Item 5 - Market for Registrant's Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
Item 6 - Selected Financial Data
Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 7A - Quantitative and Qualitative Disclosures About Market Risk
Item 8 - Financial Statements and Supplementary Data
Item 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A - Controls and Procedures
Item 9B - Other Information
Item 10 - Directors, Executive Officers and Corporate Governance
Item 11 - Executive Compensation
Item 12 - Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters
Item 13 - Certain Relationships and Related Transactions, and Director Independence
Item 14 - Principal Accountant Fees and Services
Item 15 - Exhibits and Financial Statement Schedules
Item 16 - Form 10-K Summary
Tennant Earnings 2018-12-31
TNC 10K Annual Report
10-K 1 form10-k12312018.htm FORM 10-K FILED FEBRUARY 28, 2019 Document
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2018
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________.
Commission File Number 001-16191
(Exact name of registrant as specified in its charter)
State or other jurisdiction of
incorporation or organization
701 North Lilac Drive, P.O. Box 1452
Minneapolis, Minnesota 55440
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code 763-540-1200
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Name of exchange on which registered
Common Stock, par value $0.375 per share
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined by Rule 405 of the Securities Act.
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or emerging growth company. See definitions of “large accelerated filer,” "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
The aggregate market value of the voting and non-voting common equity held by non-affiliates as of June 29, 2018, was $1,404,892,960.
As of January 31, 2019, there were 18,119,093 shares of Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s Proxy Statement for its 2019 annual meeting of shareholders (the “2019 Proxy Statement”) are incorporated by reference in Part III.
Founded in 1870 by George H. Tennant, Tennant Company, a Minnesota corporation incorporated in 1909, began as a one-man woodworking business, evolved into a successful wood flooring and wood products company, and eventually into a manufacturer of floor cleaning equipment. Throughout its history, Tennant has remained focused on advancing our industry by aggressively pursuing new technologies and creating a culture that celebrates innovation.
Today, Tennant Company is a recognized leader of the cleaning industry. We are passionate about developing innovative and sustainable solutions that help our customers clean spaces more effectively, addressing indoor and outdoor cleaning challenges. Tennant Company operates in three geographic business units including the Americas, Europe, Middle East and Africa (EMEA) and Asia Pacific (APAC).
Tennant Company is committed to empowering our customers to create a cleaner, safer and healthier world with high-performance solutions that minimize waste, reduce costs, improve safety and further sustainability goals.
Principal Products, Markets and Distribution
The Company offers products and solutions consisting of mechanized cleaning equipment, detergent-free and other sustainable cleaning technologies, aftermarket parts and consumables, equipment maintenance and repair service, specialty surface coatings, and business solutions such as financing, rental and leasing programs, and machine-to-machine asset management solutions.
The Company's 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, parking lots and streets, and more. The Company markets its offerings under the following brands: Tennant®, Nobles®, Alfa Uma Empresa Tennant™, IRIS®, VLX™, Superior Anodes, Orbio®,, IPC brands and private-label brands. Orbio-branded products and solutions are part of the emerging category of On-Site Generation (OSG). OSG technologies create and dispense effective cleaning and antimicrobial solutions on site within a facility. The Company's 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.
The Company has not experienced any significant or unusual problems in the availability of raw materials or other product components. The Company has sole-source vendors for certain components. A disruption in supply from such vendors may disrupt the Company’s operations. However, the Company believes that it can find alternate sources in the event there is a disruption in supply from such vendors.
Although the Company considers that its patents, proprietary technologies and trade secrets, customer relationships, licenses, trademarks, trade names and brand names in the aggregate constitute a valuable asset, it does not regard its business as being materially dependent upon any single item or category of intellectual property. We take appropriate measures to protect our intellectual property to the extent such intellectual property can be protected.
Although the Company’s business is not seasonal in the traditional sense, the percentage of revenues in each quarter typically ranges from 22% to 28% of the total year. The first quarter tends to be at the low end of the range reflecting customers’ initial slow ramp up of capital purchases and the Company’s efforts to close out orders at the end of each year. The second and fourth quarters tend to be toward the high end of the range and the third quarter is typically in the middle of the range.
The Company funds operations through a combination of cash and cash equivalents and cash flows from operations. Wherever possible, cash management is centralized and intercompany financing is used to provide working capital to subsidiaries as needed. In addition, credit facilities are available for additional working capital needs or investment opportunities.
The Company sells its products to a wide variety of customers, none of which are of material importance in relation to the business as a whole. The customer base includes several governmental entities which generally have terms similar to other customers.
The Company processes orders within two weeks, on average. Therefore, no significant backlogs existed at December 31, 2018 and 2017.
Public industry data concerning global market share is limited; however, through an assessment of validated third-party sources and sponsored third-party market studies, the Company is confident in its position as a world-leading manufacturer of floor maintenance and cleaning equipment. Several global competitors compete with Tennant in virtually every geography of the world. However, small regional competitors are also significant competitors who vary by country, vertical market, product category or channel. The Company competes primarily on the basis of offering a broad line of high-quality, innovative products supported by an extensive sales and service network in major markets.
Research and Development
Tennant Company has a history of developing innovative technologies to create a cleaner, safer, healthier world. The Company is committed to its innovation leadership position through fulfilling its goal to annually invest 3% of annual sales to research and development. The Company’s innovation efforts are focused on solving our customers’ needs holistically addressing a
broad array of issues, such as managing labor costs, enhancing productivity, and making cleaning processes more efficient and sustainable. Through core product development, partnerships and technology enablement we are creating new growth avenues for Tennant. These new avenues for growth go beyond cleaning equipment into business insights and service solutions.
Compliance with Federal, State and local provisions which have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, has not had, and the Company does not expect it to have, a material effect upon the Company’s capital expenditures, earnings or competitive position.
The Company employed approximately 4,300 people in worldwide operations as of December 31, 2018.
The Company's internet address is www.tennantco.com. The Company makes available free of charge, through the Investor Relations website at investors.tennantco.com, its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable when such material is filed electronically with, or furnished to, the Securities and Exchange Commission (“SEC”).
Executive Officers of the Registrant
The list below identifies those persons designated as executive officers of the Company, including their age, positions held with the Company and their business experience during the past five or more years.
David W. Huml, Senior Vice President, EMEA, APAC, Global Marketing and Operations
David W. Huml (50) joined the Company in November 2014 as Senior Vice President, Global Marketing. In January 2016, he also assumed oversight for the Company's APAC business unit. In January 2017, he assumed oversight for the Company's EMEA business and in June 2018 he assumed responsibility for Global Operations. From 2006 to October 2014, he held various positions with Pentair plc, a global manufacturer of water and fluid solutions, valves and controls, equipment protection and thermal management products, most recently as Vice President, Applied Water Platform. From 1992 to 2006, he held various positions with Graco Inc., a designer, manufacturer and marketer of systems and equipment to move, measure, control, dispense and spray fluid and coating materials, including Worldwide Director of Marketing, Contractor Equipment Division.
H. Chris Killingstad, President and Chief Executive Officer
H. Chris Killingstad (63) joined the Company in April 2002 as Vice President, North America and was named President and CEO in 2005. From 1990 to 2002, he was employed by The Pillsbury Company, a consumer foods manufacturer. From 1999 to 2002 he served as Senior Vice President and General Manager of Frozen Products for Pillsbury North America; from 1996 to 1999 he served as Regional Vice President and Managing Director of Pillsbury Europe, and from 1990 to 1996 was Regional Vice President of Häagen-Dazs Asia Pacific. He held the position of International Business Development Manager at PepsiCo Inc., from 1982-1990 and Financial Manager for General Electric, from 1978-1980.
Carol E. McKnight, Senior Vice President, Chief Administrative Officer
Carol E. McKnight (51) joined the Company in June 2014 as Senior Vice President of Global Human Resources. In 2017, Carol was named SVP and Chief Administrative Officer. Prior to joining Tennant, she was Vice President of Human Resources at ATK (Alliant Techsystems) where she held divisional
and corporate leadership positions in the areas of compensation, talent management, talent acquisition and general human resource management from 2002 to 2014. Prior to ATK, she was with New Jersey-based NRG Energy, Inc.
Mary E. Talbott, Senior Vice President, General Counsel and Corporate Secretary
Mary E. Talbott (50) joined the Company in January 2019 as Senior Vice President, General Counsel and Corporate Secretary. Prior to joining Tennant, from 2017 to 2018, she was Vice President, Assistant General Counsel and Assistant Corporate Secretary for General Cable Corporation, a global manufacturer in the development, design, manufacture, marketing and distribution of copper, aluminum and fiber optic wire and cable products for use in the energy, industrial, construction, automotive, specialty and communications markets. From 2016 to 2017, she was Vice President of Law at Macy’s, Inc., and from 2006 to 2015, she held corporate leadership positions with Scripps Networks Interactive, Inc. (which was spun off from The E.W. Scripps Company in 2008), a developer of lifestyle-oriented content for linear and interactive video platforms including television and the internet, most recently as Senior Vice President, Deputy General Counsel and Corporate Secretary.
Keith A. Woodward, Senior Vice President and Chief Financial Officer
Keith A. Woodward (54) joined the Company in December 2018 as Senior Vice President and Chief Financial Officer. Prior to joining Tennant, he was at General Mills, Inc, a global manufacturer and marketer of branded consumer foods, for over 26 years holding various finance and corporate leadership roles, most recently as Senior Vice President, Global Treasurer. Prior to General Mills, Inc., he was with PriceWaterhouseCoopers.
Richard H. Zay, Senior Vice President, The Americas and R&D
Richard H. Zay (48) joined the Company in June 2010 as Vice President, Global Marketing and was named Senior Vice President, Global Marketing in October 2013. In 2014, he was named Senior Vice President of the Americas business unit for Tennant and in 2018 he assumed responsibility for Tennant Research and Development as well. From 2006 to 2010, he held various positions with Whirlpool Corporation, a manufacturer of major home appliances, most recently as General Manager, KitchenAid Brand. From 1993 to 2006, he held various positions with Maytag Corporation, including Vice President, Jenn-Air Brand, Director of Marketing, Maytag Brand, and Director of Cooking Category Management.
The following are significant factors known to us that could materially adversely affect our business, financial condition or operating results.
We may not be able to develop or manage strategic planning and growth processes or the related operational plans to deliver on our strategies and establish a broad organization alignment, thereby impairing our ability to achieve future performance expectations.
We are continuing to refine our global company strategy to guide our next phase of performance as our structure has become more complex due to recent acquisitions. We continue to consolidate and reallocate resources as part of our ongoing efforts to optimize our cost structure and to drive synergies and growth. Our operating results may be negatively impacted if we are unable to implement new processes and manage organizational changes, which includes changes to our go-to-market strategy, systems and processes; simultaneous focus on expense control and growth; and introduction of alternative cleaning methods. In addition, if we do not effectively realize and sustain the benefits that these transformations are designed to produce, we may not fully realize the anticipated savings of these actions or they may negatively impact our ability to serve our customers or meet our strategic objectives.
We may not be able to upgrade and evolve our information technology systems as quickly as we wish and we may encounter difficulties as we upgrade and evolve these systems to support our growth strategy and business operations, which could adversely impact our abilities to accomplish anticipated future cost savings and better serve our customers.
We have many information technology systems that are important to the operation of our business and are in need of upgrading in order to effectively implement our growth strategy. Given our greater emphasis on customer-facing technologies, we may not have adequate resources to upgrade our systems at the pace which the current business environment demands. Additionally, significantly upgrading and evolving the capabilities of our existing systems could lead to inefficient or ineffective use of our technology due to lack of training or expertise in these evolving technology systems. These factors could lead to significant expenses, adversely impacting our results of operations and hindering our ability to offer better technology solutions to our customers.
Increases in the cost of, quality, or disruption in the availability of, raw materials and components that we purchase or labor required to manufacture our products could negatively impact our operating results or financial condition.
Our sales growth, expanding geographical footprint and continued use of sole-source vendors, coupled with suppliers’ potential credit issues, could lead to an increased risk of a breakdown in our supply chain. Our use of sole-source vendors creates a concentration risk. There is an increased risk of defects due to the highly configured nature of our purchased component parts that could result in quality issues, returns or production slow downs. In addition, modularization may lead to more sole-sourced products and as we seek to outsource the design of certain key components, we risk loss of proprietary control and becoming more reliant on a sole source. There is also a risk that the vendors we choose to supply our parts and equipment fail to comply with our quality expectations, thus damaging our reputation for quality and negatively impacting sales.
We have and may continue to experience higher than normal wage inflation due to skilled labor shortages. In addition, we have incurred costs associated with tariffs on certain raw materials used on our manufacturing processes. The labor shortages and tariff costs have unfavorably impacted our gross profit margins and could continue to do so if actions we are taking are not effective at offsetting these rising costs. Changes and uncertainties related to government fiscal and tax policies, including increased duties, tariffs,
or other restrictions, could adversely affect demand for our products, the cost of the products we manufacture or our ability to cost-effectively source raw materials, all of which could have a negative impact on our financial results.
We may encounter financial difficulties if the United States or other global economies experience an additional or continued long-term economic downturn, decreasing the demand for our products and negatively affecting our sales growth.
Our product sales are sensitive to declines in capital spending by our customers. Decreased demand for our products could result in decreased revenues, profitability and cash flows and may impair our ability to maintain our operations and fund our obligations to others. In the event of a continued long-term economic downturn in the U.S. or other global economies, our revenues could decline to the point that we may have to take cost-saving measures, such as restructuring actions. In addition, other fixed costs would have to be reduced to a level that is in line with a lower level of sales. A long-term economic downturn that puts downward pressure on sales could also negatively affect investor perception relative to our publicly stated growth targets.
Our ability to effectively operate our Company could be adversely affected if we are unable to attract and retain key personnel and other highly skilled employees, provide employee development opportunities and create effective succession planning strategies.
Our growth strategy, expanding global footprint, changing workforce demographics and increased improvements in technology and business processes designed to enhance the customer experience are putting increased pressure on human capital strategies designed to recruit, retain and develop top talent.
Our continued success will depend on, among other things, the skills and services of our executive officers and other key personnel. Our ability to attract and retain highly qualified managerial, technical, manufacturing, research, sales and marketing personnel also impacts our ability to effectively operate our business. As companies grow and increase their hiring activities, there is an inherent risk of increased employee turnover and the loss of valuable employees in key positions, especially in emerging markets. We believe the increased loss of key personnel within a concentrated region could adversely affect our sales growth.
In addition, there is a risk that we may not have adequate talent acquisition resources and employee development resources to support our future hiring needs and provide training and development opportunities to all employees. This, in turn, could impede our workforce from embracing change and leveraging the improvements we have made in technology and other business process enhancements.
Inadequate funding or insufficient innovation of new technologies may result in an inability to develop and commercialize new innovative products and services.
We strive to develop new and innovative products and services to differentiate ourselves in the marketplace. New product development relies heavily on our financial and resource investments in both the short term and long term. If we fail to adequately fund product development projects or fund a project which ultimately does not gain the market acceptance we anticipated, we risk not meeting our customers' expectations, which could result in decreased revenues, declines in margin and loss of market share.
We may consider acquisition of suitable candidates to accomplish our growth objectives. We may not be able to successfully integrate the businesses we acquire to achieve operational efficiencies, including synergistic and other benefits of acquisition.
We may consider, as part of our growth strategy, supplementing our organic growth through acquisitions of complementary businesses or products. We have engaged in acquisitions in the past, such as the acquisition
of the IPC Group, and we believe future acquisitions may provide meaningful opportunities to grow our business and improve profitability. Acquisitions allow us to enhance the breadth of our product offerings and expand the market and geographic participation of our products and services.
However, our success in growing by acquisition is dependent upon identifying businesses to acquire, integrating the newly acquired businesses with our existing businesses and complying with the terms of our credit facilities. We may incur difficulties in the realignment and integration of business activities when assimilating the operations and products of an acquired business or in realizing projected efficiencies, cost savings, revenue synergies and profit margins. Acquired businesses may not achieve the levels of revenue, profit, productivity or otherwise perform as expected. We are also subject to incurring unanticipated liabilities and contingencies associated with an acquired entity that are not identified or fully understood in the due diligence process. Current or future acquisitions may not be successful or accretive to earnings if the acquired businesses do not achieve expected financial results.
In addition, we may record significant goodwill or other intangible assets in connection with an acquisition. We are required to perform impairment tests at least annually and whenever events indicate that the carrying value may not be recoverable from future cash flows. If we determine that any intangible asset values need to be written down to their fair values, this could result in a charge that may be material to our operating results and financial condition.
We are subject to competitive risks associated with developing innovative products and technologies, including but not limited to, not expanding as rapidly or aggressively in the global market as our competitors, our customers not continuing to pay for innovation and competitive challenges to our products, technology and the underlying intellectual property.
Our products are sold in competitive markets throughout the world. Competition is based on product features and design, brand recognition, reliability, durability, technology, breadth of product offerings, price, customer relationships and after-sale service. Although we believe that the performance and price characteristics of our products will produce competitive solutions for our customers’ needs, our products are generally priced higher than our competitors’ products. This is due to our dedication to innovation and continued investments in research and development. We believe that customers will pay for the innovations and quality in our products. However, it may be difficult for us to compete with lower priced products offered by our competitors and there can be no assurance that our customers will continue to choose our products over products offered by our competitors. If our products, markets and services are not competitive, we may experience a decline in sales volume, an increase in price discounting and a loss of market share, which adversely impacts revenues, margin and the success of our operations.
Competitors may also initiate litigation to challenge the validity of our patents or claims, allege that we infringe upon their patents, violate our patents or they may use their resources to design comparable products that avoid infringing our patents. Regardless of whether such litigation is successful, such litigation could significantly increase our costs and divert management’s attention from the operation of our business, which could adversely affect our results of operations and financial condition.
We may encounter risks to our IT infrastructure, such as access and security, that may not be adequately designed to protect critical data and systems from theft, corruption, unauthorized usage, viruses, sabotage or unintentional misuse.
Global cybersecurity threats and incidents can range from uncoordinated individual attempts to gain unauthorized access to IT systems to sophisticated and targeted measures known as advanced persistent threats, directed at the Company, its products and its customers. We seek to deploy comprehensive measures to deter, prevent, detect, react to and mitigate these threats, including identity and access controls, data protection,
vulnerability assessments, continuous monitoring of our IT networks and systems and maintenance of backup and protective systems.
Despite these efforts, cybersecurity incidents, depending on their nature and scope, could potentially result in the misappropriation, destruction, corruption or unavailability of critical data and confidential or proprietary information (our own or that of third parties) and the disruption of business operations. The potential consequences of a material cybersecurity incident include financial loss, reputational damage, litigation with third parties, theft of intellectual property, diminution in the value of our investment in research, development and engineering, and increased cybersecurity protection and remediation costs due to the increasing sophistication and proliferation of threats, which in turn could adversely affect our competitiveness and results of operations.
Actions of activist investors or others could disrupt our business.
Public companies have been the target of activist investors. One investor which owns approximately 5% of our outstanding common stock filed a Schedule 13D with the Securities and Exchange Commission in December 2017 which stated its belief that we should undertake a strategic review process regarding a consolidation transaction with a third party. In the event such investor or another third party, such as an activist investor, continues to pursue such belief or proposes to change our governance policies, board of directors, or other aspects of our operations, our review and consideration of such proposals may create a significant distraction for our management and employees. This could negatively impact our ability to execute our business plans and may require our management to expend significant time and resources. Such proposals may also create uncertainties with respect to our financial position and operations and may adversely affect our ability to attract and retain key employees.
We may be unable to conduct business if we experience a significant business interruption in our computer systems, manufacturing plants or distribution facilities for a significant period of time.
We rely on our computer systems, manufacturing plants and distribution facilities to efficiently operate our business. If we experience an interruption in the functionality in any of these items for a significant period of time for any reason, we may not have adequate business continuity planning contingencies in place to allow us to continue our normal business operations on a long-term basis. In addition, the increase in customer-facing technology raises the risk of a lapse in business operations. Therefore, significant long-term interruption in our business could cause a decline in sales, an increase in expenses and could adversely impact our financial results.
Our global operations are subject to laws and regulations that impose significant compliance costs and create reputational and legal risk.
Due to the international scope of our operations, we are subject to a complex system of commercial, tax and trade regulations around the world. Recent years have seen an increase in the development and enforcement of laws regarding trade, tax compliance, labor and safety and anti-corruption, such as the U.S. Foreign Corrupt Practices Act, and similar laws from other countries. Our numerous foreign subsidiaries and affiliates are governed by laws, rules and business practices that differ from those of the U.S., but because we are a U.S.-based company, oftentimes they are also subject to U.S. laws which can create a conflict. Despite our due diligence, there is a risk that we do not have adequate resources or comprehensive processes to stay current on changes in laws or regulations applicable to us worldwide and maintain compliance with those changes. Increased compliance requirements may lead to increased costs and erosion of desired profit margin. As a result, it is possible that the activities of these entities may not comply with U.S. laws or business practices or our Business Ethics Guide. Violations of the U.S. or local laws may result in severe criminal or civil sanctions, could disrupt our business, and result in an adverse effect on our reputation, business and
results of operations or financial condition. We cannot predict the nature, scope or effect of future regulatory requirements to which our operations might be subject or the manner in which existing laws might be administered or interpreted.
In addition to the foregoing, the European Union adopted a comprehensive General Data Privacy Regulation (the "GDPR") in May 2016 that has replaced the EU Data Protection Directive and related country-specific legislation. The GDPR became effective in May 2018. GDPR requires companies to satisfy new requirements regarding the handling of personal and sensitive data, including its use, protection and the ability of persons whose data is stored to correct or delete such data about themselves. Failure to comply with GDPR requirements could result in penalties of up to 4% of worldwide revenue.
The SEC has adopted rules regarding disclosure of the use of “conflict minerals” (commonly referred to as tin, tantalum, tungsten and gold) which are mined from the Democratic Republic of the Congo in products we manufacture or contract to manufacture. These rules have required and will continue to require due diligence and disclosure efforts.
We are subject to product liability claims and product quality issues that could adversely affect our operating results or financial condition.
Our business exposes us to potential product liability risks that are inherent in the design, manufacturing and distribution of our products. If products are used incorrectly by our customers, injury may result leading to product liability claims against us. Some of our products or product improvements may have defects or risks that we have not yet identified that may give rise to product quality issues, liability and warranty claims. Quality issues may also arise due to changes in parts or specifications with suppliers and/or changes in suppliers. If product liability claims are brought against us for damages that are in excess of our insurance coverage or for uninsured liabilities and it is determined we are liable, our business could be adversely impacted. Any losses we suffer from any liability claims, and the effect that any product liability litigation may have upon the reputation and marketability of our products, may have a negative impact on our business and operating results. We could experience a material design or manufacturing failure in our products, a quality system failure, other safety issues, or heightened regulatory scrutiny that could warrant a recall of some of our products. Any unforeseen product quality problems could result in loss of market share, reduced sales and higher warranty expense.
We may not be able to generate sufficient cash to service all of our indebtedness, and may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.
In April 2017, in connection with the acquisition of IPC Cleaning S.p.A., we entered into a new senior credit facility and indenture, and issued debt totaling approximately $400,000,000 consisting of a $100,000,000 term loan and $300,000,000 of senior notes, which funded the acquisition and replaced our current debt facility. The new senior credit facility also includes a revolving facility in an amount up to $200,000,000. We cannot provide assurance that our business will generate sufficient cash flow from operations to meet all our debt service requirements, to pay dividends, to repurchase shares of our common stock, and to fund our general corporate and capital requirements.
Our ability to satisfy our debt obligations will depend upon our future operating performance. We do not have complete control over our future operating performance because it is subject to prevailing economic conditions, and financial, business and other factors.
Our current and future debt service obligations and covenants could have important consequences. These consequences include, or may include, the following:
our ability to obtain financing for future working capital needs or acquisitions or other purposes may be limited;
our funds available for operations, expansions, dividends or other distributions, or stock repurchases may be reduced because we dedicate a significant portion of our cash flow from operations to the payment of principal and interest on our indebtedness;
our ability to conduct our business could be limited by restrictive covenants; and
our vulnerability to adverse economic conditions may be greater than less leveraged competitors and, thus, our ability to withstand competitive pressures may be limited.
Restrictive covenants in our senior credit facility and in our indenture place limits on our ability to conduct our business. Covenants in our senior credit facility and indenture include those that restrict our ability to make acquisitions, incur debt, encumber or sell assets, pay dividends, engage in mergers and consolidations, enter into transactions with affiliates, make investments and permit our subsidiaries to enter into certain restrictive agreements. The senior credit facility additionally contains certain financial covenants. We cannot provide assurance that we will be able to comply with these covenants in the future.
Foreign currency exchange rate fluctuations, particularly the strengthening of the U.S. dollar against other major currencies, could result in declines in our reported net sales and net earnings.
We earn revenues, pay expenses, own assets and incur liabilities in countries using functional currencies other than the U.S. dollar. Because our consolidated financial statements are presented in U.S. dollars, we translate revenues and expenses into U.S. dollars at the average exchange rate during each reporting period, as well as assets and liabilities into US. dollars at exchange rates in effect at the end of each reporting period. Therefore, increases or decreases in the value of the U.S. dollar against other major currencies will affect our net revenues, net earnings, earnings per share and the value of balance sheet items denominated in foreign currencies as we translate them into the U.S. dollar reporting currency. We use derivative financial instruments to hedge our estimated transactional or translational exposure to certain foreign currency-denominated assets and liabilities as well as our foreign currency denominated revenue. While we actively manage the exposure of our foreign currency market risk in the normal course of business by utilizing various foreign exchange financial instruments, these instruments involve risk and may not effectively limit our underlying exposure from foreign currency exchange rate fluctuations or minimize the effects on our net earnings and the cash volatility associated with foreign currency exchange rate changes. Fluctuations in foreign currency exchange rates, particularly the strengthening of the U.S. dollar against major currencies, could materially affect our financial results.
ITEM 1B – Unresolved Staff Comments
ITEM 2 – Properties
The Company’s corporate offices are owned by the Company and are located in the Minneapolis, Minnesota, metropolitan area. Manufacturing facilities located in Minneapolis, Minnesota; Holland, Michigan; Chicago, Illinois; Uden, the Netherlands and the Italian cities of Venice, Cremona and Reggio Emilia and in the Province of Padua are owned by the Company. Manufacturing facilities located in Louisville, Kentucky; São Paulo, Brazil; Shanghai, China, and another facility in the Province of Padua are leased to the Company. In addition, IPC uses a dedicated, third-party plant in Germany that specially manufactures heavy–duty stainless steel scrubbers and sweepers to IPC designs. IPC also owns a minor tools and supplies assembly operation in China to service local customers. The facilities are in good operating condition, suitable for their respective uses and adequate for current needs.
Sales offices, warehouse and storage facilities are leased in various locations in the United States, Canada, Mexico, Portugal, Spain, Italy, Germany, France, the Netherlands, Belgium, Norway, the United Kingdom, Japan, China, India, Australia, New Zealand and Brazil. The Company’s facilities are in good operating condition, suitable for their respective uses and adequate for current needs.
Further information regarding the Company’s property and lease commitments is included in the Contractual Obligations section of Item 7 and in Note 17 to the Consolidated Financial Statements.
ITEM 3 – Legal Proceedings
There are no material pending legal proceedings other than ordinary routine litigation incidental to the Company’s business.
ITEM 5 – Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
MARKET INFORMATION – Tennant's common stock is traded on the New York Stock Exchange, under the ticker symbol TNC. As of February 14, 2019, there were 312 shareholders of record.
DIVIDEND INFORMATION – Cash dividends on Tennant’s common stock have been paid for 74 consecutive years. Tennant’s annual cash dividend payout increased for the 47th consecutive year to $0.85 per share in 2018, an increase of $0.01 per share over 2017. Dividends are generally declared each quarter. On February 14, 2019, the Company announced a quarterly cash dividend of $0.22 per share payable March 15, 2019, to shareholders of record on February 28, 2019.
DIVIDEND REINVESTMENT OR DIRECT DEPOSIT OPTIONS – Shareholders have the option of reinvesting quarterly dividends in additional shares of Company stock or having dividends deposited directly to a bank account. The Transfer Agent should be contacted for additional information.
TRANSFER AGENT AND REGISTRAR – Shareholders with a change of address or questions about their account may contact:
Equiniti Trust Company
P.O. Box 64874
St. Paul, MN 55164-0854
EQUITY COMPENSATION PLAN INFORMATION – The following table provides information about shares of the Company's Common Stock that may be issued under the Company's equity compensation plans, as of December 31, 2018.
(a) Number of securities to be issued upon exercise of outstanding options, warrants and rights(1)
(b) Weighted-average exercise price of outstanding options, warrants and rights(2)
(c) Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
Equity compensation plans approved by security holders
Equity compensation plans not approved by security holders
Amount includes outstanding awards under the 1997 Non-Employee Director Stock Option Plan, the 2007 Stock Incentive Plan, the Amended and Restated 2010 Stock Incentive Plan, each as amended, and the 2017 Stock Incentive Plan (the "Plans"). Amount includes shares of Common Stock that may be issued upon exercise of outstanding stock options under the Plans. Amount also includes shares of Common Stock that may be paid in cash upon exercise of outstanding stock appreciation rights under the Plans. Amount also includes shares of Common Stock that may be issued upon settlement of restricted stock units and deferred stock units (phantom stock) under the Plans. Stock appreciation rights, restricted stock units and deferred stock units may be settled in cash, stock or a combination of both. Column (a) includes the number of shares that could be issued upon a complete distribution of all outstanding stock options and stock appreciation rights (1,084,567) and restricted stock units and deferred stock units (230,554).
(2)Column (b) includes the weighted-average exercise price for outstanding stock options and stock appreciation rights.
SHARE REPURCHASES – On October 31, 2016, the Board of Directors authorized the repurchase of an additional 1,000,000 shares of our common stock. This is in addition to the 392,892 shares remaining under our prior repurchase program. Share repurchases are made from time to time in the open market or through privately negotiated transactions, primarily to offset the dilutive effect of shares issued through our share-based compensation programs. As of December 31, 2018, our 2017 Credit Agreement restricts the payment of dividends or repurchasing of stock if, after giving effect to such payments and assuming no default exists or would result from such payment, our leverage ratio is greater than 2.50 to 1, in such case limiting such payments to an amount ranging from $50.0 million to $75.0 million during any fiscal year based on our leverage ratio after giving effect to such payment. Our Senior Notes due 2025 also contain certain restrictions, which are generally less restrictive than those contained in the 2017 Credit Agreement.
For the Quarter Ended
December 31, 2018
Total Number of Shares Purchased(1)
Average Price Paid Per Share
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
October 1–31, 2018
November 1–30, 2018
December 1–31, 2018
Includes 760 shares delivered or attested to in satisfaction of the exercise price and/or tax withholding obligations by employees who exercised stock options or restricted stock under employee share-based compensation plans.
STOCK PERFORMANCE GRAPH – The following graph compares the cumulative total shareholder return on Tennant’s common stock to two indices: S&P SmallCap 600 and Morningstar Industrials Sector. The graph below compares the performance for the last five fiscal years, assuming an investment of $100 on December 31, 2013, including the reinvestment of all dividends.
Net Earnings (Loss) Attributable to Tennant Company
% of Net Sales
Per Share Data:
Basic Net Earnings (Loss) Attributable to Tennant Company
Diluted Net Earnings (Loss) Attributable to Tennant Company
Diluted Weighted Average Shares
Total Tennant Company Shareholders’ Equity
Net Cash Provided by Operations
Capital Expenditures, Net of Disposals
Free Cash Flow
Depreciation and Amortization
Number of employees at year-end
The results of operations from our 2017 acquisition of the IPC Group have been included in the Selected Financial Data presented above since its acquisition date on April 6, 2017.
2018 includes pre-tax acquisition and integration costs, restructuring charges, professional services, building design costs, and a gain on a sale of business in selling and administrative expense of $6,869, $1,032, $1,914, $1,556, and $(955), respectively ($5,363, $874, $1,445, $1,175, and $(721) after-tax, respectively, or $0.29, $0.05, $0.08, $0.06, $(0.04) per diluted share, respectively). Additionally, 2018 included a pre-tax pension curtailment gain in other expense of $(165) ($(134) after-tax or $(0.01) per diluted share). In addition, 2018 net earnings attributable to Tennant Company includes an acquisition-related tax adjustment of $883 and a mandatory repatriation tax expense of $362 ($0.05 and $0.02 per diluted share, respectively).
2017 includes a fair value step-up adjustment to acquired inventory in cost of sales of $7,245 pre-tax ($5,237 after-tax, or $0.30 per diluted share), pre-tax acquisition costs, restructuring charges and a pension settlement charge in selling and administrative expense of $10,560, $10,519 and $6,373, respectively ($9,748, $7,559 and $4,020 after-tax, or $0.55, $0.43 and $0.23 per diluted share, respectively). 2017 also includes pre-tax acquisition-related financing costs and acquisition costs in total other expense, net of $7,378 and $814, respectively ($4,619 and $660 after-tax, or
$0.26 and $0.04 per diluted share, respectively). In addition, 2017 net loss attributable to Tennant Company includes a $2,388 net income tax expense ($0.14 per diluted share) as a result of the impacts of the 2017 tax reform legislation.
2015 includes restructuring charges of $3,744 pre-tax ($3,095 after-tax or $0.17 per diluted share) and a non-cash impairment of long-lived assets of $11,199 pre-tax ($10,822 after-tax or $0.58 per diluted share).
On January 1, 2018, we adopted ASU No. 2017-07, Compensation—Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. The components of net pension and postretirement benefit costs, except for service costs, are required to be presented in the Condensed Consolidated Statements of Operations separately from the service cost component in nonoperating expenses. See Note 2.
2017 was revised for misclassifications as discussed in Note 3.
ITEM 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
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. Tennant is committed to creating and commercializing breakthrough, sustainable cleaning innovations to enhance its broad suite of products, including floor maintenance and outdoor cleaning equipment, detergent-free and other sustainable cleaning technologies, aftermarket parts and consumables, equipment maintenance and repair service, specialty surface coatings and asset management solutions. Tennant 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, parking lots and streets, 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.
The following table compares the historical results of operations for the years ended December 31, 2018, 2017 and 2016 in dollars and as a percentage of Net Sales (in thousands, except per share amounts and percentages):
Cost of Sales
Research and Development Expense
Selling and Administrative Expense
Total Operating Expense
Profit from Operations
Other Income (Expense):
Net Foreign Currency Transaction Losses
Other Expense, Net
Total Other Expense, Net
Profit (Loss) Before Income Taxes
Income Tax Expense
Net Earnings (Loss) Including Noncontrolling Interest
Net Earnings (Loss) Attributable to Noncontrolling Interest
Net Earnings (Loss) Attributable to Tennant Company
Net Earnings (Loss) Attributable to Tennant Company per Share - Diluted
Net Sales in 2018 totaled $1,123.5 million, a 12.0% increase as compared to Net Sales of $1,003.1 million in 2017.
The components of the consolidated Net Sales change for 2018 as compared to 2017, and 2017 as compared to 2016, were as follows:
2018 v. 2017
2017 v. 2016
The 12.0% increase in consolidated Net Sales for 2018 as compared to 2017 was driven by:
Organic sales increased approximately 5.5% which excludes the effects of foreign currency translation exchange and acquisitions, due to an approximate 3.9% volume increase and a 1.6% price increase. The volume increase was driven by growth in all geographic regions, with particular strength in the Americas from higher sales of commercial equipment in the strategic account channel. Strong organic sales in Germany and France and strength in China and Australia also contributed to the strong organic sales growth. The price increase was the result of selling price increases in most geographies, with an effective date of February 1, 2018. The impact to gross margin is estimated to be minimal as these selling price increases were taken to offset inflation.
6.2% from the full year impact of the April 2017 acquisition of the IPC Group.
A favorable impact from foreign currency exchange of approximately 0.3%.
The 24.1% increase in consolidated Net Sales for 2017 as compared to 2016 was primarily due to the following:
22.2% from the April 2017 acquisition of the IPC Group and the expansion of our commercial floor coatings business through the August 2016 acquisition of the Florock® brand.
An organic sales increase of approximately 1.4% which excludes the effects of foreign currency exchange and acquisitions, due to an approximate 1.5% price increase, partially offset by a volume decrease of 0.1%. The price increase was the result of selling price increases, typically in the range of 2% to 4% in most geographies, with an effective date of February 1, 2017. The impact to gross margin was minimal as these selling price increases were taken to offset inflation. The slight volume decrease was primarily due to increased sales in Latin America and EMEA being more than offset by volume decreases in North America. Sales of new products introduced from 2015 to 2017 totaled 48% of equipment revenue in 2017. This compares to 37% of equipment revenue in 2016 from sales of new products introduced from 2014 to 2016.
A favorable impact from foreign currency exchange of approximately 0.5%.
The following table sets forth annual Net Sales by geographic area and the related percentage change from the prior year (in thousands, except percentages):
Europe, Middle East and Africa
Americas – In 2018, Americas Net Sales increased 7.9% to $691.0 million as compared with $640.3 million in 2017. The direct impact of the second quarter 2017 acquisition of the IPC Group favorably impacted Net Sales by approximately 1.1%. In addition, an unfavorable impact of foreign currency translation exchange effects within the Americas impacted Net Sales by approximately 0.7% in 2018. As a result, organic sales growth in the Americas favorably impacted Net Sales by approximately 7.5% due to strong equipment sales in North America resulting from increases in all channels, particularly strategic accounts and the distribution channel. The Americas also experienced increased parts and service sales in 2018 as well as strong sales in Latin America, particularly Brazil.
In 2017, Americas Net Sales increased 5.5% to $640.3 million as compared with $607.0 million in 2016. The direct impact of the IPC Group and Florock acquisitions favorably impacted Net Sales by approximately 4.4%. In addition, a favorable direct impact of foreign currency translation exchange effects within the Americas impacted Net Sales by approximately 0.4% in 2017. As a result, organic sales growth in the Americas favorably impacted Net Sales by approximately 0.7% due to strong sales performance in Latin America, particularly Brazil and Mexico, from focused go-to-market strategies in our direct channel. This was partially offset by lower sales in North America, where sales growth through the distribution channel were more than offset by service sales.
Europe, Middle East and Africa – EMEA Net Sales in 2018 increased 22.6% to $335.6 million as compared to 2017 Net Sales of $273.7 million. In 2018, the direct impact of the second quarter 2017 acquisition of the IPC Group favorably impacted Net Sales by approximately 18.2%. In addition, a favorable impact of foreign currency translation exchange effects within EMEA impacted Net Sales by approximately 3.0% in 2018. As a result, organic sales growth in EMEA favorably impacted Net Sales by approximately 1.3% due to strong growth in Germany and France, partially offset by challenging comparable sales performance in Italy.
EMEA Net Sales in 2017 increased 112.1% to $273.7 million as compared to 2016 Net Sales of $129.0 million. In 2017, the direct impact of the IPC Group acquisition favorably impacted Net Sales by approximately 105.3%. In addition, a favorable direct impact of foreign currency translation exchange effects within EMEA impacted Net Sales by approximately 1.3% in 2017. As a result, organic sales growth in EMEA favorably impacted Net Sales in 2017 by approximately 5.5% due to strong sales growth in most European countries from strong demand in both the direct and distributor channels being partially offset by lower sales in the UK.
Asia Pacific – APAC Net Sales in 2018 increased 8.8% to $96.9 million as compared to 2017 Net Sales of $89.1 million. In 2018, the direct impact of the second quarter 2017 acquisition of the IPC Group favorably impacted Net Sales by approximately 6.3%. In addition, an unfavorable direct impact of foreign currency translation exchange effects within APAC impacted Net Sales by approximately 0.6% in 2018. As a result, organic sales growth in APAC favorably impacted Net Sales by approximately 3.2% primarily due to sales growth in China, India and Australia from strong commercial and industrial product sales through the direct and strategic account channels slightly offset by sales declines in Japan and Korea.
APAC Net Sales in 2017 increased 22.8% to $89.1 million as compared to 2016 Net Sales of $72.5 million. In 2017, the direct impact of the IPC Group acquisition favorably impacted Net Sales by approximately 22.7%. In addition, a favorable direct impact of foreign currency translation exchange effects within APAC impacted Net Sales by approximately 0.1% in 2017. As a result, organic sales growth in APAC was essentially flat due to sales growth in China from strong sales through the direct and distributor channels being offset by sales declines primarily in Korea and Singapore resulting from a challenging economic environment.
Gross Profit margin was 39.6%, or 25 basis points lower in 2018 compared to 2017. Gross Profit margin was unfavorably impacted by manufacturing productivity issues associated with raw material and labor shortages, robust strategic account sales which negatively impacted our mix, higher freight costs and negative impacts from tariffs. The unfavorable Gross Profit margin impacts were partially offset by improved operational performance in both manufacturing and service as well as favorable pricing in North America and EMEA. In addition, Gross Profit margin was favorably impacted by a $7.2 million, or approximately 70 basis points, fair value inventory step-up flow through related to our acquisition of the IPC Group in 2017 that did not repeat in 2018.
Gross Profit margin was 390 basis points lower in 2017 compared to 2016 due primarily to the $7.2 million, or approximately 70 basis points, fair value inventory step-up flow through related to our acquisition of the IPC Group and field service productivity challenges related to a high number of open service trucks of $5.1 million, or approximately 50 basis points. In addition, Gross Profit margin was unfavorably impacted by mix of sales by channel and region, primarily resulting from higher sales through the distribution in North America and lower gross margins from the IPC Group. The near-term unfavorable impacts from investments in manufacturing automation initiatives and high levels of raw material cost inflation also contributed to lower Gross Profit margin in 2017.
Research and Development Expense – Tennant continues to invest in innovative product development with 2.7% of 2018 Net Sales spent on Research and Development ("R&D"). We continue to invest in developing innovative new products and technologies and the advancement of detergent-free products, fleet management and other sustainable technologies. New products and product variants launched in 2018 included the T600 series of scrubbers and our first autonomous floor care machine.
R&D Expense decreased $1.3 million, or 4.0%, in 2018 as compared to 2017. As a percentage of Net Sales, 2018 R&D Expense decreased 46 basis points compared to the prior year. The decrease in R&D as a percentage of sales reflects the impact of higher revenue in 2018 and the timing of anticipated project spend in 2018, including investment in our strategic relationship with Brain Corp., to accelerate development of our autonomous floor cleaning technology. We continue to invest in R&D at levels necessary to propel our clear technology leadership position.
R&D Expense decreased $2.7 million, or 7.8%, in 2017 as compared to 2016. As a percentage of Net Sales, 2017 R&D Expense decreased 110 basis points compared to the prior year. The decrease in R&D spending was primarily due to headcount reduction related to the first quarter 2017 restructuring action.
Selling and Administrative Expense – Selling and Administrative Expense ("S&A Expense") increased by $21.5 million, or 6.4%, in 2018 compared to 2017. As a percentage of Net Sales, 2018 S&A Expense decreased 170 basis points to 31.7% from 33.4% in 2017. The primary drivers of the increase were approximately $18.3 million of IPC-related S&A expense due to an additional quarter in 2018 and $12.6 million in compensation-related expenses. These increases were offset by a decrease of $9.5 million in restructuring costs from 2017 to 2018.
Selling and Administrative Expense ("S&A Expense") increased by $86.2 million, or 34.7%, in 2017 compared to 2016. As a percentage of Net Sales, 2017 S&A Expense increased 270 basis points to 33.4% from 30.7% in 2016. S&A Expense was unfavorably impacted by $15.7 million and $10.6 million of amortization expense and acquisition costs, respectively, related to our acquisition of the IPC Group. In addition, S&A Expense was unfavorably impacted by $10.5 million of restructuring charges taken in the 2017 first and fourth quarters.
Total Other Expense, Net
Interest Income – Interest Income was $3.0 million in 2018, an increase of $0.6 million from 2017. The increase between 2018 and 2017 was primarily due to an extra quarter of interest income related to foreign currency swap activities.
Interest Income was $2.4 million in 2017, an increase of $2.1 million from 2016. The increase between 2017 and 2016 was primarily due to interest income related to foreign currency swap activities.
Interest Expense – Interest Expense was $23.3 million in 2018, as compared to $25.4 million in 2017. The lower Interest Expense in 2018 was primarily due to carrying a lower level of debt on our Consolidated Balance Sheets due to debt paydowns, as further described in the Liquidity and Capital Resources section that follows.
Interest Expense was $25.4 million in 2017, as compared to $1.3 million in 2016. The higher Interest Expense in 2017 was primarily due to carrying a higher level of debt on our Consolidated Balance Sheets related to our acquisition activities, as well as a $6.2 million charge to expense the debt issuance costs for loans which were refinanced or repaid, as further described in the Liquidity and Capital Resources section that follows.
Net Foreign Currency Transaction Losses – Net Foreign Currency Transaction Losses were $1.1 million in 2018 as compared to $3.4 million in 2017. The favorable change in the impact from foreign currency transactions in 2018 was primarily due to fluctuations in foreign currency rates, specifically between the Euro, Brazilian real and the U.S. dollar, and settlements of transactional hedging activity in the normal course of business. Additionally an unfavorable $1.1 million mark-to-market adjustment of a foreign exchange call option was recorded in 2017 that did not recur in 2018. This instrument was held in connection with our acquisition of the IPC Group in April 2017.
Net Foreign Currency Transaction Losses were $3.4 million in 2017 as compared to $0.4 million in 2016. The unfavorable change in the impact from foreign currency transactions in 2017 was primarily due to fluctuations in foreign currency rates, specifically between the Euro and U.S. dollar, settlements of transactional hedging activity in the normal course of business and a $1.1 million mark-to-market adjustment of a foreign exchange call option, an instrument held in connection with our acquisition of the IPC Group in April 2017.
Other Expense, Net – Other Expense, Net was $0.7 million in 2018 as compared to $7.9 million in 2017. The favorable change in Other Expense, Net was due primarily to a pension settlement loss of $6.4 million in 2017 that did not recur in 2018.
Other Expense, Net was $7.9 million in 2017 as compared to $0.4 million in 2016. The unfavorable change in Other Expense, Net was due primarily to a pension settlement loss of $6.4 million and additional expense recorded as a result of the acquisition of the IPC Group.
The overall effective income tax rate was 6.4%, (380.2)% and 29.9% in 2018, 2017 and 2016, respectively.
The expense for 2018 included a $1.5 million tax benefit associated with $6.9 million of acquisition and integration-related costs associated with our integration of the IPC Group and pending acquisition of Gaomei Cleaning Equipment Company, a $0.2 million tax benefit associated with $1.0 million of restructuring charge, a $0.4 million tax benefit associated with $1.6 million of building design costs, a $0.5 million tax benefit associated with $1.9 million of costs related to non-operational professional service fees, a $0.2 million tax expense associated with a $1.0 million gain on the sale of assets of our Waterstar business, a $0.9 million benefit associated with an acquisition tax adjustment, and a $0.4 million benefit related to finalizing the income tax effect of the one-time transition tax on certain unrepatriated earnings. These special items impacted the 2018 effective tax rate by (6.2%).
Our effective tax rate fluctuates from year to year due to the global nature of our operations. The effective tax rate change from 2017 was primarily due to the lower corporate tax rate provided by the Tax Act beginning in the first quarter of 2018, the mix in full year taxable earnings by country, the tax expense benefit related to the exercise of soon-to-expire stock options and a favorable tax ruling from the Italian tax authorities related to the deductibility of interest expense in Italy.
On December 22, 2017, legislation popularly referred to as the Tax Act was enacted, resulting in significant changes from previous tax law, including, but not limited to, requiring a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries and a reduction in the U.S. federal corporate income tax rate from 35% to 21% and established new laws that impacted 2018.
ASC 740 requires a company to record the effects of a tax law change in the period of enactment. ASU 2018-05 allowed a company to record a provisional amount when it did not have the necessary information available, prepared or analyzed in reasonable detail to complete its accounting for the change in the law. The measurement period ends when the company has obtained, prepared and analyzed the information necessary to finalize its accounting, but cannot extend beyond one year.
During the third quarter of 2018, the accounting for the remeasurement of the deferred taxes and transition tax was finalized. Adjustments to the provisional amounts were not material to the consolidated financial statements. The accounting for the income tax effects of the Tax Act is complete as of December 31, 2018.
The tax expense for 2017 included a $3.7 million tax benefit associated with $18.8 million of acquisition and financing costs related to the IPC Group acquisition, a $3.0 million tax benefit associated with a $10.5 million restructuring charge, a $2.4 million tax benefit associated with a $6.2 million pension settlement, a $2.0 million tax benefit associated with $7.2 million of expense related to inventory step-up amortization, a $2.0 million tax expense related to the write-down of net U.S. deferred tax assets at the lower enacted tax rates and $0.4 million tax expense related to the transition tax on cash and cash equivalent balances related to accumulated earnings associated with our international operations as a result of Tax Legislation. These special items impacted the 2017 year-to-date overall effective tax rate by 412.9%.
Excluding the 2017 special items and the effect of the Tax Act, the tax rate increased from 29.9% in 2016 due primarily to the mix in full year taxable earnings by country.
There were no special items that affected the tax rate in 2016.
Other Comprehensive Income (Loss)
Foreign Currency Translation Adjustments – For the years ended December 31, 2018 and 2017, we recorded a pre-tax foreign currency translation loss of $16.2 million and a gain of $28.4 million, respectively. For the year ended December 31, 2016, we recorded pre-tax foreign currency translation gains of $0.1 million in Other Comprehensive Income (Loss). These adjustments resulted from translating the financial statements of our non-U.S. dollar functional currency subsidiaries into our reporting currency, which is the U.S. dollar, as well as other adjustments permitted by ASC 830 – Foreign Currency Matters.
During 2018, we recorded a pre-tax currency translation loss of $16.2 million. These adjustments were caused primarily by the strengthening of the U.S. dollar to most currencies. In 2018, the U.S. dollar strengthened by approximately 5% to the Euro and approximately 15% to the Brazilian Real.
During 2017, we recorded pre-tax currency translation gains of $28.4 million. These adjustments were caused primarily by the appreciation of the Euro against the U.S. dollar. In 2017, the Euro appreciated against the U.S. dollar by approximately 14%.
During 2016, we recorded translation gains of $3.4 million relating to the Brazilian real, and translation losses of $1.3 million for the Euro, $1.0 million for the Chinese renminbi, $0.9 million for the British pound and $0.1 million for various other currencies. These adjustments were caused by the appreciation of the U.S. dollar against these currencies of between 3% and 17%, and the strengthening of the Brazilian real of 22% in 2016.
Pension and Retiree Medical Benefits – The summarized changes in Accumulated Other Comprehensive Loss for the three years ended December 31 were as follows:
Pension and Postretirement Medical Benefits
Prior Service Costs
Net actuarial (gain) loss
Amortization of prior service cost
Amortization of net actuarial loss
Total recognized in other comprehensive (income) loss
The $1.7 million gain in 2018 was primarily due to a $1.7 million actuarial gain relating to an annual actuarial analysis resulting from a 67 basis point increase in the U.S. pension discount rate, a 27 basis point increase in the non-U.S. discount rate and a 69 basis point increase in the postretirement discount rate.
The $5.9 million gain in 2017 was primarily due to a $6.4 million settlement charge related to the termination of the U.S. Pension Plan and a $0.1 million credit related to amortization of accumulated actuarial losses. These gains were partially offset by $0.6 million of net actuarial losses relating to an increase of $1.2 million in the pension benefit obligation in 2017 due to changes in demographic experience and other changes, a $0.6 million increase in the pension benefit obligation resulting from a 64 basis point decrease in the U.S. pension discount rate, a 19 basis point decrease in the non-U.S. discount rate and a 32 basis point decrease in the postretirement discount rates and a $1.0 million decrease in the pension benefit obligation due to a higher than expected actual return on assets.
The $2.2 million loss in 2016 was primarily due to a $2.4 net actuarial loss relating to an increase of $3.2 million in the projected benefit obligation resulting from a 16 basis point decrease in the U.S. pension discount rate, a 95 basis point decrease in the non-U.S. discount rate and a 12 basis point
decrease in the postretirement discount rate. There was an approximate $0.6 million decrease in the pension benefit obligation in 2016 relating to demographic experience and other changes, as well as a $0.2 million decrease due to a higher than expected actual return on assets. The net actuarial loss was partially offset by a $0.1 million credit relating to amortization of accumulated actuarial losses and prior service costs.
Cash Flow Hedging – For the years ended December 31, 2018 and 2017, we recorded pre-tax adjustments on cash flow hedge financial instruments of a gain of $1.3 million and a loss of $7.7 million, respectively, in Other Comprehensive Income (Loss) as further disclosed in Note 13 to the Company's Consolidated Financial Statements. For the year ended December 31, 2016, we recorded a pre-tax loss of $0.3 million in Other Comprehensive Income (Loss) for these items.
The $1.3 million gain in 2018 was primarily due to the strengthening of the U.S. dollar relative to the Canadian dollar and Euro. During 2018, the U.S. dollar strengthened approximately 8% to the Canadian dollar and approximately 5% to the Euro.
The $7.7 million loss in 2017 was primarily due to $26.2 million of losses recognized primarily as a result of our Euro to U.S. dollar foreign exchange cross currency swaps to mitigate our Euro exposure on our cash flows associated with an intercompany loan from a wholly-owned European subsidiary. The loss was partially offset by $18.5 of losses reclassified from Accumulated Other Comprehensive Loss to the Consolidated Statements of Earnings.
The $0.3 million pre-tax loss in 2016 was driven by our cash flow exposure to the Canadian dollar resulting from changes in this currency relative to the U.S. dollar.
Liquidity and Capital Resources
Liquidity – Cash and Cash Equivalents totaled $85.6 million at December 31, 2018, as compared to $58.4 million as of December 31, 2017. Cash and Cash Equivalents held by our foreign subsidiaries totaled $59.2 million as of December 31, 2018, as compared to $39.1 million as of December 31, 2017. 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 December 31, 2018, and 1.8 as of December 31, 2017, and our working capital was $219.8 million and $186.6 million, respectively.
Our Debt-to-Capital ratio was 53.0% as of December 31, 2018, compared with 56.0% as of December 31, 2017. Our capital structure was comprised of $355.1 million of Debt and $314.4 million of Tennant Company Shareholders’ Equity as of December 31, 2018.
Operating Activities – Cash provided by operating activities was $80.0 million in 2018, $54.2 million in 2017 and $57.9 million in 2016. In 2018, cash provided by operating activities was driven primarily by net earnings, after adding back non-cash items, a $12.6 million increase in Employee Compensation and Benefits liabilities and an increase in Accounts Payable of $4.6 million due to timing of payments. These cash inflows were partially offset by cash outflows resulting from an increase in Accounts Receivable of $7.6 million resulting from higher sales levels, the variety of payment terms offered and mix of business as well as a $16.6 million increase in Inventories to support future sales growth.
In 2017, cash provided by operating activities was driven primarily by net earnings, after adding back non-cash items, an increase in Other Current Liabilities of $14.6 million due to additional accruals recorded as a result of the IPC Group consolidation and the fourth quarter 2017 restructuring action and an increase in Accounts Payable of $10.8 million due to timing of payments. These cash inflows were partially offset by cash outflows resulting from an increase in Accounts Receivable of $14.4 million resulting from higher sales levels, the variety of payment terms offered and mix of business.
In 2016, cash provided by operating activities was driven primarily by net earnings, after adding back non-cash items, partially offset by an increase in Accounts Receivable of $9.3 million resulting from higher sales levels, particularly in December 2016, the variety of payment terms offered and mix of business.
Investing Activities – Net cash used in investing activities was $16.0 million in 2018, $375.3 million in 2017 and $40.6 million in 2016. In 2018, we used $18.7 million for net capital expenditures. Net capital expenditures included investments in information technology process improvement projects, tooling related to new product development and manufacturing equipment. We also used $2.8 million for the purchase of a technology license and other intangibles. In addition, we received $4.0 million in proceeds from the sale of assets of our Waterstar business.
In 2017, we used $354.1 million, net of cash acquired, in relation to our acquisition of the IPC Group and the final installment payment for the acquisition of the Florock brand and $17.9 million for net capital expenditures. Net capital expenditures included investments in information technology process improvement projects, tooling related to new product development and manufacturing equipment. We also used $2.5 million for the purchase of the distribution rights to sell the i-mop and $1.5 million as a result of a loan to i-team North America B.V., a joint venture that operates as a distributor of the i-mop in North America. The details regarding the joint venture and our distribution of the i-mop are described further in Note 5 to the Consolidated Financial Statements.
In 2016, we used $25.9 million for net capital expenditures. Net capital expenditures included investments in information technology process improvement projects, tooling related to new product development and manufacturing equipment. In addition, our acquisition of the Florock brand and the assets of Dofesa Barrdio Mecanizado, a long-time distributor based in Central Mexico, used $12.9 million, net of cash acquired. We also used $2.0 million as a result of a non-interest bearing cash advance to TCS EMEA GmbH, the master distributor of our products in Central Eastern Europe, Middle East and Africa.
Financing Activities – Net cash used in financing activities was $32.8 million in 2018. Net cash provided by financing activities was $319.5 million in 2017. Net cash used in financing activities was $9.6 million in 2016. In 2018, proceeds from the incurrence of Long-Term Debt associated with the pending Gaomei acquisition and the issuance of Common Stock provided $11.0 million and $5.9 million, respectively. These cash inflows were partially offset by cash outflows resulting from $38.3 million of Long-Term Debt payments and dividend payments of $15.3 million. Our annual cash dividend payout increased for the 47th consecutive year to $0.85 per share in 2018, an increase of $0.01 per share over 2017.
In 2017, proceeds from the incurrence of Long-Term Debt associated with the IPC acquisition and the issuance of Common Stock provided $440.0 million and $6.9 million, respectively. These cash inflows were partially offset by cash outflows resulting from $96.2 million of Long-Term Debt payments, $16.5 million related to payments of debt issuance costs and dividend payments of $15.0 million.
In 2016, dividend payments used $14.3 million, the purchases of our common stock per our authorized repurchase program used $12.8 million and the payment of Long-Term Debt used $3.5 million. These cash ouflows were partially offset by proceeds resulting from the incurrence of Long-Term Debt of $15.0 million, the issuance of Common Stock of $5.3 million and the excess tax benefit on stock plans of $0.7 million.
On October 31, 2016, the Board of Directors authorized the repurchase of an additional 1,000,000 shares of our common stock. At December 31, 2018, there were 1,392,892 remaining shares authorized for repurchase.
There were no shares repurchased in 2018 in the open market, no shares repurchased in 2017 and 246,474 shares repurchased during 2016, at average repurchase prices of $51.78 during 2016 . Our 2017 Credit Agreement restricts
the payment of dividends or repurchasing of stock if, after giving effect to such payments and assuming no default exists or would result from such payment, our leverage ratio is greater than 2.50 to 1, in such case limiting such payments to an amount ranging from $50.0 million to $75.0 million during any fiscal year based on our leverage ratio after giving effect to such payment. Our Senior Notes due 2025 also contain certain restrictions, which are generally less restrictive than those contained in the 2017 Credit Agreement.
Indebtedness – In order to finance the acquisition of the IPC Group, on April 4, 2017, the Company and certain of our foreign subsidiaries entered into a Credit Agreement (the “2017 Credit Agreement”) with JPMorgan, as administrative agent, Goldman Sachs Bank USA, as syndication agent, Wells Fargo, National Association, U.S. Bank National Association, and HSBC Bank USA, National Association, as co-documentation agents, and the lenders (including JPMorgan) from time to time party thereto.
On April 18, 2017, we issued and sold $300,000,000 in aggregate principal amount of our 5.625% Senior Notes due 2025 (the “Notes”), pursuant to an Indenture, dated as of April 18, 2017, among the company, the Guarantors (as defined therein), and Wells Fargo Bank, National Association, a national banking association, as trustee. The Notes are guaranteed by Tennant Coatings, Inc., and Tennant Sales and Service Company (collectively, the “Guarantors”), which are wholly-owned subsidiaries of the company.
For further details regarding our indebtedness, see Note 11 to the Consolidated Financial Statements.
Contractual Obligations – Our contractual obligations as of December 31, 2018, are summarized by period due in the following table (in thousands):
Less Than 1 Year
1 - 3 Years
3 - 5 Years
More Than 5 Years
Interest payments on long-term
Interest payments on capital leases
Retirement benefit plans(2)
Deferred compensation arrangements(3)
Total contractual obligations
(1)Long-term debt represents borrowings through our Notes and the 2017 Credit Agreement with JPMorgan. Interest on the Notes accrues at the rate of 5.625% per annum and is payable semiannually in cash on each May 1 and November 1, commencing on November 1, 2017. Repayment of the principal amount of the Senior Notes is due upon expiration of the agreement in 2025. Interest payments on our 2017 Credit Agreement with JPMorgan were calculated using the December 31, 2017 30-day LIBOR rate plus a spread.
(2)Our retirement benefit plans, as described in Note 15 to the Consolidated Financial Statements, require us to make contributions to the plans from time to time. Contributions to the various plans are dependent upon a number of factors including the market performance of plan assets, if any, and future changes in interest rates, which impact the actuarial measurement of plan obligations. As a result, we have only included our 2019 expected contribution in the contractual obligations table.
(3)The unfunded deferred compensation arrangements covering certain current and retired management employees totaled $5.1 million as of December 31, 2018. Our estimated distributions in the contractual obligations table are based upon a number of assumptions including termination dates and participant distribution elections.
(4)Operating lease commitments consist primarily of office and warehouse facilities, vehicles and office equipment as discussed in Note 17 to the Consolidated Financial Statements.
(5)Purchase obligations include all known open purchase orders, contractual purchase commitments and contractual obligations as of December 31, 2018.
(6)Other obligations include residual value guarantees as discussed in Note 17 to the Consolidated Financial Statements.
Total contractual obligations exclude our gross unrecognized tax benefits of $5.7 million and accrued interest and penalties of $0.4 million as of December 31, 2018. We expect to make cash outlays in the future related to uncertain tax positions. However, due to the uncertainty of the timing of future cash flows, we are unable to make reasonably reliable estimates of the period of cash settlement, if any, with the respective taxing authorities. For further information related to unrecognized tax benefits, see Note 18 to the Consolidated Financial Statements.
Newly Issued Accounting Guidance
In February 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2016-02, Leases (Topic 842). This ASU changes current U.S. GAAP for lessees to recognize lease assets and lease liabilities on the balance sheet for those leases classified as operating leases under previous U.S. GAAP. Under the new guidance, lessor accounting is largely unchanged. The amendments in this ASU are effective for annual periods beginning after December 15, 2018, including interim periods within that reporting period, which is our fiscal 2019. We expect the adoption of this standard will have a material impact on the consolidated balance sheets for recognition of operating lease related assets and liabilities. We do not expect a material impact to the consolidated statements of operations. See FN 1 for further discussion.
Derivatives and Hedging
In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, which better aligns accounting rules with a company's risk management activities, better reflects the economic results of hedging in financial statements and simplifies hedge accounting treatment. This ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, which is our fiscal 2019. We have determined that the adoption of this standard will not have a material impact on our consolidated financial statements and related disclosures.
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.
Critical Accounting Policies and Estimates
Our Consolidated Financial Statements are based on the selection and application of accounting principles generally accepted in the United States
of America, which require us to make estimates and assumptions about future events that affect the amounts reported in our Consolidated Financial Statements and the accompanying notes. Our significant accounting policies are described in Note 1 to the Consolidated Financial Statements. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results could differ from those estimates, and any such differences may be material to the Consolidated Financial Statements. We believe that the following policies may involve a higher degree of judgment and complexity in their application and represent the critical accounting policies used in the preparation of our Consolidated Financial Statements. If different assumptions or conditions were to prevail, the results could be materially different from our reported results.
Goodwill – Goodwill represents the excess of cost over the fair value of net assets of businesses acquired and is allocated to our reporting units at the time of the acquisition. We analyze Goodwill on an annual basis and when an event occurs or circumstances change that may reduce the fair value of a reporting unit below its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value.
We performed an analysis of qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the quantitative goodwill impairment test. The qualitative test is used as an indicator to identify if there is potential goodwill impairment. If the qualitative test indicates there may be an impairment, we perform the quantitative test, which measures the amount of the goodwill impairment, if any. We perform our goodwill impairment analysis as of year-end or when an event occurs or circumstances change that may reduce the fair value of a reporting unit below its carrying amount, and use our judgment to develop assumptions for the discounted cash flow model that we use, if necessary. Management assumptions include forecasting revenues and margins, estimating capital expenditures, depreciation, amortization and discount rates.
If our goodwill impairment testing resulted in one or more of our reporting units’ carrying amount exceeding its fair value, we would write down our reporting units’ carrying amount to its fair value and would record an impairment charge in our results of operations in the period such determination is made. Subsequent reversal of goodwill impairment charges is not permitted. Based on our analysis of qualitative factors, we determined that it was not more likely than not that the fair value of the North America, Latin America, EMEA and APAC reporting units was less than its respective carrying amount. We elected to perform a quantitative analysis of the Coatings reporting unit. Based on the quantitative analysis of that reporting unit, it was determined there was no goodwill impairment at December 31, 2018. We had Goodwill of $182.7 million as of December 31, 2018.
Income Taxes – We are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating our actual current tax obligations based on expected income, statutory tax rates and tax planning opportunities in the various jurisdictions. We also establish reserves for uncertain tax matters that are complex in nature and uncertain as to the ultimate outcome. Although we believe that our tax return positions are fully supportable, we consider our ability to ultimately prevail in defending these matters when establishing these reserves. We adjust our reserves in light of changing facts and circumstances, such as the closing of a tax audit. We believe that our current reserves are adequate. However, the ultimate outcome may differ from our estimates and assumptions and could impact the income tax expense reflected in our Consolidated Statements of Operations.
Tax law requires certain items to be included in our tax return at different times than the items are reflected in our results of operations. Some of these differences are permanent, such as expenses that are not deductible in our tax returns, and some differences will reverse over time, such as depreciation
expense on property, plant and equipment. These temporary differences result in deferred tax assets and liabilities, which are included within our Consolidated Balance Sheets. Deferred tax assets generally represent items that can be used as a tax deduction or credit in our tax returns in future years but have already been recorded as an expense in our Consolidated Statements of Operations. We assess the likelihood that our deferred tax assets will be recovered from future taxable income, and, based on management’s judgment, to the extent we believe that recovery is not more likely than not, we establish a valuation reserve against those deferred tax assets. The deferred tax asset valuation allowance could be materially different from actual results because of changes in the mix of future taxable income, the relationship between book and taxable income and our tax planning strategies. As of December 31, 2018, a valuation allowance of $11.5 million was recorded against foreign tax loss carryforwards, foreign tax credit carryforwards and state credit carryforwards.
Cautionary Factors Relevant to Forward-Looking Information
This annual report on Form 10-K, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7, contains certain statements that are considered “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:
Ability to effectively manage strategic plans or growth processes.
Ability to successfully upgrade and evolve our information technology systems.
Fluctuations in the cost, quality or availability of raw materials and purchased components.
Geopolitical and economic uncertainty throughout the world.
Ability to attract, retain and develop key personnel and create effective succession planning strategies.
Ability to develop and commercialize new innovative products and services.
Ability to integrate acquisitions, including IPC.
Competition in our business.
Ability to successfully protect our information technology systems from cyber security risks.
Potential disruption of our business from actions of activist investors or others.
Occurrence of a significant business interruption.
Ability to comply with global laws and regulations.
Unforeseen product liability claims or product quality issues.
Ability to generate sufficient cash to satisfy our debt obligations.
Internal control over financial reporting risks resulting from our acquisition of IPC.
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. Information about factors that could materially affect our results can be found in Part I, Item 1A - Risk Factors. 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.
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 Securities and Exchange Commission 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.
ITEM 7A – Quantitative and Qualitative Disclosures About Market Risk
Commodity Risk – We are subject to exposures resulting from potential cost increases related to our purchase of raw materials or other product components. We do not use derivative commodity instruments to manage our exposures to changes in commodity prices such as steel, oil, gas, lead and other commodities.
Various factors beyond our control affect the price of oil and gas, including, but not limited to, worldwide and domestic supplies of oil and gas, political instability or armed conflict in oil-producing regions, the price and level of foreign imports, the level of consumer demand, the price and availability of alternative fuels, domestic and foreign governmental regulation, weather-related factors and the overall economic environment. We purchase petroleum-related component parts for use in our manufacturing operations. In addition, our freight costs associated with shipping and receiving product and sales and service vehicle fuel costs are impacted by fluctuations in the cost of oil and gas.
Fluctuations in worldwide demand and other factors affect the price for lead, steel and related products. We do not maintain an inventory of raw or fabricated steel or batteries in excess of near-term production requirements. As a result, increases in the price of lead or steel can significantly increase the cost of our lead- and steel-based raw materials and component parts.
During 2018, we experienced inflation on our raw materials and other purchased component costs. We continue to focus on mitigating the risk of future raw material or other product component cost increases through supplier negotiations, ongoing optimization of our supply chain, the continuation of cost reduction actions and product pricing. The success of these efforts will depend upon our ability to leverage our commodity spend in the current global economic environment. If the commodity prices increase significantly and we are not able to offset the increases with higher selling prices, our results may continue to be unfavorably impacted in 2019.
Foreign Currency Exchange Rate Risk – Due to the global nature of our operations, we are subject to exposures resulting from foreign currency exchange fluctuations in the normal course of business. Our primary exchange rate exposures are with the Euro, Australian and Canadian dollars, British pound, Japanese yen, Chinese renminbi, Brazilian real and Mexican peso against the U.S. dollar. The direct financial impact of foreign currency exchange includes the effect of translating profits from local currencies to U.S. dollars, the impact of currency fluctuations on the transfer of goods between our operations in the United States and our international operations and transaction gains and losses. In addition to the direct financial impact, foreign currency exchange has an indirect financial impact on our results, including the effect on sales volume within local economies and the impact of pricing actions taken as a result of foreign exchange rate fluctuations.
In the normal course of business, we actively manage the exposure of our foreign currency exchange rate market risk by entering into various hedging instruments with counterparties that are highly rated financial institutions. We may use foreign exchange purchased options or forward contracts to hedge our foreign currency denominated forecasted revenues or forecasted sales to wholly-owned foreign subsidiaries. Additionally, we hedge
our net recognized foreign currency assets and liabilities with foreign exchange forward contracts. We hedge these exposures to reduce the risk that our net earnings and cash flows will be adversely affected by changes in foreign exchange rates. We do not enter into any of these instruments for speculative or trading purposes to generate revenue.
These contracts are carried at fair value and have maturities between one and 12 months. The gains and losses on these contracts generally approximate changes in the value of the related assets, liabilities or forecasted transactions. Some of the derivative instruments we enter into do not meet the criteria for cash flow hedge accounting treatment; therefore, changes in fair value are recorded in Foreign Currency Transaction Losses on our Consolidated Statements of Operations.
We use foreign currency exchange rate derivatives to hedge our exposure to fluctuations in exchange rates for anticipated intercompany cash transactions between Tennant Company and its subsidiaries. During 2017, we entered into Euro to U.S. dollar foreign exchange cross currency swaps for all of the anticipated cash flows associated with an intercompany loan from a wholly-owned European subsidiary. We entered into these foreign exchange cross currency swaps to hedge the foreign currency denominated cash flows associated with this intercompany loan, and accordingly, they are not speculative in nature. We designated these cross currency swaps as cash flow hedges. The hedged cash flows as of December 31, 2018 included €174,000 of total notional value. As of December 31, 2018, the aggregate scheduled interest payments over the course of the loan and related swaps amounted to €24,000. The scheduled maturity and principal payment of the loan and related swaps of €150,000 are due in April 2022. There were no new cross currency swaps designated as cash flow hedges as of December 31, 2018.
For further information regarding our foreign currency derivatives and hedging programs, see Note 13 to the Consolidated Financial Statements.
For details of the estimated effects of currency translation on the operations of our operating segments, see Item 7 – Management's Discussion and Analysis of Financial Condition and Results of Operations.
Other Matters – Management regularly reviews our business operations with the objective of improving financial performance and maximizing our return on investment. As a result of this ongoing process to improve financial performance, we may incur additional restructuring charges in the future which, if taken, could be material to our financial results.
ITEM 8 – Financial Statements and Supplementary Data
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the shareholders and board of directors
Opinions on the Consolidated Financial Statements and Internal Control Over Financial Reporting
We have audited the accompanying consolidated balance sheets of Tennant Company, and subsidiaries (the Company) as of December 31, 2018 and 2017, the related consolidated statements of operations, comprehensive income, equity, and cash flows for each of the years in the three-year period ended December 31, 2018, and the related notes and financial statement schedules included in Item 15.A.2 (collectively, the consolidated financial statements). We also have audited the Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2018, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018 based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Change in Accounting Principle
As discussed in Note 2 to the consolidated financial statements, the Company has changed its method of accounting for revenue in 2018 due to the adoption of FASB Accounting Standards Codification (Topic 606), Revenue from Contracts with Customers.
Basis for Opinion
The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ KPMG LLP
We have served as the Company's auditor since 1954.