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. 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, although some locations continue to face labor shortages.   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, although we expect the increased cost of freight, materials and labor to continue to impact our gross profit and overall operating results for the fourth quarter of 2021, early 2022, and potentially beyond.   18 Table of Contents   Results   The following table compares the results of operations for the three and nine months ended September 30, 2021 and 2020, respectively (in millions, except per share data and percentages):       Three Months Ended     Nine Months Ended       September 30,     September 30,       2021     %     2020     %     2021     %     2020     %   Net sales   $ 272.0       100.0     $ 261.9       100.0     $ 814.4       100.0     $ 728.0       100.0   Cost of sales     162.8       59.9       158.3       60.4       477.0       58.6       432.0       59.3   Gross profit     109.2       40.1       103.6       39.6       337.4       41.4       296.0       40.7   Research and development expense     8.4       3.1       7.4       2.8       24.1       3.0       21.4       2.9   Selling and administrative expense     76.9       28.3       77.8       29.7       232.7       28.6       218.9       30.1   Operating income     23.9       8.8       18.4       7.0       80.6       9.9       55.7       7.7   Interest expense, net     (0.6 )     (0.2 )     (4.4 )     (1.7 )     (6.6 )     (0.8 )     (13.4 )     (1.8 ) Net foreign currency transaction loss     (0.7 )     (0.3 )     (0.9 )     (0.3 )     (0.2 )     (0.0 )     (5.0 )     (0.7 ) Loss on extinguishment of debt     —       —       —       —       (11.3 )     (1.4 )     —       —   Other expense, net     (0.3 )     (0.1 )     (0.2 )     (0.1 )     —       —       (0.2 )     (0.0 ) Income before income taxes     22.3       8.2       12.9       4.9       62.5       7.7       37.1       5.1   Income tax expense     0.8       0.3       1.2       0.5       5.5       0.7       5.9       0.8   Net income including noncontrolling interest     21.5       7.9       11.7       4.5       57.0       7.0       31.2       4.3   Net income attributable to Tennant Company   $ 21.5       7.9     $ 11.7       4.5     $ 57.0       7.0     $ 31.2       4.3   Net income attributable to Tennant Company per share - diluted   $ 1.14             $ 0.63             $ 3.02             $ 1.68             Net Sales   Consolidated net sales for the third quarter of 2021 totaled $272.0 million, a 3.9% increase as compared to consolidated net sales of $261.9 million in the third quarter of 2020. Consolidated net sales for the first nine months of 2021 were $ 814.4 million, an 11.9% increase compared to consolidated net sales of $728.0 million in the first nine months of 2020.   The 3.9% increase in consolidated net sales in the third quarter of 2021 as compared to the same period in 2020 was driven by:     •  An organic sales increase of approximately 4.7%, which excludes the effects of foreign currency exchange and divestitures. The organic sales increase was primarily due to volume growth across the Americas and EMEA 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 1.2%.   The 11.9% increase in consolidated net sales in the first nine months of 2021 as compared to the same period in 2020 was driven by:     •  An organic sales increase of approximately 10.9%, 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 3.0%.   The following table sets forth the net sales by geographic area for the three and nine months ended September 30, 2021 and 2020 (in millions, except percentages):       Three Months Ended     Nine Months Ended       September 30,     September 30,       2021     2020     % Change     2021     2020     % Change   Americas   $ 166.7     $ 167.7       (0.6 )%   $ 491.7     $ 466.6       5.4 % Europe, Middle East and Africa     80.7       69.5       16.1 %     246.8       196.3       25.7 % Asia Pacific     24.6       24.7       (0.4 )%     75.9       65.1       16.6 % Total   $ 272.0     $ 261.9       3.9 %   $ 814.4     $ 728.0       11.9 %     19 Table of Contents   Americas   Net sales in the Americas were $166.7 million for the third quarter of 2021, a decrease of 0.6% from the third quarter of 2020. Foreign currency exchange within the Americas favorably impacted net sales by approximately 0.5% in the third quarter of 2021. The divestiture of the Coatings business in the first quarter of 2021 resulted in a decline in net sales of approximately 3.1%. Organic sales growth in the Americas favorably impacted net sales by approximately 2.0% for the third quarter of 2021 due to strong sales in Latin America, particularly in Brazil and Mexico, along with strong, region-wide results for the Company's parts and consumables and service, despite a decline in the Company's Autonomous Mobile Robot ("AMR") business, due to the lapping of a large order in North America in the prior-quarter. At the same time, the region was directly impacted by global supply-chain and labor constraints, which resulted in lower revenue than expected and increased backlog levels.   Net sales in the Americas were $491.7 million for the first nine months of 2021, an increase of 5.4% from the first nine months of 2020. Foreign currency exchange within the Americas favorably impacted net sales by 0.2%. The divestiture of the Coatings business resulted in a decline in net sales of approximately 3.1%. Organic sales growth in the Americas favorably impacted net sales by 8.3% due to growth in most regions and products compared to the first nine months of 2020, which was more impacted by COVID-19. The growth was partly offset by declines in the Company's AMR business, due to the lapping of a large order in North America in the prior year.   Europe, Middle East and Africa ("EMEA")   EMEA net sales were $80.7 million for the third quarter of 2021, an increase of 16.1% from the third quarter of 2020. Foreign currency exchange within EMEA favorably impacted net sales by approximately 2.1% in the third quarter of 2021. Organic sales growth in EMEA favorably impacted net sales by approximately 14.0% for the third quarter primarily due to market growth across the region and product categories compared to the third quarter of 2020, which was greatly impacted by COVID-19.   EMEA net sales were $246.8 million for the first nine months of 2021, an increase of 25.7% from the first nine months of 2020. Foreign currency exchange within EMEA favorably impacted net sales by approximately 8.7% in the first nine months of 2021. Organic sales growth in EMEA favorably impacted net sales by approximately 17.0% for the first nine months of 2021 primarily due to market growth across the region and product categories compared to the first nine months of 2020, which was more impacted by COVID-19.   Asia Pacific ("APAC")   APAC net sales were $24.6 million for the third quarter of 2021, a decrease of 0.4% from the third quarter of 2020. Foreign currency exchange within APAC favorably impacted net sales by approximately 2.7% in the third quarter of 2021. The divestiture of the Coatings business resulted in a decline in net sales of approximately 0.2%. Organic sales decline in APAC unfavorably impacted net sales by approximately 2.9% for the third quarter primarily due to decreases in China and Japan, partly caused by supply-chain and labor challenges in our North American plants which supply APAC. The decline in APAC was partly offset by strong results for parts and consumables and service, along with strength in Australia across all product categories.   APAC net sales were $75.9 million for the first nine months of 2021, an increase of 16.6% from the first nine months of 2020. Foreign currency exchange within APAC favorably impacted net sales by approximately 5.8% in the first nine months of 2021. Organic sales growth in APAC favorably impacted net sales by approximately 10.8% for the first nine months of 2021 primarily due to growth across the region, primarily in Australia and China, partly offset by supply chain and labor challenges in our North American plants which supply APAC.   Gross Profit   Gross profit margin of 40.1% was 50 basis points higher in the third quarter of 2021 compared to the third quarter of 2020. The increase was in spite of supply and labor constraints, and reflects the lapping of a number of strategic investments and productivity challenges based on lower volume due to the pandemic-related slowdown in the prior year.    Gross profit margin of 41.4% was 70 basis points higher in the first nine months of 2021 compared to the first nine 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 nine months of 2020. The benefits represent wage subsidies received from various European and Canadian authorities that are not required to be repaid. All government benefits for the first nine months of 2020 were received in the second quarter of 2020.   Operating Expense   Research and Development Expense   Research and Development ("R&D") expense was $8.4 million, or 3.1% of net sales, for the third quarter of 2021, 30 basis points higher as a percentage of net sales compared to the third quarter of 2020 due to new product development and investment in talent. R&D expense was $24.1 million, or 3.0% of net sales, for the first nine months of 2021, nearly flat as a percentage of net sales compared to the first nine 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 $76.9 million for the third quarter of 2021, a decrease of $0.9 million compared to the third quarter of 2020. As a percentage of net sales, S&A expense for the third quarter of 2021 decreased 140 basis points to 28.3% from 29.7% in the third quarter of 2020. The S&A expense decrease in the third quarter of 2021 was primarily driven by adjustments to management incentives, partially offset by more normalized spending throughout the quarter compared to the third quarter of 2020.   S&A expense was $232.7 million for the first nine months of 2021, an increase of $13.8 million compared to the first nine months of 2020. As a percentage of net sales, S&A expense for the first nine months of 2021 decreased 150 basis points to 28.6% from 30.1% in the first nine months of 2020. The S&A decrease in the first nine months of 2021 was primarily driven by a 130 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. This benefit was partially offset by more normalized spending compared to the first nine months 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. The benefits represent wage subsidies received from various European and Canadian authorities that are not required to be repaid.   Total Other Expense, Net   Interest Expense, Net   Interest expense, net was $0.6 million and $6.6 million of net expense in the third quarter and first nine months of 2021, respectively, compared to $4.4 million and $13.4 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 and a lower amount of outstanding debt.   Net Foreign Currency Transaction Loss   Net foreign currency transaction loss was $0.7 million and $0.9 million in the third quarter of 2021 and 2020, respectively. Net foreign currency transaction loss was $0.2 million in the first nine months of 2021, compared to $5.0 million in the same period of 2020. The unfavorable impact from foreign currency transactions in the first nine months of 2021 and 2020 was primarily due to strengthening of the U.S. dollar relative to the Brazilian Real and Mexican Peso. The reduction of losses recognized in the first nine months of 2021 compared to the same period in 2020 is driven by stabilization in the currency markets in the current year versus the previous year.   Loss on Extinguishment of Debt   There was no loss on extinguishment of debt in the third quarter of 2021. Loss on extinguishment of debt was $11.3 million in the first nine months of 2021 due to the restructuring of debt that occurred in the second quarter of 2021.   Income Taxes   The effective tax rate for the third quarter of 2021 was 3.8%, as compared to 9.7% for the third quarter of 2020. The tax expense for the third quarter of 2020 included a $0.4 million tax benefit associated with $1.7 million of non-recurring expenses. The underlying tax rate for the third quarter of 2020 was 11.3% excluding these non-recurring expenses and related tax benefits.   The effective tax rate for the first nine months of 2021 was 8.8% compared to 15.9% for the same period of 2020. The tax expense for the nine months ended September 30, 2021 included a $1.1 million benefit associated with $3.2 million of non-recurring expenses. The tax expense for the nine months ended September 30, 2020 included a $1.2 million benefit associated with $4.1 million of non-recurring expenses. The underlying tax rate excluding these non-recurring items was 10.1% and 17.2% for 2021 and 2020 respectively.   Excluding these non-recurring expenses, the effective tax rate for both the third quarter and the first nine months of 2021 decreased primarily due to a tax benefit resulting from an election to step-up the tax basis of certain assets for Italian tax purposes.   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 $140.6 million at September 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 1.9 as of September 30, 2021 and December 31, 2020, and our working capital was $250.1 million and $239.3 million, respectively. Our debt-to-capital ratio was 37.7% as of September 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 September 30, 2021, we had outstanding borrowings of $99.4 million and $168.0 million under our term loan facility and revolving facility, respectively. As of September 30, 2021, we had letters of credit and bank guarantees outstanding in the amount of $2.9 million, leaving approximately $279.1 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.   The Company's Board of Directors has authorized a quarterly cash dividend of $0.25 per share payable December 15, 2021, to shareholders of record at the close of business on November 30, 2021.   Cash Flow from Operating Activities   Operating activities provided $62.9 million of cash for the nine months ended September 30, 2021. Cash provided by operating activities was driven primarily by inflows from a strong performance influencing net income, offset by outflows from an increase in working capital of $10.8 million.   Cash Flow from Investing Activities   Investing activities during the nine months ended September 30, 2021 provided $12.6 million, resulting from $24.7 million of proceeds from the sale of our Coatings business net of cash divested, partially offset by $12.0 million of capital expenditures. Cash used for capital expenditures decreased from the nine months ended September 30, 2020 due to the investments in the new corporate headquarters that occurred in 2020.   Cash Flow from Financing Activities   Net cash used in financing activities was $72.3 million during the first nine months of 2021. Proceeds from borrowings of $315.8 million were mainly offset by payments of debt of $361.2 million, dividend payments of $12.9 million, repurchases of common stock of $7.5 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.