Tennant Co (TNC) Q2 2019 Earnings Call Transcript

TNC earnings call for the period ending June 30, 2019.

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Motley Fool Transcribers
Jul 31, 2019 at 4:23PM
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Tennant Co (NYSE:TNC)
Q2 2019 Earnings Call
Jul 31, 2019, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning. My name is Denise and I will be your conference operator today. At this time, I'd like to welcome everyone to Tennant Company's 2019 Second Quarter Earnings Conference Call. This call is being recorded. [Operator Instructions] Thank you for participating in Tennant Company's 2019 Second 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 -- Director of Global Financial Planning and Analysis and Investor Relations

Thank you, Denise. Good morning, everyone, and welcome to Tennant Company's second quarter 2019 earnings conference call. I am 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 of Finance and Corporate controller; and Mary Talbott, Senior Vice President and General Counsel.

Today, we will update you on our ongoing progress against our core strategies, our performance during the recent second quarter and our full year guidance. Chris, will first brief you on our strategies and operations, and Keith will cover the financials. After our remarks, we will open the call 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 August 31, 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 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.

Additionally on this call, we will discuss non-GAAP measures that include or exclude certain items. Our 2019 second quarter earnings release, includes 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'll 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 today. For the past couple of quarters, we have begun to discuss how Tennant Company is in transition. We are moving from a period of strategic expansion, designed to extend and diversify our geographic and addressable market footprint, to a more concentrated and deliberate focus on unlocking the benefits of this broader platform and driving profitable growth. This concentration on balancing reasonable growth with stronger EBITDA expansion forms the center of the strategic plan we are developing and will take us into the future.

As indicated last quarter, we have already begun to implement certain initiatives from this plan. And while these efforts continue to develop and mature, they are already beginning to have a positive impact. We will have more to share with you on this plan in the coming months. But today, I want to provide you with some high-level insights into our approach and how it is starting to drive decision-making. We have a clear understanding of how we intend to shape the future of Tennant Company.

Three growth pillars support our strategy and focus on profitable growth. The first is winning where we have competitive advantage. Within this pillar, we are deeply evaluating all aspects of our business portfolio, which includes our products, geographies, channels and customers. To truly understand the components where we have the strongest value proposition. These insights will help us inform where to better invest our capital and better apply our resources, so we can pursue the strongest opportunities. They will also help us decide what products and services we need to move away from. This effort has already led to some early decisions in terms of portfolio refinement and targeted sunsetting of certain products.

During the second quarter, we made the strategic decision to exit the Green Machine and Orbio businesses. This is just one example of how we believe Tennant can refine our portfolio in such a way that both enhances our category leadership and our profit potential. Tennant is a much larger and more diversified organization than it was three years ago. This gives us many strengths and advantages, but also significant opportunity to refine our business portfolio and optimize what it is capable of.

The second strategic pillar is reducing complexity and building scalable processes across our business. Our growth has not only diversified Tennant by markets and product tier, but it has also greatly expanded, and in some ways made more complex our operating platform. This pillar is an integral step toward increasing and improving the profitability of our products, efficiencies within our manufacturing and supply chain and how we source material and support our overall enterprise. It means, rethinking each product, process, looking for ways to simplify how we work across our entire business platform and looking for ways to apply technology and automation to create new efficiencies. Our efforts in this second pillar are designed to more fully extract the benefits of this larger platform we have created.

Our third strategic pillar is building on our position as an innovation leader. Tennant continues to build its reputation on innovation, and finding creative ways to bring new compelling solutions to our customers. One example of this commitment is our autonomous floor cleaning technology. As you may recall, earlier this year we announced our relationship with Walmart for this new technology. As Keith will discuss in a moment, our early work with Walmart was, as expected, a meaningful revenue contributor in the second quarter. Autonomous cleaning technology can deliver enormous value and are alive for our customers, in particular strategic customers with broad needs and efficiency imperatives. We are pleased with the way AMR is being received and we are very excited by the promising role robotics will play in the future. We believe we have first mover advantage at large scale commercialization of this technology and we intend to fully capitalize on it.

We have much more work to do on all of these fronts, but our results for the second quarter begin to illustrate the potential impact of these initiatives. Like most industrial companies, we continue to operate in an environment marked by uncertain end market conditions and economic headwinds in the form of tariffs and raw material cost pressures. Furthermore, we face the opportunistic challenges that come with our own efforts to transform, efforts that we intend to further invest in this year. All this change means we have and will continue to operate the business with discipline and prudence. This approach guided our performance and outlook in the first half of this year and is informing the adjustments to our outlook we are making today.

Now, I'll turn the call over to Keith.

Keith Woodward -- Senior Vice President and Chief Financial Officer

Thank you, Chris, and good morning, everyone. In my comments today, references to earnings per share, both GAAP and non-GAAP are on a fully diluted basis. As Chris stated, Tennant second quarter results reflect a blend of factors from mixed and market conditions to our ongoing efforts to better balance our growth goals with profitability enhancing initiatives.

For the second quarter of 2019, Tennant reported net sales of $299.7 million, up 2.6% year-over-year. Organic sales, which excludes the impact of recent acquisitions and currency effects, rose 3.8%. Our total organic sales exceeded our internal expectations and the makeup by region was different than we expected. We believe this performance showcases the value of our diversification of revenue streams and explains why we are pleased with the organic sales performance in the quarter, especially considering the difficult comparison to strong organic sales results in last year's Q2.

On the bottom line, our second quarter 2019 reported net earnings grew 16.5% to $14.8 million, or $0.81 per diluted share. On an adjusted basis, net earnings grew 37.7% to $20.8 million, or $1.13 per share. While we continue to strive for more progress in terms of profit expansion, we are encouraged by our margin and EBITDA improvements in the quarter.

Now, let's take a closer look at our sales results. As you may know, 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 were up 6% or 7.8% on an organic basis. Solid sales performance in the Americas reflects broad-based strength across the entire region, specifically our strategic accounts channel, service, parts and consumables, the newly introduced T7 AMR autonomous cleaning machines and a strong quarter in Brazil in both the industrial and commercial product areas.

It's worth noting that sales contributions from our recently announced partnership with Walmart contributed to the quarter as expected, and we are optimistic about the growth potential from this new product offering. We continue to expect this contribution to gradually ramp up over the course of the year and into 2020.

Moving on to EMEA. Sales here reflect the same general market softness and headwinds being experienced by other industrial companies with exposure to this region. Reported sales in EMEA declined 7.4%, or 2.9% down organically. This continued softness appears to be caused by a general theme of market uncertainty across the region, which is resulting in customers delaying purchases. While facing these headwinds, it's important to note, we remain committed to our integration efforts in this region, which remain on track and we believe will better position our business for future success.

On to the Asia Pacific region. Reported sales were up 12.7%, but declined 0.5% organically. As you may recall, we closed on the acquisition of Gaomei at the beginning of 2019 and our reported Q2 results now reflect a full quarter contribution from this division. On an organic basis, our sales performance largely reflects timing of sales, which were moved in -- which were part of the 2019 first quarter and weaker sales in Korea. Given that shift, it's helpful to look at combined organic sales for the first half of 2019, which were up 3.6% year-over-year.

Now, on to margins and expenses. As Chris pointed out, our strategic pillars are all focused on the goal of producing EBITDA enhancing growth. We have considerable progress yet to make, but we believe that Tennant's profitability performance in the second quarter shows that we are on the right path.

Adjusted gross margin in the 2019 second quarter improved 130 basis points year-over-year to 41.4%. This gain was led by positive pricing actions, favorable sales mix, cost reduction initiatives and continued operational efficiencies that also allowed us to overcome headwinds in the form of tariffs and raw material price inflation.

Taking a look at expenses. Our focus on operational rigor and tight expense management is another strategic pillar, and during the quarter, helped contribute to our expense leverage. Specifically during the 2019 second quarter, our adjusted S&A expenses improved by 80 basis points year-over-year.

Our profitability enhancement initiatives combined to deliver significant EBITDA expansion during the quarter, and as a result, our adjusted EBITDA increased 17.1% to $41.8 million, or 13.9% of sales.

As we move into the back half of 2019, I want to address our expectations for EBITDA margin that are included in our adjusted outlook. We currently expect EBITDA margin in the back half of 2019 to be lower than the first half due to a ramp-up in investments in services organization, operations, and R&D. As Chris noted, the nature of these investments supports our strategic pillars and are focused on boosting our efficiency and effectiveness and the strength of our portfolio, all of which we expect to enhance EBITDA margins over time. Along with these investments, our guidance also reflects the continued headwinds associated with specific regional market uncertainty, inflation, tariffs and other cost of goods pressure.

Speaking next to our tax rate. During the second quarter, Tennant realized a discrete tax benefit due to a partial release of our valuation allowance on deferred tax assets. This resulted in an adjusted effective tax rate for the quarter of 11.7% and will lower the adjusted effective tax rate we foresee for 2019.

Turning now to cash flow, capital allocation and balance sheet items. Tennant generated $22.5 million in cash from operations for the second quarter, which reflects the Company's overall strong performance. During the same period, Tennant also reduced our outstanding debt by $5.8 million and paid $4 million in cash dividends to shareholders. Better managing our balance sheet is a part of the additional rigor we intend to build into the business. We believe we have more work to do in terms of managing working capital, especially our inventory. The simplification and refinement of our product portfolio that Chris talked about will help us achieve this goal.

As stated in today's earnings announcement, given Tennant's performance in the first half of 2019, we are increasing our 2019 guidance, which is as follows: net sales of $1.15 billion to $1.165 billion with organic sales growth in the range of 3% to 4%; full-year reported GAAP earnings of $1.80 to $2 per diluted share; adjusted EPS of $2.65 to $2.85 per diluted share; adjusted EBITDA of $131 million to $135 million; capital expenditures of approximately $35 million to $40 million; and an effective tax rate of approximately 16%. Our revised guidance accounts for the impact of new autonomous cleaning technology we are bringing to market, known macroeconomic and end-market factors and the additional investments we intend to make in the business to help achieve profitable growth.

With that, we'd like to open the call up for questions.


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Questions and Answers:

Operator

[Operator Instructions] Your first question comes from Brett Kearney with Gabelli Funds LLC. Your line is open.

Brett Kearney -- Gabelli Funds LLC -- Analyst

Hi, guys. Thanks for taking my question.

Chris Killingstad -- President and Chief Executive Officer

Hey, Brett.

Brett Kearney -- Gabelli Funds LLC -- Analyst

Very strong cash flow generation in the quarter, further paying down debt. I think net leverage is close to 2 times now. Just wanted to ask, how you are thinking about capital deployment, I guess, in the back half of this year into 2020?

Keith Woodward -- Senior Vice President and Chief Financial Officer

So, Brett, just to clarify, you're talking about just overall capital expenditures and investments?

Brett Kearney -- Gabelli Funds LLC -- Analyst

Yeah. Yeah. Debt pay down versus anything you might do, even on the M&A front as well.

Keith Woodward -- Senior Vice President and Chief Financial Officer

Yeah. Here's what I'd say, is that, we've been fairly open about our goal to pay down our debt and our leverage, which we continue to do, is our first priority. We'll continue to be a dividend payer as we have been for 74 years. And we continue to make those investments, where we think we have the highest returns from a CapEx standpoint. We did make a slight adjustment in our overall capital expenditure guidance. We took that down $5 million just based on truing up our real estimates in that regard. But I think you'll see more of the same in terms of where we're going in the back half with our capital allocation. We will speak to that more as part of our overall kind of longer term strategy, when we come out with that and get more specific, Brett. But for now, the way we've been approaching it is, it will be very consistent in the back half.

Brett Kearney -- Gabelli Funds LLC -- Analyst

All right. That's great. Congrats on a terrific quarter.

Keith Woodward -- Senior Vice President and Chief Financial Officer

Thanks, Brett.

Chris Killingstad -- President and Chief Executive Officer

Thank you.

Operator

[Operator Instructions] Okay. Since there are no more questions queued up at this time, I'll turn the call back over to management for closing -- oh sorry, we do have one question. Chris Moore from CJS Securities. Your line is open.

Christopher Moore -- CJS Securities -- Analyst

Hey, good morning, guys.

Chris Killingstad -- President and Chief Executive Officer

Good morning, Chris.

Christopher Moore -- CJS Securities -- Analyst

Good morning. Yeah. Maybe go back to topic we talked about quite a bit on the gross margin side. Again, just trying to get a sense as to -- that new normal that we're heading toward, keeping in mind strategic account sales bring it down a little bit, low as the IPC gross margin although they tend to kind of head back on the operating margin side. Given some of these improved efficiencies that you're putting in place now and continue to, can you give a sense of what that -- can we get back to the 42% gross margin level, is that aggressive or...

Keith Woodward -- Senior Vice President and Chief Financial Officer

Yeah. Here's what I'd say, Chris, we've made the shift to really focusing on EBITDA margins, given the nature of just different businesses around the globe and -- but we certainly have our eye on gross margins and we know that's an important piece of this. We are -- what we're saying is, as our mix of business shifts a bit in the second half, that's a little bit of the pressure on EBITDA in the back half. And -- but overall, we're just trying to navigate through what we see is just -- the tariffs that we were anticipating in the first half got delayed a bit. Now, those are back to more of our expectations, so we don't see the upside there. And then it's just more of this mix of business that's coming through in our overall margins and what we expect.

In terms of your question around longer term, I would just put that in our overall just our EBITDA goals and where we're headed in the future. And we'll get a lot more specific about that longer term algorithm as we come out and talk about that longer term strategy. But we need good gross margins to deliver good EBITDA. And so, it's really the totality of the P&L, EBITDA and the right mix, really good SG&A management and discipline around that and making sure that flows through to EBITDA on a consistent basis.

Christopher Moore -- CJS Securities -- Analyst

Got it. Yeah. That was -- I know that EBITDA is kind of longer term goal is 15% up. I'll leave that alone for now until you guys talk further to it. Historically, you have kind of talked about the last six weeks of Q3 being really crucial to that quarter's results. Is that still the case? And then kind of how much visibility do you have for the balance of Q3 and into Q4?

Keith Woodward -- Senior Vice President and Chief Financial Officer

Yeah. Again, because I'm relatively new, Chris, I'm not as familiar with that six weeks. What I would say is, the balance of this business across quarters is pretty consistent. So, from my standpoint, it's just consistent delivery across each of the quarters, each of the months and just making sure that we're focused appropriately. You might be talking about seasonality and buying cycles, et cetera. We've factored all that into our thinking and our planning. And so, we just need to make sure that we're doing -- laying out and executing our plans as expected. And so, that's factored into our guidance.

Christopher Moore -- CJS Securities -- Analyst

Got it. And then the last question, somewhere in the commentary you talked about S&A and R&D shifts into the second half of the year. Can you just talk to that a little bit in terms of was there some delay on that front that that input results a little bit in Q2?

Keith Woodward -- Senior Vice President and Chief Financial Officer

Yeah. If I talked specifically to R&D, we delayed a little bit of our timing of our investments there. And now we're ramping up as we really get after AMR, we see additional opportunities in the automated robotic area. So heavier investments around that in the second half. And then we have a couple of other just kind of core platforms around these sustainable processes. Just in terms of our service platform and investing in that and getting that to the level that we expect around mobility, et cetera. And just IT investments is another key part of that S&A investment in the back half.

Christopher Moore -- CJS Securities -- Analyst

Got it. All right. Appreciate it, guys.

Keith Woodward -- Senior Vice President and Chief Financial Officer

Sure.

Chris Killingstad -- President and Chief Executive Officer

Our pleasure.

Operator

There are no further questions queued up at this time. I'll turn the call back over to management for closing remarks.

Chris Killingstad -- President and Chief Executive Officer

Before we conclude, I need to thank our global Tennant team members, who are pushing forward on initiatives around each of the three strategic pillars and are helping to drive Tennant toward delivering higher levels of value to both our customers and our shareholders. We are pleased with our performance in the first half of 2019 and excited as we move into the back half. Thank you for your time today and for your questions. Take care, everybody.

Operator

[Operator Closing Remarks]

Duration: 26 minutes

Call participants:

William Prate -- Director of Global Financial Planning and Analysis and Investor Relations

Chris Killingstad -- President and Chief Executive Officer

Keith Woodward -- Senior Vice President and Chief Financial Officer

Brett Kearney -- Gabelli Funds LLC -- Analyst

Christopher Moore -- CJS Securities -- Analyst

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