Tennant Co

NYSE:TNC

Earnings Call Transcript 2021-Q3

[Operator]

00:01 Good morning. My name is Frank, 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. [Operator Instructions] Thank you for participating in Tennant Company's twenty twenty one third quarter earnings conference call.

00:44 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.

[William Prate, Investor Relations]

01:00 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.

01:19 On today's call, we will update you regarding our third quarter performance and guidance for twenty twenty-one. Dave will review 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.

01:46 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 from those contained in the statements. These risks and uncertainties are described in today's news release and the documents we filed with the Securities and Exchange Commission.

02:13 We encourage you to review those documents, 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.

02:47 I will now turn the call over to Dave.

[Dave Huml, President and CEO]

02:50 Thanks, William, and thank you, everyone for joining us today. Our third quarter results reflect returns to 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.

03:13 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 in geographic market. The increased demand for our products combined with the effect of macrolevel constraints on our production capabilities contributed to a record order backlog that varies by product category and region and is now three to five times our historical averages.

03:45 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.

04:19 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 the example, we are making the necessary investments to add production of our T16 line to our China plant mid next year.

04:51 The T16 is a highly maneuverable battery operator right 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 cost 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 wave in our Minneapolis plant that will improve production flow reduce the amount of labor spent machining parts and will allow us to source items that we would have otherwise purchased from vendors.

05:31 New tooling specifically cooling related to our rotation moulding machines is another example of how we are investing in our business to support our for local This lets us manufacture key components at the point of assembly, meaning we can avoid situations we're manufacturing one location before shipping to a second location for final assembly.

05:55 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 of within our machines, our main drivers of our increased backlog are directly affecting our ability to deliver on our full year potential.

06:30 However, we will continue to control everything we can control and we're diligently to capitalize on the strong demand environment. An important component of our enterprise strategy is a long-term move towards 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.

07:01 Of course, our commitment to quality and safety and meeting the needs of our customers will not waiver. Regarding labor shortage of 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.

07:22 We're 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 encouraged by these actions, which are having a positive effect on our recruiting and helping to mitigate the ongoing labor challenges. As they will discuss, while our revised full year guidance reflects continues to be a challenging operating environment, our team remains committed to meaning the needs of our customers and executing against our enterprise strategy to deliver on our long term financial commitments.

08:03 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 on price points. Our mid-tier products have been well received by our customers and distributors.

08:34 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 and best in class sales and service support. During the past year, we've also introduced two keen 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 customer’s needs.

09:12 With the addition of these new products, we have been able to strategically enter new verticals outside of just retail, including manufacturing logistics and 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.

09:37 The one strategic pillar I haven't yet touched on as 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 assess all of our strategic accounts and distributor partners.

09:56 In Australia, this allowed us to realign over forty percent of our strategic account customers and eighty percent 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.

10:26 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.

10:47 With that, I will turn the call over to Fay for discussion of our financials.

[Fay West, SVP and CFO]

10:51 Thank you, Dave, and good morning, everyone. For the third quarter of twenty twenty one, Tennant reported net sales of two 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.

11:17 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 the 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.

11:56 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 in 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.

12:21 North America delivered modest organic growth as 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.

13:05 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.

13:33 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.

13:58 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.

14:29 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 materially 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 expectation.

15:16 Net income in the third quarter was twenty one point five million dollars or one point one four dollars per diluted share compared to eleven point seven million dollars or zero point six three dollars per diluted share in the year ago period. Adjusted diluted EPS, which excludes non-operational items and amortization expense was one point three three dollars per share compared to zero point nine zero dollars per share in the year ago period. The increase year-over-year was primarily driven by lower interest expense and increased business performance.

15:45 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.

16:18 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.

16:44 Turning to cash flow and balance sheet items. Our long term capital allocation strategy is to first fund operations and investment in growth, appropriately managed leverage, pursue strategic and accretive M&A and then to return excess free cash flow over time to shareholders through dividends and share repurchases.

17:06 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.

17:37 Our strong free cash flow generation allowed us to return capital to shareholders through the following actions. First, and as previously announced, Tennant Board of directors has authorized a nine percent increase in the company's quarterly cash dividend to zero point two 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.

18:12 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 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.

18:37 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.

19:11 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.

19:26 With that, I'll turn it back over to Dave.

[Dave Huml, President and CEO]

19:29 Thanks, Fay. The challenges we're facing with global supply chain and labor shortages are not unique to tenants 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.

19:57 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 enhanced shareholder value.

20:17 We will now open the call to questions. Operator, please go ahead.

[Operator]

20:22 [Operator Instructions] Your first question comes from the line of Chris Moore with CJS Securities. Your line is open.

[Chris Moore, CJS Securities]

20:42 Hey good morning, guys. Thanks for taking a few questions.

[Fay West, SVP and CFO]

20:45 Good morning.

[Dave Huml, President and CEO]

20:46 Good morning, Chris.

[Chris Moore, CJS Securities]

20:47 Good morning. Record backlog, a lot of that relates to the parts availability. Beyond that, are you seeing much pre buying accelerated buying by customers as they factor in the supply chain challenges?

[Dave Huml, President and CEO]

21:02 Yeah, Thanks for the question, Chris. We mentioned our backlog is about three to five times normal rates. That was at about a two percent to three time 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 strengths on our plant outlook are driven by our primarily supply chain challenges. The customer orders are seemed 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 at our own long lead times are real and they want to, 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 our order, demands are driven by demand in the period for the period. Not customers of buying ahead. So really encouraged by that as we look forward to Q4 in twenty twenty two.

[Chris Moore, CJS Securities]

22:14 Got it. That's helpful. Obviously, supply chain labor freight, not unique Tennant, most all the industries we cover are in that boat, but you operate in the market with a few dominant players and kind of the unique part here is Tennant is really the only US Player out of that group of bigger competitors. So, just trying to understand how that impact your competitive positioning in both in the US and Europe. I mean, for example, supply chain challenges in North America, are they impacting you more or less than say [Indiscernible] in North America just kind of trying to see how that big picture looks given the fact that you're kind of the loan US player?

[Dave Huml, President and CEO]

23:05 Yes, let me try and dimensional that for you, Chris. So, less important as to where headquartered what's the bigger determinant on a competitor or our ability to react to the supply chain challenges a couple other facets of our business. And one would be how low platform our product is, two would be how local-for-local or 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 and kind of where we're headquartered were our predominant and the 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 assets of supply chain from parts availability all the way through freight and labor.

23:54 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. But what we've seen in our infrastructure, in our system and we have plants in every one of our regions, which we are expanding capabilities in our local strategy. What we've seen is a very [Indiscernible] to react based on again on the platform of the products, the local-for-local supply chain and then some of the regional differences relative to the supply chain challenges. I think it's difficult to draw conclusions at this point about the extent to which the global supply chain channels would affect US based competitor versus a European based competitor.

24:41 I will tell you over here 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 I'm a given product line in the given situation, one competitor or us may have advantages, but largely speaking, we believe based on what our customers are telling us is that we're 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 quickly we can respond as the macro markets recovers.

[Chris Moore, CJS Securities]

25:18 Got it. Extremely helpful. I will jump back in line. Appreciate, guys.

[Dave Huml, President and CEO]

25:21 Thanks, Chris.

[Operator]

25:30 [Operator Instructions] Your next question comes from the line of Steve Ferazani with Sidoti. Your line is open.

[Steve Ferazani, Sidoti & Company]

25:38 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?

[Dave Huml, President and CEO]

25:58 Yes, it's a great question. One to obviously wrestle with as we move through third quarter and really our decision who took lower guidance to a and tighten the range reflects where we're at in the year and the trend we've seen in the business, the signal we're getting from the supply chain over the last five months, we spoke after Q2 results, if you recall, we really only had a couple of months about sixty days of kind of impact – and the impact on our business from supply chain challenges we now enter kind of five and the 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 thought it as appropriate given the trend we saw from quarter-to-quarter to reflect that in our full year guidance.

26:45 I think it's worth noting though. If you think back to the original guidance we issued, we were at one thirty million dollars to one hundred forty million dollars in EBITDA. We raised to one hundred forty to one fifty on the strength of our Q1 results and now we provide to one hundred and thirty seven to one hundred and forty two kind of split the difference between the original and raise guidance. And when you look at the guidance that we've given across the P&L, we're really within strike from distance of delivering our fantastic year Tennant. And so, despite the supply chain challenges that we're facing and all of the team's efforts to mitigate those impacts and that’s revise the guidance, we're still very proud of the results we're communicating, and we'll deliver for the year.

[Steve Ferazani, Sidoti & Company]

27:28 And then in terms of I guess your EPS was stronger to think our estimates on SG&A in, in terms of not necessarily year-over-year, but what changed sequentially with SG&A and how you're thinking about that fourth quarter? As the shift been entirely on incentive?

[Fay West, SVP and CFO]

27:47 So it's too part. But the big driver here is a change in guidance drives, the change in management incentives. And so, we had a cumulative of adjustment here that benefited the quarter, but it's also reflective of all cost savings initiatives as well.

[Steve Ferazani, Sidoti & Company]

28:07 Can you give a sense how you thinking about SG&A in Q4?

[Fay West, SVP and CFO]

28:12 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.

[Steve Ferazani, Sidoti & Company]

28:33 Okay. Great. That's helpful.

[Dave Huml, President and CEO]

28:34 Everything, think about what’s happening in the business, Steve, we're returning to work, returning to the office, business travel is picking back up and so from 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 will be spending in, and I think it's also worth noting that we're not cutting our weight through [Indiscernible] as delivering full year results. These results are a direct reflection of the organization's ability to execute against our GPS strategy. And drive structural changes in our business that provided for benefit in out years.

[Steve Ferazani, Sidoti & Company]

29:08 If I could get one more in in terms of balance sheet continues to improve. You raised the dividend and actually more than we're expecting small buyback when you're thinking about the balance sheet debt repayments versus potential additional buyback given that you typically raise once a year, how you're thinking about those three buckets?

[Fay West, SVP and CFO]

29:33 So, capital allocation priorities really have not changes, this is our first goal is owing into investment in the business where we think the largest return exists and has least amount of risk and to manage our leverage and our leverage is really below our targeted range right now 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 strong balance sheet and strong free cash flows, it really did allow us to increase our dividends and to execute against share repurchase an effort to return excess cash to our shareholders without compromising growth.

[Steve Ferazani, Sidoti & Company]

30:24 How would you think about that over the next three or four quarters?

[Fay West, SVP and CFO]

30:27 As far as share repurchases?

[Steve Ferazani, Sidoti & Company]

30:30 Yep.

[Fay West, SVP and CFO]

30:31 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.

[Steve Ferazani, Sidoti & Company]

30:46 Got it. Thanks much Dave. Thanks, Fay.

A - Dave Huml

30:47 Thanks, Steve.

[Operator]

30:50 There are no further questions at this time. I would like to turn the call over to management for their closing remarks.

[Dave Huml, President and CEO]

30:59 Thank you. And before we close, please note that we will soon be posting on our IR website. The first and a series of videos to offer a deeper look 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 we're 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 enabling else across our enterprise help and support our customers and our business. I sincere thank you.

31:41 This concludes our earnings call. Have a good day.

[Operator]

31:45 Ladies and gentlemen, thank you for your participation. This concludes today's conference call. You may now disconnect.