Xenia Hotels & Resorts Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
October 31, 2023

There are 7 speakers on the call.

Operator

Good morning. My name is Christa, and I'll be your conference operator today. At this time, I would like to welcome everyone to Tennant Company's 2023 Third Quarter Earnings Conference Call. This call is being recorded. There will be time for Q and A at the end of the call.

Operator

After the Q and A, please stay on the line for closing remarks from management. If you have joined our call today via telephone and logged into the conference call presentation on your computer. Please mute the audio on your computer to avoid potentially quality issues during the call. Thank you for participating in Tennant Company's 2023 Third Quarter Earnings Conference Call. Beginning today's meeting is Mr.

Operator

Lorenzo Bassi, Vice President, Finance and Investor Relations for Tennant Company. Mr. Bassi. You may begin.

Speaker 1

Good morning, everyone, and welcome to Tennant Company's Q3 2023 earnings conference call. I'm Lorenzo Vessey, Vice President, Finance and Investor Relations. Joining me on the call today are Dave Hummel, Tennant's President and CEO and Fay West, Senior Vice President and CFO. Today, we will provide you with an update on our Q3 performance, Dave will provide you an update on our operations and enterprise strategy, and Faye will cover our financials. After our prepared remarks, we will open the call to questions.

Speaker 1

An earnings press release and slide presentation that accompanies this conference call are available on our Investor Relations website. 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 Lindsay. 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.

Speaker 1

Additionally, on this conference call, we will discuss non GAAP measures that include or exclude certain items. Our 2023 Q3 earnings release and presentations include the comparable GAAP measure and a reconciliation of these non GAAP measures to our GAAP results. I'll now turn the call over to Dave.

Speaker 2

Thank you, Lorenzo, and hello, everyone. On the call today, I will be discussing highlights From the Q3, our outlook for the remainder of 2023, our performance against our current enterprise strategy targets and The framework and transition to our new planned enterprise growth strategy. I'm very pleased to report our strong Q3 results, Which built on the momentum we generated in the first half of the year. This was the 4th consecutive quarter our global team delivered strong organic net sales and adjusted EBITDA growth above our expectations. Our performance puts us on pace to deliver a record setting year.

Speaker 2

I could not be prouder of the teams who have worked diligently to execute our enterprise strategy, manage the supply chain crisis and serve Tennant's customers around the world. In the Q3, we achieved net sales of $304,700,000 the quarter. We continued to reduce lead times and deliver the exceptional products and services our customers expect from Tennant. Backlog levels have returned to normal in nearly all product lines, except for those industrial products that are exclusively produced out of our Minneapolis plan. We expanded gross margins to 43.3 percent and delivered adjusted EBITDA of $45,900,000 Our price realization efforts along with a moderating inflation environment drove our strong operating performance.

Speaker 2

Additionally, we converted over 100% net income to free cash flow as we continue to make improvements in working capital. This enables us to focus on making strategic investments and return capital to shareholders through dividends and share repurchases. Based on our performance during the quarter and outlook for the Q4, We are increasing our full year 2023 net sales guidance to between $1,230,000,000 to 1,250,000,000 an adjusted EBITDA guidance to between $190,000,000 $200,000,000 Both of these established record highs for the company. We expect that order rates will remain resilient and that parts availability and inflation will remain at current levels, allowing us to deliver exceptional results for 2023. Faye will talk about our new guidance in more detail as she discusses our financials.

Speaker 2

Over the last several years, we have provided regular updates on Tennant's enterprise strategy. Developed in 2019, this strategy focused on driving structural improvements into our business to deliver expanded profitability. Its 3 pillars are 1, winning where we have a competitive advantage 2, reducing complexity and building scalable processes and 3, innovating for profitable growth. These pillars were designed to drive shareholder value and increase adjusted EBITDA margins to 15% by 2024. I am happy to announce that based on our anticipated full year results, we believe we will meet each of our key financial targets by the end of 2023.

Speaker 2

We targeted annual net sales organic growth rate of 2% to 3% net of divestitures. We expect deliver an organic growth rate of approximately 3%. We targeted annual adjusted EBITDA growth rate of 6% to 10%. We expect to deliver 9%. We targeted annual adjusted EBITDA margin improvement of 50 basis points to 100 basis points And we expect to deliver on average approximately 75 basis points of adjusted EBITDA expansion per year, achieving an adjusted EBITDA margin of greater than 15%.

Speaker 2

All of this was achieved a year ahead of schedule amidst the global pandemic and unprecedented global supply chain disruptions. It is a compelling demonstration of the strength of our global team as well as our organizational agility. As we successfully conclude our prior enterprise strategy, we have been planning the next chapter for our company, a pivot to growth. Over the last 4 years, we have built new execution capabilities and rigor and have implemented structural changes that provide a solid foundation for Tennant. We intend to leverage this foundation as we move forward.

Speaker 2

The long term prospects for Tennant Company are very bright and our new growth focused enterprise strategy, Our growth pillar will target differentiated sales growth in the mid single digits and above market growth rates. We will expand profit margins and maintain operating efficiency through pricing discipline, prudent expense management and investments in productivity. Our performance pillar will elevate how our businesses run-in order to optimize cost structure, accelerate decision making, deliver an improved customer experience and embed our sustainability ambitions into our enterprise strategy. We will achieve this by standardizing and optimizing global processes informed by our customer value proposition, investing to modernize and consolidate our existing ERP systems to a best in class SAP cloud based solution. Over the next 2 years, this initiative will build a digital infrastructure for Tennant that will scale as we grow, driving incremental operating efficiency And resulting in incremental cost savings and accelerating our sustainability progress by embedding our thriving people, healthy planet framework across our enterprise to deliver results for our customers, employees and other stakeholders.

Speaker 2

Our performance goals can only be met if our organization attracts and retains talented people who can drive change and help deliver our exceptional products and services to our customers. Our people pillar will achieve this by investing in our employee value proposition So that we can deliver a clear, consistent and compelling promise to employees and prospects about reasons to work at Tennant Company And accelerating our DE and I roadmap and representation ambitions to create an inclusive environment in which all of our employees can thrive. Through our growth strategy, we will proactively supplement organic growth with strategic acquisitions that enhance shareholder value. Based on our financial strength, compelling value proposition and extendable and winning business model, we believe we are well positioned to drive growth Through acquisitions. Tenet has a solid position in an attractive and growing core market with 13% share of an 8 $500,000,000 addressable cleaning market.

Speaker 2

Our first area of focus will be to grow the core through bolt on acquisitions, closing product gaps and strengthening our channel position in attractive geographies. We will also look to leverage our strengths, capabilities and unique assets to explore attractive adjacencies and expand into non cleaning mobile equipment. We will focus primarily on mobile equipment companies that have similar supply chain and manufacturing characteristics, similar end markets or channels and potential cross selling opportunities with the legacy Tennant footprint. Our ideal targets will provide opportunities to extend autonomy and leverage our service infrastructure and expertise. Lastly, we will focus on the connected autonomy technology stack by identifying products and services we want to either develop internally, source on the open market or acquire directly.

Speaker 2

Our disciplined M and A process will focus on those opportunities that provide the right strategic value, operational fit and financial return. We are shifting our M and A approach from reactive to proactive and are resourcing our organization accordingly. With that, I will turn the call over to Faye for a discussion of our financials.

Speaker 3

Thank you, Dave, and good morning, everyone. In the Q3 of 2023, Tennant delivered net income of $22,900,000 an increase of $7,300,000 the prior year period. Strong operating performance was fueled by higher net sales and gross margin expansion. Net sales growth and gross margin improvement were driven by both higher price realization and volume increases. Selling and administrative expenses were higher in the quarter as compared to the prior year period due to higher variable costs the Q3 associated with the increase in operating performance.

Speaker 3

As a percentage of net sales, S and A expense for the Q3 of 2023 increase by 170 basis points to 28.9 percent from 27.2% in the prior year quarter. As we discussed during the Q2, we anticipated an increase in S and A expense and focused our incremental spending on employees and strategic investments to fuel growth opportunities. Higher interest expense and higher income tax expense also impacted net income, in line with our expectations. Net interest expense increased to $3,300,000 in Q3, up from $2,200,000 in the prior year period. The increase was due to rising interest rates on our variable interest rate debt.

Speaker 3

Our interest rate net of hedges was approximately 4.4%. Income tax expense Of $7,000,000 was $2,800,000 higher than the prior year. The comparison between periods was impacted by a decrease in discrete tax benefits recognized during the quarter along with unfavorable changes in the mix and forecasted earnings by country. The 3rd quarter's effective tax rate of 23.4% is in line with full year expectations. 3rd quarter adjusted earnings per diluted share, which excludes amortization, increased to $1.34 per share from $0.98 per share in the prior year period, driven by our strong operating performance.

Speaker 3

Turning to Slide 9. Net sales for the quarter were $304,700,000 a 15.9% increase compared to the prior year period or 13.9% on an organic basis. Approximately 65% of the year over year growth Was attributed to pricing, while the remaining 35% was driven by volume. We ended the quarter with approximately $214,000,000 a backlog, a reduction of $41,000,000 from the end of the second quarter. Continued parts availability standing backlog and deliver customer orders.

Speaker 3

Net sales growth of $41,800,000 in the quarter was primarily due to this reduction in backlog. As a quick reminder, Tennant groups its sales into 3 regions. The Americas include all of North America and Latin America EMEA covers Europe, the Middle East and Africa And Asia Pacific includes Australia, China, Japan and other Asian markets. Each of our regions achieved year over year net sales growth. Net sales in the Americas grew substantially 21.4% to $211,200,000 or 20.8 percent on an organic basis, While FX had a favorable impact of approximately 0.6%.

Speaker 3

This significant year over year growth in our largest region was well above expectations. It was driven by an approximately equal mix of price realization and volume increases lead by strong equipment sales in North America. Net sales in EMEA in the 3rd quarter increased 4.3% over the prior year to $72,000,000 A favorable FX impact of approximately 7.1% was driven by volume declines in both equipment and parts and consumables, partly offset by price realization in all product categories. EMEA volumes were impacted by weaker than expected market conditions. Net sales in the Asia Pacific region increase by 8% over the prior year to $21,500,000 or 11.8% on an organic basis.

Speaker 3

We also group our sales into the following categories: equipment, parts and consumables and service and other. We experienced growth in all categories in the Q3 of 2023 as compared to the prior year period, most notably in equipment sales, which grew 23.2% year over year, well above our expectations. Turning to adjusted EBITDA. Adjusted EBITDA for Q3 was $45,900,000 an increase of $12,100,000 versus the prior year period. Adjusted EBITDA margin was 15.1%, an improvement of 220 basis points versus the prior year.

Speaker 3

Our sales growth driven by both volume and price, Gross profit of $132,000,000 was $31,300,000 higher than the Q3 of last year. Gross margin of 43.3 percent in the Q3 of 2023 improved 500 basis points compared to the prior year. We have successfully returned to pre pandemic gross margin rates based on strong price realization, which offsets the multi year impact of inflation. S and A expense of $88,200,000 increase $16,800,000 compared to the prior year quarter due to higher variable costs associated with increased operating performance And incremental spending on strategic investments. We anticipate S and A expense as a percentage of sales on a full year basis will be comparable to the prior year.

Speaker 3

Turning now to capital deployment. Net cash provided by operating activities was $54,000,000 in the 3rd quarter compared to net cash used in operating activities of approximately $15,000,000 in the year ago period. The increase was the result of improved operating performance coupled with a significant reduction in strategic inventory spend. Capital expenditures of approximately $4,000,000 were in line with our expectations and are on pace to meet our full year guidance. In alignment with our capital allocation priorities, we returned capital to our shareholders with dividend payments of $5,000,000 and repurchased approximately 22,000 shares of our common stock for $1,700,000 We also announced a 5.7% increase in dividends to $0.28 per share, marking the 52nd consecutive year The company has increased its annual cash dividend payout.

Speaker 3

Tenant's liquidity remains strong with a balance of $97,000,000 in cash cash equivalents at the end of the Q3 and $316,900,000 of unused borrowing capacity on the company's revolving credit facility. At the midpoint of our full year guidance range, our net leverage was approximately 0.6 times adjusted EBITDA, lower than our stated goal of 1.5 times to 2.5 times. We have remained focused on maintaining a strong balance sheet. Given our robust cash flow generation and in the current interest rate environment, we have directed cash to reduce debt by 50 $6,200,000 in the Q3. Moving to guidance.

Speaker 3

Our strong performance in 2023 and emerge stronger than ever. As Dave mentioned, we navigated a global pandemic and supply chain disruptions, while still delivering on our enterprise strategy a year ahead of schedule. The changes we have made over the past 3 years demonstrate that our goal of mid single digits and above market growth rates is sustainable. We are pleased with our Q3 results and based on the continuing trends, we are increasing our full year 2023 guidance. Our year to date results have benefited greatly from a significant increase in the availability of parts and we believe we will continue to see overall improvement our supply chain.

Speaker 3

The improvement in parts availability allowed us to increase our production to fulfill open orders and meaningfully reduce backlog. Given this trend, we expect 4th quarter net sales to be between $298,000,000 $318,000,000 an adjusted EBITDA to be between $39,000,000 $49,000,000 Implied in our guidance is our expectation that we will be able to reduce backlog below $200,000,000 and will return to more normalized levels of backlog by the end of 2024 or early 2025. Overall, demand has been resilient. We are monitoring global order rates very closely, especially as we see some market softening in EMEA. Further, we anticipate continued strong price realizations.

Speaker 3

However, gross margins may see some variability in the Q4 as our revenue mix will see some seasonal geographical changes. Based on the timing of spend, R and D expense will be higher in the Q4. We remain cautious and prudent in our spending, but As expected, we anticipate that S and A will be higher in the Q4 as we invest in employees and strategic growth opportunities. Given these factors and the strong profitable growth in the 1st three quarters of the year, we are raising our outlook for the full year of 2023. Specifically, we now expect net sales to be in the range of $1,230,000,000 to $1,250,000,000 reflecting organic sales growth of 12.5 percent to 14.5 percent adjusted EBITDA to be in the range of $190,000,000 to $200,000,000 an adjusted EBITDA margin to be in the range of 15.4% to 16%.

Speaker 3

With that, I will turn it back to Dave.

Speaker 2

Thank you, Fay. We are on pace for a record 2023 for Tennant Company and I could not be prouder of the work our high performance teams have achieved. I'd like to take this opportunity to invite everyone to an Investor Day we will be having in New York in spring of 2024. More details will be published soon. With that, we'll open the call up to questions.

Speaker 2

Operator, please go ahead. Hello?

Speaker 3

Hello.

Speaker 4

Yes. I'm not sure if the line is dead or

Speaker 2

Oh, Good morning. We're having trouble locating our operator. Why don't you go ahead and ask your question? We'll moderate ourselves. Terrific.

Speaker 4

All right. This is Chris Moore from CJS.

Speaker 2

All right. All right. This is Chris Moore from CJS. All notable.

Speaker 4

All right. First of all, congratulations. Great quarter, great year to date. It looks interesting, lots here. So You talked about orders being resilient.

Speaker 4

I think they had been pretty much flat year over year Q1 and Q2. Is that about where you ended Q3?

Speaker 2

Well, first and foremost, thank you. I appreciate the The record quarter, we're really proud of the results we delivered. From an order perspective, yes, we've been describing our order pattern as resilient Given all of the potential for disruption over the last 5 quarters of supply chain crisis and growing backlog and inflation etcetera. Q3 orders were slightly up versus the same quarter in 2022. If you recall, Q2 was a tougher order quarter for us, and we described it as a flattish, which left us questioning what Q3 would hold.

Speaker 2

So the fact that Q3 orders were up on a quarter over quarter basis, gave us some confidence as we look towards Q4. It also appears that we're returning to some semblance of normal seasonality, which allows us to be more predictable on how we forecast our business. Q3 was in line with our expectations. And I'll note at an enterprise level, if you dig within the quarter, one of the metrics we use to get a signal from the business about how the order demand is shaping up as an average daily order rate. And on an average daily order rate basis, September was actually our highest quarter Excuse me, our highest month, year to date.

Speaker 2

So 1 month is not a quarter or a year make, but the fact that we finished Q3 strong As another important data point because some optimism not only on the quarter, but for the year. The one area we're monitoring very closely is EMEA. Orders have been softening in EMEA. Year to date, they were down slightly in the quarter. We think we understand what's underneath that.

Speaker 2

It's driven from a macroeconomic perspective. We want to keep close tabs and we're taking appropriate actions as far as how we plan our business given the softening order pattern in EMEA. But we're monitoring closely to make sure that we're rightsizing the business appropriately and responding to the signals we're getting. Having said that, our share position provides significant upside for us in the EMEA marketplace. And so we're not pulling up tents and going home just because orders are a little bit soft and there's some macroeconomic headwinds.

Speaker 4

Got it. Very helpful. Conversely, it looks like volume was up a bit in China, which Lots of companies are calling out kind of challenges there. Anything you're seeing on that front?

Speaker 2

Yes, it was a great quarter in China. To Markets reopened, we're up over 20% in the region. Obviously, it was an easier comparable. But the fact The market is open. We're able to operate freely and get our product out into the channels and out in front of customers.

Speaker 2

We are harvesting the reopening within the marketplace. It's a positive outlook. We have a similar outlook for order demand in China in Q4, a continuing trend of positivity year over year. So we continue to be bullish on our opportunity in China. And the fact that we've invested we invested in an acquisition in China, our Kaomei brand.

Speaker 2

We have a very broad product portfolio. We've made investments and continue to invest in our multi channel go to market in China. And so we think we're really well positioned to capitalize on the reopening and the market demand in the China marketplace here as we exit the year and set up for 2024.

Speaker 4

Got it. Just lots of talk about a longer higher fed equation. Just Curious how you're looking at pricing beyond 23%. Historically, maybe normal was 1% or 2%. Just any big picture thoughts in terms of what pricing will look like beyond 2023?

Speaker 2

Yes. We're working on that now and pulling the data from the marketplace, not only from internal inflation projections, etcetera, but also market competitiveness. There's been so many moves in the marketplace, over the last couple of There's been so many moves in the marketplace, over the last couple of years. We want to make sure that we're offering a very compelling value proposition With our products and continue to offer strong customer economics with our price positioning as we move into 2024. Having said that, We're imagining that we will move to a more traditional kind of an annual price increase kind of pricing structure for 2024.

Speaker 2

In 2021, 2022, we obviously had to do mid year price increases in response to the massive inflation that was layering into our business. So We expect to move into more of a normal annualized kind of price increase. I think in the low single digits is reasonable if you look what the outlook for inflation is. And importantly, the price increases we published to date and coming through 2023 cover us on a multiyear inflation basis. So we feel like we trued up in our whole as we enter 2024 and we'll look for kind of low single digit type increase across the board.

Speaker 2

Within that average across the company, there are opportunities where we can take more price and be more aggressive where we have a competitive advantage, where we have a strategic opportunity. We want to make sure that we're harvesting those opportunities. And in other categories where it's more competitive and we've got to get more aggressive to go gain share, we're going to pull that lever as well. The other piecing relative to pricing that we'll maintain is our discipline around discounting. That was a muscle that we enhanced coming through our prior enterprise strategy.

Speaker 2

And so All of our operating geographies and our business units have a very rigorous process and discipline in place for managing discounting to make sure that where we give discount, It's specifically targeting incremental volume or share gain.

Speaker 4

Got it. Maybe just the last one for me. The Pivot to Growth looks really interesting. On the M and A side, is the just the current pipeline, is there much In there at this point in time or it's really getting renewed at this point?

Speaker 2

Yes. We're populating the pipeline as we speak. As we speak, given that the first leg of our M and A strategy is to grow the core, we know many of these players from operating in this marketplace. And so populating the funnel at least with our known potential targets is relatively simple. We are taking a very comprehensive look back within each of the three pillars of our strategy to populate the funnel with potential candidates and then we'll put them through filtering to decide which ones we want to pursue proactively while we're monitoring the entire category for action if something becomes available and we have to be more opportunistic.

Speaker 2

But I would say that the grow the core funnel is probably the most populated just because that's the closest adjacency, but we've begun to Populate the rest of the funnel as well. We'll be activating reach outs here. We have started and we'll continue to reach outs here as we move into the coming quarters.

Speaker 4

Got it. All really helpful. I will step back and hopefully, operator, we'll get things going.

Speaker 3

Thank you. Thanks.

Operator

Your next question comes from the line of Steve Farazani from Sidoti. Please go ahead.

Speaker 5

Good morning, everyone. Appreciate the detail on the call. I guess the surprise to me in the quarter was how Strong gross margin continued, given that obviously it was going to be reduced backlog conversion. And given your guidance adjustment that you're still you moved to the high end of the sales range, is the guidance change primarily related On the EPS side, to the really healthy gross margins, even though you said you might have a little bit of a step down in Q4?

Speaker 2

Answering your second question first, yes. The drop through on the expanded margins Reflect in our increased guidance. And the gross margin expansion has really been a hard fought battle here as we've tried to weather the inflation that's layered into the business over the prior 7 to 9 quarters. We have a number of levers we pulled to offset inflation. At At First Plus, we push back on increases in every form possible.

Speaker 2

We also have built a cost out muscle so that we have a very comprehensive cross functional process we use to rack and stack the greatest opportunities to drive cost back out of the business and we fund and resource those as part of our annual plan. We're also improving our SIOP capability through our enterprise strategy we just concluded so that we can operate with greater productivity. Having a better outlook and forecast for what we expect to sell allows our manufacturing supply chain to plan better and operate more productively. As kind of our option of last resort, we move with strategic price increases. And so the margin expansion that you saw in the quarter is really a result of strong price realization and publishing prices to cover a multiyear inflation.

Speaker 2

So this is inflation we already incurred in the business either in this year or in prior years since really making ourselves whole.

Speaker 5

Was Did you have more than one price increase this year?

Speaker 2

No, we didn't. This is the realization on the formerly published price increases.

Speaker 5

Okay. You've announced and released a lot of new products over the last 12 months. Can you, if not quantify, at least qualitatively talk about success or future potential reaching a wider audience with some of these new products and also whether you're starting to see Greater sales with your current customer base given the greater availability of products.

Speaker 2

Yes. We're really excited about our new product pipeline. And if you look back at the products we've introduced, they've fallen into 3 broad categories. 1 is in the area of small space. And I've talked about small space offerings as being a really attractive segment because there are small space applications in virtually every one of our served vertical markets We can sell these products through every one of our channels.

Speaker 2

And so it's a really attractive and compelling space. Our IMOP product, IMOFT XL, IMOFT and IMOFT Lite have been very significant product launches. We also had our CS5 in our small space category. Really pleased with the success of those products and we'll continue to iterate and launch more products into the small space category. These tend to be smaller ticket value per unit.

Speaker 2

And so you have to sell a lot of them to add up to the revenue of an industrial machine, for example. But they're an important component of owning the entire space within our customer. We have channel leverage we can obtain. It supports our brand as being the comprehensive supplier. And ultimately, the goal is to convert mop and bucket.

Speaker 2

And so get out of the mop and bucket cleaning and move into a mechanized solution. So We're really pleased with the progress to date. You'll continue to see more new products in the small space category. We've been Extending our product lines by taking our acquired platforms from IPC and Gaomei and rebranding them and bring them into new geographies So that we can compete at more mid tier price points competitively and maintain margins. It also allows us to maintain premium pricing On our legacy Tennant brand, for example, that has been very, very successful in terms of maintaining margin on the legacy branded side, the premium position, But also serving existing customers and new customers at those more competitive price points and going toe to toe with competitors Where in the past we would have had to discount our premium product to compete, now we have a product that's been designed for that mid tier application That we can sell profitably and deliver a fantastic customer experience and we can wrap all the premium product and the mid tier product In the Tenet ecosystem of aftermarket service and support.

Speaker 2

So it's really a compelling offer as we approach both new And existing customers with our mid tier offerings. And we're doing that you go around, we're doing that on a global basis because those mid tier opportunities exist in virtually every market that we currently compete and participate. And last but not least, we talk a lot about AMR. We have introduced multiple products in the AMR space. And so we believe today we have the broadest portfolio.

Speaker 2

We're really excited about our T16 AMR. We've talked about it on former calls. It gives us a robot to sell into industrial applications in manufacturing and warehousing logistics. That has been a traditional tenant strength for the company in those vertical markets. Our customers were asking for a robotic solution in those markets And we believe we have a differentiated offering.

Speaker 2

We also believe that over we do believe adoption could be quicker in those environments because you don't have the added complexity Having to deal with the public walking through those environments. And those types of customers are more adept at making capital And delivering a return on those investments because it's largely operating within down within the four walls of their facility. And so we think that adoption Can actually be quicker and over time, we think that could be a larger robotics opportunity from a certain market potential than some of the other vertical markets that we entered earlier in our journey. So excited about AMR and the new product opportunity in that space as well as we go forward. You should expect to see new products in those three categories as we move forward.

Speaker 2

We're investing. We've maintained our investment in R and D as we come through the prior years. We'll see the fruits of those labors as we launch new products here in the future years. I'm really excited about where we're heading with our new product pipeline.

Speaker 5

Great. If I get one last in, it's not the most exciting topic, but it was in your deck, Modernization of ERP, I know that can go for companies really, really well and it can also in the near term prevent challenge present challenges. You talk a little bit about where you are on that? What you think the opportunities are and how you avoid problems that other companies obviously have historically run into when they've tried to implement new ERP.

Speaker 2

I appreciate the question. Obviously, it's top of mind and we felt it was appropriate to signal that we're doing work to plan for this. John, ERP migration is never you said it, it's not particularly exciting. It's not particularly fun to contemplate and it's not without risk. But I will tell you that I have a high level of conviction that it is necessary and it's critical to build out our digital infrastructure to enable our growth, to provide scale leverage as we move forward, enhance our cybersecurity, to improve our compliance and ultimately deliver a better customer experience and make Tenant Company easier to do business with.

Speaker 2

So I have a high level conviction that it's the right direction for the company. We're operating on a 15 year old system today and across our global enterprise. We have 8 different ERPs or instances of ERPs, which makes it extremely cumbersome to operate. To It's kind of non negotiable, in my mind at this point. You may ask, well, why now?

Speaker 2

And as we've talked about it and in close partnership with our Board of Directors, we're kind of through, largely with our Board of Directors. We're kind of through largely through the disruptions of the prior years, including the supply chain disruption. We've demonstrated that we're taking backlog down meaningfully and operating at a more predictable fashion relative to supply chain. And importantly, we're launching a new 3 year strategy. And so to be able to introduce the ERP consolidation in the context of a growth strategy Allows us to resource it appropriately, to make the appropriate trade offs and to plan for the investment that the ERP consolidation will be while we continue to grow the core Business around it.

Speaker 2

I'm really viewing this as an investment for the next 10 to 15 years of this fantastic business that we've been entrusted to manage. Where we're at, we really devoted 2023 to a planning exercise. We've pulled forward most of our large scoping decisions. We have selected our final ERP and negotiating our statements of work as well as our partners that will support our integration. We are working through our resourcing plans to make sure that we have the appropriate amount of internal and external resources supply to the project and we're working on our business case to understand what will be the investment required and what return can we expect for the investment.

Speaker 2

So 2023 has been largely devoted to planning and it's one of the areas that we were counseled as we went out and benchmarked and studied best practices And talk to others who had gone before us on this journey. Appropriate planning ahead of time, pulling forward big scope decisions, so you can avoid scope creep and delays in decision making later in the program, picking the best partners and being very crisp on what the expectations are, As well as appropriately resourcing the project are areas that were identified that we could mitigate the inherent risk in a program like this. This will be a significant investment of time and money as we go forward. We'll solidify our thinking around the business case as well as the return we expect to get for the investment And share more details as we move forward. But we want to make you aware that we've done some work and we're heading that direction.

Speaker 5

Great.

Operator

Thanks, Dave. You Your next question comes from the line of Tim Moore from E. F. Hutton. Please go ahead.

Speaker 6

Thanks and congratulations on the very impressive gross margin expansion and clearly the operational efficiencies. It was really nice to see the 9% hike to the adjusted EPS midpoint of the range this year. Fay, you already gave commentary maybe about the Q4 possible gross margin, but How should we think maybe about gross margin for next year? Is 41% more realistic of your magnitude, maybe After you lap some of the heavier price realizations this year?

Speaker 3

Yes. So we're actively working on 2024, And we'll be able to provide some additional guidance really after in the Q1 of next year. We are operating in gross margin range, ranges that we think are achievable and could be sustainable going forward. So I think, just stay tuned on kind of more specifics as to what we anticipate in 2024. But I think where we landed on a full year basis is a good proxy.

Speaker 6

Great. That's helpful color and I look forward to the February earnings call. And then I just had a question about your backlog. I mean, it was inevitable decrease, More normalized supply chain, all the industrial companies, their backlogs are coming down in the sector. I was just wondering maybe, Dave, how close are you to maybe On a more normalized component supply chain and line disruptions.

Speaker 6

I know that you've made a lot of good progress on that. I'm just trying to Think in my head, are you like 90% on the way there with avoiding that drag from the supply chain, as I try to parse out really the gross margin expansion from better operational efficiencies and utilization versus kind of the catch up pricing realization.

Speaker 2

Yes. I would say broadly speaking, we're through the major supply chain challenges that we experienced. It's hard for me to put a percentage on it because We always manage supply chain challenges. I would say we spent 7 quarters talking about pumps and circuit boards. And while we're still actively managing those commodities and those parts for our production, it's not at the heightened crisis level that we were in, as you say, Like this time last year where we were spending a lot of time and energy and resources and investments to try to overcome those 2 a specific commodity.

Speaker 2

So yes, I think we're approaching a more normalized kind of supply Supply Chain Management, we've made some investments to improve our capability there. As recently as this quarter, we've invested both in people and in systems to improve our supply chain capabilities. And that's really to enable ourselves to operate more productively and support our growth going forward. We're not going back and preparing for yesterday's problems. We're looking forward and saying we've survived, we've built some new muscles.

Speaker 2

Most of the investments we've made have paid off over time and now we will make sure that we have the capability to support the business going forward. I think your question led off with kind of the backlog reduction and how to think about backlog. In the quarter, we took backlog down at enterprise level from $469,000,000 At our inflation adjusted rate, a normalized backlog level for the enterprise would be In the $50,000,000 $60,000,000 range varying by quarter. Obviously, we have some seasonality where we'll be buying ahead to service, but $50,000,000 to $60,000,000 So you can think about the gap still to close from the $214,000,000 that we're exiting this quarter to down to the more normalized rate. We expect to make progress against that and the continuing quarters on the strength of supply chain and the strengthening supply chain.

Speaker 2

Having said that, the backlog is becoming increasingly consolidated in industrial product, that is manufactured in one plant in Minneapolis. And those products are only built for the globe. They're only built in that one plant. And so when you think about having an elevated backlog concentrated in 1 or 2 or 3 assembly lines. It becomes more difficult to move the needle on a quarterly basis as we reduce those backlogs.

Speaker 2

So it allows us to laser focus on the investments and adjustments we need to make to reduce the backlog. Every dollar of backlog represents a customer that's waiting on a tenant product. So we are Highly motivated to get the product out the door and we'll update on the progress we make, but I expect that we'll be able to reduce backlog at a decreasing rate as we move forward because of the consolidation on single products within the Minneapolis plant.

Speaker 6

Great. That's helpful color. I just have a 2 part question now.

Speaker 3

Maybe if you maybe you've done

Speaker 6

a great job explaining some of the drivers behind the industrial end markets. We get the warehouses and logistics and compact. And is there any other things that are driving kind of the industrial side and market growth, which seems Be vastly outpacing retail and schools and hospitals.

Speaker 2

Yes, I think it's a really dynamic space, may be more dynamic than it's been over the past, at least my tenure here at this company. So Depending on how wide you open your aperture, there are conversations around reshoring and we've got some of our businesses reporting Some benefit out in the future from restoring primarily along the border and in Mexico is where we hear companies are contemplating expanding square footage on a more to serve domestic market closer to home. I think that you See companies investing in kind of Industry 4.0 because they've got labor shortages and the rising inflation, cost of labor and the labor component of there, whether they're a Manufacturing environment or warehousing logistics environment. Labor is becoming more scarce and more expensive. And so to the extent they can invest in automation to reduce the reliance on labor, that's going to be a positive Across vertical markets and the labor tailwind is consistent across all of our vertical markets.

Speaker 2

So you see virtually every vertical market we operate in is trying to automate to reduce the reliance on labor and or make it easier to hire lower skilled labor to do the work. And then so I think that the macro trends are largely blowing in our favor. You mentioned specifically manufacturing and Warehouse and Logistics. I think there has been obviously, there are segments within those categories that are growing at a higher rate than some other segments. If Think about the growth in EV and the growth in the supply chain for EV and lithium ion batteries, etcetera.

Speaker 2

Those are primarily new square footage to service those categories. And then the last one that has been more of a decade long trend has been e commerce. As e commerce has grown, There's been a differing addition in square footage both in retail as well as back end, back in the distribution centers to support e commerce. And so as e commerce continues to grow and all the outlook is that e commerce will be a significant portion the holiday season this year as we move through Q4 that creates opportunity for us. What I would tell you is we translate the tailwinds of macro trends Into what it could mean for tenant.

Speaker 2

The tenant equipment tends to come in late stage after New Square footage is built. So You'll hear about the project and you'll read about it even if you get Dodge reports and then they'll be in construction. Construction will take longer than they would like because they can't find the labor. And then the last thing they do before they turn the keys over to the owner is clean the space and then they move into more operational maintenance cleaning and that's when we see The incremental benefit of the new square footage being added. But we think the vertical markets we serve have a number of tailwinds to them on a macro basis.

Speaker 2

We're really excited about

Speaker 6

Is it being rebranded still for other low cost countries like Brazil? And maybe if you can give us Some progress update on that and the opportunity there for maybe that low cost compact ride on too.

Speaker 2

Yes. We've When I talked about new products answering the earlier question, we've been leveraging our acquired platforms to more competitively position ourselves and compete in those mid tier markets around the world. And so that's both our IPC The Italian manufactured platform as well as our legacy Gaomei China produced platforms. We've been bringing those into local brands throughout the world, both the Italian legacy product as well as the Galame legacy product. Really excited about it.

Speaker 2

We've moved to Gal Me U. S. But Gal Me specifically. We have rebranded that product into Latin America With some success, early success. I guess a pretty recent occurrence.

Speaker 2

And we're also taking it elsewhere within China. And so excuse me, within Southeast Asia. So you can imagine, we're bringing that into other brands. So There's still upside from taking that Gaomei brand, Gaomei legacy platform into other brands. To we're contemplating a move into enjoy their geographies and we'll do it where it makes sense.

Speaker 2

For our developed markets, Meaning, North America and Europe and Australia, New Zealand, for example, we're assessing whether we need to have 3 different price points compete in the marketplace, meaning a good, better, best, Gaomei legacy, IPC legacy and Tennant legacy. It's probably overkill for the majority of markets we're in. So a 2 tiered offering makes more sense as we look at the applications and the customers and the channels And our positioning strategy. So the decision is whether the IPC product is a better fit or the Gal Mate product is a better fit for the mid tier within those geographies.

Speaker 6

That's terrific to hear. Thanks for sharing that. And I'll turn it back over to the operator. Thanks.

Operator

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

Speaker 2

Thank you. And thank you for your interest in Tennant Company. This concludes our earnings call. Have a great day.

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Earnings Conference Call
Xenia Hotels & Resorts Q3 2023
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