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 September 30, 2024 and 2023. 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 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 Recent macroeconomic events including inflation, slower economic growth, and political unrest have led to economic uncertainty and volatility globally. Our business is influenced by customer spending and global demand for our products. We are closely monitoring a weaker-than-expected economic environment in our EMEA region and are facing challenging business conditions in APAC, especially in China, where excess manufacturing capacity and government-induced overproduction are resulting in increased pricing pressure. The global nature of our operations subjects us to exposures resulting from both foreign currency exchange fluctuations in the normal course of business and geopolitical risks stemming from global conflicts. While we do not have any direct operations or employees in areas experiencing conflicts, our operating results have been and may continue to be negatively impacted by supply chain constraints and inflationary pressures from these conflicts. As described in Part I, Item 1A - Risk Factors in the annual report on Form 10-K for the fiscal year ended December 31, 2023, we may encounter financial difficulties if the U.S. or other global economies experience an additional or continued long-term economic downturn as our product sales are sensitive to declines in capital spending by our customers. Any sustained adverse impacts to our business, the industries in which we operate, market demand for our products, and/or certain suppliers or customers may also affect our future results of operations, financial position, or cash flows. We are actively monitoring the global macroeconomic environment, including geopolitical conflict, the potential impact of global supply chain constraints on material inflation, and change in demand for our products. Outlook Despite the challenging economic environment, particularly in EMEA and APAC, we remain confident in the long-term overall health of our business and the strength of our products and services across the markets we serve. 26 Table of Contents Results The following table compares the results of operations for the three and nine months ended September 30, 2024 and 2023, respectively (in millions, except per share data and percentages): Three Months Ended September 30, Nine Months Ended September 30, 2024 % 2023 % 2024 % 2023 % Net sales $ 315.8 100.0 $ 304.7 100.0 $ 957.8 100.0 $ 932.2 100.0 Cost of sales 182.0 57.6 172.7 56.7 543.8 56.8 535.2 57.4 Gross profit 133.8 42.4 132.0 43.3 414.0 43.2 397.0 42.6 Selling and administrative expense 92.7 29.4 88.2 28.9 275.5 28.8 256.9 27.6 Research and development expense 10.5 3.3 9.1 3.0 31.8 3.3 26.0 2.8 Operating income 30.6 9.7 34.7 11.4 106.7 11.1 114.1 12.2 Interest expense, net (2.7) (0.9) (3.3) (1.1) (7.5) (0.8) (11.0) (1.2) Net foreign currency transaction (loss) gain (0.4) (0.1) (0.4) (0.1) 0.1 — 0.5 0.1 Other (expense) income, net — — (1.1) (0.4) 0.2 — (1.8) (0.2) Income before income taxes 27.5 8.7 29.9 9.8 99.5 10.4 101.8 10.9 Income tax expense 6.7 2.1 7.0 2.3 22.4 2.3 23.3 2.5 Net income $ 20.8 6.6 $ 22.9 7.5 $ 77.1 8.0 $ 78.5 8.4 Net income per share - diluted $ 1.09 $ 1.21 $ 4.03 $ 4.19 Net Sales Consolidated net sales for the third quarter of 2024 totaled $315.8 million, a 3.6% increase as compared to consolidated net sales of $304.7 million in the third quarter of 2023. The components of the consolidated net sales change were as follows: Three Months Ended September 30, Nine Months Ended September 30, 2024 vs. 2023 Price 1.8% 3.1% Volume 0.9% (1.0)% Organic growth 2.7% 2.1% Acquisitions 1.3% 0.8% Foreign currency (0.4)% (0.2)% Total growth 3.6% 2.7% The 3.6% increase in consolidated net sales in the third quarter of 2024 as compared to the same period in 2023 was driven by: • Organic sales growth of 2.7% was primarily due to price realization and higher equipment sales in the Americas, partly offset by lower organic sales in the EMEA and APAC regions; • Inorganic growth of 1.3% driven by the acquisition of TCS; partly offset by • A net unfavorable impact from foreign currency exchange of approximately 0.4%. The 2.7% increase in consolidated net sales in the first nine months of 2024 as compared to the same period in 2023 was driven by: 27 Table of Contents • Organic sales growth of 2.1% attributed to price realization across all regions and favorable product and channel mix and higher equipment sales in the Americas, partly offset by lower organic sales in the EMEA and APAC regions; • Inorganic growth of 0.8% driven by the acquisition of TCS; partly offset by • A net unfavorable impact from foreign currency exchange across all regions of approximately 0.2%. The following table sets forth the net sales by geographic area for the three and nine months ended September 30, 2024 and 2023 (in millions, except percentages): Three Months Ended September 30, Nine Months Ended September 30, 2024 2023 % Change 2024 2023 % Change Americas $ 218.7 $ 211.2 3.6 % $ 662.1 $ 632.2 4.7 % Europe, Middle East and Africa 76.3 72.0 6.0 % 234.6 234.1 0.2 % Asia Pacific 20.8 21.5 (3.3) % 61.1 65.9 (7.3) % Total $ 315.8 $ 304.7 3.6 % $ 957.8 $ 932.2 2.7 % Americas Americas net sales were $218.7 million for the third quarter of 2024, an increase of 3.6% from the third quarter of 2023 driven by: • Organic sales growth of 4.6% was driven by higher equipment sales and strong price realization; and • A net unfavorable impact from foreign currency exchange of approximately 1.0%. Americas net sales were $662.1 million for the first nine months of 2024, an increase of 4.7% from the first nine months of 2023 driven by: • Organic sales growth of 5.0% driven by strong price realization and higher equipment sales, including favorable product and channel mix in North America, partly offset by unit volume declines in North America commercial equipment; and • A net unfavorable impact from foreign currency exchange of approximately 0.3%. Europe, Middle East and Africa ("EMEA") EMEA net sales were $76.3 million for the third quarter of 2024, an increase of 6.0% from the third quarter of 2023 driven by: • Inorganic sales increase of 5.8% due to the acquisition of TCS; • A net favorable impact from foreign currency exchange of approximately 1.0%; partly offset by • Organic sales decrease of 0.8% driven by volume declines in both equipment and parts and consumables, partly offset by price realization. EMEA net sales were $234.6 million for the first nine months of 2024, an increase of 0.2% from the first nine months of 2023 driven by: • Inorganic sales increase of 3.3% due to the acquisition of TCS; • A net favorable impact from foreign currency exchange of approximately 0.5%; partly offset by • Organic sales decrease of 3.6% driven by volume declines in both equipment and parts and consumables, partly offset by price realization. Asia Pacific ("APAC") APAC net sales were $20.8 million for the third quarter of 2024, a decrease of 3.3% from the third quarter of 2023 driven by: • Organic sales decrease of 4.3% driven by volume declines in China and Australia, partly offset by price realization in Australia; and • A net favorable impact from foreign currency exchange of approximately 1.0%. 28 Table of Contents APAC net sales were $61.1 million for the first nine months of 2024, a decrease of 7.3% from the first nine months of 2023 driven by: • Organic sales decrease of 6.2% attributed to volume declines in China, partly offset by price realization in Australia; and • A net unfavorable impact from foreign currency exchange of approximately 1.1%. Gross Profit Gross profit margin of 42.4% was 90 basis points lower in the third quarter of 2024 compared to the third quarter of 2023. The margin rate decrease is primarily attributed to higher inflationary pressure on materials as well as elevated freight costs, partly offset by price realization. Gross profit margin of 43.2% was 60 basis points higher in the first nine months of 2024 compared to the first nine months of 2023. The margin rate increase was driven by price realization and cost saving initiatives, which more than offset the effects of inflation. Strong margin rates are also supported by favorable product mix, including higher industrial equipment sales. Operating Expense Selling and Administrative Expense Selling and administrative expense ("S&A expense") was $92.7 million for the third quarter of 2024, an increase of $4.5 million compared to the third quarter of 2023. As a percentage of net sales, S&A expense for the third quarter of 2024 increased 50 basis points to 29.4% from 28.9% in the third quarter of 2023. S&A expense was $275.5 million for the first nine months of 2024, an increase of $18.6 million compared to the first nine months of 2023. S&A expense as a percentage of net sales for the first nine months of 2024 increased 120 basis points to 28.8% from 27.6% in the first nine months of 2023. The S&A expense increase in both periods was driven by higher costs linked to our strategic investments and higher compensation and benefits expense related to incremental resources to support the Company's enterprise growth strategy, partly offset by lower bad debt expense, lower legal fees, and a decrease in warranty claims. Research and Development Expense Research and development expense ("R&D expense") was $10.5 million, or 3.3% of net sales, for the third quarter of 2024, with R&D expense as a percentage of net sales increasing 30 basis points compared to the third quarter of 2023. R&D expense was $31.8 million, or 3.3% of net sales, for the first nine months of 2024, increasing 50 basis points compared to the first nine months of 2023. We continue to invest in developing innovative products and technologies at levels necessary to propel our technology and innovative leadership position. Total Other Expense, Net Interest Expense, Net Interest expense, net was $2.7 million in the third quarter of 2024 compared to $3.3 million in the same period of 2023. The decrease was the result of lower weighted average outstanding borrowings. The following table compares the debt levels, average interest rate, interest income and interest expense for the three and nine months ended September 30, 2024 and 2023, respectively (in millions, except percentages): 29 Table of Contents Three Months Ended September 30, Nine Months Ended September 30, 2024 2023 2024 2023 Weighted Average Outstanding Borrowings $ 213.6 $ 262.4 $ 213.9 $ 291.3 Average interest rate 6.54 % 6.48 % 6.51 % 6.19 % Interest expense 3.6 4.3 10.4 13.5 Interest income (0.9) (1.0) (2.9) (2.5) Interest expense, net $ 2.7 $ 3.3 $ 7.5 $ 11.0 Our debt portfolio as of September 30, 2024 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 $120.0 million notional amount of interest rate swaps that exchange a variable rate of interest for a fixed rate of interest of 4.076% over the term of the agreements. Net Foreign Currency Transaction Gain (Loss) Net foreign currency transaction loss was $0.4 million in the third quarters of 2024 and 2023. The unfavorable impact was primarily due to the strengthening of the U.S. dollar relative to the Chinese renminbi and Mexican peso. Net currency transaction gain was $0.1 million in the first nine months of 2024 compared to a gain of $0.5 million in the first nine months of 2023. The favorable impact was primarily due to hedging gains on foreign denominated receivables. Income Taxes The effective tax rate for the third quarter of 2024 was 24.4% compared to 23.4% for the third quarter of 2023. The increase was primarily due to an increase in nondeductible executive compensation and unfavorable changes in the mix in forecasted earnings by country. The effective tax rate for the first nine months of 2024 was 22.5% compared to 22.9% for the first nine months of 2023. The decrease was primarily due to an increase in discrete tax benefits associated with share-based compensation partly offset by an increase in nondeductible executive compensation. 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 $76.8 million at September 30, 2024 compared to $186.2 million at December 31, 2023. The decrease was the result of the Company's ability to obtain key component parts and drive strong production levels. Backlog includes orders that can be cancelled or postponed at the option of the customer at any time without penalty. Liquidity and Capital Resources Liquidity Cash, cash equivalents and restricted cash totaled $91.3 million at September 30, 2024 compared to $117.1 million as of December 31, 2023. Wherever possible, cash management is centralized and intercompany financing is used to provide working capital to subsidiaries as needed. Our current ratio was 2.2 as of September 30, 2024 and 2.1 as of December 31, 2023. Our primary working capital, which is comprised of accounts receivable, inventories and accounts payables, was $334.0 million as of September 30, 2024 and $312.1 million as of December 31, 2023. Our debt-to-capital ratio was 24.4% as of September 30, 2024 compared to 25.8% as of December 31, 2023. 30 Table of Contents As of September 30, 2024, we had letters of credit and bank guarantees outstanding in the amount of $3.2 million, leaving approximately $439.3 million of unused borrowing capacity on our revolving facility. Cash Flow from Operating Activities Net cash provided by operating activities during the nine months ended September 30, 2024 was $52.2 million compared to net cash provided by operating activities of $124.6 million during the nine months ended September 30, 2023. The decrease was the result of consumption of working capital and spend on our ERP modernization project of $25.6 million. Cash Flow from Investing Activities Net cash used in investing activities during the nine months ended September 30, 2024 was $69.1 million compared to net cash used in investing activities of $15.2 million during the nine months ended September 30, 2023. The increase in cash outflows was primarily driven by cash used for the investment in Brain Corp of $32.1 million and cash used, net of cash acquired, for the acquisition of TCS of $25.7 million. Cash Flow from Financing Activities Net cash used in financing activities during the nine months ended September 30, 2024 was $8.1 million compared to net cash used in financing activities of $87.1 million during the nine months ended September 30, 2023. The decrease in cash outflows was primarily driven by proceeds from exercises of stock options and net proceeds from borrowings, partly offset by share repurchases and dividend payments. Newly Issued Accounting Guidance See Note 2 to the consolidated financial statements for information on new accounting pronouncements. In October 2023, the FASB issued ASU 2023-06 Disclosure Improvements: Codification Amendments in Response to the SEC's Disclosure Update and Simplification Initiative, which aims to clarify or improve disclosure and presentation requirements on a variety of topics and align the requirements in the FASB accounting standard with the Securities and Exchange Commission regulations. This guidance is effective for the Company no later than June 30, 2027. We do not expect the amendments in this update to have a material impact on our consolidated financial statements. In November 2023, the FASB issued ASU 2023-07 Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures, which requires an entity to disclose significant segment expenses impacting profit and loss that are regularly provided to the chief operating decision maker. The amendments in this ASU are required to be adopted for fiscal years beginning after December 15, 2023, and interim periods within fiscal years beginning after December 15, 2024. Early adoption is permitted. We are currently evaluating the impact of adoption on our financial disclosures. In December 2023, the FASB issued ASU 2023-09 Income Taxes (Topic 740): Improvements to Income Tax Disclosures, which is intended to enhance the transparency and decision usefulness of income tax disclosures. The amendments in ASU 2023-09 address investor requests for enhanced income tax information primarily through changes to the rate reconciliation and income taxes paid information. The amendments in this ASU are required to be adopted for fiscal years beginning after December 15, 2024. Early adoption is permitted for annual financial statements that have not yet been issued. The amendments should be applied on a prospective basis although retrospective application is permitted. We are currently evaluating the impact of adoption on our financial disclosures. 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 31 Table of Contents 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; 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, 2023. 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, 2023. For additional information, refer to Item 7A of our annual report on Form 10-K for the year ended December 31, 2023.