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.   COVID-19 Impact   We continue to actively manage our business to respond to the COVID-19 pandemic and related impacts. We maintain our commitment to protect the health and safety of our employees and customers. We have continued our enhanced safety protocols on-site at our manufacturing facilities, and continue to monitor the evolving situation and guidance from local authorities. Governments across the world have taken actions during the first quarter of 2022, including stay-at-home orders, to limit the spread of COVID-19. These actions, specifically in China, have and may continue to reduce operating activities and negatively impact financial results.   During the first quarter of 2022, we continued to experience disruption in the supply of raw materials and component parts, as well as price inflation and inefficiencies as a result of supply chain issues. We have established 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. The Company continues work to minimize the impact of price inflation in inputs and market supply challenges by employing local-for-local and region-for-region manufacturing and sourcing to allow us to manufacture our products closer to our customers. At the same time, our engineering teams are evaluating platform design to allow for available parts and to increase our sourcing flexibility. Regarding transportation, we have set up tracking, reporting and communication channels with carriers to understand their risks and to evaluate available options where necessary.   Russia and Ukraine Conflict   The crisis in Russia and Ukraine that began in February 2022 continues as of the date of this Form 10-Q. While we do not have any direct operations or employees in Russia or Ukraine and have suspended sales to Russia and Belarus, our operating results have and may continue to be negatively impacted by supply chain constraints and inflationary pressures stemming from this conflict. In addition to fully adhering to all sanctions, we will continue to monitor developments in the region. Sales to Russia and Belarus represented less than 1% of consolidated net sales and less than 2% of Europe, Middle East and Africa net sales for the year ended December 31, 2021.   Outlook   We expect the supply chain challenges and inflationary trends to continue throughout 2022. Global economic conditions continue to be highly volatile and uncertainty remains regarding the timing of a full recovery. We anticipate that we will need to remain agile as we manage these evolving challenges throughout the year. Strong overall demand for our products has returned to pre-pandemic levels and we remain confident in the long-term growth trends for all our products and markets.   17 Table of Contents   Results   The following table compares the results of operations for the three months ended March 31, 2022 and 2021, respectively (in millions, except per share data and percentages):       Three Months Ended       March 31,       2022     %     2021     %   Net sales   $ 258.1       100.0     $ 263.3       100.0   Cost of sales     159.2       61.7       150.0       57.0   Gross profit     98.9       38.3       113.3       43.0   Selling and administrative expense     76.6       29.7       79.4       30.2   Research and development expense     7.7       3.0       7.4       2.8   Gain on sale of business     —       —       (9.8 )     (3.7 ) Operating income     14.6       5.7       36.3       13.8   Interest expense, net     (0.3 )     (0.1 )     (3.9 )     (1.5 ) Net foreign currency transaction gain     0.6       0.2       0.5       0.2   Other (expense) income, net     (0.2 )     (0.1 )     0.1       0.0   Income before income taxes     14.7       5.7       33.0       12.5   Income tax expense     4.4       1.7       7.3       2.8   Net income attributable to Tennant Company   $ 10.3       4.0     $ 25.7       9.8   Net income attributable to Tennant Company per share - diluted   $ 0.55             $ 1.37             Net Sales   Consolidated net sales for the first quarter of 2022 totaled $258.1 million, a 2.0% decrease as compared to consolidated net sales of $263.3 million in the first quarter of 2021.   The 2.0% decrease in consolidated net sales in the first quarter of 2022 as compared to the same period in 2021 was driven by:     •  A net unfavorable impact from foreign currency exchange across all regions of approximately 2.2%;   •  An organic sales increase of approximately 0.8%, which excludes the effects of foreign currency exchange and divestitures. The organic sales increase was primarily due to the impact of higher selling prices across all regions, partly offset by volume declines resulting from continued supply chain constraints; and   •  An unfavorable impact from the divestiture of our Coatings business in the first quarter of 2021 of 0.6%.   The following table sets forth the net sales by geographic area for the three months ended March 31, 2022 and 2021 (in millions, except percentages):       Three Months Ended       March 31,       2022     2021     % Change   Americas   $ 160.3     $ 157.8       1.6 % Europe, Middle East and Africa     78.7       80.9       (2.7 )% Asia Pacific     19.1       24.6       (22.4 )% Total   $ 258.1     $ 263.3       (2.0 )%   18 Table of Contents   Americas   Americas net sales were $160.3 million for the first quarter of 2022, an increase of 1.6% from the first quarter of 2021. Organic sales growth in the Americas favorably impacted net sales by approximately 2.3% mainly due to higher selling prices, partly offset by lower volume. Demand in the region remained strong; however, diminished parts availability, due to global supply chain constraints, resulted in increased backlog levels. Additionally, foreign currency exchange within the Americas favorably impacted net sales by approximately 0.2% in the first quarter of 2022. These items were offset by the divestiture of the Coatings business in the first quarter of 2021 resulting in a decline in net sales of approximately 0.9% in the first quarter of 2022.   Europe, Middle East and Africa ("EMEA")   EMEA net sales were $78.7 million for the first quarter of 2022, a decrease of 2.7% from the first quarter of 2021. Foreign currency exchange within EMEA unfavorably impacted net sales by approximately 6.9%. Organic sales growth in EMEA favorably impacted net sales by approximately 4.2% primarily due to higher selling prices, growth in services, and higher sales of parts and consumables.   Asia Pacific ("APAC")   APAC net sales were $19.1 million for the first quarter of 2022, a decrease of 22.4% from the first quarter of 2021. Organic sales decline in APAC unfavorably impacted net sales by approximately 20.2% primarily due to government shutdowns in China related to COVID-19 outbreaks as well as softer demand in certain markets partly offset by volume upside in Australian markets. Foreign currency exchange within APAC unfavorably impacted net sales by approximately 2.2% in the first quarter of 2022.   Gross Profit   Gross profit margin of 38.3% was 470 basis points lower in the first quarter of 2022 compared to the first quarter of 2021. The decrease was due to material inflation and higher freight costs, partly offset by price increases.   Operating Expense   Selling and Administrative Expense   Selling and administrative expense ("S&A expense") was $76.6 million for the first quarter of 2022, a decrease of $2.8 million compared to the first quarter of 2021. As a percentage of net sales, S&A expense for the first quarter of 2022 decreased 50 basis points to 29.7% from 30.2% in the first quarter of 2021. The S&A expense decrease in the first quarter of 2022 was primarily driven by lower variable employee compensation expenses.   Research and Development Expense   Research and Development ("R&D") expense was $7.7 million, or 3.0% of net sales, for the first quarter of 2022, 20 basis points higher as a percentage of net sales compared to the first quarter of 2021 due to new product development.   We continue to invest in developing innovative products and technologies at levels necessary to propel our technology and innovation leadership position.   19 Table of Contents   Total Other Expense, Net   Interest Expense, Net   Interest expense, net was $0.3 million in the first quarter of 2022 compared to $3.9 million in the same period of 2021. The decrease 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. Our debt portfolio as of March 31, 2022, was comprised of debt predominately in U.S. dollars. We are exposed to changes in interest rates as a result of borrowing activities with variable interest rates that impact interest incurred.    Net Foreign Currency Transaction Gain   Net foreign currency transaction gain was $0.6 million and $0.5 million in the first quarter of 2022 and 2021, respectively. The favorable impact was primarily due to strengthening of the Brazilian real relative to foreign-denominated payables.   Income Taxes   The effective tax rate for the first quarter of 2022 was 30.1% compared to 22.1% for the first quarter of 2021. The effective tax rate increased primarily due to the mix in forecasted full year taxable earnings by country and a decrease in discrete tax benefit items recognized during the quarter.   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.   Backlog   Backlog is one of the many indicators of business conditions in the Company's markets. Our order backlog at March 31, 2022 was approximately five times larger compared to March 31, 2021. The increase in our order backlog year over year was primarily due to higher order rates coupled with persistent supply chain challenges that impacted our ability to obtain raw materials and component parts. Unless these factors change, we expect our backlog level to remain high throughout 2022. Backlog includes orders that can be cancelled or postponed at the option of the customer at any time without penalty.   20 Table of Contents   Liquidity and Capital Resources   Liquidity   Cash, cash equivalents and restricted cash totaled $110.4 million at March 31, 2022, as compared to $123.6 million as of December 31, 2021. Wherever possible, cash management is centralized and intercompany financing is used to provide working capital to subsidiaries as needed. Our current ratio was 2.0 as of March 31, 2022 and 1.8 as of December 31, 2021, and our primary working capital, which is comprised of accounts receivable, inventories and accounts payables, was $263.9 million and $250.5 million, respectively. Our debt-to-capital ratio was 39.2% as of March 31, 2022, compared to 38.1% as of December 31, 2021.   As of March 31, 2022, we had letters of credit and bank guarantees outstanding in the amount of $2.9 million, leaving approximately $264.1 million of unused borrowing capacity on our revolving facility.   The Company's Board of Directors has authorized a quarterly cash dividend of $0.25 per share payable June 15, 2022, to shareholders of record at the close of business on May 31, 2022.   Cash Flow from Operating Activities   Net cash used in operating activities during the three months ended March 31, 2022 was $10.1 million, driven primarily by inflows from net income, by adding back non-cash items of $13.8 million, a decrease in accounts receivable of $10.1 million and an increase in accounts payable of $2.0 million. This was offset by outflows from an increase in inventory of $29.0 million and a decrease in employee compensation and benefits of $12.6 million.   Cash Flow from Investing Activities   Net cash used in investing activities during the three months ended March 31, 2022 was $8.6 million, resulting from $5.0 million related to capital expenditures and $3.7 million from investments in leased assets.   Cash Flow from Financing Activities   Net cash provided by financing activities was $8.3 million during the first three months of 2022. Proceeds from borrowings of $15.0 million were mainly offset by dividend payments of $4.6 million, payments for repurchases of common stock for employee tax withholdings obligations of $1.2 million and payments of debt of $0.9 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, 2021.   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.   21 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, 2021. For additional information, refer to Item 7A of our annual report on Form 10-K for the year ended December 31, 2021.