported $180.0 million of unused revolving capacity before letters of credit and bank guarantees, and approximately $174.3 million after them. Weighted-average debt cost was approximately 5.4% (4.5% net of a related cross-currency swap). The company was in compliance with financial covenants.
Material changes and notable items
- Q3 Americas sales rose 8.9% and APAC sales rose 7.4%; EMEA sales fell 5.8%, reflecting weaker France and Italy comparisons and unfavorable currency effects. Nine-month EMEA growth included a substantial contribution from IPC.
- Q3 gross margin faced adverse sales mix, raw-material and labor shortages, higher freight and logistics costs, and newly enacted tariffs. The 2017 comparison benefited from $2.2 million of IPC inventory step-up expense flowing through cost of sales; that benefit did not recur in 2018.
- Q3 selling and administrative expense included a roughly $1.0 million gain on the Waterstar business sale. The sale generated $4.0 million cash proceeds. Q3 expense also reflected higher acquisition/integration costs and professional fees, partly offset by lower IPC-related amortization.
- The 2018 nine-month effective tax rate was 5.8%. Results included discrete tax benefits, including $3.6 million from exercised soon-to-expire stock options and a favorable Italian tax ruling; the Tax Act transition-tax accounting was finalized in Q3.
- Foreign-currency translation reduced nine-month other comprehensive income by $14.2 million. Accounts-receivable days increased to 67 from 63 at year-end and inventory days increased to 101 from 96.
Outlook, risks and contingencies
- Management expected full-year gross margin of approximately 40.5% of sales and R&D spending of approximately 3.0% of sales. Pricing increases were expected to contribute 1%–2% to full-year sales, with minimal gross-margin impact as they were intended to offset inflation.
- Tennant planned to introduce its first autonomous floor-care machine in Q4 2018 and continued investment in autonomous-cleaning technology, including its strategic relationship with Brain Corp. It expected to complete the Gaomei acquisition in China in Q1 2019; the purchase price and net assets were described as not significant.
- Key disclosed risks include raw-material and component cost, quality or availability; tariffs and currency movements; competition and global economic uncertainty; product development and acquisition integration (including IPC); cybersecurity and business interruption; product liability and quality; and generating sufficient cash to meet debt obligations. Management also identified internal-control risks associated with the IPC acquisition.
- Vehicle lease residual-value guarantees totaled $8.4 million; a $0.3 million estimated loss liability was recorded. Management stated there were no material pending legal proceedings beyond routine litigation and no material changes to previously disclosed risk factors.
Important facts for investors to verify
- Whether sales and margin trends persist, particularly EMEA performance and the effects of tariffs, freight, labor and raw-material constraints.
- Whether inventory growth and higher DIOH convert into sales and cash, and whether receivables collection remains on track.
- Progress on debt reduction, covenant headroom, future required repayments and the availability of revolver capacity.
- How much reported earnings and the low effective tax rate depend on nonrecurring sale gains, acquisition-related items and discrete tax benefits.
- Delivery against the stated full-year margin and R&D outlook, and execution of autonomous-product plans and the proposed Gaomei acquisition.