Good morning. My name is Rob, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Tennant Company's 2022 Third Quarter Earnings Conference Call. This call is being recorded. There will be time for Q&A at the end of the call. [Operator Instructions] After the Q&A, please stay on the line for closing remarks from management. [Operator Instructions] Thank you for participating in Tennant Company's 2022 third quarter earnings conference call. Beginning today's meeting is Mr. Lorenzo Bassi, Vice President, Finance for Tennant Company. Mr. Bassi, you may begin.

Good morning, and welcome to Tennant Company's third quarter 2022 earnings conference call. I'm Lorenzo Bassi, Vice President of Finance. Joining me today are Dave Huml, Tennant's President and CEO; and Fay West, our Senior Vice President and CFO. On today's call, we will update you regarding our third quarter performance and revised guidance for 2022. Dave will brief you on our operations and enterprise strategy, and Fay will cover the financials. After their remarks, we will open the call to questions. Please note, a slide presentation accompanies this conference call and is available on our Investor Relations website at investors.tennantco.com. 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 third quarter earnings release includes the comparable GAAP measures and a reconciliation of these non-GAAP measures to our GAAP results. Our earnings release was issued this morning via Business Wire and is also posted on our Investor Relations website at investors.tennantco.com. I'll now turn the call over to Dave.

Thank you, Lorenzo, and thank you all for joining the call today. Our third quarter results reflect continued customer preference for Tennent's portfolio of cleaning products and solutions and demonstrate our commitment to maintaining profitability in the current operating environment. Incremental price realization, growth in aftermarket services, parts and consumables and strong cost discipline contributed to sequential improvement in adjusted EBITDA and adjusted EBITDA margin in the third quarter. Additionally, pricing and cost-out actions covered the impact of inflation on a dollar-for-dollar basis in the quarter. While adjusted EBITDA for the quarter was in line with our expectations, we achieved those results differently than planned, and this has informed our full year expectations. On our previous calls, we outlined several strategic initiatives as well as targeted investments in inventory in order to stabilize our supply chain, unlock production and reduce product lead times in the second half. We continued to action against these initiatives, which have provided incremental benefits, but supply challenges persist, most notably for electronic components and sub components. As a result, production has not ramped as quickly as we had expected and did not increase sequentially in the third quarter, which adversely impacted sales volumes across all regions. We do believe, however, that because of our continuing efforts, we are better positioned for success going forward. This is critically important as we work to address our global backlog, which has grown steadily since 2021 and is now over $280 million, roughly 5 times normal levels. Our near-term priority is to reduce our backlog and satisfy the customer orders that we have already secured. We are actively working to reduce lead times and appreciate our customers' patience and flexibility during this period of extended lead times. Based on the minimal number of order cancellations to-date, we have confidence…

Thank you, Dave. Third quarter net income was $15.6 million compared to $21.5 million in the year ago period. Excluding non-operational items, such as amortization and restructuring charges, adjusted EPS for the third quarter was $0.99 per diluted share compared to $1.33 per diluted share in the year ago period. Lower gross profit, higher interest expense due to higher underlying rates and an increase in income tax expense were the primary drivers of the year-over-year decrease. Gross margins were impacted by inflationary headwinds, the timing and realization of pricing actions as well as lower production volumes. Certain discrete tax items were favorable in the prior year period and were non-recurring in 2022. S&A costs were favorable compared to the prior year and partially offset this decrease. Foreign currency adversely impacted adjusted EPS by $0.14 per diluted share. For the third quarter of 2022, Tennant reported net sales of $262.9 million, a 3.3% decrease compared to the prior year. Comparisons between periods were significantly impacted by foreign currency fluctuations, which drove a 5% decrease in net sales. On a constant currency basis, organic sales increased 1.7%. Tennant groups its sales into three geographies: the Americas, which includes North America and Latin America; EMEA, which includes Europe, the Middle East and Africa; and Asia-Pacific, which includes China, Japan, Australia and other Asian markets. Organic sales in the Americas and EMEA increased 4.6% and 0.6%, respectively, versus the prior year period. The increase in the Americas was primarily due to the impact of higher selling prices as well as volume increases in Latin America. Growth in services, parts and consumables as well as the impact of higher selling prices contributed to the year-over-year growth in EMEA. APAC organic sales declined 14%, primarily due to volume declines in China as local shutdowns related to…

[Operator Instructions] And your first question comes from the line of Chris Moore from CJS Securities. Your line is open.

Hey. Good morning, guys. Thanks for taking a couple of questions. So looking for increased volumes in Q4. Maybe you could just talk a little bit about your visibility now into Q4 at this point versus three months ago, visibility into Q3.

Yeah. Good morning, Chris. Thinking about our revised guidance and the implied Q4, let me break down how we're thinking about delivering the quarter. We talked in the second quarter about taking a number of actions to ramp our output in Q4, and we executed those actions. We are getting impact but not the full impact that we expect particularly on the side of securing more parts to fuel production. So Q4 implies an increase in output production from our plants. It's on par with plant output from Q1 and Q2. So we think it's reasonable, and we have line of sight to achieving it. In addition to that, our Q4 performance implied in our revised guidance. We need to continue to realize price at the rate that we have been and we're confident that we can do that. And we've been augmenting and we'll continue to augment our revenue with products from less constrained plants. So we talk about leveraging our mid-tier products produced in Italy and China into other geographies and into channels and to customers where some of our other products are more constrained as well as 100% sourced products. For example, the IMOP product that we sell successfully. We're counting on some IMOP sales to augment our revenue in the fourth quarter. So we've got a line of sight to delivering it. It will come different -- from different actions than we had anticipated when we last spoke, but we do have line of sight to deliver in the quarter and therefore, the revised guidance.

Got it. That's helpful. Are there any wild cards in Q4? I mean are you assuming an improved electronic components flow or kind of anything that still is a little bit outside of your control at this stage?

Well, I'll preface my remarks for saying 2022 has been a year of wild cards. If you think about the combined effect of FX and Russia-Ukraine impacts on energy and the EBITDA headwind that's created for us, anything could happen in Q4. But as we think about it and particularly it is relevant as we think about the parts shortages on electronics. We've got line of sight to deliver the quarter. We've taken actions to secure an inventory of some Tier 2 components. We are reflecting the continued volatility and unpredictability in supply chain in our guidance. And so at this point, we have line of sight, and the guidance really reflects a balanced view of both our risks and opportunities. And so we're confident we can deliver on the revised guidance.

Got it. That's helpful. So obviously, you talked about continuing to work price. You're scrambling on the supply side a little bit. Gross margins were 38.3% in Q3 down 180 basis points. I'm just trying to get what is a reasonable estimate for Q4. Let me put it a different way. What would it take to get to approach 40%? Is that in Q4? Is that too aggressive or is that something that could be achievable?

Yeah. We don't guide on gross margin typically. But you -- since you offered a number, I’ll -- I think that's unrealistic to think that we'll achieve that rate in Q4. But let me comment more broadly on how we're thinking about pricing because really, when you think about margin expansion, it's largely the pricing versus inflation story and our ability to offset it. We've continued to publish increases at rates we believe will cover inflation over the long haul, our realized inflation. We are getting strong price realization. I think that's partially due to operating in an inflationary environment, but also speaks to the strength of the Tennant brand and the strength of the Tennant selling (ph) organization in driving price and realizing price as it's published. We've continued to publish off-cycle price increases in 2022, and those are reading through. Our pricing impact is affected and delayed by backlog as the price rolls through our backlog. And so the inflation in 2022 has come through more strongly than we had originally forecasted. We are pricing in response and taking aggressive pricing action to offset it. We actually offset inflation in Q3. We covered it, and we will come very close to covering it on a full year basis with what we see today. And so we really need to see how Q4 shakes out and look at that price versus inflation equation and take appropriate action into the future. So hopefully that gives you a little more color around the margin story for Q4.

And maybe building on what Dave just said on Q3, particularly, right, on the gross margin. So we have seen an expansion of roughly 40 basis points in our margin sequentially in Q3 over Q2. And as a proof point of the continuous realization of pricing, 90 bps coming from pricing and then partly offset by inflation net of cost out and some mix in there as well. But so kind of the proof point is the expansion between Q3 and Q4 of margin by 40 bps.

Got it. That's very helpful. I will leave it there. I appreciate it, guys.

Thanks, Chris.

Thank you.

Your next question comes from the line of Steve Ferazani from Sidoti. Your line is open.

Good morning, everyone. Wanted to get a sense of -- I mean, I guess there are two pieces here, which is supply chain constraints and demand now. And if you can sort of give a sense of are you expecting any further easing on supply chain or does this run well into 2023? And if you can sort of walk through the demand picture from your three different regions?

Yes, I'd be happy to. Thanks for the question, Steve. I'll answer the supply chain question first. We don't anticipate significant easing and supply chain into 2023. We just don't see it, or have line of sight to it. We have no commitments from suppliers that would give us -- or performance that would give us a reason to believe. So the actions that we've taken and are taking are having impact. We have pockets of success. The challenge on supply chain is you need 100% of the parts in order to ship a completed unit. And so while we've had some pockets of success on individual components, specifically Tier 2 electronics, it's not been a sufficient amount or across the broad range of components we need to support a material ramp in production. So just environmentally from the market, we don't expect a meaningful increase or improvement in supply chain in Q4 or out into 2023. We're monitoring it closely, and we'll obviously take advantage of any improvement that we're able to realize either from the broader market or from the many actions we've executed to secure inventory, and better plan with our suppliers, set up duplicate suppliers for some constrained components and localize our supply chain to better serve our local production plant. So we're poised to benefit as the market improves. From a demand perspective, let me give a bit of color around what we're seeing in demand. And really, it's hard to talk about demand without also talking about backlog, but I think we covered backlog sufficiently in the release and maybe in the prior questions. We've seen moderating demand after really seven quarters of increased demand and we've been -- what we're seeing now, if you just isolate to Q3 is demand that has softened…

I appreciate that, thoughtful answer. If I can get one more and given the first-three quarters on the cash flow. Are you -- do you think you can be break even cash flow this year or are you expecting negative this year at this point?

Yeah. Listen, I'm pleased with the investments we've made in the business and somebody asked me the other day if I would do it over again, I absolutely would. Largely, the cash flow picture is a result of the investments we made in inventory and the inventory investments were to drive parts into the system to recover from the supply chain challenges we've had, increased plan to output and service our backlog. And so we have inventory on hand. It's one of the reasons we chose to quantify our backlog as well because -- our inventory, we've grown it to $199 million. We added $11 million in third quarter. And without the context of a $280 million backlog, it's hard to understand why we would make those investments. Now knowing that we've got the $280 million, $200 million of its current, it provides an approach. So we're comfortable with the investments we've made from an inventory perspective, and that's what drive -- it just driven the cash flow picture year-to-date. We're anticipating that we'll be cash flow positive in fourth quarter, but not for the year given the investments we've made to date. But again, I think the inventory doesn't spoil or we're going to need it here as we move through Q4 and as we seek to reduce that backlog heading into 2023.

Fair to say your cash flow perspective is driven by your supply chain perspective, if supply chain is getting a lot easier that would convert a lot faster.

Absolutely, and if supply chain -- it's painful to look at a $280 million backlog, $200 million of which is current and think about the kind of year we could be delivering, if we were able to secure the parts to increase production. So absolutely, as we're able to loosen up and unlock some of the supply chain constraints will be -- our belief is we'll be able to quickly convert that into increased production outputs and our cash flow picture reverses very quickly.

Fair enough. Thanks, Dave. Thanks, Fay.

Thanks, Steve.

[Operator Instructions] Your next question comes from the line of Tim Moore from EF Hutton. Your line is open.

Thanks. And I was impressed by your EBITDA margin improvement despite the component shortages and China shutdowns and foreign currency drags on the top line. It was nice to see the SG&A leverage in the quarter. I have about four questions. First off, I was just wondering, we're seeing a lot of industrial companies be in the same boat with the transitory deceleration in their volumes in the September quarter. And on the supply chain components front, I was wondering if you could kind of elaborate on, are you doing assemblies and then having to revisit the production because you're getting to, let's say, 80% to 90% assembled, you're missing one or two components and have to go back to finish the product. So I'm just wondering if that's also eating away at the gross margin.

It is eating away at gross margin. It's also increased our inventory because we use -- we termed the phrase built but not shipped. And these are -- you can think about it this way. When we have the opportunity with an assembly slot to build a 99.9% complete unit, and primarily those units are waiting on circuit boards rather than give up the production slot and install the line or shut the line down, we will build ahead units that are missing on -- typically circuit boards. And so we'll build ahead to complete unit, we'll set it aside when the circuit boards arrive, we bring the unit back out, assemble it with the circuit board test it and ship it. It's obviously a less productive way to run the plant, but we've convinced ourselves based on the analysis we've done that not only does it preserve the leverage we get on the productivity we get, on keeping the assembly lines running but also, over time, we're able to put more product out than we would otherwise be able to running the plant in a more normal fashion. So we're utilizing the built not shipped methodology but as needed across our operations.

That makes sense. And it also seems like that's kind of a coiled spring of maybe some margin expansion, whenever things that they ever do normalize for [Indiscernible] you won't have to go revisit and do one more final step sometime next year, whenever things hopefully come back in line with the supply chain. My next question is, I know the 10-Q is not out yet for a breakdown of equipment versus parts and services. Are you seeing the parts and services revenue line items hold up better than equipment in the September quarter?

Yes. So the Q actually is out or will be out today, we should be posting here today. And when we look at equipment and parts and consumables, it's roughly in line with last year. There is sequential growth, certainly in North America and in EMEA, but that's slightly offset by foreign currency headwinds. So when you're looking at comparability about this is impacted by foreign currency.

Okay. Great. I guess, you would just posted when I checked a half an hour ago, but what about on the robotics topic? Has the level of interest in the AMRs? Have they held up? I know you had record sales year-to-date when you mentioned that [Technical Difficulty] just kind of more [Technical Difficulty] if you can give us any color on the robotics?

Yeah. I'd be happy to. Interest and demand for our robotics platforms continues to be very robust. The platforms we have allow us to engage customers across virtually every vertical market we serve and the pipeline of interest is still there. Now robotics have not been immune to the supply chain challenges we've seen either. So there's about $10 million worth of backlog on AMR sitting in that total backlog number. But we're really pleased with progress on AMR. I know Sam's Club was public with their completion of a 600 unit roll out of scanning tower, inventory scanning tower mounted to our AMR equipment in that environment. And we think that's a proof point of not only the demand for robotics cleaning equipment to solve our customers' most pressing labor shortages, but also an example of a potentially attractive adjacency for us to explore in the future. So we're really proud of the team's agility to be able to capture that order, deploy the inventory scanning towers and get Sam's Club up and running remains to be seen, whether Sam's Club can realize the return on the investment in terms of the improvement -- their operational improvements that they're targeting, and we're partnering with them to make sure that we can deliver the up time on the equipment to keep the scanning data flowing the way they need to. But yeah, globally, we're very pleased with our robotics offering. It continues to be one of our most exciting growth vectors as a company. We've invested significantly to have the portfolio we have now, and I firmly believe that we are the leader in the industry in robotics cleaning equipment. So we're excited, we're continuing to double down on the space.

Great. Now that's good to hear. I was very impressed learning a lot about that inventory scanner a few months ago and have a bunch of colleagues and friends that I know how much of a drag it is to do the manual inventory work and EV attachment. What about -- can you kind of give us more of a sneak peak, Dave or Fay on the innovation pipeline that you look at over the next year? I know you mentioned the IMOP in the current quarter, but are there any interesting launches or any adjacency's that you feel like you can hammer home more and grow significantly next year as you look out to the pipeline and launch schedule?

Short answer, yes. We are very bullish on our new product innovation and the pipeline and what we're going to bring to market to help solve our customers' toughest challenges. We don't typically like to pre-release our new products on our earnings call, but I'll give you just kind of an indication of where we're heading as far as innovation vectors that I think will give you a sense. I've already mentioned how bullish we are on robotics and also the data associated with robotics as we pull data off of these machines and the environments that we're operating in, we think there's a data adjacency to explore as well. We're hearing a demand from our customers for electrification of products as they seek to eliminate internal combustion engines and pursue their own sustainability goals. And so we are equally aligned and we expect to be moving in that direction. We've been leveraging our acquired brands, I'll say, one of our mid-tier brands, legacy IPC platforms and legacy Gaomei platforms into other geographies. And those are really interesting to us because they allow us to penetrate new segments within the market, more price competitive segments compete on a different price point and also a different durability, reliability level and the performance that the customer expects. It also allows us to maintain the premium on our Tennant branded product as that occupies a higher price points and delivers a more robust range of performance attributes to those customers that need it in their application and are willing to pay for it. And then we mentioned IMOP, I would broaden the conversation to say we've continued to see an opportunity in cleaning of small space environments. Tennant's legacy has really been around larger store formats and larger floors where we are the best available option to keep those floor sizes clean. We noticed there's an opportunity of small spaces within larger buildings, but also small stand-alone spaces. And so that brought us to leverage the IMOP product as well as launch our own CS5 product, which is a small portable compact cleaning machine, mechanized cleaning machine that can replace the mop and bucket in some applications and provide a better-finished product [Indiscernible] floors. So that small space environment in someplace else, you can expect to see us continuing to innovate to help our customers solve problems.

That's terrific color, and it seems very promising. My last question is with nearly $60 million cash on the books and a lot of untapped borrowing capacity. I know that the management team is very busy. There's constraints in the whole operational chain you're improving your efficiencies. But have you started seeing some attractive acquisition opportunities come up or asking multiples coming down to be more reasonable over the past few months as the stock markets pulled off since April?

Yeah. Listen, we're not going to comment specifically on M&A activity, but broadly, I'll give you a sense of how we're thinking about it. There's no shortage of challenges to manage in the short term. And the way we think about it is we have to, because of the environment, manage the urgent in the short term, but also focus on the importance for the long term. And inorganic growth, it can be a powerful component of our capital allocation priorities going forward. We've already demonstrated that with a number of acquisitions we've made in the past. So we continue to be very open and opportunistic. Obviously, as you noted, we've got the [ powder ] to move if we want to. We are continuing to canvas the spaces we find most attractive for opportunities, and we feel like we're well poised both financially and strategically to move if we decide to. It's a very interesting environment, as you mentioned, from a valuation perspective, given what's happened in the broader stock market valuations are moving all over the place. Borrowing rates have increased dramatically. So it's certainly a volatile environment, and it's prudent for us to keep tabs on potentially interesting opportunities and going to be opportunistic. But we think we're well positioned to move if we decide to, and it certainly is a key component, and we highlight where it fits in our capital allocation priorities moving forward.

Well, thanks, Dave and Fay for the color and that concludes my questions.

Thank you.

Thanks, Tim.

And we have a follow-up question from the line of Chris Moore from CJS Securities. Your line is open.

Hey. Thanks for taking the follow-up. Just curious, of the $280 million in backlog, roughly how much of that do you have 100% of the parts for today?

Zero. If we had the parts to fill any unit in our backlog, it would be out the door.

Got it. Appreciate it.

I know, it sounds like a very short answer, but that's the [Multiple Speakers] we would pull out all the stops, meaning production, we would get it done and fill that customer order because that backlog -- backlog is a positive and negative, and it's painful to have that many customers that want our product and we're unable to deliver to them. So if we could secure 100% of the components to build a product, Fay and I would probably go down and assemble it ourselves.

Fair enough. I appreciate it guys.

Thank you.

Thank you.

And since there are no further questions at this time, I would like to turn the call over to management for some closing remarks.

Thank you. I want to personally thank every Tennant employee globally for their hard work, collaboration, and customer commitment as we're working together to create a cleaner, safer, healthier world. Lastly, I wanted to note that we will be presenting at the following conferences: the Baird Global Industrial Conference on November 8th and the NYSE Industrials Virtual Investor Access Day on November 16th. This concludes our earnings call. Thank you for your time and have a great day.

This concludes today's conference call. You may now disconnect.