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Tennant Co (TNC -0.80%)
Q1Â 2019 Earnings Call
April 30, 2019, 11:00 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good morning. My name is Jason and I will be your conference operator today. At this time I would like to welcome everyone to Tennant Company's 2019 First Quarter Earnings Conference Call. This call is being recorded. [Operator Instructions]. Oh thank you for participating in Tennant company's 2019 First Quarter Earnings Conference Call. Beginning today's meeting is Mr. William Prate, Director of Global Financial Planning and Analysis and Investor Relations for Tennant Company. Mr. Prate, you may begin.
William Prate -- -- Analyst
Thank you Jason. Good morning everyone and welcome to Tennant company's First Quarter 2019 Earnings Conference Call. I'm William Prate, Director of Global Financial Planning and Analysis and Investor Relations.
Joining me today are Chris Killingstad, Tennant's President and CEO; Keith Woodward, Senior Vice President and CFO; Tom Stueve, Vice President and Treasurer; Andy Cebulla, Vice President, Finance and Corporate Controller and Mary Talbott, Senior Vice President and General Counsel.
Today we will review our ongoing progress against our core strategies. Our performance during the recent first quarter and our full year guidance. Chris will first brief you on our operations and Keith will cover the financials. After our remarks, we will open the call up for questions. We are using slides to accompany this conference call. These slides, along with a replay of today's call, will be available on our Investor Relations website at investors.tennantco.com until May 30, 2019.
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 risk 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. Our 2019 first quarter earnings release include 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. Now I will turn the call over to Chris.
Chris Killingstad -- President and Chief Executive Officer
Thank you, William and thanks to all of you for joining us. Tennant company is a business undergoing an important transition. The core strategies we have been pursuing for the past several years have unquestionably been focused on growth, expanding and diversifying our geographic reach, broadening our go-to-market channels, strengthening our ability to address the mid tier market and building a robust and innovative new product pipeline. We have had a lot of success in each of these areas, but that success has not translated into the EBITDA growth as rapidly as we would have liked. As we move into 2019, our focus is turning much more deliberately toward a balance between reasonable growth and enhancing our EBITDA expansion activities. These efforts are in full swing and are beginning to show progress. They are a central component of our new strategic plan that, as we mentioned on our last call, we intend to share with you in more detail later this year.
During our first quarter Tennant posted mixed results, but results began to reflect a more intense focus on profitable growth. Looking at sales performance, Tennant posted a decline in net sales during the first quarter, which was a combination of negative organic sales and negative impact due to currency. Our organic results primarily reflect a couple of factors. The first is a challenging sales comparison, due to the large level of strategic account sales in the prior period. Industry market softness was also a contributing factor, specifically in the United Kingdom.
Looking at earnings performance, as I previously noted, our focus on EBITDA expansion is playing a more significant role in our decision making at Tennant. Increasingly, we are focused on prioritizing sales efforts where our value proposition is strongest. Optimizing our operations and supply chain and mitigating external factors impacting our margins. Our early efforts positively impacted both our gross margin and EBITDA performance this quarter. Gross margin in the 2019 first quarter jumped 120 basis points year over year.
Like many industrial companies we continue to face macro-driven factors including (ph) terrorist[/ph type skilled labor markets, material inflation and higher freight costs. Our gross margin performance in the quarter benefited from Tennant's positive impact from pricing actions, favorable channel mix and our efforts to mitigate those prevailing headwinds.
As a result,our gross margin performance along with disciplined expense management, we improved EBITDA by 17% or 200 basis points over last year. All in all, we are pleased with the progress we made this quarter on profitability improvement and fully intend to build on this momentum. As you may know Tennant has built its reputation on innovation and finding creative ways to bring new compelling solutions to our customers. Earlier this month, Tennant announced an agreement to supply our autonomous T7 AMR solution to Wal-Mart. This is just one example of Tennant's position as a leader developing innovations that can help all our customers and, in this case, a large strategic customer with sophisticated needs run their businesses more safely, efficiently and profitably.
The application of robotic cleaning technology is a promising emerging trend and the advantages for our customers will be substantial. This relationship with Wal-Mart represents an important first step toward broader adoption of autonomous cleaning equipment in the marketplace. We are pleased by how our T7 AMR's are being received and we are very excited by the promising role robotics will play in our future. We believe, we have the first mover advantage at large scale commercialization of this technology and we intend to fully capitalize on.
During the first quarter, we also announced our decision to relocate our corporate headquarters to neighboring Eden Prairie, Minnesota. This move will give Tennant several advantages by allowing us to repurpose our current headquarters to optimize our manufacturing operations and drive efficiencies at this location, adding space to accommodate additional growth. Helping attract and retain talent and allowing for better collaboration by bringing together the roughly five hundred employees who are currently spread among separate buildings around our current headquarters location. Ultimately this move underscores our commitment to strengthening Tennant for the future. We intend to complete the move in the first half of 2020.
Now, I'll ask Keith to take you through Tennant's first quarter financial results. Keith.
Keith Woodward -- Senior Vice President and Chief Financial Officer
Thank you Chris. In my comments today, references to earnings per share, both GAAP and non-GAAP, are on a fully diluted basis. As Chris stated, we are committed to building strength across our entire enterprise with a particular emphasis on EBITDA dollar growth and expansion. Our performance in the first quarter illustrates progress along these lines as well as some challenges. Most of those challenges took the form of tougher sales comparisons as we lacked strong growth in strategic accounts last year. For the first quarter of 2019, Tenant reported net sales of $262.5 million. That was down 3.8% which included a 3.4% reduction from currency translation, a reduction of 0.8% on an organic basis and a positive plus 0.4% impact from our Gaomei acquisition.
Turning to the bottom line, our first quarter 2019 reported net earnings grew 64% to $5.4 million or $0.29 per share. On an adjusted basis, net earnings grew 82% to $9.1 million or $0.49 per share. As I will explain more in a moment, we are encouraged by our margin and EBITDA improvement in the quarter and continue to strive for more progress.
Now let's examine our sales results. We group sales into three geographies, the Americas, which includes all of 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.
Sales in the Americas region declined 1.1%, but actually increased 0.3% on an organic basis.The increase reflects strong Latin America sales with strength in Mexico and was partially offset by a challenging comparison to last year's strong strategic account activity in the region. It's important to note sales contributions from our recently announced partnership with Wal-Mart, for our autonomous cleaners, did not contribute significantly to the quarter. We expect this contribution to gradually ramp up over the course of the year and into 2020.
Onto EMEA, reported sales in this region were down 12% or 5% percent organically and we're primarily impacted by two factors. The first, like the Americas, EMEA sales also reflected the comparison to last year's strong strategic account and distributor channel activity and secondly, EMEA sales during the period also reflect some general industry market softness in the United Kingdom.
Looking at the Asia Pacific region, we are pleased with the sales performance in this geography during Q1. Reported sales were up 10.3% or 8.4% organically reflecting broad strength across the region. We were also happy to finalize the closing of the acquisition of Gaomei this January and look forward to them becoming a solid contributor to this region as we move forward.
Now turning to margins and expenses. As Chris pointed out, our focus on EBITDA growth in addition to innovation, is increasingly guiding our decision making and we are pursuing broad based initiatives designed to address this. While we still have more progress to make, we are encouraged by our gross margin and EBITDA improvement during the 2019 first quarter. Gross margin improved to 41.2%, up 120 basis points year-over-year. The improvement was led by a favorable channel mix and positive pricing actions, as well as our ongoing efforts to mitigate the impacts of prevailing macro headwinds, such as tariffs, raw material price inflation and higher air freight costs.
Taking a look at our R&D and S&A expense levels, R&D spend as a percentage of sales decreased 20 basis points year-over-year. As we've stated before, we are committed to investing in R&D at levels that allow us to remain competitive, meet our customer needs and sustain our leadership position as a top innovator in the industry. We also continued our practice of proactive S&A discipline. During the quarter, adjusted S&A expenses were down 3.7% on an absolute basis and roughly flat, as a percentage of sales. EBITDA remains an important profitability measure for Tennant. We are pleased with our EBITDA dollar growth and expansion during the quarter, growing 17% or up 200 basis points to 11.2%. This reflects our holistic focus on the entire P&L and balancing top line initiatives while managing costs with strategic growth investments.
As we look ahead we will continue to focus on the activities that can help us improve our EBITDA performance including expanding organic revenue, driving operational cost leverage, working to offset macro headwinds such as inflation tariffs and other costs of goods pressures and tightly managing controllable expenses.
Turning now to cash flow, capital allocation and balance sheet items, Tennant used $11.6 million in cash for operations for the first quarter. Primarily for inventory expansion to support future sales and employee compensation and benefit related payments. During the quarter, the company paid down an additional $8 million in outstanding debt and paid another $4 million in cash dividends to shareholders.
As stated in today's earnings announcement, we are reaffirming our 2019 guidance which is as follows, net sales of $1.15 billion to $1.17 billion with organic sales growth in the range of 2% to 3%. Full year reported GAAP earnings of $2.05 to $2.25 per diluted share. adjusted EPS of $2.30 to $2.50 per diluted share, adjusted EBITDA of $129 million to $133 million, capital expenditures of approximately $40 million to $45 million and an effective tax rate of approximately 20%.
With that we will open the call to your questions.
Questions and Answers:
Operator
(Operator Instructions) Your first question comes from the line of Chris Moore from CJS Securities. Your line is open.
Christopher Paul Moore -- CJS Securities -- Analyst
Hey good morning guys. Thanks for taking some questions.
William Prate -- Director, Global Financial Planning and Analysis and Investor Relations
Good morning Chris.
Christopher Paul Moore -- CJS Securities -- Analyst
Good morning. Maybe just kind of bigger picture, obviously when you think a Tennant, the first thing you think of as equipment sales, but that said, it seems like kind of a service model approach is becoming increasingly important. Can you talk to that a little bit and kind of how that model's evolving? I can talk to that. No, I mean, service, I actually I refer to the service as our secret sauce. I mean, If you look at
Chris Killingstad -- President and Chief Executive Officer
Service, I basically refer to service as our secret sauce. I mean if you look at a market like North America where we really have the only national, both direct sales and service footprint, it is an important competitive advantage and I think it's one of the reasons that we actually won the Wal-Mart business as well. So service and the PNC business collectively have always been around 30% of our sales. They hover in that direction but I think as we go forward with a new strategic plan, one of the emphasis areas is going to be to see how we can further leverage our service model to drive more equipment business but also to drive more parts of consumables business. As we've said about the margins on the service labor are not all that interesting but the margins on our PNC business are extremely attractive and today we're not getting our fair share, that's our judgment, and we're going to strive to grow that much more aggressively as we go forward.
Christopher Paul Moore -- CJS Securities -- Analyst
Helpful. Does the -- on the autonomous scrubber side of things, does that change anything, is that the kind of service component of that is that more important, less important or maybe talk to that kind of whole revenue model a bit more?
Chris Killingstad -- President and Chief Executive Officer
Right. Well I think, with Wal-Mart now it's still evolving, but I -- our judgment is that it's going to become -- this is more important because not only we are having to service the machine and all the cleaning components but you have all the robotic component as well and the software updating that needs to take place on a regular basis and so the coordination between us and Brain, which is our partner on that front, is going to be crucial as part of our service model. So, I would say that service in the autonomous space is an even more important component of our our board our value proposition going forward.
Christopher Paul Moore -- CJS Securities -- Analyst
Got it. Thank you. Gross margins were obviously quite strong this quarter, talked about kind of the different pieces that were driving that. S, looking at it from more of a kind of perhaps a fiscal 19 perspective, is that kind of the new normal or is it likely to do especially as strategic accounts, kind of come become more important, up and down? is it is that 41 too likely to know slide back a little bit?
Keith Woodward -- Senior Vice President and Chief Financial Officer
Yeah Chris, this is Keith. I would say it's likely to slide back a little bit. What we've said about autonomous cleaning and autonomous T7 is it's slightly it's below from a gross margin standpoint versus our company average but it's a creative from an EBITDA percentage. So as we start to ramp that up here in the back half we would expect to see a little bit of pressure there as well as just the ongoing tariffs and inflation that we expect to hit us. So probably we will slide back a bit.
Christopher Paul Moore -- CJS Securities -- Analyst
Got it. Last question. Just now we talked about IPC a little bit, I mean the acquisition was almost two years ago. It still feels like there is some integration taking place. Is that accurate? And if it is, kind of which areas are still a bit of work in process?
Chris Killingstad -- President and Chief Executive Officer
I mean, I think as we've said, the IPC acquisition has and continues to exceed our expectations but we're in the middle of doing a lot of the heavy lifting on the integration of the key countries, the U.K., Germany, France and Spain bringing the two teams together, the Tennant team and the IPC team together and basically creating a new operating model. So, I would say here over the last three, four, or five months maybe we've been a little bit more internally focused as we've tried to get that right. But we are kind of at the later stages of all that effort and our belief is that once in place and we turn outward again the benefits of the integration are going to be significant.
Christopher Paul Moore -- CJS Securities -- Analyst
Got it. Let me jump back in line. I appreciate it guys.
Chris Killingstad -- President and Chief Executive Officer
Sure Chris.
Operator
[Operator Instructions]. Your next question comes from the line of Mark Andres Rodriguez from Stonegate Capital Markets, Inc. Your line is open.
Marco Andres Rodriguez -- Stonegate Capital Markets, Inc., Research Division -- Analyst
Good morning guys. Thank you for taking my questions.
Chris Killingstad -- President and Chief Executive Officer
Good morning
Keith Woodward -- Senior Vice President and Chief Financial Officer
Good morning Mark.
Marco Andres Rodriguez -- Stonegate Capital Markets, Inc., Research Division -- Analyst
Morning .Hey, I was wondering if maybe you could talk a little bit more about the organic growth expectations. Obviously you had the guidance of 2 to 3 percent for fiscal 19, maybe if you can just talk a little bit about how you kind of expect that organic growth to fold out through the remaining three quarters, just kind of given the fact that you had real strong strategic account growth last year.
Chris Killingstad -- President and Chief Executive Officer
Yeah. Now it's way we're lapping very strong strategic account growth. One of the strongest years we ever had. So that's a challenge but the fact is we're sticking to our revenue guidance, a little bit behind in the first quarter. But if you look at our backlog and you and you look at the visibility we have to the pipeline going forward, we're confident that we can get to those numbers and we will be a creative on the base business without Wal-Mart AMR.
Keith Woodward -- Senior Vice President and Chief Financial Officer
I'd also add to that, Marco, just to say we're gonna be very focused on getting at the profitability that makes sense for us and the returns that we want. So we're just going to be disciplined about that as we go forward and managing it accordingly. So you'll see us just continue and that's incorporated in our 2 to 3 percent guidance.
Marco Andres Rodriguez -- Stonegate Capital Markets, Inc., Research Division -- Analyst
Got you. Okay. And then if you could talk a little bit here about your expectations just on the geographies and your expectations in terms of the organic growth rates there.
Chris Killingstad -- President and Chief Executive Officer
Well we said ,we should have organic growth in all three geographies again this year. That is our expectation. Good news is that Asia-Pacific is which you know we've struggled with that part of the business for a while had extremely strong results in the first quarter. I'm not sure we can maintain it at quite that level but we should have robust organic growth there the rest of the year. We look at EMEA and how we've grown in the mid single digits in the last two years, expect to maintain that kind of growth in EMEA and the North America has been our growth engine for many many years now, it is a pretty consistent track record of delivering decent organic sales growth and that is our expectation going forward. The other thing I'd add to that Marco is North America, keep in mind the ramp up of Wal-Mart AMR is coming in the second, third and fourth quarter so that will help us as well as we go forward in the Americas region.
Marco Andres Rodriguez -- Stonegate Capital Markets, Inc., Research Division -- Analyst
Gotcha. Then kind of shifting gears here to the operating expense side, I heard the commentary you had on R&D, the growth rate has been kind of on the downside here for the last couple of years and then a pretty significant year-over-year decline. Can you maybe just help frame a little bit more the R&D, it seems to be a bit of a change in strategic direction. I understand obviously you want to spend to make sure that you're competitive consistently in the marketplace, but just kind of help us understand a little bit more as far as where that sort of kind of levels out.
Chris Killingstad -- President and Chief Executive Officer
Well, the first thing that we look at is how robust is our new product pipeline in terms of meeting the greatest needs in the marketplace and right now we find that we basically are able to fully fund all the major programs including AMR with the budget that we have in place. Yes, I mean as a percent of sales it's been under 3% on a number of occasions, but also remember that we're a much bigger business now so the number of dollars we're spending against R&D are higher as a percent of sales when you're $1.1 billion, $1.2 billion business. I think that over time they gradually decline a little bit. But we, we as the innovation leader are single-mindedly focused on this and we will never allow our innovation agenda, our R&D agenda to be anything less than optimal to serve the needs of our customers and drive our growth.
Keith Woodward -- Senior Vice President and Chief Financial Officer
I would build on it Marco as well to say we're just getting smarter about our spend. We're much more focused on where we're really addressing operator needs and spending on those areas versus maybe exploring areas where it's not truly differentiated innovation and to Chris's point, the absolute level of our R&D spending has been fairly consistent. We peaked in 2016 and that was largely behind a lot of the automation with robotics and when we partnered with Brain, that basically took us back down to that $30 million, $31 million, $32 million level from kind of that $34 million, $35 million level. So we feel good about where we're at and the team is very focused on the right spending and getting the right returns.
Marco Andres Rodriguez -- Stonegate Capital Markets, Inc., Research Division -- Analyst
Gotcha. And on the SG&A line, the adjust number around $88 million or so in change, So you -- obviously, that -- there was a restructuring charges while there that stripped out. Just kind of want to get a better feel. Is that $18.5 million, is that kind of a new run or should we be expecting additional restructuring type costs in the next couple of quarters?
Chris Killingstad -- President and Chief Executive Officer
We have a little bit more restructuring to come for the rest of the year Marco but (inaudible) is focused on two markets of the biggest, it's China and Australia. We have placed new management teams in both of those geographies over the last year or so. They're kind of getting their feet on the ground and starting to operate to our expectations and the results are reflecting that. The other thing we're doing is that in China for example most of our sales were driven through our district distribution network and that was a little more volatile and so we've been gun to shift more and more of our effort to a direct markets, especially in the major metropolitan centers because that again is where we are advantaged in geographies like Europe and the U.S. and that's also helping us drive sales, and you're going to see more of that as we go forward. And then Goimae is a critical strategic play for us to in figuring out how we continue to grow that in the mid-tier piece of that market. So we're excited about that.
Yeah, it's not material to our results yet, but remember what we're trying to do with Goimae in China is what we are doing with IPC in EMEA right. We have not traditionally have had access to the mid-tier market either in EMEA or in China and in China it's by far the biggest part of the market. So the opportunity through Goimae in China is very significant.
Marco Andres Rodriguez -- Stonegate Capital Markets, Inc., Research Division -- Analyst
Great. Thank you guys.
Unidentified Speaker --
Welcome. Thanks, Prate.
Operator
Since there are no further questions at this time, I would like to turn the call over to management for closing remarks.
William Prate -- -- Analyst
Well, before I conclude, I again want to thank our Global Tenant team members who are pushing forward on initiatives to deliver innovation to our customers and value to our shareholders. We are excited as we move further into 2019 and are committed to delivering on our guidance and driving shareholder value. Thank you for your time today and for your questions. Take care everybody.
Operator
That concludes today's conference call. You may now disconnect.
Duration: 33 minutes
Call participants:
William Prate -- -- Analyst
Chris Killingstad -- President and Chief Executive Officer
Keith Woodward -- Senior Vice President and Chief Financial Officer
Christopher Paul Moore -- CJS Securities -- Analyst
William Prate -- Director, Global Financial Planning and Analysis and Investor Relations
Marco Andres Rodriguez -- Stonegate Capital Markets, Inc., Research Division -- Analyst
Unidentified Speaker --
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