TENNANT CO 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations   Overview   Tennant Company is a world leader in designing, manufacturing and marketing solutions that empower customers to achieve quality cleaning performance, reduce environmental impact and help create a cleaner, safer, healthier world. The Company is committed to creating and commercializing breakthrough, sustainable cleaning innovations to enhance its broad suite of products, including floor maintenance and cleaning equipment, detergent-free and other sustainable cleaning technologies, aftermarket parts and consumables, equipment maintenance and repair service, and asset management solutions. Our products are used in many types of environments, including retail establishments, distribution centers, factories and warehouses, public venues such as arenas and stadiums, office buildings, schools and universities, hospitals and clinics, and more. Customers include contract cleaners to whom organizations outsource facilities maintenance as well as businesses that perform facilities maintenance themselves. The Company reaches these customers through the industry's largest direct sales and service organization and through a strong and well-supported network of authorized distributors worldwide.   Impact of COVID-19   Because we are a global company, our results of operations are affected by macroeconomic conditions. We continue to see economic and geopolitical uncertainty in many regions around the world. The coronavirus ("COVID-19") pandemic has increased the uncertainty globally and has resulted in general economic disruption. Governments across the world have taken numerous actions to limit the spread of COVID-19, including stay-at-home orders, which have reduced operating activities across global businesses, and have recently begun rolling out vaccine programs.   We continue to actively manage our business to respond to the COVID-19 impact. We have prioritized the health and safety of our employees and customers. We have established a dedicated enterprise-wide response team and implemented work-from-home processes for much of our workforce, which partially remain in effect. We have established cross-functional and frequent communications with suppliers to review, track and prioritize high-risk components. We have also identified and activated alternative suppliers, materials and components as needed. To date, we have been able to avoid major supply disruptions. Regarding transportation, we have set up tracking, reporting and communication channels with carriers to understand their risks and to evaluate available options where necessary. In addition, all of our factories currently have the potential to operate at full capacity.   We continue to monitor the evolving situation and guidance from authorities. The timing and extent of the impact of the pandemic is influenced by factors such as variants, vaccination rates and broader economic impacts. Accordingly, we cannot reasonably estimate the long-term impact of the pandemic on our financial results.   18 Table of Contents   Results   The following table compares the results of operations for the three and six months ended June 30, 2021 and 2020, respectively (in millions, except per share data and percentages):       Three Months Ended     Six Months Ended       June 30,     June 30,       2021     %     2020     %     2021     %     2020     %   Net sales   $ 279.1       100.0     $ 214.0       100.0     $ 542.4       100.0     $ 466.1       100.0   Cost of sales     164.2       58.8       124.5       58.2       314.2       57.9       273.8       58.7   Gross profit     114.9       41.2       89.5       41.8       228.2       42.1       192.3       41.3   Research and development expense     8.3       3.0       6.6       3.1       15.7       2.9       14.0       3.0   Selling and administrative expense     86.2       30.9       60.0       28.0       155.8       28.7       141.0       30.3   Operating income     20.4       7.3       22.9       10.7       56.7       10.5       37.3       8.0   Interest expense, net     (2.1 )     (0.8 )     (4.8 )     (2.2 )     (6.0 )     (1.1 )     (9.0 )     (1.9 ) Net foreign currency transaction gain (loss)     —       —       —       —       0.5       0.1       (4.1 )     (0.9 ) Loss on extinguishment of debt     (11.3 )     (4.0 )     —       —       (11.3 )     (2.1 )     —       —   Other income (expense), net     0.2       0.1       (0.2 )     (0.1 )     0.3       0.1       —       —   Income before income taxes     7.2       2.6       17.9       8.4       40.2       7.4       24.2       5.2   Income tax (benefit) expense     (2.6 )     (0.9 )     3.6       1.7       4.7       0.9       4.7       1.0   Net income including noncontrolling interest     9.8       3.5       14.3       6.7       35.5       6.5       19.5       4.2   Net income attributable to Tennant Company   $ 9.8       3.5     $ 14.3       6.7     $ 35.5       6.5     $ 19.5       4.2   Net income attributable to Tennant Company per share - diluted   $ 0.51             $ 0.77             $ 1.88             $ 1.05             Net Sales   Consolidated net sales for the second quarter of 2021 totaled $279.1 million, a 30.4% increase as compared to consolidated net sales of $214.0 million in the second quarter of 2020. Consolidated net sales for the first six months of 2021 were $ 542.4 million, a 16.4% increase compared to consolidated net sales of $ 466.1 million in the first six months of 2020.   The 30.4% increase in consolidated net sales in the second quarter of 2021 as compared to the same period in 2020 was driven by:     •  An organic sales increase of approximately 27.5%, which excludes the effects of foreign currency exchange and divestitures. The organic sales increase was primarily due to volume growth across all regions;   •  An unfavorable impact from the divestiture of our Coatings business of 2.5%; and   •  A net favorable impact from foreign currency exchange across all regions of approximately 5.4%.     The 16.4% increase in consolidated net sales in the first six months of 2021 as compared to the same period in 2020 was driven by:     •  An organic sales increase of approximately 14.3%, which excludes the effects of foreign currency exchange and divestitures. The organic sales increase was primarily due to volume growth across all regions due to continued recovery from COVID-19 in 2021;   •  An unfavorable impact from the divestiture of our Coatings business of 2.0%; and   •  A net favorable impact from foreign currency exchange across all regions of approximately 4.1%.   The following table sets forth the net sales by geographic area for the three and six months ended June 30, 2021 and 2020 (in millions, except percentages):       Three Months Ended     Six Months Ended       June 30,     June 30,       2021     2020     % Change     2021     2020     % Change   Americas   $ 167.2     $ 136.3       22.7 %   $ 325.0     $ 298.9       8.7 % Europe, Middle East and Africa     85.2       54.8       55.5 %     166.1       126.8       31.0 % Asia Pacific     26.7       22.9       16.6 %     51.3       40.4       27.0 % Total   $ 279.1     $ 214.0       30.4 %   $ 542.4     $ 466.1       16.4 %     19 Table of Contents   Americas   Net sales in the Americas were $167.2 million for the second quarter of 2021, an increase of 22.7% from the second quarter of 2020. Foreign currency exchange within the Americas favorably impacted net sales by approximately 1.1% in the second quarter of 2021. The divestiture of the Coatings business resulted in a decline in net sales of approximately 3.8%. Organic sales growth in the Americas favorably impacted net sales by approximately 25.4% for the second quarter of 2021 due to growth in most channels and products compared to the second quarter of 2020, which was greatly impacted by COVID-19. The growth was partly limited by increased backlog levels in North America from parts shortages due to supply chain challenges and labor shortages.   Net sales in the Americas were $325.0 million for the first six months of 2021, an increase of 8.7% from the first six months of 2020. Foreign currency exchange within the Americas favorably impacted net sales by 0.1%. The divestiture of the Coatings business resulted in a decline in net sales of approximately 3.2%. Organic sales growth in the Americas favorably impacted net sales by 11.8% due to growth in most regions and products compared to the first six months of 2020, which was more impacted by COVID-19. The growth was partly offset by declines due to the prior period's strong sales performance in the strategic account channel.   Europe, Middle East and Africa ("EMEA")   EMEA net sales were $85.2 million for the second quarter of 2021, an increase of 55.5% from the second quarter of 2020. Foreign currency exchange within EMEA favorably impacted net sales by approximately 15.3% in the second quarter of 2021. Organic sales growth in EMEA favorably impacted net sales by approximately 40.2% for the second quarter primarily due to market growth across the region compared to the second quarter of 2020, which was greatly impacted by COVID-19.   EMEA net sales were $166.1 million for the first six months of 2021, an increase of 31.0% from the first six months of 2020. Foreign currency exchange within EMEA favorably impacted net sales by approximately 12.3% in the first six months of 2021. Organic sales growth in EMEA favorably impacted net sales by approximately 18.7% for the first six months of 2021 primarily due to market growth across the region compared to the first six months of 2020, which was more impacted by COVID-19.   Asia Pacific ("APAC")   APAC net sales were $26.7 million for the second quarter of 2021, an increase of 16.6% from the second quarter of 2020. Foreign currency exchange within APAC favorably impacted net sales by approximately 7.0% in the second quarter of 2021. Organic sales growth in APAC favorably impacted net sales by approximately 9.6% for the second quarter primarily due to strength in Australia across all product categories. China net sales were flat due to parts shortages caused by supply chain challenges.   APAC net sales were $51.3 million for the first six months of 2021, an increase of 27.0% from the first six months of 2020. Foreign currency exchange within APAC favorably impacted net sales by approximately 7.8% in the first six months of 2021. Organic sales growth in APAC favorably impacted net sales by approximately 19.2% for the first six months of 2021 primarily due to growth across the region, primarily in Australia and China.   Gross Profit   Gross profit margin of 41.2% was 60 basis points lower in the second quarter of 2021 compared to the second quarter of 2020. The decrease primarily reflected higher freight, material and labor costs and the impact of government credits received in the second quarter of 2020, partially offset by favorable pricing and cost-savings actions. The government benefits included in gross profit in the second quarter of 2020 were $3.8 million. The benefits represent wage subsidies received from various European and Canadian authorities that are not required to be repaid.   Gross profit margin of 42.1% was 80 basis points higher in the first six months of 2021 compared to the first six months of 2020. The increase primarily reflected increased favorable pricing and cost-savings actions, partially offset by higher freight, material and labor costs and the impact of government credits received in the first six months of 2020, as described above. All government benefits for the first six months of 2020 were received in the second quarter of 2020.   While we are currently unable to estimate the duration and the financial magnitude, we expect the increased cost of freight, materials and labor to negatively impact our results for the last half of 2021, and potentially beyond.   Operating Expense   Research and Development Expense   Research and Development ("R&D") expense was $8.3 million, or 3.0% of net sales, for the second quarter of 2021, flat as a percentage of net sales compared to the second quarter of 2020. R&D expense was $15.7 million, or 2.9% of net sales, for the first six months of 2021, flat as a percentage of net sales compared to the first six months of 2020.   We continue to invest in developing innovative products and technologies at levels necessary to propel our technology and innovation leadership position.       20 Table of Contents   Selling and Administrative Expense   Selling and administrative expense ("S&A expense") was $86.2 million for the second quarter of 2021, an increase of $26.2 million compared to the second quarter of 2020. As a percentage of net sales, S&A expense for the second quarter of 2021 increased 290 basis points to 30.9% from 28.0% in the second quarter of 2020. The S&A expense increase in the second quarter of 2021 was primarily driven by more normalized spending throughout the quarter compared to the second quarter of 2020 when the Company took cost containment actions, including employee furloughs, reduction in travel spending, and temporary pay reductions, as well as benefits from government programs received related to COVID-19 and adjustments to management incentives. The government benefits included in S&A expense in the first six months of 2020 were $1.4 million and did not repeat in 2021. The benefits represent wage subsidies received from various European and Canadian authorities that are not required to be repaid.   S&A expense was $155.8 million for the first six months of 2021, an increase of $14.8 million compared to the first six months of 2020. As a percentage of net sales, S&A expense for the first six months of 2021 decreased 160 basis points to 28.7% from 30.3% in the first six months of 2020. The S&A increase in the first six months of 2021 was primarily driven by the same factors as the drivers for the changes during the second quarter of 2021 compared to the second quarter of 2020, offset by a 180 basis point benefit related to the inclusion in S&A expense of a $9.8 million pre-tax gain on the sale of the Coatings business that occurred in the first quarter of 2021.   Total Other Expense, Net   Interest Expense, Net   Interest expense, net was $2.1 million and $6.0 million of net expense in the second quarter and first six months of 2021, respectively, compared to $4.8 million and $9.0 million of net expense in the same periods of 2020, respectively. The decrease in both periods of 2021 was due to the restructuring of debt in the second quarter of 2021, which resulted in lower interest expense from more favorable interest rates.   Net Foreign Currency Transaction Gain (Loss)   Net foreign currency transaction gain (loss) was a less than $0.1 million loss in the second quarter of 2021 and 2020. Net foreign currency transaction gain (loss) was a $0.5 million gain in the first six months of 2021, compared to a $4.1 million loss in the same period of 2020. The favorable impact from foreign currency transactions in the first six months of 2021 was primarily due to the strengthening of the Brazilian real relative to the euro during this time. The unfavorable impact from foreign currency transactions in the first six months of 2020 was primarily due to significant strengthening of the U.S. dollar relative to the Brazilian real and Mexican peso.   Loss on Extinguishment of Debt   Loss on extinguishment of debt was $11.3 million in the second quarter and first six months of 2021 due to the restructuring of debt that occurred in the second quarter of 2021.   Other Income (Expense), Net   Other income (expense), net was $0.2 million and $0.3 million of income in the second quarter and first six months of 2021, an increase of $0.4 million and $0.3 million compared to the same periods in 2020, respectively.   Income Taxes   The effective tax rate for the second quarter of 2021 was (37.0)%, as compared to the second quarter of 2020 of 19.7%. The effective tax rate for the first six months of 2021 was 11.6% compared to 19.3% for the same period of 2020.   The tax benefit for the second quarter of 2021 included a $2.7 million tax benefit associated with the $11.3 million loss on extinguishment of debt, a $0.3 million tax benefit associated with a $0.9 million restructuring charge, and a $0.5 million tax benefit associated with a $0.7 million acquisition contingent consideration adjustment. The underlying tax rate for the quarter was 4.0% excluding these non-recurring expenses and related tax benefits.   The tax expense for the second quarter of 2020 included a $0.1 million tax benefit associated with a $0.3 million restructuring charge. The underlying tax rate was 20.4% excluding these non-recurring expenses and related tax benefits.   Excluding these non-recurring expenses, the effective tax rate for both the second quarter and the first six months of 2021 decreased primarily due to a high level of discrete tax benefit items recognized in 2021 compared to 2020 and the mix in expected full year taxable earnings by country. For the second quarter of 2021, the discrete tax benefits included the release of certain tax reserves as a result of a lapse in the applicable statute of limitations and a $3.4 million benefit associated with the reversal of a valuation allowance related to tax loss carryovers in the Netherlands. The reversal was driven by a change in law providing an unlimited carryforward period.   In general, it is our practice and intention to permanently reinvest the earnings of our foreign subsidiaries and repatriate earnings only when the tax impact is zero or immaterial. No deferred taxes have been provided for withholding taxes or other taxes that would result upon repatriation of our foreign investments to the United States.   21 Table of Contents   Liquidity and Capital Resources   Liquidity   Cash, cash equivalents and restricted cash totaled $135.1 million at June 30, 2021, as compared to $141.0 million as of December 31, 2020. Wherever possible, cash management is centralized and intercompany financing is used to provide working capital to subsidiaries as needed. Our current ratio was 1.8 as of June 30, 2021 and 1.9 as of December 31, 2020, and our working capital was $238.1 million and $239.3 million, respectively. Our debt-to-capital ratio was 38.1% as of June 30, 2021, compared to 43.2% as of December 31, 2020.   In the second quarter of 2021, we signed an agreement (the "2021 Credit Agreement") that restructured our previous credit agreement. The 2021 Credit Agreement provides greater flexibility with fewer restrictive covenants and more favorable interest rates than the previous arrangement, consisting of a term loan facility in an amount up to $100.0 million and a revolving facility in an amount up to $450.0 million with an option to expand the revolving facility by up to $275.0 million with the consent of the lenders willing to provide additional borrowings in the form of increases to their revolving facility commitment or funding of incremental term loans. As a result, we expect future interest expense to be lower by approximately $1.0 million per month as compared to periods prior to the debt restructuring. In the second quarter of 2021, we used the proceeds from the 2021 Credit Agreement to retire our 5.625% Senior Notes due 2025. As of June 30, 2021, we had outstanding borrowings of $100.0 million and $168.0 million under our term loan facility and revolving facility, respectively. As of June 30, 2021, we had letters of credit and bank guarantees outstanding in the amount of $3.2 million, leaving approximately $278.8 million of unused borrowing capacity on our revolving facility. See Note 8 to the Consolidated Financial Statements for more detail on the 2021 Credit Agreement.   Cash Flow From Operating Activities   Operating activities provided $37.8 million of cash for the six months ended June 30, 2021. Cash provided by operating activities was driven primarily by inflows from a strong performance influencing net income, by adding back non-cash items of $32.0 million and an increase in accounts payable of $16.9 million. These cash inflows were partially offset by cash outflows resulting from an increase in inventories of $32.3 million and an increase in receivables of $13.5 million.   Cash Flow From Investing Activities   Investing activities during the six months ended June 30, 2021 provided $16.7 million, resulting from $24.7 million of proceeds from the sale of our Coatings business net of cash divested, partially offset by $8.0 million of capital expenditures.   Cash Flow From Financing Activities   Net cash used in financing activities was $58.6 million during the first six months of 2021. Proceeds from borrowings of $315.8 million were mainly offset by payments of debt of $360.4 million, dividend payments of $8.6 million and a debt extinguishment payment of $8.4 million.   Newly Issued Accounting Guidance   See Note 2 to the Consolidated Financial Statements for information on new accounting pronouncements.   No other new accounting pronouncements issued but not yet effective have had, or are expected to have, a material impact on our results of operations or financial position.   Cautionary Statement Relevant to Forward-Looking Information   This Form 10-Q, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 2, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements generally can be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “estimate,” “anticipate,” “believe,” “project,” or “continue” or similar words or the negative thereof. These statements do not relate to strictly historical or current facts and provide current expectations of forecasts of future events. Any such expectations or forecasts of future events are subject to a variety of factors. Particular risks and uncertainties presently facing us include: geopolitical and economic uncertainty throughout the world; uncertainty surrounding the impacts and duration of the COVID-19 pandemic; our ability to comply with global laws and regulations; our ability to adapt to customer pricing sensitivities; the competition in our business; fluctuations in the cost, quality or availability of raw materials and purchased components; our ability to adjust pricing to respond to cost pressures; unforeseen product liability claims or product quality issues; our ability to attract, retain and develop key personnel and create effective succession planning strategies; our ability to effectively develop and manage strategic planning and growth processes and the related operational plans; our ability to successfully upgrade and evolve our information technology systems; our ability to successfully protect our information technology systems from cybersecurity risks; the occurrence of a significant business interruption; our ability to maintain the health and safety of our workers; our ability to integrate acquisitions; and, our ability to develop and commercialize new innovative products and services.   We caution that forward-looking statements must be considered carefully and that actual results may differ in material ways due to risks and uncertainties both known and unknown. Shareholders, potential investors and other readers are urged to consider these factors in evaluating forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements. Additional information about factors that could materially affect our results can be found in Part I, Item 1A, Risk Factors in our annual report on Form 10-K for the year ended December 31, 2020 and Part II, Item 1A of this Form 10-Q.   We undertake no obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by law. Investors are advised to consult any further disclosures by us in our filings with the SEC and in other written statements on related subjects. It is not possible to anticipate or foresee all risk factors, and investors should not consider any list of such factors to be an exhaustive or complete list of all risks or uncertainties.   22 Table of Contents   Item 3. Quantitative and Qualitative Disclosures About Market Risk   There have been no material changes in our market risk since December 31, 2020. For additional information, refer to Item 7A of our annual report on Form 10-K for the year ended December 31, 2020.