Tennant Company (NYSE: TNC) — FY 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017; the filing also provides unaudited fourth-quarter results. Unless otherwise stated, amounts are in U.S. dollars.
Business context
Tennant designs, manufactures and sells commercial cleaning equipment and related products and services. In April 2017, it acquired Italy-based IPC Group, expanding its product range and international presence. IPC contributed $174.4 million of sales from its acquisition date through year-end. Tennant reports one business segment.
Financial results and liquidity
| Metric | FY 2017 | FY 2016 |
|---|---|---|
| Net sales | $1,003.1 million | $808.6 million |
| Gross margin | 40.3% | 43.5% |
| Operating profit and margin | $27.0 million; 2.7% | $68.5 million; 8.5% |
| Net earnings (loss) attributable to Tennant | $(6.2) million; $(0.35) diluted EPS | $46.6 million; $2.59 diluted EPS |
| Cash provided by operations | $54.2 million | $57.9 million |
| Capital expenditures, net of disposals | $17.9 million | $25.9 million |
| Free cash flow, as presented by the company | $36.2 million | $32.0 million |
Sales rose 24.1%; acquisition-related growth contributed 22.2 percentage points, while organic growth was 1.4% (price +1.5%, volume -0.1%) and currency added 0.5%. Fourth-quarter sales were $279.3 million versus $211.7 million; Tennant recorded a quarterly net loss of $3.2 million versus earnings of $15.4 million.
At year-end, cash and cash equivalents were $58.4 million, working capital $186.6 million, and the current ratio 1.8 (2.2 in 2016). Balance-sheet debt was $376.8 million versus $36.2 million; debt-to-capital increased to 56.0% from 11.5%. The company had $180 million of unused revolving capacity before outstanding letters of credit. Dividends were $0.84 per share for the year.
Material changes and unusual items
- The IPC acquisition drove most reported sales growth and materially increased goodwill, intangible assets and debt. IPC’s reported results included acquisition-accounting and integration effects.
- Gross margin fell 320 basis points, reflecting the $7.2 million acquired-inventory fair-value step-up, service productivity challenges, sales mix, IPC margins, manufacturing automation investment and raw-material inflation.
- Operating results included $15.7 million of IPC intangible amortization, $10.6 million of acquisition costs, $10.5 million of restructuring charges, a $6.4 million pension settlement charge and the $7.2 million inventory step-up. Interest expense rose to $25.4 million, including a $6.2 million charge for debt issuance costs on refinanced or repaid loans.
- The Tax Cuts and Jobs Act resulted in a provisional $2.4 million tax expense. The reported effective tax rate was an unusual negative 380.2%, reflecting the pretax loss and significant discrete tax items; management expected the lower U.S. corporate tax rate to favorably affect the tax rate.
- Operating cash flow declined modestly year over year. The company cited higher receivables and increased days sales outstanding (63 versus 59) and days inventory on hand (96 versus 89).
Outlook, risks and contingencies
The filing gives no specific revenue or earnings guidance. Management said restructuring savings were expected to offset the related charges in approximately one year. It warned that further significant raw-material cost increases not offset by pricing could adversely affect 2018 results.
Key risks include integrating IPC and completing its internal-control integration, servicing acquisition-related debt and complying with restrictive covenants, competition and product innovation, supply-chain concentration and input-cost inflation, foreign exchange, cybersecurity and business interruption, and global economic and regulatory uncertainty. An investor owning approximately 5% had advocated a strategic review involving a possible consolidation transaction, which Tennant said could distract management. The company reported no material pending legal proceedings beyond routine matters.
Management and the auditor concluded internal control over financial reporting was effective at year-end; IPC’s controls were excluded from the assessment under the permitted acquisition transition period. Previously reported control weaknesses were stated to have been remediated.
Important facts for investors to verify
- Whether IPC integration delivers expected operating benefits and whether its reported losses and acquisition accounting affect ongoing profitability.
- How margins, service productivity, raw-material costs and organic sales trends develop after the 2017 decline in operating margin.
- Debt reduction, cash generation, interest burden, covenant headroom and the effect of debt restrictions on dividends or share repurchases.
- Final accounting for the Tax Act and whether the expected tax-rate benefit materializes.
- Progress in incorporating IPC into internal controls and any changes in the strategic-review or activist-investor situation.