TENNANT CO 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Overview Tennant Company is a world leader in designing, manufacturing and marketing solutions that empower customers to achieve quality cleaning performance, reduce environmental impact and help create a cleaner, safer, healthier world. The Company is committed to creating and commercializing breakthrough, sustainable cleaning innovations to enhance its broad suite of products, including floor maintenance and cleaning equipment, detergent-free and other sustainable cleaning technologies, aftermarket parts and consumables, equipment maintenance and repair service, and asset management solutions. Our products are used in many types of environments, including retail establishments, distribution centers, factories and warehouses, public venues such as arenas and stadiums, office buildings, schools and universities, hospitals and clinics, and more. Customers include contract cleaners to whom organizations outsource facilities maintenance as well as businesses that perform facilities maintenance themselves. The Company reaches these customers through the industry's largest direct sales and service organization and through a strong and well-supported network of authorized distributors worldwide. Macroeconomic Events We continue to actively manage our business to respond to the COVID-19 pandemic and related impacts. We maintain our commitment to protect the health and safety of our employees and customers. We have enhanced our on-site safety protocols at our manufacturing facilities and continue to monitor the evolving situation and guidance from local authorities. Governments across the world have taken actions, including stay-at-home orders, to limit the spread of COVID-19. These actions, specifically in China, have and may continue to reduce operating activities and negatively impact financial results. We continue to experience disruption in the supply of key component parts, as well as price inflation and inefficiencies as a result of supply chain issues. We have established frequent communications with suppliers to review, track and prioritize high-risk components. We have also identified and activated alternative suppliers, materials and components as needed. We continue to work closely with our suppliers to achieve a deeper integration into our suppliers' supply chains, including the procurement of sub-component parts. The Company continues work to minimize the impact of price inflation on inputs and market supply challenges by employing local-for-local and region-for-region manufacturing and sourcing to allow us to manufacture our products closer to our customers. At the same time, our engineering teams are evaluating platform design to increase our sourcing flexibility. The crisis in Russia and Ukraine that began in February 2022 continues as of the date of this Form 10-Q. While we do not have any direct operations or employees in Russia or Ukraine and have suspended sales to Russia and Belarus, our operating results have and may continue to be negatively impacted by supply chain constraints and inflationary pressures stemming from this conflict. Sales to Russia and Belarus represented less than 1% of consolidated net sales and less than 2% of Europe, Middle East and Africa net sales for the year ended December 31, 2021. In addition to fully adhering to all sanctions, we will continue to monitor developments in the region, including the impact of rising commodity and energy prices. 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. 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. Volatility in the foreign exchange market has and may continue to negatively impact the financial results of our international operations. As described in Part I, Item 1A - Risk Factors, in the annual report on Form 10-K for the fiscal year ended December 31, 2021, we may encounter financial difficulties if the United States or other global economies experience an additional or continued long-term economic downturn as our product sales are sensitive to declines in capital spending by our customers. 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 macroeconomic environment, especially the potential impact of global supply chain constraints on material inflation, and the potential decreased demand for our products. 26 Table of Contents Outlook Global economic conditions continue to be highly volatile and uncertainty remains regarding the timing of a full recovery from supply chain challenges and inflationary trends. We continue to monitor costs in the current inflationary environment and will take pricing action accordingly. We anticipate that we will need to remain agile as we continue to manage evolving challenges. We remain confident in the long-term growth trends for all 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, 2022 and 2021, respectively (in millions, except per share data and percentages): Three Months Ended September 30, Nine Months Ended September 30, 2022 % 2021 % 2022 % 2021 % Net sales $ 262.9 100.0 $ 272.0 100.0 $ 801.2 100.0 $ 814.4 100.0 Cost of sales 162.2 61.7 162.8 59.9 495.5 61.8 477.0 58.6 Gross profit 100.7 38.3 109.2 40.1 305.7 38.2 337.4 41.4 Selling and administrative expense 71.4 27.2 76.9 28.3 227.1 28.3 242.5 29.8 Research and development expense 7.9 3.0 8.4 3.1 23.5 2.9 24.1 3.0 Gain on sale of assets — — — — (3.7) (0.5) (9.8) (1.2) Operating income 21.4 8.1 23.9 8.8 58.8 7.3 80.6 9.9 Interest expense, net (2.2) (0.8) (0.6) (0.2) (3.7) (0.5) (6.6) (0.8) Net foreign currency transaction (loss) gain — — (0.7) (0.3) (0.4) — (0.2) — Loss on extinguishment of debt — — — — — — (11.3) (1.4) Other (expense) income, net 0.6 0.2 (0.3) (0.1) 0.1 — — — Income before income taxes 19.8 7.5 22.3 8.2 54.8 6.8 62.5 7.7 Income tax expense 4.2 1.6 0.8 0.3 12.3 1.5 5.5 0.7 Net income $ 15.6 5.9 $ 21.5 7.9 $ 42.5 5.3 $ 57.0 7.0 Net income per share - diluted $ 0.83 $ 1.14 $ 2.27 $ 3.02 Net Sales Consolidated net sales for the third quarter of 2022 totaled $262.9 million, a 3.3% decrease as compared to consolidated net sales of $272.0 million in the third quarter of 2021. Consolidated net sales for the first nine months of 2022 were $801.2 million, a 1.6% decrease compared to consolidated net sales of $814.4 million in the first nine months of 2021. The 3.3% decrease in consolidated net sales in the third quarter of 2022 as compared to the same period in 2021 was driven by: • A net unfavorable impact from foreign currency exchange across all regions of approximately 5.0%; partly offset by • An organic sales increase of approximately 1.7%, which excludes the effects of foreign currency exchange. The organic sales increase was primarily due to the impact of higher selling prices across all regions partially offset by volume declines due to supply chain constraints impacting the availability of certain component parts. 27 Table of Contents The 1.6% decrease in consolidated net sales in the first nine months of 2022 as compared to the same period in 2021 was driven by: • A net unfavorable impact from foreign currency exchange across all regions of approximately 3.8%; • An organic sales increase of approximately 2.3%, which excludes the effects of foreign currency exchange and divestitures. The organic sales increase was primarily due to the impact of higher selling prices across all regions, partially offset by volume declines resulting from continued supply chain constraints; and • An unfavorable impact from the divestiture of our Coatings business in the first quarter of 2021 of 0.1%. The following table sets forth the net sales by geographic area for the three and nine months ended September 30, 2022 and 2021 (in millions, except percentages): Three Months Ended September 30, Nine Months Ended September 30, 2022 2021 % Change 2022 2021 % Change Americas $ 174.0 $ 166.7 4.4 % $ 512.7 $ 491.7 4.3 % Europe, Middle East and Africa 69.0 80.7 (14.5) % 225.0 246.8 (8.8) % Asia Pacific 19.9 24.6 (19.1) % 63.5 75.9 (16.3) % Total $ 262.9 $ 272.0 (3.3) % $ 801.2 $ 814.4 (1.6) % Americas Americas net sales were $174.0 million for the third quarter of 2022, an increase of 4.4% from the third quarter of 2021. Organic sales grew 4.6% in the Americas, mainly due to higher selling prices across the region, volume increases in Latin America, and growth in parts and consumables in North America. This was partially offset by volume declines on equipment in North America. Diminished parts availability on certain component parts due to global supply chain constraints has limited our ability to increase production. Additionally, foreign currency exchange within the Americas unfavorably impacted net sales by approximately 0.2% in the third quarter of 2022. Americas net sales were $512.7 million for the first nine months of 2022, an increase of 4.3% from the first nine months of 2021. Organic sales grew 4.5% in the Americas, mainly due to higher selling prices, partially offset by lower volume. This was partially offset by the divestiture of the Coatings business in the first nine months of 2021 resulting in a decline in net sales of approximately 0.2% in the first nine months of 2022. Europe, Middle East and Africa ("EMEA") EMEA net sales were $69.0 million for the third quarter of 2022, a decrease of 14.5% from the third quarter of 2021. Foreign currency exchange within EMEA unfavorably impacted net sales by approximately 15.1%. Organic sales grew 0.6% in EMEA, primarily due to higher selling prices and growth in parts and consumables. This was partially offset by volume declines as lack of component parts due to global supply chain constraints has limited our ability to increase production. EMEA net sales were $225.0 million for the first nine months of 2022, a decrease of 8.8% from the first nine months of 2021. Foreign currency exchange within EMEA unfavorably impacted net sales by approximately 11.4%. Organic sales grew 2.6% in EMEA, primarily due to higher selling prices, growth in services, and higher sales of parts and consumables. Asia Pacific ("APAC") APAC net sales were $19.9 million for the third quarter of 2022, a decrease of 19.1% from the third quarter of 2021. Organic sales declined 14.0% in APAC, primarily due to volume declines in China as government shutdowns related to COVID-19 continue to unfavorably impact demand. Foreign currency exchange within APAC unfavorably impacted net sales by approximately 5.1% in the third quarter of 2022. 28 Table of Contents APAC net sales were $63.5 million for the first nine months of 2022, a decrease of 16.3% from the first nine months of 2021. Organic sales declined 12.6% in APAC, primarily due to government shutdowns in China related to COVID-19 outbreaks impacting our ability to deliver finished goods to customers. This was partly offset by volume growth in Australian markets. Foreign currency exchange within APAC unfavorably impacted net sales by approximately 3.7% in the first nine months of 2022. Gross Profit Gross profit margin of 38.3% was 180 basis points lower in the third quarter of 2022 compared to the third quarter of 2021. The decrease was attributable to the broad effects of inflation on materials, labor, and freight costs, partly offset by higher selling prices. Inflation contributed to a $ 2.1 million LIFO charge during the third quarter of 2022 compared to $ 3.7 million in the third quarter of 2021. Gross profit margin of 38.2% was 320 basis points lower in the first nine months of 2022 compared to the first nine months of 2021. The decrease was due to inflation on materials, labor, and higher freight costs, partly offset by price increases. Inflation contributed to a LIFO charge of $ 8.1 million during the first nine months of 2022 compared to $ 5.9 million in the first nine months of 2021. Operating Expense Selling and Administrative Expense Selling and administrative expense ("S&A expense") was $71.4 million for the third quarter of 2022, a decrease of $5.5 million compared to the third quarter of 2021. As a percentage of net sales, S&A expense for the third quarter of 2022 decreased 110 basis points to 27.2% from 28.3% in the third quarter of 2021. The S&A expense decrease in the third quarter of 2022 was primarily driven by lower variable employee compensation expenses and cost containment initiatives. S&A expense was $227.1 million for the first nine months of 2022, a decrease of $15.4 million compared to the first nine months of 2021. As a percentage of net sales, S&A expense for the first nine months of 2022 decreased 150 basis points to 28.3% from 29.8% in the first nine months of 2021. The S&A expense decrease in the first nine months of 2022 was primarily driven by lower variable employee compensation expenses partially offset by increased costs related to strategic initiatives to address limited availability of component parts. Research and Development Expense Research and development expense ("R&D expense") was $7.9 million, or 3.0% of net sales, for the third quarter of 2022, essentially flat compared to the third quarter of 2021. R&D expense was $23.5 million, or 2.9% of net sales, for the first nine months of 2022, flat as a percentage of net sales compared to the first nine months of 2021. 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 $2.2 million in the third quarter of 2022 compared to $0.6 million in the same period of 2021. The increase was the result of rising interest rates on our variable interest rate debt. Interest expense, net was $3.7 million in the first nine months of 2022 compared to $6.6 million in the same period of 2021. The decrease was a result of restructuring of debt in the second quarter of 2021, which resulted in lower interest expense due to a lower amount of outstanding debt. Our debt portfolio as of September 30, 2022 was comprised of debt predominately in U.S. dollars. We are exposed to changes in interest rates as a result of borrowing activities with variable interest rates that impact interest incurred. 29 Table of Contents Net Foreign Currency Transaction Loss Net foreign currency transaction loss was less than $0.1 million and $0.7 million in the third quarter of 2022 and 2021, respectively. Net foreign currency transaction loss was $0.4 million and $0.2 million in the first nine months of 2022 and 2021, respectively. The unfavorable impact was primarily due to strengthening of the U.S. dollar relative to the Brazilian real on foreign denominated liabilities. Income Taxes The effective tax rate for the third quarter of 2022 was 21.2% compared to 3.6% for the third quarter of 2021. The effective tax rate for the first nine months of 2022 was 22.4% compared to 8.8% for the first nine months of 2021. The effective tax rate for both the third quarter and the first nine months of 2022 increased primarily due to a high level of discrete tax benefit items in 2021 compared to 2022 and the mix in expected full year taxable earnings by country. The discrete tax benefits in 2021 included a tax benefit resulting from an election to step-up the tax basis of certain assets for Italian tax purposes, as well as the release of certain valuation allowances related to net operating loss carryovers. The valuation allowance release was driven by a change in law providing an unlimited carryforward period. In general, it is our practice and intention to permanently reinvest the earnings of our foreign subsidiaries and repatriate earnings only when the tax impact is zero or immaterial. No deferred taxes have been provided for withholding taxes or other taxes that would result upon repatriation of our foreign investments to the United States. Backlog Backlog is one of the many indicators of business conditions in the Company's markets. Our order backlog was approximately $281.7 million at September 30, 2022 compared to $288.7 million at June 30, 2022 and $169.7 million at December 31, 2021. The increase in our order backlog is primarily due to persistent supply chain challenges that impacted our ability to obtain key component parts. Unless these factors change, we expect our backlog level to remain elevated. 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 $59.2 million at September 30, 2022, as compared to $123.6 million as of December 31, 2021. Wherever possible, cash management is centralized and intercompany financing is used to provide working capital to subsidiaries as needed. Our current ratio was 2.1 as of September 30, 2022 and 1.8 as of December 31, 2021, and our primary working capital, which is comprised of accounts receivable, inventories and accounts payables, was $308.9 million and $250.5 million, respectively. Our debt-to-capital ratio was 39.8% as of September 30, 2022, compared to 38.1% as of December 31, 2021. As of September 30, 2022, we had letters of credit and bank guarantees outstanding in the amount of $3.1 million, leaving approximately $261.9 million of unused borrowing capacity on our revolving facility. Cash Flow from Operating Activities Net cash used in operating activities during the nine months ended September 30, 2022 was $38.8 million compared to net cash provided by operating activities of $62.9 million during the nine months ended September 30, 2021. The increase in cash used was primarily driven by an increase in working capital attributable to investments in inventory to support a ramp in production, higher accounts receivables due to increased sales to customers with extended payment terms, and increased cash payments for employee compensation and benefits and taxes. We anticipate that inventory levels will begin to decrease in the fourth quarter as production increases. We also actively manage our accounts receivable portfolio and expect increased collection activity in the fourth quarter. 30 Table of Contents Cash Flow from Investing Activities Net cash used in investing activities during the nine months ended September 30, 2022 was $19.0 million compared to net cash provided by investing activities of $12.6 million during the nine months ended September 30, 2021. The increase of cash outflows was primarily the result of lower cash proceeds from the prior year sale of our Coatings business in 2021. Cash Flow from Financing Activities Net cash used in financing activities decreased during the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021 primarily due to a decrease in repayments of borrowings in the first nine month of 2022. The Company used the proceeds from borrowings to invest in constrained component parts to prepare for a ramp in production. Newly Issued Accounting Guidance See Note 2 to the Consolidated Financial Statements for information on new accounting pronouncements. No other new accounting pronouncements issued but not yet effective have had, or are expected to have, a material impact on our results of operations or financial position. Cautionary Statement Relevant to Forward-Looking Information This Form 10-Q, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 2, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements generally can be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “estimate,” “anticipate,” “believe,” “project,” or “continue” or similar words or the negative thereof. These statements do not relate to strictly historical or current facts and provide current expectations of forecasts of future events. Any such expectations or forecasts of future events are subject to a variety of factors. Particular risks and uncertainties presently facing us include: geopolitical and economic uncertainty throughout the world; uncertainty surrounding the impacts and duration of the COVID-19 pandemic; our ability to comply with global laws and regulations; our ability to adapt to customer pricing sensitivities; the competition in our business; fluctuations in the cost, quality or availability of raw materials and purchased components; our ability to adjust pricing to respond to cost pressures; unforeseen product liability claims or product quality issues; our ability to attract, retain and develop key personnel and create effective succession planning strategies; our ability to effectively develop and manage strategic planning and growth processes and the related operational plans; our ability to successfully upgrade and evolve our information technology systems; our ability to successfully protect our information technology systems from cybersecurity risks; the occurrence of a significant business interruption; our ability to maintain the health and safety of our workers; our ability to integrate acquisitions; and our ability to develop and commercialize new innovative products and services. We caution that forward-looking statements must be considered carefully and that actual results may differ in material ways due to risks and uncertainties both known and unknown. Shareholders, potential investors and other readers are urged to consider these factors in evaluating forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements. Additional information about factors that could materially affect our results can be found in Part I, Item 1A, Risk Factors in our annual report on Form 10-K for the year ended December 31, 2021. We undertake no obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by law. Investors are advised to consult any further disclosures by us in our filings with the SEC and in other written statements on related subjects. It is not possible to anticipate or foresee all risk factors, and investors should not consider any list of such factors to be an exhaustive or complete list of all risks or uncertainties. Item 3. Quantitative and Qualitative Disclosures About Market Risk There have been no material changes in our market risk since December 31, 2021. For additional information, refer to Item 7A of our annual report on Form 10-K for the year ended December 31, 2021. 31 Table of Contents