TENNANT CO 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 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 March 31, 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 during the first quarter of 2023 has benefited from fewer supply chain disruptions enabling us to obtain key component parts. Uncertainty remains on the timing of a full recovery from supply chain inefficiencies. 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. If we continue to experience certain supply shortages, or if there are additional disruptions in our supply chain, it could materially or adversely impact our operating results and financial condition. We continue to operate and adapt to these temporary supply chain disruptions. We minimizes 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 continue evaluating platform design to increase our sourcing flexibility. 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 macroeconomic environment, especially the potential impact of global supply chain constraints on material inflation, and the potential decreased demand for our products. Outlook Global economic conditions continue to be highly volatile and uncertainty remains regarding supply chain challenges, inflationary trends, and short-term market demand. We continue to monitor the environment and will take pricing and other actions accordingly. We anticipate that we will need to remain agile as we continue to navigate evolving challenges. We remain confident in the long-term growth trends for our products and services in the markets we serve. 22 Table of Contents Results The following table compares the results of operations for the three months ended March 31, 2023 and 2022, respectively (in millions, except per share data and percentages): Three Months Ended March 31, 2023 % 2022 % Net sales $ 305.8 100.0 $ 258.1 100.0 Cost of sales 180.3 59.0 159.2 61.7 Gross profit 125.5 41.0 98.9 38.3 Selling and administrative expense 81.7 26.7 76.6 29.7 Research and development expense 7.9 2.6 7.7 3.0 Operating income 35.9 11.7 14.6 5.7 Interest expense, net (3.7) (1.2) (0.3) (0.1) Net foreign currency transaction (loss) gain (0.1) — 0.6 0.2 Other expense, net (0.1) — (0.2) (0.1) Income before income taxes 32.0 10.5 14.7 5.7 Income tax expense 7.7 2.5 4.4 1.7 Net income $ 24.3 7.9 $ 10.3 4.0 Net income per share - diluted $ 1.30 $ 0.55 Net Sales Consolidated net sales for the first quarter of 2023 totaled $305.8 million, an 18.5% increase as compared to consolidated net sales of $258.1 million in the first quarter of 2022. The components of the consolidated net sales change were as follows: Three Months Ended March 31, 2023 vs. 2022 Price 10.7% Volume 10.3% Organic growth 21.0% Foreign currency (2.5)% Total growth 18.5% The 18.5% increase in consolidated net sales in the first quarter of 2023 as compared to the same period in 2022 was driven by: • Organic sales growth of approximately 21.0%, which excludes the effects of foreign currency exchange. The organic sales growth was primarily due to growth across all regions 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 2.5%. 23 Table of Contents The following table sets forth the net sales by geographic area for the three months ended March 31, 2023 and 2022 (in millions, except percentages): Three Months Ended March 31, 2023 2022 % Change Americas $ 204.4 $ 160.3 27.5 % Europe, Middle East and Africa 82.1 78.7 4.3 % Asia Pacific 19.4 19.1 1.4 % Total $ 305.8 $ 258.1 18.5 % Americas Americas net sales were $204.4 million for the first quarter of 2023, an increase of 27.5% from the first quarter of 2022 driven by: • Organic sales growth of 27.9% driven equally by price realization and volume increases in both service and equipment sales; partly offset by • A net unfavorable impact from foreign currency exchange of approximately 0.4%. Europe, Middle East and Africa ("EMEA") EMEA net sales were $82.1 million for the first quarter of 2023, an increase of 4.3% from the first quarter of 2022 driven by: • Organic sales growth of 10.6% driven by broad-based growth across all product categories, led by equipment, and across our direct geographies, especially in the United Kingdom and Iberia; partly offset by • A net unfavorable impact from foreign currency exchange of approximately 6.3%. Asia Pacific ("APAC") APAC net sales were $19.4 million for the first quarter of 2023, an increase of 1.4% from the first quarter of 2022 driven by: • Organic sales growth of 7.0% driven by growth across our product categories, particularly equipment sales, and across our direct geographies, especially Australia, China and India; partly offset by • A net unfavorable impact from foreign currency exchange of approximately 5.6%. Gross Profit Gross profit margin of 41.0% was 270 basis points higher in the first quarter of 2023 compared to the first quarter of 2022. The increase was driven by pricing realization, offsetting the impact of multi-year inflation on materials and labor. Operating Expense Selling and Administrative Expense Selling and administrative expense ("S&A expense") was $81.7 million for the first quarter of 2023, an increase of $5.1 million compared to the first quarter of 2022. The S&A expense increase in the first quarter of 2023 was primarily driven by higher variable costs associated with increased operating performance, such as warranty costs and other employee costs. As a percentage of net sales, S&A expense for the first quarter of 2023 decreased 300 basis points to 26.7% from 29.7% in the first quarter of 2022, driven by both the leverage attributable to our sales and gross margin growth, as well as out cost-containment initiatives. 24 Table of Contents Research and Development Expense Research and development expense ("R&D expense") was $7.9 million, or 2.6% of net sales, for the first quarter of 2023, essentially flat compared to the first quarter 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 $3.7 million in the first quarter of 2023 compared to $0.3 million in the same period of 2022. The increase was the result of higher debt levels coupled with rising interest rates on our variable interest rate debt. Our debt portfolio as of March 31, 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 (Loss) Gain Net foreign currency transaction loss was $0.1 million in the first quarter of 2023 compared to a gain of $0.6 million in the first quarter of 2022. 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 first quarter of 2023 was 24.1% compared to 29.9% for the first quarter of 2022. The decrease was primarily due to the mix in forecasted full year taxable earnings by country and an increase in discrete tax benefit items recognized during the quarter. 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 approximately $298.5 million at March 31, 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. We expect our backlog level to remain elevated amid uncertainty in the supply chain environment. 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 $91.4 million at March 31, 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 March 31, 2023 and 2.2 as of December 31, 2022. and our primary working capital, which is comprised of accounts receivable, inventories and accounts payables, was $340.3 million and $332.0 million, respectively. Our debt-to-capital ratio was 37.8% as of March 31, 2023, compared to 38.9% as of December 31, 2022. As of March 31, 2023, we had letters of credit and bank guarantees outstanding in the amount of $2.7 million, leaving approximately $242.3 million of unused borrowing capacity on our revolving facility. 25 Table of Contents Cash Flow from Operating Activities Net cash provided by operating activities during the three months ended March 31, 2023 was $31.1 million compared to net cash used by operating activities of $10.1 million during the three months ended March 31, 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 three months ended March 31, 2023 was $6.8 million compared to net cash used by investing activities of $8.6 million during the three months ended March 31, 2022. The decrease in cash outflows was the result of lower investment in leased assets partially offset by higher capital expenditures 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 three months ended March 31, 2023 was $10.3 million compared to net cash provided by financing activities of $8.3 million during the three months ended March 31, 2022. The increase in cash outflows was driven by repayments of borrowings. The Company also repurchased 73,525 shares of common stock for $5.0 million during the first quarter of 2023 as we continue 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 26 Table of Contents 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, 2022. For additional information, refer to Item 7A of our annual report on Form 10-K for the year ended December 31, 2022.