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.   Macroeconomic Events   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, 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.   We continue 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 increase our sourcing flexibility. Regarding transportation, we have set up tracking, reporting and communication channels with carriers to understand their risks and to evaluate alternatives where necessary.   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. 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. In addition to fully adhering to all sanctions, we will continue to monitor developments in the region, including the impact of rising commodity and energy prices.   As described in Part I, Item 1A - Risk Factors, in the annual report on Form 10-K for the fiscal year ended December 31, 2021, we may encounter financial difficulties if the United States or other global economies experience an additional or continued long-term economic downturn as our product sales are sensitive to declines in capital spending by our customers. We are actively monitoring the macroeconomic environment, especially the potential impact of global supply chain constraints on material inflation, and the potential decreased demand for our products.   Outlook   We expect the supply chain challenges and inflationary trends to continue in the second half of 2022. Global economic conditions continue to be highly volatile and uncertainty remains regarding the timing of a full recovery. We continue to monitor prices in the current inflationary environment and will take action accordingly. Strategic investments made during the second quarter have positioned us to address the strong overall demand for our products in 2022. However, we anticipate that we will need to remain agile as we continue to manage evolving challenges throughout the year. We remain confident in the long-term growth trends for all our products and services in the markets we serve.   18 Table of Contents   Results   The following table compares the results of operations for the three and six months ended June 30, 2022 and 2021, respectively (in millions, except per share data and percentages):       Three Months Ended     Six Months Ended       June 30,     June 30,       2022     %     2021     %     2022     %     2021     %   Net sales   $ 280.2       100.0     $ 279.1       100.0     $ 538.3       100.0     $ 542.4       100.0   Cost of sales     174.1       62.1       164.2       58.8       333.3       61.9       314.2       57.9   Gross profit     106.1       37.9       114.9       41.2       205.0       38.1       228.2       42.1   Selling and administrative expense     79.1       28.2       86.2       30.9       155.7       28.9       165.6       30.5   Research and development expense     7.9       2.8       8.3       3.0       15.6       2.9       15.7       2.9   Gain on sale of assets     (3.7 )     (1.3 )     —       —       (3.7 )     (0.7 )     (9.8 )     (1.8 ) Operating income     22.8       8.1       20.4       7.3       37.4       6.9       56.7       10.5   Interest expense, net     (1.2 )     (0.4 )     (2.1 )     (0.8 )     (1.5 )     (0.3 )     (6.0 )     (1.1 ) Net foreign currency transaction (loss) gain     (1.0 )     (0.4 )     —       —       (0.4 )     (0.1 )     0.5       0.1   Loss on extinguishment of debt     —       —       (11.3 )     (4.0 )     —       —       (11.3 )     (2.1 ) Other (expense) income, net     (0.3 )     (0.1 )     0.2       0.1       (0.5 )     (0.1 )     0.3       0.1   Income before income taxes     20.3       7.2       7.2       2.6       35.0       6.5       40.2       7.4   Income tax expense (benefit)     3.7       1.3       (2.6 )     (0.9 )     8.1       1.5       4.7       0.9   Net income   $ 16.6       5.9     $ 9.8       3.5     $ 26.9       5.0     $ 35.5       6.5   Net income per share - diluted   $ 0.89             $ 0.51             $ 1.44             $ 1.88             Net Sales   Consolidated net sales for the second quarter of 2022 totaled $280.2 million, a 0.4% increase as compared to consolidated net sales of $279.1 million in the second quarter of 2021. Consolidated net sales for the first six months of 2022 were $538.3 million, a 0.8% decrease compared to consolidated net sales of $542.4 million in the first six months of 2021.   The 0.4% increase in consolidated net sales in the second quarter of 2022 as compared to the same period in 2021 was driven by:     •  A net unfavorable impact from foreign currency exchange of approximately 4.0%; and   •  An organic sales increase of approximately 4.4%, which excludes the effects of foreign currency exchange. The organic sales increase was primarily due to the impact of higher selling prices across all regions, partially offset by volume declines due to limited availability of certain component parts resulting from continued supply chain constraints.   The 0.8% decrease in consolidated net sales in the first six months of 2022 as compared to the same period in 2021 was driven by:     •  A net unfavorable impact from foreign currency exchange of approximately 3.1%;   •  An organic sales increase of approximately 2.6%, 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, partially 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 0.3%.   The following table sets forth the net sales by geographic area for the three and six months ended June 30, 2022 and 2021 (in millions, except percentages):       Three Months Ended     Six Months Ended       June 30,     June 30,       2022     2021     % Change     2022     2021     % Change   Americas   $ 178.4     $ 167.2       6.7 %   $ 338.7     $ 325.0       4.2 % Europe, Middle East and Africa     77.3       85.2       (9.3 )%     156.0       166.1       (6.1 )% Asia Pacific     24.5       26.7       (8.2 )%     43.6       51.3       (15.0 )% Total   $ 280.2     $ 279.1       0.4 %   $ 538.3     $ 542.4       (0.8 )% 19 Table of Contents   Americas   Americas net sales were $178.4 million for the second quarter of 2022, an increase of 6.7% from the second quarter of 2021. Organic sales grew 6.5% in the Americas, mainly due to higher selling prices across the region and volume increases in Latin America, partially offset by volume declines in North America. 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 second quarter of 2022.   Americas net sales were $338.7 million for the first six months of 2022, an increase of 4.2% from the first six months of 2021. Organic sales grew 4.5% in the Americas, mainly due to higher selling prices, partially offset by lower volume. Additionally, foreign currency exchange within the Americas favorably impacted net sales by approximately 0.2% in the first six months of 2022. These items were offset by the divestiture of the Coatings business in the first six months of 2021 resulting in a decline in net sales of approximately 0.5% in the first six months of 2022.   Europe, Middle East and Africa ("EMEA")   EMEA net sales were $77.3 million for the second quarter of 2022, a decrease of 9.3% from the second quarter of 2021. Foreign currency exchange within EMEA unfavorably impacted net sales by approximately 12.3%. Organic sales grew 3.0% in EMEA, primarily due to higher selling prices, growth in services and parts and consumables. This was partially offset by volume declines as lack of component parts due to global supply chain constraints has limited our ability to meet the strong demand in the region.   EMEA net sales were $156.0 million for the first six months of 2022, a decrease of 6.1% from the first six months of 2021. Foreign currency exchange within EMEA unfavorably impacted net sales by approximately 9.7%. Organic sales grew 3.6% in EMEA, primarily due to higher selling prices, growth in services, and higher sales of parts and consumables.   Asia Pacific ("APAC")   APAC net sales were $24.5 million for the second quarter of 2022, a decrease of 8.2% from the second quarter of 2021. Organic sales declined 4.5% in APAC, primarily due to volume declines in China as government shutdowns related to COVID-19 continue to unfavorably impact demand. This was partially offset by growth in equipment and parts and consumables in Australia. Foreign currency exchange within APAC unfavorably impacted net sales by approximately 3.7% in the second quarter of 2022.   APAC net sales were $43.6 million for the first six months of 2022, a decrease of 15.0% from the first six months of 2021. Organic sales declined 12.0% in APAC, primarily due to government shutdowns in China related to COVID-19 outbreaks impacting our ability to deliver finished goods to customers. This was partly offset by volume upside in Australian markets. Foreign currency exchange within APAC unfavorably impacted net sales by approximately 3.0% in the first six months of 2022.   Gross Profit   Gross profit margin of 37.9% was 330 basis points lower in the second quarter of 2022 compared to the second quarter of 2021. The decrease was attributable to the broad effects of inflation on materials, labor, and freight costs, partly offset by higher selling prices. Inflation contributed to a $4.9 million LIFO charge during the second quarter of 2022 compared to $2.4 million in the second quarter of 2021.   Gross profit margin of 38.1% was 400 basis points lower in the first six months of 2022 compared to the first six months of 2021. The decrease was due to inflation on materials and higher freight costs, partly offset by price increases.  Inflation contributed to a LIFO charge of $6.0 million during the first six months of 2022 compared to $2.2 million in the first six months of 2021.   Operating Expense   Selling and Administrative Expense   Selling and administrative expense ("S&A expense") was $79.1 million for the second quarter of 2022, a decrease of $7.1 million compared to the second quarter of 2021. As a percentage of net sales, S&A expense for the second quarter of 2022 decreased 270 basis points to 28.2% from 30.9% in the second quarter of 2021. The S&A expense decrease in the second quarter of 2022 was primarily driven by lower variable employee compensation expenses, partially offset by increased strategic project spend initiatives to address strong overall demand.   S&A expense was $155.7 million for the first six months of 2022, a decrease of $9.9 million compared to the first six months of 2021. As a percentage of net sales, S&A expense for the first six months of 2022 decreased 160 basis points to 28.9% from 30.5% in the first six months of 2021. The S&A expense decrease in the first six months of 2022 was primarily driven by lower variable employee compensation expenses.   Research and Development Expense   Research and development ("R&D") expense was $7.9 million, or 2.8% of net sales, for the second quarter of 2022, essentially flat compared to the second quarter of 2021. R&D expense was $15.6 million, or 2.9% of net sales, for the first six months of 2022, flat as a percentage of net sales compared to the first six months of 2021.   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   Total Other Expense, Net   Interest Expense, Net   Interest expense, net was $1.2 million in the second quarter of 2022 compared to $2.1 million in the same period of 2021. Interest expense, net was $1.5 million in the first six months of 2022 compared to $6.0 million in the same period of 2021. 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. Our debt portfolio as of June 30, 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 (Loss) Gain   Net foreign currency transaction (loss) gain was a $1.0 million loss and less than $0.1 million loss in the second quarter of 2022 and 2021, respectively. Net foreign currency transaction (loss) gain was a $0.4 million loss and a $0.5 million gain in the first six months of 2022 and 2021, respectively. The unfavorable impact was primarily due to strengthening of the U.S. dollar relative to the Brazilian real on foreign denominated liabilities.   Income Taxes   The effective tax rate for the second quarter of 2022 was 18.2% compared to (36.1)% for the second quarter of 2021. The effective tax rate for the first six months of 2022 was 23.1% compared to 11.7% for the first six months of 2021. The effective tax rate for both the second quarter and the first six months of 2022 increased primarily due to a high level of discrete tax benefit items in 2021 compared to 2022 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.   Backlog   Backlog is one of the many indicators of business conditions in the Company's markets. Our order backlog at June 30, 2022 was approximately three times larger compared to June 30, 2021. During the second quarter of 2022, our order backlog increased approximately 11.0%. The increase in our order backlog 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.   21 Table of Contents   Liquidity and Capital Resources   Liquidity   Cash, cash equivalents and restricted cash totaled $73.8 million at June 30, 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 June 30, 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 $283.9 million and $250.5 million, respectively. Our debt-to-capital ratio was 38.0% as of June 30, 2022, compared to 38.1% as of December 31, 2021.   As of June 30, 2022, 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.   On August 3, 2022, the Company's Board of Directors authorized a quarterly cash dividend of $0.25 per share payable September 15, 2022, to shareholders of record at the close of business on August 31, 2022.   Cash Flow from Operating Activities   Net cash used in operating activities during the six months ended June 30, 2022 was $23.6 million compared to net cash provided by operating activities of $37.8 million during the six months ended June 30, 2021. The increase in cash used was primarily driven by an increase in working capital attributable to the effects of inflation as well as an investment in constrained component parts to prepare for a ramp in production.   Cash Flow from Investing Activities   Net cash used in investing activities during the six months ended June 30, 2022 was $10.1 million compared to net cash provided by investing activities of $16.7 million during the six months ended June 30, 2021.  The increase of cash outflows was primarily the result of lower cash proceeds from the prior year sale of our Coatings business in 2021.   Cash Flow from Financing Activities   Net cash used in financing activities decreased during the six months ended June 30, 2022 compared to the six months ended June 30, 2021 primarily due to a decrease in repayments of borrowings in the first six month of 2022.   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.   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, 2021. For additional information, refer to Item 7A of our annual report on Form 10-K for the year ended December 31, 2021.