Tennant Co: Form 10-Q for the period ended Sep 30, 2023

The following Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) provides a comparison of the Company's results of operations, as well as liquidity and capital resources for the quarters ended September 30, 2023 and 2022. The MD&A should be read in conjunction with the Company's consolidated financial statements and notes included in Item 1 of this Quarterly Report. Throughout this MD&A, the Company refers to measures used by management to evaluate performance, including financial measures that are not defined under generally accepted accounting principles (GAAP) in the U.S. Net sales excluding foreign currency translation (i.e., organic sales) is not a measure of financial performance under GAAP; however, the Company believes it is useful in understanding its financial results and provides comparable measures for understanding the operating results of the Company between different periods.

Overview

Tennant Company is a world leader in designing, manufacturing and marketing solutions that empower customers to achieve quality cleaning performance, reduce environmental impact and help create a cleaner, safer, healthier world. The Company is committed to creating and commercializing breakthrough, sustainable cleaning innovations to enhance its broad suite of products, including floor maintenance and cleaning equipment, detergent-free and other sustainable cleaning technologies, aftermarket parts and consumables, equipment maintenance and repair service, and asset management solutions. Our products are used in many types of environments, including retail establishments, distribution centers, factories and warehouses, public venues such as arenas and stadiums, office buildings, schools and universities, hospitals and clinics, and more. Customers include contract cleaners to whom organizations outsource facilities maintenance as well as businesses that perform facilities maintenance themselves. The Company reaches these customers through the industry's largest direct sales and service organization and through a strong and well-supported network of authorized distributors worldwide.

Macroeconomic Events

Supply chain challenges continue to impact the global economy. Our operating performance throughout 2023 has benefited from fewer supply chain disruptions enabling us to obtain key component parts, increase production and reduce backlog. If there are additional disruptions in our supply chain, or we continue to experience certain supply shortages, it could materially or adversely impact our operating results and financial condition. We continue to address and adapt to these temporary supply chain disruptions.

As described in Part I, Item 1A - Risk Factors in the annual report on Form 10-K for the fiscal year ended December 31, 2022, we may encounter financial difficulties if the U.S. or other global economies experience an additional or continued long-term economic downturn as our product sales are sensitive to declines in capital spending by our customers. Any sustained adverse impacts to our business, the industries in which we operate, market demand for our products, and/or certain suppliers or customers may also affect our future results of operations, financial position, or cash flows. We are actively monitoring the global macroeconomic environment, including geopolitical conflict, the potential impact of global supply chain constraints on material inflation, and change in demand for our products.

Outlook

We continued to deliver strong net sales and net income growth in the third quarter of 2023. Our performance reflects actions and investments we made beginning in 2022 and have continued to execute upon throughout 2023 and into 2024. Global economic conditions continue to be highly volatile and uncertainty remains regarding supply chain challenges, inflationary trends, and overall business environment. We remain confident in the long-term growth trends for our products and services in the markets we serve.

Results

The following table compares the results of operations for the three and nine months ended September 30, 2023 and 2022, respectively (in millions, except per share data and percentages):

Net Sales

Consolidated net sales for the third quarter of 2023 totaled $304.7 million, a 15.9% increase as compared to consolidated net sales of $262.9 million in the third quarter of 2022. The components of the consolidated net sales change were as follows:

The 15.9% increase in consolidated net sales in the third quarter of 2023 as compared to the same period in 2022 was driven by:

• Organic sales growth of 13.9%, which excludes the effects of foreign currency exchange. The organic sales growth was primarily due to equipment sales growth in the Americas and APAC partly offset by volume declines in EMEA; and
• A net favorable impact from foreign currency exchange across all regions of approximately 2.0%.

The 16.4% increase in consolidated net sales in the first nine months of 2023 as compared to the same period in 2022 was driven by:

• Organic sales growth of 16.6%, which excludes the effects of foreign currency exchange. The organic sales increase was primarily due to growth across all regions and product categories, led by strong sales growth in the Americas region; partly offset by
• A net unfavorable impact from foreign currency exchange across all regions of approximately 0.2%.

The following table sets forth the net sales by geographic area for the three and nine months ended September 30, 2023 and 2022 (in millions, except percentages):

Americas

Americas net sales were $211.2 million for the third quarter of 2023, an increase of 21.4% from the third quarter of 2022 driven by:

• Organic sales growth of 20.8% driven nearly equally by price realization and volume increases in equipment sales and service across the region; and
• A net favorable impact from foreign currency exchange of approximately 0.6%.

Americas net sales were $632.2 million for the first nine months of 2023, an increase of 23.3% from the first nine months of 2022 driven by:

• Organic sales growth of 23.3% driven nearly equally by price realization and volume increases in all product categories across the region.

Europe, Middle East and Africa ("EMEA")

EMEA net sales were $72.0 million for the third quarter of 2023, an increase of 4.3% from the third quarter of 2022 driven by:

• Organic sales decline of 2.8% driven by volume declines in both equipment and parts and consumables partly offset by price realization in all product categories; and
• A net favorable impact from foreign currency exchange of approximately 7.1%.

EMEA net sales were $234.1 million for the first nine months of 2023, an increase of 4.0% from the first nine months of 2022 driven by:

• Organic sales growth of 3.6% driven by price realization partly offset by volume declines across all product categories. The organic growth was led by price realization on equipment sales across our direct geographies, especially in Iberia; and
• A net favorable impact from foreign currency exchange of approximately 0.4%.

Asia Pacific ("APAC")

APAC net sales were $21.5 million for the third quarter of 2023, an increase of 8.0% from the third quarter of 2022 driven by:

• Organic sales growth of 11.8% driven primarily by price realization on equipment sales in Australia and volume growth in equipment sales in China; partly offset by
• A net unfavorable impact from foreign currency exchange of approximately 3.8%.

APAC net sales were $65.9 million for the first nine months of 2023, an increase of 3.8% from the first nine months of 2022 driven by:

• Organic sales growth of 8.3% driven by price realization on equipment sales across our direct geographies, especially Australia, China and India; partly offset by
• A net unfavorable impact from foreign currency exchange of approximately 4.5%.

Gross Profit

Gross profit margin of 43.3% was 500 basis points higher in the third quarter of 2023 compared to the third quarter of 2022. Gross profit margin of 42.6% was 440 basis points higher in the first nine months of 2023 compared to the first nine months of 2022. The increase in both periods was driven by pricing realization, more than offsetting the impact of multi-year inflation.

The LIFO impact for the three and nine months ended September 30, 2023 was a charge of $0.7 million and a benefit of $2.5 million, respectively, compared to a LIFO charge of $2.1 million and $8.1 million in the three and nine months ended September 30, 2022, respectively. The change in LIFO impact was attributable to a stabilized inflationary environment on materials in 2023.

Operating Expense

Selling and Administrative Expense

Selling and administrative expense ("S&A expense") was $88.2 million for the third quarter of 2023, an increase of $16.8 million compared to the third quarter of 2022. As a percentage of net sales, S&A expense for the third quarter of 2023 increased 170 basis points to 28.9% from 27.2% in the third quarter of 2022. The S&A expense increase in each period was primarily driven by higher variable costs associated with increased operating performance.

S&A expense was $256.9 million for the first nine months of 2023, an increase of $29.8 million compared to the first nine months of 2022. The increase was primarily driven by higher variable costs associated with increased operating performance and investments in strategic initiatives. S&A expense as a percentage of net sales for the first nine months of 2023 decreased 70 basis points to 27.6% from 28.3% in the first nine months of 2022. The decrease as a percentage of net sales was driven by our sales growth in the comparable periods, as well as our cost-containment initiatives.

Research and Development Expense

Research and development expense ("R&D expense") was $9.1 million, or 3.0% of net sales, for the third quarter of 2023, with R&D expense as a percentage of net sales remaining flat as compared to the third quarter of 2022. R&D expense was $26.0 million, or 2.8% of net sales, for the first nine months of 2023, essentially flat compared to the first nine months of 2022.

We continue to invest in developing innovative products and technologies at levels necessary to propel our technology and innovation leadership position.

Total Other Expense, Net

Interest Expense, Net

Interest expense, net was $3.3 million in the third quarter of 2023 compared to $2.2 million in the same period of 2022. The increase was the result of higher interest rates on our variable interest debt. Interest expense, net was $11.0 million in the first nine months of 2023 compared to $3.7 million in the first nine months of 2022. The increase was the result of higher debt levels coupled with rising interest rates on our variable interest rate debt. The following table compares the debt levels, average interest rate, interest income and interest expense for the three and nine months ended September 30, 2023 and 2022, respectively (in millions, except percentages):

Our debt portfolio as of September 30, 2023 was comprised of debt predominately in U.S. dollars. The Company manages its floating rate debt exposure using fixed rate interest rate swaps to reduce the Company's risk of the possibility of increased interest costs. The Company has an aggregate $120 million notional amount of interest rate swaps that exchange a variable rate of interest for a fixed rate of interest of 4.076% over the term of the agreements.

Net Foreign Currency Transaction Gain (Loss)

Net foreign currency transaction loss was $0.4 million in the third quarter of 2023 compared to less than $0.1 million in the third quarter of 2022. The unfavorable impact was primarily due to the strengthening of the U.S. dollar relative to the Brazilian real and Mexican peso. Net foreign currency transaction gain was $0.5 million in the first nine months of 2023 compared to a loss of $0.4 million in the first nine months of 2022. The favorable impact was primarily due to hedging gains on foreign denominated receivables.

Income Taxes

The effective tax rate for the third quarter of 2023 was 23.4% compared to 21.2% for the third quarter of 2022. The increase was primarily due to a decrease in discrete tax benefits recognized during the quarter.

The effective tax rate for the first nine months of 2023 was 22.9% compared to 22.4% for the first nine months of 2022. The increase was driven by a decrease in discrete tax benefits recognized, as well as unfavorable changes in the mix of forecasted earnings by jurisdiction.

In general, it is our practice and intention to permanently reinvest the earnings of our foreign subsidiaries and repatriate earnings only when the tax impact is zero or immaterial. No deferred taxes have been provided for withholding taxes or other taxes that would result upon repatriation of our foreign investments to the U.S.

Backlog

Backlog is one of the many indicators of business conditions in the Company's markets. Our order backlog was $213.9 million at September 30, 2023 compared to $326.4 million at December 31, 2022. The decrease was the result of the Company's ability to obtain key component parts and increase production levels. Backlog includes orders that can be cancelled or postponed at the option of the customer at any time without penalty.

Liquidity and Capital Resources

Liquidity

Cash, cash equivalents and restricted cash totaled $97.0 million at September 30, 2023 compared to $77.4 million as of December 31, 2022. Wherever possible, cash management is centralized and intercompany financing is used to provide working capital to subsidiaries as needed. Our current ratio was 2.3 as of September 30, 2023 and 2.2 as of December 31, 2022. Our primary working capital, which is comprised of accounts receivable, inventories and accounts payables, was $328.0 million as of September 30, 2023 and $332.0 million as of December 31, 2022. Our debt-to-capital ratio was 28.9% as of September 30, 2023 compared to 38.9% as of December 31, 2022.

As of September 30, 2023, we had letters of credit and bank guarantees outstanding in the amount of $3.1 million, leaving approximately $316.9 million of unused borrowing capacity on our revolving facility.

Cash Flow from Operating Activities

Net cash provided by operating activities during the nine months ended September 30, 2023 was $124.6 million compared to net cash used by operating activities of $38.8 million during the nine months ended September 30, 2022. The increase was the result of improved operating performance and moderating investments in working capital.

Cash Flow from Investing Activities

Net cash used in investing activities during the nine months ended September 30, 2023 was $15.2 million compared to net cash used by investing activities of $19.0 million during the nine months ended September 30, 2022. The decrease in cash outflows was primarily driven by the timing of property, plant and equipment investments as the Company continues to deploy cash flow toward operational capital needs.

Cash Flow from Financing Activities

Net cash used in financing activities during the nine months ended September 30, 2023 was $87.1 million compared to net cash used by financing activities of $1.2 million during the nine months ended September 30, 2022. The increase in cash outflows was primarily driven by repayments of borrowings and share purchases. The Company repurchased 165,098 shares of common stock for $11.7 million during the first nine months of 2023 as we continued to focus on returning capital to shareholders in line with our capital allocation priorities.

Newly Issued Accounting Guidance

See Note 2 to the consolidated financial statements for information on new accounting pronouncements.

No other new accounting pronouncements issued but not yet effective have had, or are expected to have, a material impact on our results of operations or financial position.

Cautionary Statement Relevant to Forward-Looking Information

This Quarterly Report, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 2, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements generally can be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “estimate,” “anticipate,” “believe,” “project,” or “continue” or similar words or the negative thereof. These statements do not relate to strictly historical or current facts and provide current expectations of forecasts of future events. Any such expectations or forecasts of future events are subject to a variety of factors. Particular risks and uncertainties presently facing us include: geopolitical and economic uncertainty throughout the world; uncertainty surrounding the impacts and duration of the COVID-19 pandemic; our ability to comply with global laws and regulations; our ability to adapt to customer pricing sensitivities; the competition in our business; fluctuations in the cost, quality or availability of raw materials and purchased components; our ability to adjust pricing to respond to cost pressures; unforeseen product liability claims or product quality issues; our ability to attract, retain and develop key personnel and create effective succession planning strategies; our ability to effectively develop and manage strategic planning and growth processes and the related operational plans; our ability to successfully upgrade and evolve our information technology systems; our ability to successfully protect our information technology systems from cybersecurity risks; the occurrence of a significant business interruption; our ability to maintain the health and safety of our workers; our ability to integrate acquisitions; and our ability to develop and commercialize new innovative products and services.

We caution that forward-looking statements must be considered carefully and that actual results may differ in material ways due to risks and uncertainties both known and unknown. Shareholders, potential investors and other readers are urged to consider these factors in evaluating forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements. Additional information about factors that could materially affect our results can be found in Part I, Item 1A, Risk Factors in our annual report on Form 10-K for the year ended December 31, 2022.

We undertake no obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by law. Investors are advised to consult any further disclosures by us in our filings with the SEC and in other written statements on related subjects. It is not possible to anticipate or foresee all risk factors, and investors should not consider any list of such factors to be an exhaustive or complete list of all risks or uncertainties.

There have been no material changes in our market risk since December 31, 2022. For additional information, refer to Item 7A of our annual report on Form 10-K for the year ended December 31, 2022.

Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and our Principal Financial and Accounting Officer, has evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2023 (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)). Based on that evaluation, our Chief Executive Officer and our Principal Financial and Accounting Officer have concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and that such information is accumulated and communicated to our management, including our principal executive and our principal financial officers, as appropriate, to allow timely decisions regarding required disclosure.

Changes in Internal Controls

There were no changes in our internal controls over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

We documented our risk factors in Item 1A of Part I of our annual report on Form 10-K for the year ended December 31, 2022. There have been no material changes to our risk factors since the filing of that report.