Tennant Company (TNC) Q2 2018 Earnings Conference Call Transcript

Tennant Company (TNC 0.24%)
Q2 2018 Earnings Conference Call
Jul. 25, 2018 11:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning. My name is Sarah, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Tennant Company's second-quarter 2018 earnings conference call. This line is being recorded.

[Operator instructions] Thank you for participating in Tennant Company's second-quarter 2018 earnings conference call. Beginning today's meeting is Mr. Tom Paulson, senior vice president and chief financial officer for Tennant Company. Mr.

Paulson, you may begin.

Tom Paulson -- Chief Financial Officer

Thanks, Sarah. Good morning, everyone, and welcome to Tennant Company's second-quarter 2018 earnings conference call. I'm Tom Paulson, senior vice president and chief financial officer of Tennant Company. Joining me today are Chris Killingstad, Tennant's president and CEO; Tom Stueve, vice president and treasurer; Andy Cebulla, vice president of finance and corporate controller; and Kristin Stokes, deputy general counsel.

Today, we will review recent progress against our core strategies, our performance during the 2018 second quarter, and our updated outlook for 2018. First, Chris will brief you on our operations, and then I'll cover the financials. After that, we'll open up the call for questions. We're using slides to accompany this conference call.

We hope this makes it easier for you to review our results. A replay of this conference call, along with these slides, will be available on our Investor Relations website at investors.tennantco.com following this call until August 25, 2018. Now, 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 file 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. For each non-GAAP measure, we also provide the most directly comparable GAAP measure.

There were non-GAAP items in both the 2018 and 2017 second quarters. Our 2018 second-quarter earnings release includes a reconciliation of those 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 this point, I'll turn the call over to Chris.

Chris Killingstad -- President and Chief Executive Officer

Thank you, Tom, and thanks to all of you for joining us. During the second quarter, we made solid progress against our core strategies and generated additional momentum across a broad range of performance measures. Overall, we are pleased with our progress to date, and we are confident in the underlying performance of the business. Our first strategy is to diversify our revenue streams by expanding our sales growth drivers across all geographic regions, channels and product categories.

During the second quarter, Tennant once again generated organic growth in each of our three geographic regions. This marks the third consecutive quarter of sales expansion across all geographies. Sales grew in each of our different go-to-market channels: direct, distributor and, in particular, strategic accounts. We're also excited to see that enhancements we've made in our service, parts and consumables business continued to benefit our results in the second quarter.

In total, 2018 second-quarter consolidated net sales grew 7.9 %, or 5.2% organically, to approximately $292 million. We are pleased with our sales execution efforts thus far in 2018, and we expect continued positive momentum in the back half of the year. Our second strategy is to fully realize -- or to realize the full potential of the IPC acquisition by successfully integrating the business. IPC expands and diversifies our revenues by region, product category and sales channel, and also broadens our growth platform.

Our current focus remains on identifying revenue growth opportunities within our combined organizations as well as capturing organizational and sourcing efficiencies. We will continue this integration process as thoughtfully as possible with the primary goal of enhancing shareholder value. Underlying IPC business performance and integration progress remains solidly on track. Our third strategy is our commitment to operating effectively, which includes the investments we made last year into our field service capabilities and manufacturing operations.

We have resolved many of the challenges from last year. And these strategic investments have been key to improving the efficiency and effectiveness of our service offerings and our manufacturing performance. However, today's current market conditions are presenting new headwinds in terms of raw material and labor shortages that are affecting our near-term operational productivity and gross margins. Additionally, we expect recently implemented tariffs and continued robust strategic account sales growth to also have an impact on our full-year gross margins.

Therefore, we are recalibrating our gross margin expectations for 2018. We remain highly disciplined in our expense management, which is reflected in our S&A expense during the quarter. After properly adjusting for nonoperational expenses and amortization, our S&A expense ratio improved approximately 80 basis points, and we are pleased with this expense leverage. Our fourth strategy is our commitment to reinforcing our technology leadership and supporting our robust new product pipeline.

Tennant is fiercely committed to bringing category-leading products to market, and we continue to invest in R&D at levels necessary to maintain our clear technology leadership. In Q2 2018, our vitality index was approximately 35%, well above our stated goal of 30%. Our vitality index represents the percent of revenue from new product introduced in the past three years and directionally measures how well our customers are responding to our new product offerings. We are confident in the underlying performance of the business and are pleased with the progress we are making across our various strategies.

I am confident in our ability to navigate future macroeconomic challenges and capitalizing on the opportunities ahead. We are committed to continuous business improvement and remain confident that our strategies will drive improved shareholder value. Now I'll ask Tom to take you through Tennant's second-quarter financial results. Tom?

Tom Paulson -- Chief Financial Officer

Thanks, Chris. In my comments today, references to earnings per share are on a fully diluted basis except for the 2017 GAAP results, which were calculated with the basic weighted average shares outstanding due to the as-reported net loss. However, non-GAAP 2017 earnings per share are calculated on a fully diluted basis. And as a reminder, this is the first quarter that IPC results are embedded in our organic results and regional reporting.

As Chris noted, we witnessed improvement in several areas during the quarter, most notably in broad-based sales growth, expense leverage, cash flow and EBITDA growth. These all illustrate our discipline and commitment to executing on our core strategies. For the second quarter 2018, Tennant reported net sales of $292.2 million, roughly 7.9% higher year over year, with organic sales improving 5.2%. Our organic sales result exclude a favorable currency impact of approximately 2.7%.

Looking at the bottom line. Second-quarter 2018 net income was $12.7 million, or $0.69 per diluted share. Our reported results in the quarter reflected $3.1 million in pre-tax expenses, or $0.13 per share, related to nonoperational special items, primarily IPC acquisition integration costs. Excluding these items, Tennant reported adjusted net earnings of $15.1 million, or $0.82 per share.

By comparison, Tennant reported adjusted net earnings of $10.6 million, or $0.58 per share, in the year-ago quarter. It's worth mentioning that our results also include pre-tax expense of $5.5 million, or $0.23 per share, from amortization of the intangible assets related to the IPC acquisition. Our results also reflect two discrete tax benefits totaling $3 million, or $0.16 per share. These benefits are the result of two events.

The first is a favorable ruling from Italian tax authorities related to the deductibility of interest expense in Italy, resulting from the IPC acquisition. This is a direct result of our tax strategies around the transaction. The second is the exercising of soon-to-expire stock options. As a result of these items, we are adjusting our tax guidance, which I'll outline shortly.

Now taking a closer look at the 2018 second quarter. We group sales into three geographic regions: the Americas, which encompasses all North America and Latin America; EMEA, which covers Europe, the Middle East, and Africa; and Asia Pacific, which includes China, Japan, Australia, and other Asian markets. In the Americas, 2018 second-quarter sales rose 5.7%, up 6% organically. Our organic growth was driven by expansion in our strategic accounts in North America, continued sales strength in our service, parts, and consumables business, higher industrial equipment sales in South America and continued broad-based strength in Brazil.

Turning to EMEA. Reported sales improved 13% or 3.6% organically in the second quarter, driven by strength across the entire region, with particular strength in France and Germany. Looking at the Asia Pacific region. Sales were up 7.2% or 5.1% organically, driven by continued performance on our IPC business and Australian strategic account channel.

Turning now to gross margins. Tennant's gross margin of 2018 second quarter was 40.7%, compared to the rate in the same quarter last year of 38.6% on a GAAP basis, or 40.9% on as-adjusted basis, in the prior year. We have worked diligently over the past several quarters on initiatives to improve our gross margin, in particular, our investments in robotics and inventory management system and our field service capabilities. These have been highly successful.

However, gross margins were impacted by other factors in the second quarter that we also expect to have an effect on the back half of the year. As Chris mentioned, labor and raw material shortages impacted our operational productivity in the quarter, resulting from the competitive market environment in which we operate. Our gross margin was also impacted by mix, specifically due to the robust growth of our strategic account revenue. Lastly, higher freight and logistics costs had a negative impact on our margins in the quarter.

These items combined negatively impacted our year-over-year margin rate by approximately 110 basis points, and we were partially offset by pricing and other improvements to our operations. Looking toward the back half of 2018, we're anticipating these items, along with recently enacted tariffs, to have a negative impact on our full-year gross margin rate. Breaking down these headwinds, we expect an approximate 20-basis-point impact from strategic account mix, roughly 20 basis points from tariffs and approximately 10 basis points from labor and raw material shortages. Consequently, we are adjusting our gross margin expectations for 2018.

Research and development expense in the 2018 second quarter totaled $7.9 million, or 2.7% of sales. That's compared to $7.9 million, or 2.9% of sales, in the same period last year. We remain committed to investing at levels that reinforce our technology leadership position and robust new product pipeline. Selling and administrative expense in the 2018 second quarter was $91.9 million, or 31.4% of sales, compared to the prior-year quarter of $87.3 million, or 32.2% of sales.

The second quarters of 2018 and 2017 included nonoperational charges of $3.1 million and $4.9 million, respectively. Excluding these items, S&A expense as a percent of sales was flat at 30.4%. As a reminder, 2018 second quarter includes $5.5 million, or 1.9% of amortization expense related to IPC, compared to $3.1 million, or 1.1% of sales, in last year's second quarter. It's worth clarifying that the 2017 second-quarter amortization did not reflect the entire amount related to the IPC acquisition and was ultimately captured in the third quarter of 2017 as a catch-up.

This represents approximately $2 million, or 70 basis points as a rate of sales. Moving on to EBITDA. As we discussed previously, earnings before interest, taxes, depreciation, and amortization is an important measure for Tennant, given the impact of noncash amortization expense and our increased level of interest expense as a result of the IPC acquisition. Our 2018 second-quarter adjusted EBITDA was $35.7 million, or 12.2% of sales, up 120 basis points compared to the prior quarter of $29.8 million, or 11% of sales.

We are committed to continually drive EBITDA leverage even with the headwinds we're facing related to gross margins. We continue to focus on initiatives that can help us improve across every profitability measure. These include driving organic revenue growth, controlling fixed costs in our manufacturing areas as volume rises, managing inflation at the gross profit line and standardizing and simplifying processes globally to continue to improve the scalability of our business model while minimizing increases in our operating expenses. Shifting to our tax rate.

Our as-adjusted effective tax rate for the 2018 second quarter was 6.8%, compared to 29.1% in the year-ago quarter. This illustrates the impact during the quarter of two discrete tax benefits mentioned previously and the impact of the new tax legislation in the U.S. Based on both higher-than-anticipated benefits, we are updating our forecasted tax rate to 20% for the full-year 2018. Tennant's cash from operations for the second quarter was $20.4 million, compared to cash from operations at $8.6 million in the 2017 second quarter, which marks a significant increase.

Looking at other aspects of our capital allocation. Tennant also paid cash dividends of $3.8 million in the second quarter of 2018 and reduced our debt by $14 million. Now moving to our outlook for the full year 2018. As Chris stated, we are pleased with our broadbased progress across our strategies.

Our updated guidance takes into consideration our current sales momentum, operational efficiency initiatives, improvements to our forecasted tax rate as well as anticipated headwinds related to our gross margin outlook. Based on these factors, we are increasing our 2018 outlook and guidance for sales, EPS, adjusted EPS and adjusted EBITDA. For 2018, we now estimate full-year net sales to be in the range of $1.10 billion to $1.12 billion, up 9.7% to 11.7% or 4% to 4.5% organically compared to the prior year. We are also tightening and increasing both the low and high ranges of our estimated adjusted earnings per share to a range of $1.95 to $2.10, which includes $4 million to $5 million of special items, including IPC acquisition and integration costs.

We now expect 2018 full-year GAAP earnings in the range of $1.75 to $1.90 per share. And we're raising the anticipated adjusted EBITDA range to $117 million to $121 million. In terms of timing, and similar to prior years, we do anticipate the fourth quarter to be the strongest of the remaining quarters. Our revised 2018 annual financial outlook includes the following additional assumptions: reasonable growth in all regions, especially strategic accounts in North America; gross margin performance of around 41%; R&D expense around 3% of sales; capital expenditures in the range of $25 million to $30 million; and an effective tax rate of approximately 20%.

At this point, I'll turn the call over to Chris.

Chris Killingstad -- President and Chief Executive Officer

Thank you, Tom. All right. So before we open the line for Q&A, I'd like to take a moment to acknowledge my colleague and my friend, Tom. Today, we announced Tom's plans to retire in the coming months.

Tom joined Tennant in 2006. And in his 12 years with the company, he has contributed significantly to Tennant's transformation as a global industry leader, including a major role in the IPC acquisition, the largest in our history. His leadership and personal commitment to advancing Tennant's strategic initiatives has positioned us to capitalize on new growth opportunities, enhance value for all of our stakeholders and continue our journey to reinvent how the world cleans. We have initiated a search to identify Tennant's next Chief Financial Officer.

As we mentioned in the news release, Tom has agreed to remain with the company until the search has concluded and the successor has been chosen. So while he is -- he still has some time in the chair, I ask that you please join me today in thanking him and congratulating him as he plans to spend more time on the golf course and spoil his grandchildren. So with that, we'll open it up to Q&A. Sarah?

Questions and Answers:

Operator

[Operator Instructions] Our first question will come from the line of Mr. Chris Moore from CJS Securities. Please go ahead.

Chris Moore -- CJS Securities -- Analyst

Hey, good morning, guys.

Tom Paulson -- Chief Financial Officer

Good morning, Chris.

Chris Killingstad -- President and Chief Executive Officer

Good morning,

Chris Moore -- CJS Securities -- Analyst

And I'll be the first. Congratulations, Tom.

Tom Paulson -- Chief Financial Officer

Thanks, Chris. Appreciate it.

Chris Moore -- CJS Securities -- Analyst

Sure, absolutely. Maybe just to start with IPC. It looks like IPC derives less of their revenues from parts, consumables, and services. First, is that correct? And why is that? And is that an opportunity?

Tom Paulson -- Chief Financial Officer

That's a factual statement, and it is an opportunity. And it's predominantly -- there's really two drivers of that. And one is that, generally, in a distribution-based business, which 80% is distribution, that -- it's more difficult to get you a fair share of the parts and consumables business. Also, their product portfolio tends to be smaller equipment, not as industrial based.

And the parts and consumables component of the aftermarkets is smaller on -- smaller pieces of more remunerable equipment. But it presents a real opportunity. It's one of the areas we're very focused against creating leverage with our direct service organization in Europe and other parts of the world in conjunction with the distribution service functions. So I think it really is an opportunity to get more than our fair share, both from a revenue and I think it can also be margin enhancing over time.

Chris Moore -- CJS Securities -- Analyst

Got it. Appreciate it. Obviously, you guys called out the headwinds, tariffs, raw materials, labor, etc., that the obvious impact is on the margins. Is there any potential for any of those to impact you on the revenue growth side?

Tom Paulson -- Chief Financial Officer

Possibly. I mean, anytime you start to have supply shortages and -- it can have some effect on revenue. I'd like to think that the worst that could happen is it would affect timing, not cause us to lose revenue. So that's certainly our desire, and we'll do everything in our power to not -- we just want to please customers.

We don't want to miss any revenue. And one of the issues we have is we're just not big enough, frankly, to have the kind of leverage you might want to have with some of your suppliers, and we're a low-unit and a high-mix business. And so that does make the material supply more difficult at times. But we're doing everything in our power to shore it up, and we certainly hope that at worst, it only affects the timing of revenue.

Chris Killingstad -- President and Chief Executive Officer

Yes. One of the things we're doing is that operations and sales are working hand-in-hand to figure out the priority orders and the priority customers where we can't miss deadlines. And then -- and also then in the second tier are ones where you can maybe -- you can delay for a couple of weeks and it's fine, and then a third tier where it's not as crucial. And I think that's going to help us manage at least in the short term here through this issue and not have an impact to sales.

But if this were to continue for an extended period of time, where it gets worse than it currently is, then it may be more difficult.

Tom Paulson -- Chief Financial Officer

It is one of the times where having a direct organization really matters. It's just the depth of the relationship that we have with the customers, we can very actively manage that, but there's a risk.

Chris Moore -- CJS Securities -- Analyst

Got it. Got it. Appreciate it. Last one, tax rate.

So the guidance going down to 20%, reasonable to assume that -- I know you're not there yet, but fiscal '19 is slightly back closer to the 24% that we started out this year?

Tom Paulson -- Chief Financial Officer

I would say that if I -- we're not ready to give guidance for next year, but I would be comfortable the range could be 20% or 21%, up to 24%. But I mean, I'd like to think that we can permanently keep it in the low 20s, but we certainly are ready to commit. And the reason for that is there's two things. One, the tax legislation and the things that are going are still unclear in many cases, and also our mix of business matters enormously about where we make our profits and where our tax rate can be.

But we certainly don't anticipate going above 24%, and we could just -- it could stay down in the low 20s also.

Chris Moore -- CJS Securities -- Analyst

Got it. Appreciate it, guys.

Tom Paulson -- Chief Financial Officer

You bet. Thanks, Chris.

Chris Killingstad -- President and Chief Executive Officer

Thanks, Chris.

Chris Moore -- CJS Securities -- Analyst

Sure.

Operator

Your next question comes from the line of Marco Rodriguez from Stonegate Capital Management. Please go ahead.

Marco Rodriguez -- Stonegate Capital Management -- Analyst

Good morning, guys. Thank you for taking my questions, and congratulations, Tom.

Tom Paulson -- Chief Financial Officer

Thank you very much. I appreciate it.

Marco Rodriguez -- Stonegate Capital Management -- Analyst

Real quick. I just wanted to maybe dive down a little bit deeper into some of the potential headwinds, if you can maybe provide some more information, some more color, specifically around the tariffs, China, and then the specific raw material. Is it mostly just steel and aluminum? Or are there other areas that you're kind of seeing there as well?

Tom Paulson -- Chief Financial Officer

Yes, it's predominantly steel-related. But it's -- and this is one of the complexities of it all. It goes beyond just raw steel. Now one of the things that -- there is tariffs being put in place that affect steel as a component of other parts, and there's tariffs being charged in that regard.

So we have -- there's some impact of what we're getting from China. We have impacts of where we source other steel, which is -- Canada is one of the primary providers. So it's certainly unclear about what we have, but we feel that we've adequately covered this year. And we're quickly shifting gears to next year to really determine what kind of flexibility we have and have the access that we can take if this really does become full-bore and start affecting the full 12-month period.

Marco Rodriguez -- Stonegate Capital Management -- Analyst

Gotcha. And the tariff impacts, are there specific impacts to the invoicing that you're doing or other areas where that's impacting?

Tom Paulson -- Chief Financial Officer

Say that again, Marco, I didn't understand that.

Marco Rodriguez -- Stonegate Capital Management -- Analyst

Yes, I'm sorry. I'm trying to get just a little bit better sense on the tariffs headwinds. You made it sound like it was a cost of sales more than a revenue issue.

Tom Paulson -- Chief Financial Officer

It's a pure tariff on it as we're bringing in as predominantly componentry. So it's raw steel or it's other components, so that's steel -- and we're literally getting the tariff upcharge on that cost of goods sold that's coming through. So we're not being affected in pricing. And again, it's important that right now, we aren't making any assumptions that new tariff is coming.

These are the tariffs that we know about that are being either enacted or would appear that are likely to happen. We all know that no one really knows for sure what's going to happen. But it is -- goes to cost of goods sold, yes.

Chris Killingstad -- President and Chief Executive Officer

I was going to say one of the good things, as you know, is that we tend to produce close to the customers. So a lot of our sourcing for North America comes from North America sourcing and Europe comes from Europe, etc. So I think the impact on us versus some of the manufacturers who've already come out and reported earnings in the second quarter is less because of that strategy.

Marco Rodriguez -- Stonegate Capital Management -- Analyst

Gotcha. And in terms of the increasing costs that you guys are going to be experiencing here in the second half of the year, can you maybe talk a little bit about your ability to kind of push those additional costs through in as far as higher pricing is concerned? Or is that not just too feasible right now?

Tom Paulson -- Chief Financial Officer

Yes, I mean, one of the things that I would comment on is we've done a really nice job through the first part of the year that we are certainly covering inflation. And as we've seen and we aggressively took price, and that was on top of reasonable pricing last year. And we've enacted pricing through the first six months of the year and anticipate continuing to get that in. We firmly believe that if the market puts tariffs in place, the combination of flexibility in our supply chain and our ability to price, that we will recover and get our margins back to normal levels, it will just be a matter of timing.

But our customers understand it, and we will be able to price and exhibit flexibility to make changes in our supply chain.

Marco Rodriguez -- Stonegate Capital Management -- Analyst

Understood. And then switching gears here to your -- the North America -- or the Americas, the strategic accounts. I just want to try and get a little bit better of an understanding as far as the growth impact that you saw there from strategic accounts versus what you kind of saw in Latin America. 

Tom Paulson -- Chief Financial Officer

Yea, I mean, we're not gonna give precise strategic account numbers, but, I mean, it is the most important source of growth from an absolute level, and it did matter in Q1, it mattered in Q2, and we have solid visibility that strategic account revenue will positively affect, from a revenue standpoint, Q3 again also. But we are calling out, from our original expectations, for example, as we gave guidance on a quarter ago, we think that the full-year margin impact due to higher strategic account will negatively affect our gross margin expectation by about 20 basis points. And it's a good problem to have. I mean, the more strategic account revenue we can get, the more efficient we get, but it does directly affect our gross margins.

But it's one of those problems -- we want to call it out, but it's a good problem.

Chris Killingstad -- President and Chief Executive Officer

Yes, it affects our gross margins. Remember, the cost to serve is also less to that our net margins are not impacted, which is why you're seeing some leverage at the EBITDA line.

Tom Paulson -- Chief Financial Officer

Yes. It's part of why we're creating the leverage at the EBITDA line. I mean, that is one of our objectives. We want to be indifferent to channel strategy, serve the customers the way they want to be served, and -- but we've got to do it efficiently.

Marco Rodriguez -- Stonegate Capital Management -- Analyst

Understood. OK. It's helpful. Then in terms of the -- your reported adjusted EPS numbers, I just want to kind of confirm these discrete tax items that were a benefit to the quarter, those were not stripped out of the adjusted EPS reported number of $0.82.

Is that correct?

Tom Paulson -- Chief Financial Officer

They were not. And the reason for that is we feel there -- in the case of expiring options, that's a normal part of ongoing operations. It just happens sometimes it's smaller, sometimes it's nonexistent. And then the big benefit from the Italian situation, that's a specific action that we took.

And it was really related to deductibility last year, so our tax rate was higher. So we didn't know we were going to get the favorable ruling. But that's also an ongoing benefit in our tax rate. We'll get that deductibility as we go forward, and -- but it will move around by quarter.

Marco Rodriguez -- Stonegate Capital Management -- Analyst

Understood. And last quick question, I'll jump back in the queue. Maybe if you can just kind of update us on the field service productivity issues. I know you're starting to make improvements in Q1.

Just kind of want to get an update as far as where things stand there.

Tom Paulson -- Chief Financial Officer

Yes, we're actually -- as painful as last year was, we're really pleased with the progress that the team has made this year. We're back firmly on track. We're actually ahead of expectations from both a revenue and a margin standpoint. We've completely stabilized the organization.

Our open truck levels are back to normal. The strategy of enhancing our commercial service offering is working. And so we're really pleased with where we're at, and it will benefit Tennant as we go forward.

Chris Killingstad -- President and Chief Executive Officer

And all the people that we brought on board late last year and early this year now for the most part are fully trained and are hitting the productivity levels that we need. So that's a big benefit as well.

Marco Rodriguez -- Stonegate Capital Management -- Analyst

Understood. Thanks a lot, guys. Appreciate your time.

Tom Paulson -- Chief Financial Officer

Our pleasure. Thanks.

Operator

[Operator instructions] Your next question comes from the line of Brett Kearney from Gabelli & Company. Please go ahead.

Brett Kearney -- Gabelli & Co. -- Analyst

Hi guys. Thanks for taking the question, and congratulations Tom, very well deserved.

Tom Paulson -- Chief Financial Officer

Thanks, Brett.

Brett Kearney -- Gabelli & Co. -- Analyst

Yeah. Just wanted to ask you guys on capital allocation, as you guys are generating really good cash flow, approaching your net leverage target to two and a half times toward the end of this year. Just wanted to ask, obviously, a lot of great organic new product development capabilities in front of you, but how you're thinking about some of the cash flow the business will be generating in the back half

Tom Paulson -- Chief Financial Officer

Yes, I mean, we -- obviously we're still -- are staying consistent on our dividend policy. We have not -- although we have an authorization, we're not buying back shares. We don't see ourselves doing that anytime soon. But we are getting to the point where we've kept our acquisition pipeline active.

And we'll tell you, our focus will remain paying down debt in our organic growth. We love that -- doing other transaction. And we've talked about feel those over time, but we'd certainly hope that sometime in the not-too-distant future when our leverage gets to where it could be that we would close on another smaller transaction. It would be much smaller, and we don't expect to lever back up.

But for now, we will remain focused on debt paydown, keeping our pipeline alive.

Brett Kearney -- Gabelli & Co. -- Analyst

Great. Thanks so much.

Tom Paulson -- Chief Financial Officer

Yes. Thanks, Brett

Operator

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

Chris Killingstad -- President and Chief Executive Officer

Thanks, Sarah. Before we conclude, I want to thank the team members of Tennant who have been so critical to driving the growth, operational improvements, and technology leadership for which we are recognized today. The momentum we have is a direct result of their hard work. Tennant remains committed to enhancing long-term shareholder value by diversing our revenue streams by expanding our sales growth drivers across all geographic regions, channels and product categories; reinforcing our technology leadership and supporting our robust new product pipeline; striving for global operating effectiveness; strengthening our financial position and cash flow characteristics; as well as balancing our capital allocation strategy across growth investments, debt reduction, dividends and share repurchases; successfully completing the integration of IPC; and looking holistically at our growth plans, both organic and strategically targeted inorganic growth opportunities.

Growth does not come without challenges. We have some to address as we move forward, but we have achieved many important milestones in the first half of 2018 and look forward to building on this momentum in the back half of the year. Thank you for your time today and for your questions. Take care, everyone.

Bye-bye.

Operator

[Operator signoff]

Duration: 37 minutes

Call Participants:

Tom Paulson -- Chief Financial Officer

Chris Killingstad -- President and Chief Executive Officer

Chris Moore -- CJS Securities -- Analyst

Marco Rodriguez -- Stonegate Capital Management -- Analyst

Brett Kearney -- Gabelli & Co. -- Analyst

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