Tennant Company Falls Back Into Sales Declines

Cleaning-machine specialist Tennant (TNC 2.93%) couldn't make it two for two. After posting an encouraging return to sales growth last quarter, the company slipped back into modest declines in the third quarter, which was reported Tuesday, as its industry shrank in areas outside of the United States.

Tennant enjoyed another quarter of record results in that key market, but its expansion pace slowed as production issues got in the way.

Here's how the headline figures stacked up against the prior-year period:

Data source: Tennant's financial filings. YOY = year over year.

What happened this quarter?

Tennant's organic growth pace was negative for the third time out of the last four quarters, with slow growth in the U.S. market only partially offsetting declines elsewhere. The company also struggled with manufacturing hiccups that depressed revenue and pushed profitability lower.

Here are the key highlights of the quarter:

• Organic growth fell to a 1% pace in the U.S. region, down from 3% in the prior quarter. The slowdown was tied to short-term production challenges, according to management.
• Tennant's European and Asia-Pacific divisions, which together account for roughly 25% of sales, each fell by double digits. Europe was pulled lower by a weakening economy in the U.K., while Asia-Pacific continued to slow as the Chinese market softened.
• Gross profit margin dipped to 42.6% of sales from 43.3% due mainly to the manufacturing issues tied to Tennant's new product launches.
• Research and development spending rose to 4.2% of sales from 4% as the company continued to invest heavily in its product pipeline.
• Operating profit fell to 8% of sales from 9%.

What management had to say

Executives stressed the fact that Tennant's industry is going through a rough patch. "Despite the slow-growth environment for industrial manufacturers that led to lower sales in [some] regions," CEO Chris Killingstad said in a press release, "our Americas region posted record revenues."

Image source: Tennant.

Meanwhile, management sees new products as critical to achieving steady sales growth, even if its ramped up innovation pace risks additional manufacturing challenges like the ones that hurt profits this quarter. "We remain committed to developing new products and technologies that fuel our revenue growth," Killingstad said.

Shareholders can expect more issues like these in the near future as Tennant executes its plan to expand beyond its traditional cleaning-machine focus into areas like robotics, battery tech, and water recycling. These are promising growth segments, but the company will likely need time to build up its innovation and manufacturing competencies outside of its core business. 

Looking forward

Tennant sees the rest of its fiscal year going roughly as planned. Profitability should still come in at 43% to 44% for the year, management said, despite this quarter's surprising decline. The company left its full-year earnings and sales growth targets in place, which call for a slight revenue drop and modest profit growth to $2.47 per share as Tennant returns to modest organic growth next quarter.

The soft sales outlook has executives focused on controlling costs and boosting productivity while carefully scaling up investments in growth initiatives around product development. Tennant still targets reaching $1 billion of annual sales at a 12% operating margin, but has plenty of work ahead to achieve that result. It expects this year's revenue to weigh in at $810 million. Operating margin through the first three quarters of 2016, meanwhile, amounts to just under 8% of sales.