Cleaning machine specialist Tennant (NYSE:TNC) this week posted a sharp drop in third-quarter earnings as profitability fell below management's plan for the second straight quarter. The results led the company to lower its profit outlook despite expectations for steady, if modest, sales growth.

Here's how the headline figures compared to the prior-year period:

 Metric

Q3 2017

Q3 2016

Year-Over-Year Change

Revenue

$262 million

$200 million

31%

Net income

$3.6 million

$11.5 million

(69%)

EPS

$0.20

$0.64

(69%)

Data source: Tennan.

What happened this quarter?

Tennant's massive sales jump was mostly due to its acquisition of Italy based IPC Group. But organic growth helped, too, as the metric turned positive after a rare decline last quarter. The company had to give up profitability to keep its sales footprint moving higher, though.

An employee cleans the floor at a retail store using a walk-behind scrubber.

Image source: Getty Images.

Here are the key highlights of the quarter:

  • Organic sales returned to positive territory by rising 1.3% compared to a 2% drop last quarter. That gain included a revenue spike in Western Europe that was mostly offset by surprising weakness in the core U.S. market.
  • Gross profit margin fell by a full percentage point to 40% of sales due to several challenges, including low-margin sales, manufacturing inefficiencies, and higher input costs.
  • Research & development spending declined to 3% of sales from 4.2%.
  • Operating profitability held steady at 8.1% of sales.
  • Cash flow improved to $35 million from $21 million, which helped Tennant fund $23 in debt repayment.

What management had to say

Management said Tennant's growth was held back by a softer U.S. market while several issues combined to keep gross profitability below target. "Our third quarter results reflect slower growth in North America attributed to timing of key strategic account deals, the restructuring of our field service team, continued manufacturing inefficiencies and raw material inflation," CEO Chris Killingstad said in a press release.

"While we faced some near-term setbacks," Killingstad continued, "we are staying the course strategically and positioning Tennant to be operationally stronger than ever before." New product releases, meanwhile, are resonating with customers. "47 percent of our equipment sales stemmed from products released within the last three years, far ahead of our 30 percent target," executives noted.

Looking forward

Tennant affirmed the company's full-year revenue outlook that predicts only minor organic growth of between 1% and 2%. Executives are making slower progress than expected at raising gross profitability, and so they reduced their earnings target for the second straight quarter.

Tennant now believes adjusted earnings will be between $1.50 per share and $1.70 per share compared to the $2.20 to $2.40 range they issued in early August and the $2.40 to $2.60 target they had articulated before that. About $0.33 per share of that downgrade can be blamed on an accounting change regarding its IPC Group acquisition. The rest of the shortfall is due to a range of operational challenges, including manufacturing inefficiencies and rising costs, that management says it is working to address.

In the meantime, the IPC Group acquisition has filled out Tennant's product portfolio, both in terms of price points and geographical reach. Management says the integration of the business is running ahead of plan and now executives hope to begin capitalizing on their wider addressable market with help from a string of new product innovations.

Demitrios Kalogeropoulos has no position in any of the stocks mentioned. The Motley Fool recommends Tennant Company. The Motley Fool has a disclosure policy.