Good morning. My name is Devon and I will be your conference operator today. At this time, I would like to welcome everyone to Tennant Company’s 2022 Fourth Quarter and Full Year Earnings Conference Call. This call is being recorded. There will be a Q&A session at the end of the call.

[Operator Instructions] Thank you for participating in Tennant Company’s 2022 fourth quarter and full year earnings conference call. Beginning today’s call is Mr. Lorenzo Bassi, Vice President of Finance for Tennant Company. Mr. Bassi, you may begin..

Good morning, everyone and welcome to Tennant Company’s fourth quarter and full year 2022 earnings conference call. I am Lorenzo Bassi, Vice President of Finance. Joining me on the call today are Dave Huml, Tennant’s President and CEO; and Fay West, Senior Vice President and CFO.

Today, we will provide you with an update on our 2022 fourth quarter and full year performance as well as guidance for 2023. Dave will discuss our operations and enterprise strategy, and Fay will cover our financials. After our prepared remarks, we will open the call to questions.

Please note the slide presentation accompanies this conference call and is available on our Investor Relations website at investors.tennantco.com. Before we begin, please be advised that our remarks this morning and our answers to questions may contain forward-looking statements regarding the company’s expectations of future performance.

Such statements are subject to risks and uncertainties, and our actual results may differ materially from those contained in the statements. These risks and uncertainties are described in today’s news release and the documents we filed with the Securities and Exchange Commission.

We encourage you to review those 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 2022 fourth quarter and full year earnings release includes the comparable GAAP measures and a reconciliation of these non-GAAP measures to our GAAP results. Our earnings release was issued this morning via Business Wire and is also posted on our Investor Relations website at investors.tennantco.com. I will now turn the call over to Dave..

to win where we have competitive advantage, reduce complexity and build scalable processes and innovate for profitable growth. Despite all the potential for distraction in 2022, the team remained focused on our enterprise strategy.

As it relates to winning where we have a competitive advantage, our work is largely complete, and we’ve instilled new disciplines into how we’re managing the business going forward. We invested significant time in an 80-20 approach to rationalize our portfolio.

Since 2020, we have intentionally exited non-core product lines and businesses accounting for more than $50 million in annual revenue. Turning to the second pillar, reduce complexity and build scalable processes. As we have grown our business inorganically, we introduced multiple ERP systems.

These 8 disparate systems introduced a level of complexity into our organization as processes are not entirely standardized. This year, we plan on evaluating the benefits, costs and risk of implementing a consolidated ERP globally. We realized that an ERP implementation would be a significant undertaking, but could also unlock significant value.

We have not included any costs or capital in the current guidance for 2023 and anticipate that we will have our analysis completed in Q3 and we will update you accordingly. Overall, the implementation of our enterprise strategy is a continuous process particularly with respect to the third pillar, innovate for profitable growth.

To supplement our R&D efforts, we recognize that we have the unique opportunity to be even more intentional on inorganic growth. Our IPC and Gaomei acquisitions demonstrated our ability to successfully grow through acquisitions close to our core.

In 2023, we will conduct a strategic review to determine the most attractive adjacencies to focus our investments for inorganic growth. Before turning it over to Fay to review 2022 financial results and 2023 guidance, I wanted to acknowledge the resourcefulness and perseverance our team displayed to deliver organic sales growth in 2022.

I am very proud of the team’s efforts, and we are well positioned for future success. With that, I will turn the call over to Fay for a discussion of our financials..

net sales of $1.115 billion to $1.155 billion, reflecting organic sales growth of 3% to 7%.

Full year reported GAAP earnings in the range of $3.10 to $3.90 per diluted share; adjusted EPS of $3.70 to $4.50 per diluted share, which excludes certain non-operational items and amortization expense, adjusted EBITDA of $140 million to $160 million; capital expenditures of $20 million to $25 million and an adjusted effective tax rate of 20% to 25%, which excludes the amortization expense adjustment..

Thank you, Fay. With that, we will open the call to questions. Operator, please go ahead..

[Operator Instructions] Our first question comes from Chris Moore with CJS Securities..

Hi, good morning, guys. Thanks for taking couple of question..

Good morning, Chris..

Good morning. Maybe just start with on the production level side. So obviously, it’s not where you need to see. I’m just trying to get a little better sense in terms of how far away are you? How much visibility in getting there? Maybe asked it a different way.

Your guidance is 3% to 7% organic growth if there was no supply chain issues, would that be meaningfully higher..

Thanks for your question, Chris. I’ll try to put some additional dimensions around the plant output embedded in our Q4 and our full year results and then your hypothetical scenario where there is no part shortages is a really interesting one to us. We’d love to operate in that environment.

So while we don’t anticipate that being the environment in 2023, we would welcome that would be a welcome change for our business.

When you look at our fourth quarter performance from a revenue perspective, much of the result was driven by our price realization as we gain the benefit of previously published price increases reading through into our results.

I think what’s hidden underneath the headline and what’s really a reason for us to have some optimism is that we can map some specific increases in production output to specific investments and actions that we took in calendar year 2022 to try to overcome the part shortages.

So the fact that we can point at specific actions we took with specific suppliers on specific components and how it read out to an increase in a specific product line in Q4 gives us a cause for optimism, believing that the investments and actions we’ve taken are targeted in the right areas and that we are able to effect change.

So it’s a reason for optimism, but we certainly have not pivoted to a full recovery. And so not all of the actions we took in 2022 read out in Q4, nor do they read out as fast or at the magnitude we had hoped for or expected.

So some of the benefits of the actions and actions we took investments we made will bleed over and hopefully provide benefit in 2023. From an environmental standpoint, we don’t expect supply chain shortages to quickly rectify themselves from a landscape perspective.

We’re taking lots of actions to try to overcome the challenges that we have with our specific suppliers and our specific parts that were challenged, but we’re not expecting nor are we baking into our planning assumption, a significant recovery in the landscape of parts availability.

So as I look at the Q4 experience, I’m really proud of the efforts we took in 2022 and the investments we’ve made. We can map some of those actions to providing benefit in Q4. We’re confident that some of those will continue to provide benefit out into 2023. We are far from having a clear line of sight to recovery.

And net-net, I would say that Q4 is an important proof point along our path to stabilization. And so first, we need to stabilize before we can drive recovery. You asked – I think embedded your question, Chris, was kind of line of sight, how are we operating from a supply chain visibility perspective.

If you go back a quarter ago or two quarters ago, and I think we highlighted this on the call, certainly talked about it in our one-on-ones, we were largely hand to mouth. And so we didn’t have a predictable supply of components from our suppliers. They weren’t delivering to their committed dates or in the quantities that they committed.

And so we were hand-to-mouth trying to keep the production lines running. In some cases, on some lines, we are still hand-to-mouth, but that has gone down.

The number of lines of our hand to mouth has decreased, and we’ve gained better visibility to the supply of parts that we need for, let’s say, the next month and so rather than being hand to mouth across the majority of our lines.

Now we’ve got some visibility across the coming months and are reasonable confident we will receive the parts as they were committed from our suppliers.

And I think the other thing we see is more predictability, better predictability from our supply base, where in the past, middle 2022, we were dealing with suppliers have committed and then didn’t deliver on time or in the quantity we expected. We’re still seeing some impredictability but it seems to be improving from a predictability standpoint.

Again, not getting all the parts we need as fast as we like, but becoming more predictable. That’s why I would characterize this more as stability than kind of a trajectory of recovery yet. When you think about recovery from – purely from a supply chain perspective, we think that it will be – continue to be choppy.

We think that while we can take actions to overcome some of the challenges and have positive impacts, we are still seeing ad hoc disruptions caused by suppliers with whatever the cause is, whether they have a lack of labor or they have challenges upstream.

We are still seeing sort of ad hoc challenges we are having to manage an elevated number of suppliers to make sure that they can meet our requirements. So net-net, I would say we’re stabilizing, and we expect to be on a path to recovery, but we don’t line of sight to it yet..

Got it. Extremely helpful. Thank you for that. So it looks like you guys have done a really good job kind of managing S&A while things have been kind of up and down. It feels like I’m just wondering if this level might necessarily be sustainable moving forward. I mean I think it was 28% of revenue in 2022.

That’s quite a bit lower than where you had been a couple of years back.

Just wondering from an S&A standpoint, moving forward, are there some costs that could come back in there in ‘23 or just kind of how you’re looking at it?.

So the way that I would characterize it is we are challenging ourselves daily on how to best operate the company, including managing our cost on the S&A line. And we saw significant improvement year-over-year.

In our anticipated 2023 guidance, we’ve corrected for a certain number of things like travel, which is opening up or the reversion back to certain kind of compensation and other areas. But in general, our goal is to manage our S&A appropriately and to manage it to a percentage of sales.

And I think what we achieved in the realm of achievement in 2023..

Chris, I would just add, I think we’ve demonstrated over time and certainly in 2022 that we can manage S&A accordingly to how the business is performing. We took decisive actions throughout the year to deliver the results that we were able to and some of those around the S&A side.

I will tell you coming through Q4 and into 2023, we are going to be very cautious with our S&A spend to make sure that we don’t get ahead of ourselves before the business is signaling that we can afford the incremental investments..

God it. And maybe just last one for me. Cash flow from operations, $25 million you went through the big drivers, receivables, inventory, some other things.

Just big picture, kind of how are you looking at ‘23 versus ‘22?.

Yes, I think you’re going to see a reversion back to normal in 2023. I think we had some significant investments in working capital, primarily around inventory. And we anticipate that, that will revise that usage will revise in 2023. And so you’ll see a glide path down. as we go through 2023. So we think we will go back to normal.

So certainly, the improved performance from an operations perspective will drop through to operating cash flow as will kind of more normalized working capital activity..

Chris, it’s probably worth noting in 2022. These were really intentional investments that we made on the inventory side, given the situation we’re operating. And if you look at the year – the increase in exit inventory from Q4 ‘21 to Q4 ‘22 and just look at the components, what drove the increase, about third of it is inflation.

About third of it is intentional investments either in constrained parts inventory or with and about third of it is supporting new product launches like lithium-ion batteries and our IMOP product we talked about on the on the call, as well as we allowed an increase in our service truck inventory to support our customers and keep their machines running up to the service levels that we committed to them.

So I make the point because it’s important to dimensionalize the impact on cash flow in 2022 was intentional on our part given the environment we had to operate in..

Got it. I appreciate it. I’ll get back in line. Thanks, guys..

Thanks, Chris..

Our next question comes from Steve Ferazani with Sidoti..

Good morning, Dave. Thanks for all the detail on the call. I did want to follow-up the last question in terms of if we have that glide path to more of a normalized working capital, it looks like the additional debt you took on through the year was to meet the working capital needs. I’m just trying to think about what you’re expecting on the debt side.

And then in your guidance, what’s the interest expense?.

Yes. And so yes, you’re absolutely right. I think those investments in working capital were financed with our revolver. We are always looking at how we manage our leverage. Certainly, at the midpoint of our guidance next year, we don’t have to meaningfully reduce our leverage to get to 1.5x or below.

And we do have some amortization on our term loan that we have to pay. But with any excess cash, we could potentially pay down debt further if we need to.

And so I would say that in 2023, you saw kind of the increase in interest costs as we went through the year based on the increase in underlying rate on an average basis for 2023, net of hedging activities because we took some decisive actions in the fourth quarter to fix a portion of our floating rate debt, about $120 million or 40% of our debt to fix that out.

But what we saw from an average rate in 2022 was about just shy of 3%. But that was increasing throughout the quarters. And in the fourth quarter, it was just shy of 5%. I would say that if you look at fourth quarter interest expense, that would be a good proxy for 2023. And just based on kind of how we’ve hedged and fixed out a portion of the debt.

Our guidance does assume a moderate increase in the underlying rate. Now if it does something different than that, we will go back to you..

Okay, that’s helpful. Thank you. I do want to get back to the sales guidance, the 3% to 7%.

I’m trying to think about how much of that is pricing – do you have a mix there?.

Yes. I think if you just and Dave, I’ll start and you could just jump on. I think if you look at just our midpoint of our guidance range, it’s about a 5% year-over-year increase in organic sales. And the way to characterize that is about 20% of that we think is coming from volume and about 80% of that is coming from price..

Perfect. So what obviously, the expectation was we would see the gross margin pick up here in the fourth quarter. So you fully realize some of these price increases. But as you noted, there is still some older priced backlog, which you’re working through.

Do you have any sense what that margin might have looked like without the older priced backlog and how you’re thinking about margins? Because you’re getting – you’re really starting to make that move back to more historical levels.

I’m just trying to see how you get there given the fact that you have almost a quarter of backlog still built in there or more..

Yes. We didn’t model the quarter on the margin impact from incoming orders versus backlog. We just didn’t model it. Obviously, the more a backlog is sitting prior to one, two or three price increases and so on.

But the fact that we’re not working backlog in a fight all manner makes it really difficult to track what the impact was versus would have otherwise been. I have to say we’re encouraged by that we’re still getting strong price realization. So we’re encouraged by that. We’ve got our price increases largely published.

– few spots in the world are still yet to publish, but major geographies we published. And we’re getting good stick rate, good realization.

So it’s really credit to our selling organizations around the globe as they are doing a fantastic job selling in multiple significant price increases over the year and making sure that we get paid back for the value we’re delivering and also the inflation that we’re feeling in the business.

Fay mentioned, we’re counting on about our growth for 2023 is roughly 80-20 between price and volume.

It will be interesting, and we’re monitoring closely not only order demand patterns, but also price realization as inflation moderates and our planning assumption is that largely speaking, inflation will moderate and so we’re monitoring whether our realization sticks at the same rate that we’ve been able to achieve kind of coming through 2022.

But our guidance does imply some expansion of our gross margins. We don’t guide on gross margins obviously, it’s embedded in our guidance..

Maybe building on what Dave said, if you look, Steve, at the over – broadly over the course of ‘22, while we occurred inflation with our price realization from a margin standpoint on a full year basis, it was actually diluted from a rate standpoint.

However, if you look at Q4, you start to see more of those price adjustments to significantly cover inflation largely for margin at 39.6% was over the average by about more than 100 basis points over the average over the first three quarters. So that can kind of give you an indication of how we’re going into 2023..

Great. Perfect. Thank you. Last one for me, if I could squeeze it in.

Just your thoughts on China, obviously, the expectation is we will see more of a reopening as this year moves on? And how much that can impact here? Are you seeing anything yet?.

Yes. We’re watching it closely. We were off dramatically in 2022 in China from a demand perspective. Obviously, the news that the government decided to lift the COVID restrictions as well as the requirements for testing and allow freedom of movement around the country was welcome news to us as we look at our business in China.

Really, the restrictions were lifted and then the country went on holiday. And so while we talk to our team and our channel partners as well as customers, there is some optimism about the reopening of the market I would say we’re all waiting to see it materialize into orders.

And it’s just too early to tell whether the promise of an opening and an increase in our business will fully be realized. The other thing we’re looking at we’re really positioning ourselves to be ready to satisfy the demand if it when it comes.

So from a plant staffing perspective, from a parts availability perspective, we’re staying close to our channel partners and our customers so that we’re ready to react as the demand materializes..

Great. Thanks everyone..

Thanks, Steve..

Our final question comes from Tim Moore with EF Hutton..

Thanks, and nice job with the 10% organic sales growth in the quarter and the sequential improvement from the September quarter on that front.

Just getting back to your 2023 guidance, just regarding the higher end of the range, what factor or two factors might be the main swing factors to achieve more at the high end of the range? Is it really the supply chain or does it also depend on something else like more AMR orders?.

Yes. Listen, we have upside in our new products. There is no question, specifically AMR.

But if you think about the big lever that could – is a big thing that could be a change from our planning assumption and allow us to achieve the high end of the revenue range, it would be a loosening in supply chain so that we could get the parts and react and fill the – not only incoming orders, but meaningfully reduce our backlog.

We’re working hard. We talk a lot about the actions we took in 2022 to position ourselves to overcome some of the most persistent challenges. And while some of them started to read out in 2022, some of them have not yet begun to read out.

And so we really need that improvement in the environment as well as full traction from the actions and investments we took in 2022 to deliver at the high end of the range.

And that’s the reason for such a broad range on the revenue line really is where we’re taking actions, controlling what we can control, but much of that supply chain recovery is out of our hands..

That’s helpful. And I know you’ve already elaborated and mentioned about the component shortages, and you’ve been very good about giving detail on that every quarter.

I guess I’m just wondering, have you seen a good improvement in the last few months on specifically on your dual sourcing and your direct procuring for some difficult to source components.

Is that much better than it was maybe in September, October?.

Yes. It’s really a mixed bag. We talked a lot about on prior calls about circuit boards and electronic components that go into circuit boards. We made a number of targeted investments and took some targeted actions. And some of those actions did read out and contribute to our Q4 performance.

On the other hand, we made investments and actions on other constrained components and didn’t see the benefit in the quarter, although we’re still confident that over time, over time, those will build will read out and provide benefit.

So it’s kind of a mixed bag from our vantage point, and we’re mapping the improvement that we’re seeing, we’re mapping more to the actions and investments we’ve taken that any kind of a broader recovery in supply chain..

Great. You mentioned earlier I’m just trying to think about some of the innovation drivers for 2023. You mentioned earlier you took the mid-tier products for IPC and even Gaomei under the Tennant brand, do the IPC extensions recently.

Is there anything else for small space cleaning or anything else such as, I don’t know, Equipment as a Service being rolled out into more countries for 2023?.

Yes.

We’re really excited about our small space offerings, not only the IMOP products we highlighted in the script, but also we’ve got another product CS5, which we launched, which is a fantastic compact cleaning machine allows us to further penetrate that small space cleaning – we’re excited about the upside in AMR, we continue to be excited about the upside in AMR from our three product portfolio and the fact that we can address customers across virtually all of our vertical markets and increasingly on a global basis, so excited about the upside that we can realize from AMR.

And you mentioned the rebranding of our IPC and Gaomei branded products into the Tennant brand. That’s a really interesting proposition. It was not the original intent when we made the acquisitions. It was a secondary benefit that we would harvest over time.

And given the situation we found ourselves in from a supply chain perspective, it makes sense to accelerate that strategy. And we’re really pleased with how successfully we’ve positioned those products at a compelling price point in the marketplace where it’s not dilutive to the Tennant brand or dilutive to margins.

And I think a large part of the value proposition is that we can take a product that’s designed to a different performance spec, wrap the entire Tennant ecosystem support around it and sell a mixed fleet to our customers. And so customers in North America are familiar with the Tennant brands. They rely on us for our service and aftermarket support.

Now they can buy a product in the Tennant brand that they know and trust with the ecosystem of support they expect at a price point that is warranted for the application and provides them a fantastic alternative.

So really excited about the early returns on that strategy and expect to continue to accelerate with that strategy in North America in 2023 and beyond..

That’s very helpful to hear. My last question is about have you seen any order cancellations over the past few months or customers starting to maybe downgrade to some of the lower tier price models. And then if you can maybe elaborate also on Equipment as a Service. I know you were doing that in some countries.

And do you think you’ll continue rolling that out assertively this year?.

Yes. So on this topic of order – and I apologize, you brought up Equipment as a Service in the prior question. From an order cancellation perspective, we have not seen any material order cancellations. It’s kind of the rare exception. I attribute that to the fact that we’re booking orders and the customer has full knowledge of our lead times.

So they are fully aware of how long they are going to have to wait to get the product. So it’s not like it’s a fade-in switch situation where they believe one thing and then they are surprised. So we’re seeing very few cancellations.

I’m sure there is some percentage of our order bookings that are buy ahead of price increases as well as trying to get in queue for future demand. Time will tell how much of that is kind of pull forward in demand versus real in-period demand. But I’m sure that dynamic exists.

From a sell-down perspective, there are some instances where we just couldn’t get a Tennant branded product in the lead time the customer needed. And so luckily, we had the IPC or the Gaomei branded mid-tier products to slot in and satisfy the customer. I would say that was again, that was an exception rather than a rule.

So we haven’t seen the market sort of trading down because of economic pressure or inflation pressure on their business. We’ve largely seen it hold is a mix that we would expect from a Tennant brand versus kind of other branded products in our portfolio.

And Equipment as a Service is a really compelling value proposition for some customers – we’ve been very successful with it in specific targeted geographies.

And It provides a lower entry point, for example, for a building service contractor and they can link their operating expense to the cleaning contract revenue and be more in control of their profitability by assigning not only the title of the asset, but also the responsibility for keeping it running from a service perspective over to Tennants.

We’re learning a lot in those geographies about which customers find it most compelling as a business model or as a value proposition.

And then as importantly, because the burden, the risk shifts to us to make sure that, that’s a profitable venture, we’re learning a lot about how to set ourselves up from a service perspective and an aftermarket support perspective to make sure that, that’s a very compelling proposition for us from a profitability perspective.

So I would say we’re learning a lot. We’re modeling to make sure that we’re very pleased with not only the market share gain, but also the profitability profile. And we’re optimistic. I think Equipment as a Service in some targeted applications, targeted geographies that could make a lot of sense both for Tennant and for our customers..

Great. Thanks for that color and detail, and that’s it for my questions..

Thanks, Tim..

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

Thank you all for your participation today, and thank you for your continued interest in Tennant Company. This concludes our earnings call. Have a great day..