Tennant Co (TNC) 2005 Q1 法說會逐字稿

At this time I would like to remind all parties today's conference call is being recorded. If you have any objections, you may disconnect at this time. Thank you for participating in Tennant Company's first-quarter earnings teleconference. Beginning today's meeting is Ms. Janet Dolan, President and Chief Executive Officer for Tennant Company. Ms. Dolan, you may begin.

Thank you very much. Good morning, everyone. This is Janet Dolan, and welcome to our first-quarter results conference call. With me for this call is Tony Brausen, our Vice President and Chief Financial Officer. Thank you for joining us this morning. Welcome also to all of you who are participating in the Web cast of this call. Before we proceed, I'll ask Tony to provide our Safe Harbor statement.

Good morning, everyone. Our news release was issued this morning via PRNewswire and is also posted in the Investor section of our Web site, TennantCo.com.

Our remarks this morning and answers to your 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. The risks and uncertainties include factors that affect all companies operating in global markets as well as matters specific to our Company and are described in today's news release as well as in the documents we file with the Securities and Exchange Commission. We encourage you to review those documents, particularly our Safe Harbor statements, for a description of risks and uncertainties.

And with that, I'll turn it back to Janet.

Tony will review our financial performance for the quarter in detail in a moment. First, though, I'll provide a quick overview of our results.

We are off to a strong start in 2005. Our first-quarter performance demonstrates that the work we have been doing to enhance the Company's overall earning power is beginning to deliver results. The big story in our 2005 first quarter is improved operating efficiency, that is, how we are converting more of our sales growth to profits. Leveraging our cost structure is one of our four core strategies for driving long-term profitable growth.

In our first-quarter results, you are seeing more evidence of the benefits of our prior actions, benefits that were somewhat masked in the 2004 fourth quarter by costs incurred in that period. Now, however, we are realizing more of the benefits resulting from reducing fixed and variable costs in our plants, trimming logistics costs, and improving overhead absorption in North America and Europe.

In addition to improved operating profitability, we again saw sales growth in all three geographies in the first quarter. We continue to benefit from improved sales and service coverage in Europe, and the realignment of our North American sales force, as well as contributions from newly introduced products. I will talk more about our continuing work on our core strategies later in the call. First, I will have Tony give you a recap of our first-quarter results.

Thanks, Janet. For our 2005 first quarter, we reported net earnings of $0.39 per diluted share. That is up 39% from $0.28 per diluted share in last year's first quarter. Consolidated net sales for the quarter totaled 126 million, which is up 5.8% from the comparable 2004 period. Volume growth across all three geographies and price increases accounted for most of the sales increase. Favorable foreign currency exchange effects added about 1% to first-quarter net sales.

In North America, first-quarter net sales increased 4.8% from 82.7 million. Sales grew in all categories -- equipment, coatings and service, parts and consumables. As Janet mentioned, the revenue growth in North America reflects contributions from new products as well as improved sales force effectiveness and market coverage resulting from the realignment of our sales resources.

In Europe, sales for this year's first quarter totaled 30.8 million, up 8.1% compared with the 2004 first quarter in Europe that included a large customer order. Revenue growth was driven primarily by sales of new products introduced late in 2004 and growth in service, parts and consumables. Favorable foreign currency exchange effects added about 3% to 2005 first-quarter net sales in Europe.

In our other international markets, net sales for this year's first quarter increased 6.8% to 12.5 million. Higher sales in Latin America and the Middle East provided much of the revenue growth with favorable foreign currency exchange effects adding about 1%. Our gross margin for the 2005 first quarter was 42.9% compared with 40.3% in last year's first quarter. Several factors contributed to this 260 basis point increase. First, our sales mix in North America in this year's first quarter included a larger than usual percentage of higher-margin direct sales and less of the lower-margin distributor sales.

We believe the channel mix in the first quarter favored direct sales for two reasons. First, to improve our sales effectiveness, we have extended the reach of our direct sales force into some areas that have previously been underserved, including small to midsize warehouse and manufacturing facilities. We are now collaborating with our distributors to reach these customers.

Second, our sales to distributors were skewed somewhat into the fourth quarter of 2004 as distributors placed large orders for the large number of new products were introduced late last year. As distributors sell through inventory from those initial orders, we expect the balance of the direct and the distributor sales in North America to return to more typical levels and the channel mix benefit we enjoyed in the first quarter will be less pronounced.

The cost reduction actions we took in the latter part of 2004 were a second factor benefiting our first-quarter gross margin, as those actions helped reduce fixed costs in our plants.

The third factor benefiting first-quarter gross margin was improving operating efficiencies, including lower logistics costs and a higher percentage of European-built product in our first-quarter sales. Our overhead absorption in Europe benefited from this.

Finally, our first-quarter gross margins also benefited from favorable foreign currency exchange effects and the impact of price increases taken previously to offset rising material costs. We think price increases have brought us close to covering the impact of higher materials costs, and in particular, the higher steel prices.

Our first-quarter gross margins do not yet reflect the impact of the first-quarter increase in oil prices. The impact of the increase lags (ph) the actual rise in oil costs and will affect us in 2005 in the form of higher costs for resins, rubber parts, such as tires, gaskets and hoses, floor coatings and freight.

Our R&D, a critical driver of our renovation strategy, totaled 4.5 million in the quarter, up nearly 10% from last year's first quarter but in line with our long-term target of 3 to 4% of net sales.

Selling and administrative expenses for this year's first quarter totaled 43.4 million. That's up from 39.6 million in the year-ago quarter. The major components to the increase were higher performance-based stock compensation costs, volume-based costs, such as sales incentives and warranty accruals resulting from the higher sales in the quarter, foreign currency exchange effects, Sarbanes-Oxley compliance costs and inflationary influences, such as higher salaries, higher fuel costs for our several hundred sales and service vehicles, higher healthcare and other costs. These increases were partially offset by the benefits of the cost reduction actions we took in 2004.

Selling and administrative costs were 34.4% of net sales in the 2005 first quarter compared with 33.2 percent of net sales in last year's first quarter.

Our operating profit for this year's first quarter totaled 6.1 million. That's up 42% compared with last year's first quarter. Operating profit benefited from the revenue growth in the quarter and the previously mentioned factors that contributed to the 260 basis point gross margin improvement. Operating margin for this year's first quarter was 4.8%, up from 3.6% in last year's first quarter, reflecting primarily the improved gross margin described a few moments ago.

Our tax rate in the quarter was 39% compared with 41% in last year's first quarter. The reduction results from the mix of earnings by country compared with the 2004 first quarter.

Turning to cash flows and the balance sheet, cash flow from operations in the 2005 first quarter was a negative 1.1 million. Cash outflows during the quarter included a large lump sum payment to a former executive under a deferred compensation plan and the payments of the 2004 performance-based incentive awards.

Our inventories at quarter end totaled 49.2 million. That's up from 59.2 million, which is up from 54.9 million at the end of the 2004 first quarter. FIFO inventory days on hand were 103 at quarter end compared with 101 at the end of the 2004 first quarter. We traditionally see the highest quarterly inventory days on hand in the first quarter as a result of seasonality influence. By comparison, first-quarter FIFO inventory days on hand two years ago were 108.

Net receivables at quarter end totaled 89.8 million. That's up from 87.2 million at the end of the 2004 first quarter, primarily because of the increase in net sales this year. Accounts Receivable days outstanding were 61 at the end of the 2005 first quarter compared with 60 at the end of the year-ago quarter.

Our capital expenditures in the 2005 first quarter totaled 3.7 million. And for the full year, we are currently expecting capital spending of 15 to 20 million. Our debt to total capitalization ratio at quarter end was 2% compared with 5% the year-ago quarter. During the 2005 first quarter, we paid down 5 million in fixed-rate debt that had matured.

And that concludes my overview of the quarter. I'll turn it back to Janet.

Thank you, Tony. We are pleased to have started the new year with a solid first quarter. We have been consistently executing on several core strategies to drive profitable growth at Tennant. Our results increasingly demonstrate that we are on the right track. The challenge going forward is to maintain the momentum we have been building. To do that, we have a variety of actions planned to further our progress on our core strategies. I will use the rest of today's call to update you regarding how we plan to continue working in 2005 on the core strategies we've previously defined for Tennant and then discuss our outlook for the year.

As you have heard me say before, we are focusing on four core strategies to drive sustainable, profitable growth. These strategies include becoming a world-class marketer, being the industry's innovation leader, extending our market coverage, particularly with the segment of the market we call cleaning pros, and leveraging our cost structure.

In the marketing category, we will continue to strengthen our capabilities across multiple fronts. For instance, we plan to use our information technology infrastructure to manage customer relations more effectively. We see opportunities to improve lead management, enhance our knowledge of particular accounts and better manage overall account profitability. In addition, we plan to improve our e-commerce capabilities. Our Web site can do more to provide a convenient channel through which our customers can request information and place orders. Particularly for products such as parts and consumables and for routine inquiries, we can enhance customer self-service capabilities while lowering our costs to fulfill some orders and respond to customers' needs.

The second of our cornerstone strategies is to lead our industry in innovation. In 2004 we completed one of the most aggressive periods for new product launches in our Company's history. This year we will be driving to build strong customer adoption of these new products, most of which just came into the market late in the year. In addition, we will maintain our commitment to invest 3 to 4% of sales in research and development, with a particular emphasis on advanced gain-changing products, such as our FaST and ReadySpace offerings.

Our R&D efforts will focus especially on anticipating and meeting the needs of our highest-value customers, customers we call cleaning pros. As we have noted before, these are customers for whom clean, well maintained and safe environments, are intrinsically important and valuable. As a result, they tend to favor integrated solutions to cleaning and maintenance challenges. Accordingly, we will continue to look at how we can create combinations of equipment and services that together offer our cleaning pro customers a superior solution and value.

Our third core strategy is to extend our market coverage with particular emphasis on reaching customers in that cleaning pros segment. Our prior actions in this area are already contributing to improved sales effectiveness in Europe and North America.

Looking ahead, we see attractive opportunities for organic growth in many European markets, as well as in Japan and China. In North America, we are using our direct sales force in concert with our distributors to extend sales coverage for certain products, the underserved and underpenetrated opportunities such as small to medium-size warehouses and manufacturing facilities.

Finally, we will continue to focus on leveraging our cost structure. As we have said today, our first-quarter results demonstrate some of the operating efficiency benefits we have already gained through prior actions to permanently reduce costs. In 2005, we will place continued emphasis on lean manufacturing and no-waste initiatives, as well as expense controls intended to keep the rate of growth in SG&A well below our rate of sales growth over the long term.

With respect to our outlook for 2005, for strong first-quarter results have us on track to achieve 2005 net earnings per share of $1.80 to $2.10. Our guidance assumes that the favorable sales mix benefit we saw in the first quarter will be tempered in future quarters by a return to a more typical balance between direct and distributor sales.

Our guidance also assumes an unfavorable effect on margins from the more recent rise in oil costs. As we previously reported, our guidance for 2005 includes up to about $0.15 per share of costs related to performance-based stock compensation. When we initially provided our 2005 guidance, we assumed our results would need to include costs related to expensing previously issued but unvested stock options as required by accounting rule changes that were scheduled to take effect later in 2005.

As you may know, the required implementation of these rule changes has been delayed to 2006. Nonetheless, our guidance still needs to take into account expenses related to performance shares, which we are using to replace stock option grants beginning this year and which account for the majority of the stock-based compensation costs we expect to incur in 2005. The recorded expense will vary with the Company's performance.

To sum up, we are pleased with our strong start in 2005. While we anticipate some headwinds in the form of oil prices and other economic and market uncertainties, we have clearly strengthened the overall earnings power of the Company through our prior actions. We have clear strategies in place to drive top line growth as well as improved profitability. For 2005 in particular, we are (technical difficulty) to benefit from the recent additions to our product line as well as expanded and more effective market coverage.

That concludes our overview, and now we would be very happy to take your questions.

(OPERATOR INSTRUCTIONS). Shelly Henbest (ph) with C.L. King.

We have been hearing about a softening in the price of steel recently, U.S. steel. And a few others came out and said that they expect prices to come down somewhat. Can you talk a little bit about how that might affect you? And is it possible that might help to offset some of the increases in oil prices that you are concerned about going forward?

Certainly, Shelly. This is Tony. We have seen, as you have read about, a softening of the steel costs from their peak levels that were experienced in the fall of last year. And in fact, we began to see that softening in the fourth quarter of last year. And that has been good news, welcome news. Certainly, it has dropped some, but nowhere near the level that it once was in terms of the cost. So it is still considerably higher than it was twelve months ago.

At the same time, when we established our guidance back in February for the year, we assumed and in fact expected and at that time knew that steel costs were declining somewhat from their peak. So we had already built that into the guidance. And those steel costs have performed pretty much as we had expected when we provided that guidance in February.

Okay. Just in terms of changes in the costs of raw materials and such, how would price increases come into play going forward? Have you already raised prices so much that there's pressure there, or is there still room to bring those up?

Shelly, it obviously depends upon the extent of the change in the cost of materials, but we're in a largely B2B marketplace. Our customers experience the same kind of cost increase impacts that we do. And so they tend to be understanding and also to, certainly, be doing the same thing in their industry. So we have, certainly, the flexibility, if we need it, but it depends upon the extent of the cost increase.

Okay, great. And I actually just have one quick question to confirm. Did you say that the stock options expensing was included in this quarter? Or that it was delayed? I was a little confused about that.

Sure. There's actually two elements to the stock compensation expense for us. One would have been the expense required in 2005 for previously granted but unvested stock options. The SEC came out within the last several weeks and delayed the implementation of that part of this accounting requirement to the first of next year. So that aspect of it, which was a smaller part of the total for us, is delayed and will not occur in our P&L this year; that will happen starting January 1st of 2006.

The other more sizable component of the stock compensation cost, as Janet mentioned, is the fact that we have essentially replace stock options beginning this year with performance shares. And that happened already; in fact, those were granted in February by the board. And so we are incurring the expenses associated with those performance shares in 2005, and that is built into the guidance range that we have provided.

So can you quantify what effect that had on SG&A in the first quarter?

Yes; that was about $300,000 in the first quarter, and we expect for the year that to be in the neighborhood of 10 to $0.15. But again, that varies with our performance; that's a performance-based plan.

(OPERATOR INSTRUCTIONS). Ms. Dolan, at this time, I show no further questions.

Why don't we go ahead and poll one more time, Dennis, just in case?

Just a moment. Wesley Galai (ph) with Wesley Galai Capital Management. You may ask your question.

We know how to pronounce your last name; we know it's Giley (ph).

I was curious, and luckily it was very strong performance in the quarter, what might be the opportunities for the shareholders to receive a meaningful dividend increase in the near-term?

Well, you know, we always look at ways that we can return some of the additional value back to shareholders, so we will certainly consider it, as we always do, looking at different options of how to use the cash and how to return value to shareholders.

It seems to me as though you're going to be generating plenty of cash this year. Is that correct?

Well, we hope to, yes.

Okay, well, thanks very much.

We'll certainly consider it.

(OPERATOR INSTRUCTIONS). Shelly Henbest with C.L. King.

I just had one more question. I just wondered if you guys had any general comments on any changes in the competitive environment or anything especially you're seeing there?

Well, Shelly, I think that -- we hope that, and certainly recognize that probably the most important impact in the competitive environment is that we've had this introduction of so many significant new products. So it is more, I think, that we are making ripples in the marketplace in terms of being the competitor to watch because we've had so many of these new products and particularly our focus on breakthrough.

(OPERATOR INSTRUCTIONS). Ms. Dolan, at this time, I show no further questions.

All right. Well, that concludes our call. And just as a reminder, our annual meeting this year, our annual meeting of shareholders, is this Thursday, May 5th at 10:30 AM Central time. And we are Web casting the meeting, so we invite you to listen in. Visit our Web site for the details.

Thank you all for joining us. We appreciate your interest in Tennant Company.

Thank you. At this time, that does conclude the Tennant Company first-quarter earnings teleconference. At this time you may disconnect. Thank you.