Tennant Company — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Unless stated otherwise, amounts are in U.S. dollars; financial statement amounts below are in millions.
Business context
Tennant designs, manufactures and sells cleaning equipment, supplies and services. It reports one segment, with sales across the Americas, EMEA and APAC. Results include IP Cleaning S.p.A. (IPC) from its April 6, 2017 acquisition.
Financial results and key metrics
| Metric | Q2 2017 | Q2 2016 | First six months 2017 | First six months 2016 |
|---|---|---|---|---|
| Net sales | $270.8 | $216.8 | $461.9 | $396.7 |
| Gross profit / margin | $104.6 / 38.6% | $95.3 / 43.9% | $184.3 / 39.9% | $172.8 / 43.6% |
| Operating profit / margin | $9.2 / 3.4% | $22.6 / 10.4% | $6.5 / 1.4% | $29.7 / 7.5% |
| Net earnings (loss) attributable to Tennant | $(2.6) | $15.3 | $(6.5) | $19.8 |
| Diluted EPS | $(0.15) | $0.85 | $(0.37) | $1.10 |
| Cash from operating activities | Six-month period: $(2.5), versus $12.4 in 2016 |
Q2 sales rose 24.9% and first-half sales rose 16.4%, but acquisitions and divestitures contributed 28.2% and 15.9%, respectively. Organic sales declined 2.3% in Q2, reflecting a 3.3% volume decline partly offset by 1.0% pricing; first-half organic sales grew 1.0%. Q2 geographic sales were $169.1 million in the Americas, $77.4 million in EMEA and $24.3 million in APAC.
At June 30, cash and cash equivalents were $53.3 million; current assets were $426.6 million and current liabilities $194.6 million. Working capital was $232.0 million and the current ratio was 2.2. Gross debt was approximately $418 million, excluding immaterial lease obligations; the debt-to-capital ratio was 59.1%, compared with 11.5% at year-end 2016. The company reported compliance with credit-facility financial covenants.
Six-month investing cash outflow was $364.9 million, including $354.1 million for acquisitions, net of cash acquired. Financing activities provided $361.9 million. The declared dividend was $0.21 per share in Q2 and $0.42 per share for the first half.
Material changes and unusual items
- IPC was acquired for $353.8 million, net of cash acquired. It contributed $59.1 million of sales and a $5.2 million net loss from the acquisition date through June 30. The preliminary purchase-price allocation included $152.7 million of goodwill and $148.7 million of identifiable intangible assets; valuations remained subject to adjustment.
- Reported margins and earnings were reduced by a $6.2 million acquired-inventory fair-value step-up charge, IPC acquisition costs ($4.7 million in Q2; $7.6 million in the first half), and financing costs ($7.4 million pre-tax in the first half). The first half also included an $8.0 million restructuring charge.
- Management cited service productivity challenges associated with restructuring, near-term costs from manufacturing automation investment and raw-material inflation as additional gross-margin pressures.
- The company issued $300 million of 5.625% senior notes due 2025 and borrowed under a new secured credit facility. At quarter-end, credit-facility borrowings were $117.8 million; the notes balance was $300 million. The reported weighted-average cost of debt was approximately 4.9%, or 4.2% net of a related cross-currency swap.
- First-half DSO was 63 days and inventory on hand was 98 days, up from 60 and 86 days, respectively, in Q2 2016. Management attributed higher inventory partly to lower-than-anticipated Q2 sales.
Outlook, risks and controls
The filing provides no specific full-year earnings or profit guidance. Management expected 2017 pricing actions to increase sales by approximately 1%–2%, with minimal gross-margin impact, and planned at least 32 new products or product variants for the year, excluding IPC products. Management expected restructuring savings to offset the charge in about one year and did not expect further costs from that action.
Key stated risks include high indebtedness and debt-service capacity, covenant restrictions, integration and synergy realization, economic and geopolitical uncertainty, competition, foreign exchange, raw-material availability and cost, product quality, and information-technology and internal-control risks. Management said disclosure controls were not effective at June 30 because of previously identified material weaknesses, including issues involving service-revenue accounting and software-development cost capitalization. Remediation was in progress, with a goal of completion by year-end 2017; the weaknesses were not yet considered remediated.
The company reported no material pending legal proceedings other than routine litigation. It also disclosed vehicle-lease residual-value guarantees of $13.3 million and a recorded estimated-loss liability of $0.4 million. Management was evaluating the effects of new accounting standards, including revenue recognition, and planned to adopt the revenue standard in fiscal 2018 using the modified retrospective approach.
Important facts for investors to verify
- Whether IPC integration, synergies and final purchase-price valuations support the acquisition’s expected benefits.
- Whether organic demand, especially in the Americas and EMEA, improves and elevated inventory and receivables normalize.
- Whether gross margins recover as inventory step-up charges, restructuring effects and automation investments abate, and inflation is managed.
- Whether operating cash generation is sufficient to service the increased debt while funding dividends and business needs; monitor covenant headroom.
- Whether the company completes and validates remediation of the disclosed internal-control material weaknesses by its stated target.