Tennant Co Q3 FY2021 Earnings Call

Good morning. My name is Brent, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Tennant Company's Twenty Twenty One Third Quarter Earnings Conference call. This call is being recorded. Thank you for participating in Tennant Company's twenty twenty one third quarter earnings conference call. Beginning today's meeting is Mr. William Prate, Senior Director of Global Financing Planning and Analysis and Investor Relations for Tennant Company. Mr. Prate, you may begin your conference.

Thank you. Good morning, everyone, and welcome to Tennant Company's third quarter twenty twenty one earnings conference call. I'm William Prate, Senior Director of Global Financial Planning and Analysis and Investor Relations. Joining me today are Dave Huml, Tennant's President and CEO and Fay West, our Senior Vice President and CFO. On today's call, we will update you regarding our third quarter performance and guidance for twenty twenty-one. Dave will brief you on our operations and enterprise strategy, and Fay will cover the financials. After their remarks, we will open the call to questions. Please note, a slide presentation accompanies this conference call and is available on our Investor Relations website at investors.tennantco.com. Before we begin, please be advised that our remarks this morning and our answers to questions may contain forward-looking statements regarding the company's expectations of future performance. Such statements are subject to risks and uncertainties and our actual results may differ materially from those contained in the statements. The risks and uncertainties are described in today's news release and the documents we filed with the Securities and Exchange Commission. We encourage you to review those, particularly our Safe Harbor statement, for a description of the risks and uncertainties that may affect our results. Additionally, on this conference call, we will discuss non-GAAP measures that include or exclude certain items. Our twenty twenty one third quarter earnings release includes the comparable GAAP measures and a reconciliation of these non-GAAP measures to our GAAP results. Our earnings release was issued this morning via Business Wire and is also posted on our Investor Relations website at investors.tennantco.com. I will now turn the call over to Dave.

Thanks, William, and thank you everyone for joining us today. Our third quarter results reflect the return of pre-pandemic demand across the majority of our geographic markets and verticals. Our comprehensive and innovative product offerings are resonating with customers during this broad-based market recovery, and we expect this demand environment to continue for the foreseeable future. While we are certainly encouraged by these positive trends, our financial performance continued to be impacted by the unexpected and prolonged global supply disruptions, inflation, and labor constraints that have affected virtually every industry and geographic market. The increased demand for our products combined with the effect of macro-level constraints on our production capabilities contributed to a record order backlog that varies by product category or region and is now three to five times our historical averages. In response, we've taken actions wherever possible to minimize the impact on our operations. Our plants continue to remain open and operate due to the significant efforts by our global teams to maximize output and to safeguard our customers' experience. While we expect that these macro headwinds will continue well into twenty twenty-two, we remain confident in our ability to drive long-term sustainable growth and improve our operational efficiencies to generate long-term value for our shareholders. We are doing so not only through short-term mitigation actions but also through the changes we've made and continue to make as part of our enterprise strategy. To minimize the impact of higher freight costs and related supply disruptions, we continue to prioritize local-for-local and region-for-region manufacturing and sourcing to allow us to manufacture our products closer to our customers. As an example, we are making the necessary investments to add production of our T16 line to our China plants mid-next year. The T16 is a highly maneuverable, battery-operated ride-on scrubber that has proven to be very popular with our customers within the APAC region. By adding production to the local market, we can help minimize freight costs, improve lead times, and better leverage our global production capacity. We have continued to make capital investments to drive greater efficiency and capacity in all of our plants. As just one example, we have invested in the new lays in our Minneapolis plant that will improve production flow, reduce the amount of labor spent machining parts, and will allow us to in-source items that we would have otherwise purchased from vendors. New tooling, specifically tooling related to our rotational molding machines, is another example of how we are investing in our business to support our local-for-local initiatives. This lets us manufacture key components at the point of assembly, meaning we can avoid situations where we manufacture in one location before shipping to a second location for final assembly. These actions help avoid unnecessary shipping delays, freight costs, added time to manufacture, and inventory carrying costs. While our teams are taking every opportunity to find creative solutions to address the current supply chain environment, each day brings new challenges in terms of parts availability. Right now, the lack of availability of hydraulic pumps, chips, and other electronic components, which are critical parts within our machines, are the main drivers of our increased backlog and are directly affecting our ability to deliver on our full-year potential. However, we will continue to control everything we can control and work diligently to capitalize on the strong demand environment. An important component of our enterprise strategy is a long-term move toward platform design. In the current environment, our engineering teams are taking a balanced approach to this initiative as they weigh the long-term benefits of platform design with the near-term need to adjust our designs to allow for available parts and to increase our sourcing flexibility. Of course, our commitment to quality and safety and meeting the needs of our customers will not waver. Regarding labor shortage, specifically in manufacturing, we are staying competitive with wages and are making every effort to attract new talent by providing a safe, rewarding, and fulfilling work environment. We are also supplementing and strengthening our talent acquisition teams by partnering with third-party vendors to assist with our employment outreach through targeted marketing campaigns and professionally staged hiring events. We are encouraged by these actions which are having a positive effect on our recruiting and helping to mitigate the ongoing labor challenges. As Fay will discuss, while our revised full-year guidance reflects what continues to be a challenging operating environment, our team remains committed to meeting the needs of our customers and executing against our enterprise strategy to deliver on our long-term financial commitments. In particular, we continue to innovate for profitable growth, which is the third pillar of our enterprise strategy. Over the past year, we've announced the introduction of new products to help address the evolving needs of our customers. Earlier this year, we introduced new mid-tier products, which leverage our IPC product portfolio, to meet the needs of a broader segment of customers by offering a wider range of performance and price points. Our mid-tier products have been well received by our customers and distributors. While they leverage the same IPC platform, these Tennant-branded products benefit from the broader customer experience associated with the Tennant brand, including the full ecosystem of application expertise, technological innovations, and best-in-class sales and service support. During the past year, we've also introduced two key new products to our AMR portfolio, including the T380AMR and the T16AMR. Together with the T7AMR, these products have created a comprehensive robotic portfolio to meet all of our customers' needs. With the addition of these new products, we have been able to strategically enter new verticals outside of just retail, including manufacturing, logistics, warehousing, and education, among others. Our AMR portfolio continues to be well received by an expanding number of customers, and we look forward to updating you on a number of other AMR innovations as they materialize. The one strategic pillar I haven't yet touched on is winning where we have a competitive advantage. For example, we recently launched a value realization exercise in Australia building on our successful North American execution back in twenty nineteen, where we assessed all of our strategic accounts and distributor partners. In Australia, this allowed us to realign over 40% of our strategic account customers and 80% of our distributor partnerships, ensuring that we have an optimized channel structure in place to serve this highly competitive market. By adjusting our customer segmentation appropriately, we can better adjust lead times, pricing, and sales support across our customer base. In doing so, we are aligning the customer experience with our profitability goals. Moreover, we are relentlessly focused on providing our customers with high-quality products and exceptional service as we execute on our enterprise strategy. With that goal in mind, we will continue to take decisive and appropriate actions to maintain our customer experience while remaining focused on our business objectives.

Thank you, Dave, and good morning, everyone. For the third quarter of twenty twenty one, Tennant reported net sales of two hundred seventy-two million dollars, an increase of three point nine percent over the prior year, which included a favorable foreign currency effect of one point two percent and a divestiture impact of negative two percent related to the sale of our coatings business in the first quarter of twenty twenty one. Organic sales, which exclude the impact of these currency effects and divestitures increased four point seven percent. As Dave mentioned, our revenue results were tempered by continued global supply chain disruptions and labor constraints with North America being the most affected. Tennant groups of sales into three geographies, the Americas, which include all of North America and Latin America, EMEA, which cover Europe, the Middle East, and Africa, and Asia Pacific, which includes China, Japan, Australia, and other Asian markets. In the third quarter, sales in the Americas decreased zero point six percent year-over-year, which included a negative divestiture impact of three point one percent organic growth of two percent and a favorable foreign exchange effect of zero point five percent. Strong customer demand in Brazil and Mexico drove a year-over-year increase in sales in Latin America. North America delivered modest organic growth compared to the prior year due to the previously mentioned supply chain and labor challenges as well as the lapping of a significant AMR order in the prior year. Additionally, the current year period benefited from an increase in our service parts and consumables businesses. Sales in EMEA increased fifteen point one percent or fourteen percent organically, including a favorable foreign exchange effect of two point one percent. The results, which were impacted by global supply chain challenges, reflected growth across all countries and product categories in the region as demand returned to pre-pandemic levels. Sales in APAC decreased zero point four percent or two point nine percent on an organic basis and included a positive foreign exchange effect of two point seven percent and a negative revenue impact of zero point two percent related to the sale of the coatings business. The sales decline was partially attributed to pandemic-related lockdowns in some regional markets during the third quarter of twenty twenty one. Supply chain disruptions and labor constraints impacting North America plants that supply APAC also limited our ability to meet orders across the region, with the largest impact experienced in China and Japan. Even so, the region experienced strong results for parts and consumables and service with strength in the Australian market across all product categories. Turning to margins. Reported and adjusted gross margin in the third quarter were both forty point one percent compared to a reported gross margin of thirty-nine point six percent and adjusted gross margin of thirty-nine point eight percent in the year-ago period. Although the comparison to the prior year was favorable, the year-ago period was unfavorably impacted by certain strategic investments and pandemic-related productivity challenges. As we highlighted during our last conference call, our third quarter adjusted gross margin was lower than the adjusted gross margin in the first half of twenty twenty-one. This decrease was primarily due to increased freight costs and productivity challenges caused by parts availability. As for expenses, during the third quarter, our adjusted S&A expenses were twenty-eight point three percent of net sales compared to twenty-nine point three percent in the year-ago period. The year-over-year improvement in leverage was a direct result of the cost-saving actions as well as the adjustment of management incentives in Q3 of twenty twenty-one to better reflect current expectations. Net income in the third quarter was twenty-one point five million dollars or one point fourteen dollars per diluted share compared to eleven point seven million dollars or zero point sixty-three dollars per diluted share in the year-ago period. Adjusted diluted EPS, which excludes non-operational items and amortization expense, was one point thirty-three dollars per share compared to zero point ninety dollars per share in the year-ago period. The increase year-over-year was primarily driven by lower interest expense and increased business performance. Adjusted EBITDA in the third quarter increased to thirty-six million dollars or thirteen point two percent of sales compared to thirty-two point six million dollars or twelve point four percent of sales in Q3 of last year. The year-over-year improvement was driven primarily by increased revenue based on strong demand as we continue to lap the pandemic-related slowdown of twenty twenty as well as improved gross margins and an adjustment of management incentives previously mentioned. As for our tax rate in the third quarter, Tennant had an adjusted effective tax rate excluding non-recurring expenses of three point eight percent compared to eleven point three percent for the third quarter of twenty twenty. The decrease in the effective tax rate was driven primarily by a tax benefit resulting from an election to step up the tax basis of certain assets in Italy. Turning to cash flow and balance sheet items. Our long-term capital allocation strategy is to first fund operations and investment in growth, appropriately manage leverage, pursue strategic and accretive mergers and acquisitions, and then to return excess free cash flow over time to shareholders through dividends and share repurchases. We ended the quarter with one hundred and forty point six million dollars in cash and cash equivalents and our net leverage of zero point nine three times adjusted EBITDA is lower than our stated goal of one point five to two point five times. Cash flow from operations was strong with twenty-five point one million dollars generated in the third quarter and sixty-two point nine million dollars generated on a year-to-date basis. Additionally, CapEx is approximately twelve million dollars for the first nine months of the year. Our strong free cash flow generation allowed us to return capital to shareholders through the following actions. First, and as previously announced, the Tennant Board of Directors has authorized a nine percent increase in the company's quarterly cash dividend to zero point twenty-five dollars per share. The increased dividend is payable on December fifteen, twenty twenty-one, to shareholders of record at the close of business on November thirtieth twenty twenty-one, marking the fiftieth consecutive year that the company has increased its annual cash dividend. Secondly, during the third quarter, Tennant repurchased approximately one hundred and two thousand shares of its common stock for seven point five million dollars under the existing share repurchase program. The increase in the dividend and our share repurchase activities are aligned with our long-term capital allocation priorities and display continued confidence in our ongoing business performance and future cash flow generation. Lastly, turning to guidance, as included in today's earnings announcement, Tennant adjusts its full-year guidance for twenty twenty-one as follows. Net sales of one point zero nine billion dollars to one point one billion dollars reflecting organic sales growth of nine percent to ten percent. Full year reported GAAP earnings in the range of three point five zero dollars to three point seven dollars per diluted share. Adjusted EPS of four point two dollars to four point four zero dollars per diluted share. Adjusted EBITDA of one hundred and thirty-seven million dollars to one hundred and forty-two million dollars. Capital expenditures of approximately twenty million dollars and an adjusted effective tax rate of approximately fifteen percent. With that, I'll turn it back over to Dave.

Thanks, Fay. The challenges we're facing with global supply chain and labor shortages are not unique to Tennant and are likely to remain for the foreseeable future. These challenges did have a direct impact on our Q3 results and our ability to meet our full potential in twenty twenty-one. However, we are encouraged by the strong response to our innovative suite of products and the market recovery that is now at pre-pandemic levels of demand. Our continued execution of our enterprise strategy has enabled us to better navigate the continued macro challenges facing the overall economy. But more importantly, the strategic actions we've taken over the past couple of years will ultimately drive long-term growth and profitability and enhance shareholder value. We will now open the call to questions. Operator, please go ahead.

Your first question comes from Chris Moore with CJS Securities. You may proceed.

Hey good morning, guys. Thanks for taking a few questions.

Good morning.

Good morning, Chris.

Record backlog, a lot of that relates to the parts availability. Beyond that, are you seeing much pre-buying or accelerated buying by customers as they factor in the supply chain challenges?

Yeah, thanks for the question, Chris. We mentioned our backlog is about three to five times normal rates. That was at about a two to three times rate coming out of the prior quarter. Driven entirely by our supply chain challenges, our demand has largely returned to pre-pandemic levels, and we're really encouraged by that. We're putting orders at a rate similar to twenty nineteen. And the constraints on our plant output are driven primarily by our supply chain challenges. The customer orders seem to be driven primarily by demand in the period. We have a few instances of customers buying ahead to get in the queue because they recognize that our long lead times are real and they want to get their spot in line for production, but those are the exception rather than the rule. We've had a few instances of customers and/or distributors buying ahead of the price increase as well. But on the whole, order demands are driven by demand in the period for the period, not customers buying ahead. So we're really encouraged by that as we look forward to Q4 in twenty twenty-two.

Got it. That's helpful. Obviously, supply chain, labor, and freight are not unique to Tennant; almost all the industries we cover are in that boat. But you operate in a market with a few dominant players. And kind of the unique part here is Tennant is really the only U.S. player out of that group of bigger competitors. So just trying to understand how that impacts your competitive positioning, both in the U.S. and Europe? I mean, for example, supply chain challenges in North America, are they impacting you more or less than say Nilfisk in North America? Just kind of trying to see how that big picture looks given the fact that you're the kind of the lone U.S. player.

Yeah. Let me try and dimensionalize that for you, Chris. Less important as to where we're headquartered, what's a bigger determinant on a competitor or our ability to react to the supply chain challenges, a couple of other facets of our business. And one would be how well platformed our product is, two would be how local-for-local our supply chain is. And so when you look at us and our competitors, those are bigger determinants of our ability to respond and react within this environment than kind of where we're headquartered or where our predominant end market is from a sales perspective. Having said that, these supply chain challenges are really global in nature and macro in nature as well as across all facets of the supply chain from parts availability all the way through freight and labor. The impact of these challenges does vary by region. And so some of these are what I would call more notable in North America when you think about some of the dynamics in our labor force, for example. What we've seen in our infrastructure and our system, and we have plants in every one of our regions which we are expanding capabilities in our local-for-local strategy, what we've seen is a variance in ability to react based on, again, the platform of the product, the local-for-local supply chain, and then some of the regional differences relative to the supply chain challenges. So I think it's difficult to draw conclusions at this point about the extent to which the global supply chain challenges would affect a U.S.-based competitor versus a European-based competitor. I will tell you what we're hearing from customers as we're out booking orders at a very robust rate. They're telling us that we are right in line from a lead time perspective with our competitors. And that's not to say that on a given product line and a given situation one competitor or us may have an advantage. But largely speaking, we believe based on what our customers are telling us is that we are on par with competition. So time will tell as this wears on and as recovery comes. I think our success will largely be marked by how quickly we can respond as the macro market recovers.

Got it. Extremely helpful. I will jump back in line. Appreciate it, guys.

Thanks, Chris.

Your next question comes from the line of Steve Ferazani with Sidoti. Your line is open.

Good morning, Dave. Good morning, Fay. Why ask on your change to EBITDA guidance? Is that entirely supply chain related? Even as the quarter was good, have you seen it yet significantly worse, and what were you thinking is timing not improvements?

Yeah. It's a great question. One that we've obviously wrestled with as we moved through the quarter. And really our decision to lower guidance and tighten the range reflects where we're at in the year and the trending we've seen in the business, the signals we're getting from the supply chain over the last five months. When we spoke after Q2 results, if you recall, we really only had a couple of months, about 60 days of kind of impact, the impact on our business from supply chain challenges. We've now entered kind of five and six months impact as we move through the third quarter. We have seen the situation deteriorate from a macro perspective, and we are working hard to overcome those challenges. But we felt it was appropriate given that the trend we saw from quarter to quarter to reflect that in our full-year guidance. I think it's worth noting though. If you think back to the original guidance we issued, we were at one hundred thirty million dollars to one hundred forty million dollars in EBITDA. We raised to one hundred forty to one hundred fifty on the strength of our Q1 results and now we provide guidance to one hundred thirty-seven to one hundred forty-two, kind of split the difference between the original and raised guidance. And when you look at the guidance that we've given across the P&L, we're really within striking distance of delivering our fantastic year at Tennant. And so, despite the supply chain challenges that we're facing and all of the team's efforts to mitigate those impacts that we've revised the guidance, we're still very proud of the results we're communicating, and we'll deliver for the year.

In terms of your EPS, it was stronger as well. I'm curious about our estimates on SG&A, specifically regarding the sequential changes and your thoughts on that for Q4. Has the shift been entirely focused on incentives?

So it's a two-part question. But I think a big driver here is a change in guidance and the change in management incentives. And so we had an accumulative adjustment here that benefited the quarter. But it's also reflective of all cost-saving initiatives as well.

Can you give a sense how you think about SG&A in Q4?

I think that we're not going to see that same kind of benefit come through that we saw in Q3. And when I look at Q4, I think it will probably be more in line with kind of our normal run rate of about eighty-five million dollars a quarter.

Okay. Great. That's helpful.

And if we think about what's happening in the business, Steve, we're returning to work, returning to the office, and business travel is picking back up. And so from an SG&A perspective, we expect to continue to support our customers and drive the demand we're seeing and set ourselves up for twenty twenty-two, that we'll be spending on SG&A. I think it's also worth noting that we're not cutting our way through SG&A to deliver these full-year results. These results are a direct reflection of the organization's ability to execute against our GPS strategy and drive the structural changes in our business that provide recurring benefits in out years.

If I could add one more point, the balance sheet continues to improve. You raised the dividend more than we anticipated, along with a small buyback. When considering the balance sheet and debt repayments versus potential additional buyback, especially since you typically raise it once a year, how are you approaching those three areas?

So, our capital allocation priorities really have not changed; this is our first goal is owing into investment in the business where we think the largest return exists and has the least amount of risk and to manage our leverage and our leverage is really below our targeted range right now of one point five to two point five times. So, I think the balance sheet as you say is very well positioned. We had generated approximately fifty million dollars of free cash flow through the first nine months of the year, which is very, very strong. So, on the basis of a strong balance sheet and strong free cash flows, it really did allow us to increase our dividends and to execute against share repurchase in an effort to return excess cash to our shareholders without compromising growth.

How would you think about that over the next three or four quarters?

As far as share repurchases? Yes, it's going to be an integrated component of our capital allocation priorities and it is at the discretion of management, but it will be part of a capital deployment strategy.

Got it. Thanks so much, Dave. Thanks, Fay.

Thanks, Steve.

There are no further questions at this time. I would like to turn the call over to management for their closing remarks.

Thank you. And before we close, please note that we will soon be posting on our IR website the first in a series of videos to offer a deeper look into our business and growth strategy. You can be notified of each video by signing up for email alerts at investors.tennantco.com. I also want to take this moment to thank our global Tennant teams for all their hard work and dedication. From our sales and service teams who are supporting our customers directly to our operations and supply team who continue to find creative solutions in today's challenging environment and to our engineers, back office, and everyone else across our enterprise helping and supporting our customers and our business, a sincere thank you. This concludes our earnings call. Have a good day.

Ladies and gentlemen, thank you for your participation. This concludes today's conference call. You may now disconnect.