Tennant Co (TNC) 2005 Q2 法說會逐字稿

Welcome and thank you for standing by. (OPERATOR INSTRUCTIONS) Again, 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 second-quarter earnings teleconference. Beginning today's meeting is Ms. Janet Dolan, President and Chief Executive Officer for Tennant Company. Ms. Dolan, you may begin.

Good morning, everyone. This is Janet Dolan and I want to welcome you to our second-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 and welcome also to all of you who are participating in the webcast of this call.

Before we proceed I will ask Tony to provide our Safe Harbor statement.

Good morning, everyone. Our news release was issued this morning via Business Wire and is also posted in the investor section of our website, tennantco.com.

Our remarks this morning and our 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 and global markets, as well as matters specific to our Company, and 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 risks and uncertainties.

With that I will turn it back to Janet.

Tony will review our financial performance for the quarter in detail in a moment. I will provide a quick overview of our results first.

As in our 2005 first quarter, the primary force driving our strong performance in the second quarter was improved operating efficiency. Our top line growth was in line with the mid to high mid single digit increases we expect to generate over the long term from the existing business. The sales growth resulted primarily from continued contributions from new products, better market coverage, and improved sales force effectiveness.

The real story through the first half of the year, though, has been our ability to deliver bottom line growth at a multiple of revenue growth. This improved earnings power is sustainable in the foreseeable future and results from our ongoing efforts to reduce fixed and variable costs and enhance our overall operating effectiveness. Our progress is clearly evident in the strong improvement in our operating margin compared with the 2004 second quarter.

Leveraging our cost structure is one of our four core strategies at Tennant. It also complements the other three, which are focused on the top line, namely becoming a world-class marketer, being our industry's innovation leader, and extending our market coverage, particularly to enhance our reach with Cleaning Pro (ph).

Leveraging our cost structure is creating the sustainable earnings power required to invest in strategies for driving revenue growth. Our performance through the first half of 2005 shows this mutual reinforcement at work. Our efforts to grow sales with smarter marketing, better market coverage, and innovative products are delivering incremental revenue growth, while our attention to leveraging our cost structure is translating more of that growth into profit that can fund further marketing, market coverage and product development initiatives.

I will turn the call back to Tony now for a recap of our second-quarter results. Following that I will provide an update on outlook for the year, as well as a strategic update.

In our comments today all references to earnings per share are to EPS on a fully diluted basis. For our 2005 second quarter we reported net earnings of $0.74 per share, up 80% from $0.41 per share in the 2004 second quarter. And for the year-to-date we reported net earnings of $1.13 per share, up from $0.69 a share in the first half of 2004.

Consolidated net sales for the quarter totaled 137.1 million, which is up 6.4% from the comparable 2004 period. The increase resulted from organic growth in all three geographic regions. New products, such as our T-Series scrubbers and ReadySpace offerings for carpet care were key contributors to volume growth.

Favorable foreign exchange effects added about 2% to net sales in the 2005 second quarter. For the year to date consolidated net sales increased 6.1% to 263.1 million. Favorable foreign currency exchange effects added about 1.5% to net sales in the year to date.

In North America second-quarter net sales increased 5.4% to 92.5 million. As in the first quarter, sales grew in all three categories -- that's equipment, service parts and consumables, and coatings -- as we continue to benefit from new products, improved sales force effectiveness and increased market coverage. For the first six months of 2005 net sales in North America increased 5.2% to 175.3 million.

In Europe sales for this year's second quarter totaled 30.7 million. That's up 7% compared with the 2004 second quarter. Growth in service parts and consumables revenues more than offset a slight decline in second quarter equipment sales in a soft European economic environment. Favorable foreign currency exchange effects added about 4% to 2005 second-quarter net sales in Europe. For the year to date net sales in Europe increased 7.2% to 61.4 million with favorable foreign currency exchange effects adding about 4% to net sales.

In our other international markets net sales for this year's second quarter increased 13% to 13.9 million. The increase resulted from volume growth in most areas, including Latin America, the Middle East and Australia. These include areas where regional economies are benefiting from higher prices for commodities such as oil and metals. Favorable foreign currency exchange effects added about 3% to net sales in the quarter. For the year to date net sales to other international markets totaled 26.4 million. That's up 10% compared with the first half of 2004. Foreign currency exchange effects added about 2% to net sales for the 2005 year-to-date period.

Our gross profit margin for the 2005 second quarter was 42.6% compared with 39.7% in last year's second quarter. Several factors contributed to this 290 basis point increase -- first, reduce fixed and variable costs in part from the workforce reduction action taking in the latter part of 2004 and in part from our lean enterprise and other initiatives; second, better overhead absorption in our plants worldwide. While equipment volumes were down slightly in Europe, for instance, we've shifted more production of Europe-sold equipment to our Netherlands plant. Third was lower net logistics costs. Fourth, last year's second-quarter gross margins were unfavorably impacted by an increase in reserves for slow-moving and excess inventory and higher steel costs. We believe with price increases we have taken, we're now at about a cost-neutral position on steel. Finally, the favorable foreign exchange impacts that we noted earlier also benefited the gross margins.

So in total, about half of the 290 basis point improvement came from cost reduction initiatives, including lean and other initiatives, and last year's workforce reduction action. About a fourth or the second-quarter 2004 factors that I mentioned -- that is steel costs and the slow-moving excess inventory reserves, and the remaining fourth was foreign exchange.

It's important to note that our second-quarter gross margin does not yet fully reflect the impact of near $60 per barrel oil prices. The impact of these higher oil prices lags the actual rise in oil costs and will affect us later in 2005 in the form of higher costs for such things as resins; rubber parts such as tires, gaskets and hoses; floor coating; and of course freight costs.

Our R&D spending in this year's second quarter totaled 4.5 million, which is up slightly from the 2004 second quarter. We continue to invest 3 to 4% of net sales in R&D in order to maintain our position as the industry's innovation leader, consistent with the core strategies Janet mentioned a few moments ago.

Selling and administrative expenses for the 2005 second quarter totaled 43.1 million. That's up from 40.2 million in the comparable 2004 period. The major components of the increase was higher performance based compensation costs resulting from our stronger economic profit performance and costs for performance shares which have replaced stock options, as we have discussed in prior quarters; also, foreign exchange effects; sales commissions, warranty expense and other volume-based costs resulting from higher sales in the quarter; and inflationary influences in areas such as compensation and higher fuel costs for our sales and service vehicles. These increases were partially offset by the benefits of cost reduction actions that we took in the latter part of 2004 and lower healthcare costs this year. Backing out the performance based compensation costs, S&A expenses would have grown at about half the rate of sales in the quarter. S&A costs were 31.4% of net sales in the 2005 second quarter and that compares with 31.2% of net sales in the 2004 second quarter.

Our operating profit for this year's second quarter totaled 10.8 million. That's up 66% compared with last year's second quarter. Operating profit benefited from the revenue growth in the quarter and the previously mentioned factors that contributed to the 290 basis point gross margin improvement, partially offset by the higher S&A expenses. Operating margin for this year's second quarter was 7.9%. That's up from 5% in last year's second quarter, reflecting primarily the improved gross margin we have just described. For the six-month period operating profit was up 56% to 16.9 million.

Our tax rate in the quarter was 38% compared with 38.5% in last year's second quarter. And for the full year we expect our tax rate to be between 38 and 39%.

Turning for a moment to cash flows and the balance sheet, cash flow from operations through the first half of 2005 totaled 18.9 million. That is compared with 16.5 million in the first half of 2004.

Our inventories at quarter end totaled 56.4 million. That's up from 52.3 million at the end of the 2004 second quarter and 55.9 million at year end. FIFO inventory days on hand were up to 93 at quarter end compared with 89 at the end of the 2004 second quarter.

Net receivables at quarter end totaled 89.4 million. That's up from 88.1 million at the end of the 2004 second quarter, primarily because of the increase in net sales in the 2005 period. Accounts receivable days outstanding work 61 at both the end of the 2005 and 2004 second quarters.

For the year-to-date period our capital expenditures totaled 8.3 million and for the full year we continue to expect capital spending to be 15 to 20 million.

Our debt to total capital ratio at the quarter end was 2% compared with 5% a year ago. Our current debt at the end of the second quarter was down by nearly 6 million from the end of the 2004 second quarter, reflecting primarily the retirement of 5 million in fixed rate debt the matured in the first quarter of this year.

And that concludes my overview of the quarter. I will turn the call back to Janet.

We're very pleased with our second-quarter performance. As noted in our earnings announcement, on the strength of our results through the first half of 2005 we're now raising our earnings outlook for the full year. Our strong start in 2005 demonstrates the powerful synergies in our core business strategies. As I mentioned in the opening, we're operating with a balanced focus on both top line growth and on leveraging our cost structure so that we can convert revenues to earnings at a multiple of our sales growth rate.

Getting the Company to a point where we can consistently deliver the kind of results we produced in the first half of 2005 has been a journey that began with the onset of the economic slowdown in 2001. Rather than battening down the hatches and just riding out the slowdown, we used it as a time to transform Tennant. We committed ourselves to exiting the downturn with the Company's sustainable earnings power substantially strengthened and our lead over our competitors widened. Therefore, even though we were in a slowdown, we invested in a number of get-ahead initiatives that were significant financial commitments at the time, but which are now producing improved financial performance.

As a result of our transformation program we now operate from a foundation strengthened with a refreshed portfolio of innovative products, improved market coverage, and a cost structure that we can continue to leverage for profitable growth. These significant investments included the comprehensive study of our North American market that we completed in 2003 which has provided us with critically important insights about our customers. Those insights helped drive changes in our product development approach, as well as in our overall go-to-market strategies in our largest market as we pursue becoming a world-class marketer.

As I mentioned in our first-quarter call, building on the customer knowledge gained from our market study, we're now investing in new information technology to further improve our marketing and service capabilities. We're placing particular emphasis on lead and customer relationship management, as well as enabling more customer self-service capabilities through e-commerce channels.

We're also in the process of equipping our service representatives in North America and Europe with wireless-enabled laptops so they can send and receive information from customer sites in real-time, improving their effectiveness on service calls and the overall operating efficiency of our service organization.

During the transformation period we also revamped our approach to new product development. We developed our clean, lean, green philosophy as a filter for new product development decisions. We also instituted a strong bias in our product development process for innovations that represent significant improvements in value received from the point of view of the customer. To date this approach has yielded breakthrough products such as our FaST home scrubbing technology and ReadySpace carpet care offerings, both of which have been key to distinguishing Tennant's offerings from competitive products, as well as driving revenue growth.

We have also continued to adjust our market coverage to gain better presence and reach with Cleaning Pro (inaudible) customers that regardless of the industry tend to place an intrinsically high-value on clean and safe environments for their own customers. In Europe we expanded our sales and service coverage both organically and through acquisition. And we have transformed the European organization into operating on a pan-European basis. In Japan and China we had added more sales coverage. And in North America we have -- reported previously, we have realigned our direct sales organization to better win and serve Cleaning Pro customers. In addition, we're collaborating with our North American distributors to extend sales coverage on certain products to under-served and under-penetrated opportunities.

While executing our marketing, market coverage and product development strategies, we have also remained sharply focused on permanently driving down costs and improving operating efficiencies. We are becoming a more operationally excellent company through both structural changes and process improvements. The progress we're making in leveraging our cost structure has been particularly evident in our financial results in the first two quarters of 2005.

Our commitment going forward is to hold the gains we've already made and continue to build on them. Accordingly, we will continue a systematic and disciplined effort to improve our overall operating effectiveness.

Thanks to the structural changes and process improvements we made during our transformation program, we're still in the early stages of wringing more efficiency out of our operations and further leveraging our cost structure. For instance, by applying lean manufacturing and no-waste principles across the Company in a disciplined and focused manner, we're getting better at flexing our operations to accommodate swings in volume, thereby minimizing the impact of downturns and maximizing the probability during upturns.

We have operating globally since 2003 on a single ERP platform. Aided by information from this system we're reducing logistics costs related to special orders and shipments.

We are increasingly shifting toward a platform-based approach in our product families that, together with our enterprise information systems, should position us to derive improved production efficiencies and sourcing and procurement savings.

In short, we see numerous opportunities to further improve our overall operating effectiveness, and thereby sustain and continue to improve upon the earnings power demonstrated in our performance through the first half of 2005.

In light of our strong performance to date, we're raising our earnings expectation for the full year. We now expect to report 2005 net earnings per share of $2.05 to $2.30. This is up from our previous guidance of $1.80 to $2.10 per share.

As Tony noted in his remarks, we have not yet seen the full impact of higher oil prices on our gross margin, and uncertainty remains regarding whether $60 per barrel oil will dampen the economy and our sales volume. In addition, we expect foreign currency exchange affects to turn unfavorable in the second half of the year. But we believe our persistent and broad-based efforts to continually improve our overall operating performance will enable us to deliver earnings per share in the stated range, which represents a full-year increase of approximately 25 to 40% compared with the $1.62 before unusual items reported in 2004. Our 2004 GAAP earnings per share was $1.46, which included a $0.16 severance charge.

Our new earnings guidance factors in the impact of costs related to our transition to the use of performance shares for stock based compensation. As we explained in the past, we're using performance shares to replace stock option grants. These costs will vary with the Company's performance.

As you know, in May I announced my plans to retire from Tennant. The search process provides for my successor is underway and proceeding according to plan. Meanwhile, our entire organization remains sharply focused on delivering a great 2005 and continuing to execute strategies that are expected to produce solid results.

To conclude, we're very happy with our performance through the first half of 2005 and we're confident about our outlook for the balance of the year. We're all very well positioned to generate further improvements in earnings on revenue growth, driven primarily by our new product offerings and enhanced market coverage.

That concludes our overview of the quarter. We will be happy to take your questions now.

(OPERATOR INSTRUCTIONS) Gregory Macosko, Lord Abbett.

Nice quarter. Very nice. You should be pleased. I'm pleased. That's very nice. Could you talk just a little bit from a growth standpoint? The other international, I guess it's relatively small. But is there anything particularly driving that growth in Latin America, Mideast, Australia?

Yes. Clearly we have seen commodity prices increase in some of the markets such as the Middle East and Central and South America and Australia. That helps our business. We have a number of great customers who are in the mining and other commodity businesses.

So that is perhaps catching up on some of the equipment that they have had in the past -- that they haven't renewed in the past maybe and just growing too?

Just certainly growing, right.

I see that on a real basis Europe was down a little bit and also equipment was down. Any background on that?

I think we've explained before that Europe of all our business units is the most prone to being impacted by large orders because they have more of their business going to go with service contractors. So the actual quarter-by-quarter business there can be more volatile than in the other parts of the business. And if you recall, we had a significant large order in Europe last year. So we get a lumpier quarter-by-quarter performance out of Europe because of that.

Just a quick correction on your comment. Real growth was actually up. The total is up 7%. FX was 4% that. So real growth is of 3. And although we did mention equipment sales were down we did have good growth in service parts and consumables that more than offset the slight decline in equipment sales.

But sequentially I think in the first quarter on a real basis wasn't it a little bit higher?

It may have been. As Janet mentioned --

No, I understand. The large orders. That's fine. I understand. Not being critical here. Just wanting to be sure that -- understanding everything. That's the point. And remind me -- I may have missed the inventory days --

The inventory days were 93 as of the end of the quarter and that compares with 89 in the year-ago second quarter.

Is that anything with seasonality or just the growth? It's up -- is it Europe or anything?

No, it's actually a little bit across the board. We're seeing a little bit higher inventories of demo and used equipment, but also inventories -- we're outsourcing more of our products, an example being the new vacuums that we launched just about a year ago. So we're carrying inventories of those products that wouldn't have been in the year-ago numbers.

But I guess really what you're emphasizing here all the way around is that it's kind of -- I mean, the most positive part of things is the fact that new products are continuing to kick in, correct?

Yes. Certainly it is new products. And it is also the strengthening in markets. Some of the markets which have been weaker over the last couple of years are certainly strengthening. So is both a combination of improving position for our customers in some markets and then new products.

What I hear you saying is we're kind of thinking that we're going to see -- you expect to see kind of 6 to 7% kind of top line overall. And I guess if we look even further out can we continue at, if we see that kind of sort of upper single digits growth, that there's still going to continue to be profit leverage at that kind of a growth rate?

Yes. I would say we're targeting over the longer term mid to upper single digits revenue growth. And absolutely yes, we would expect to continue to reap benefits from the emphasis on our operating efficiencies. And we would expect that over time to be both on the gross margin line and in the S&A line as a percent of sales as we had hoped and expect to grow S&A at less than the rate of sales growth.

What we're saying is low double digits on the bottom line then that can translate to?

Certainly in the double digits on the bottom line. That would be our expectation over the long term.

Obviously, yes. Very good. And in terms of the transition, Janet, when are we kind of thinking we might find a successor? By the year end?

That's the goal that we certainly expressed in May when we announced it. And everything is on track. The search is underway. And all I can say is it's on track. But our whole organization is really focused on delivering a great year and we're not distracted at all by the transition.

And the idea is that -- will you stay on the Board or not? Just remind me.

I'm certainly on the Board, but that's certainly a Board governance decision. And we'll make all those announcements at the time.

Keep going out on this blaze of glory, Janet. Thank you.

Wesley Galey (ph), Wesley Galey Capital Management.

That's an excellent quarter, I thought. It really reflects the job that you've done for a couple years, both of you. It seems to me that we're getting some tremendous operating leverage --

You may want to speak up just a little bit. We can't hear you very well.

It seems to me that you're getting -- you're producing some tremendous operating leverage here. If you look at the first half of this year relative to the first half of last year, or even looking at the second quarter this year to the first quarter this year, 40% more or less of the incremental revenue is dropping down to operating earnings. Can we expect to continue to see that for a while?

Well, I would perhaps caution against that kind of incremental operating margin and just point to some of the factors that we mentioned earlier in the call. That would include, for instance, we did have favorable foreign exchange benefits in the first half. Now with particularly the euro weakening in the last few months we would expect unfavorable foreign exchange influences in the second half.

We talked about the gross margin impact that we experienced a year ago which was unfavorable in the second quarter, and that related to the steel costs influences and also the fact that we took reserves at that time for slow-moving and excess. So there's a factor that was a, call it a onetime benefit here in the second quarter of this year.

And then as we also signaled, there was a little bit of uncertainty around what $60 a barrel oil will mean certainly on the revenue line, and as well of the cost side. We expect that would have an unfavorable margin influence in the second half of the year, although it is in a lagged manner because we don't buy oil directly, if you will. We buy components that have content that include oil. So that's coming on a lag basis, but we do expect that unfavorable influence to hit us in the second half of this year.

Those are some of the factors that I would point to to caution against the type of incremental operating margin improvement that we enjoyed in the first half continuing in the second half.

If we look at it on the basis of operating margins overall, the latest 12 months is about 6%. Can that continue to move forward to the high 9 or 10% area?

That is certainly our goal. I know you have followed us for some time, and clearly we were above 9 in 2000, and our goal was certainly to get back to that and exceed it going forward.

Good. Again, that's an excellent job. Thank you.

You may want to just point out for those on the call that if they're pressing star one, they need to un-mute their phone ahead of pressing star one in order for it to be effective.

Andrea Sharkey, Sidoti & Co.

Congratulations on a great quarter. I guess I wanted to maybe dig in a little bit to the oil impact. Did you see any of that this quarter, or has that not hit your costs at all yet?

Really not to any great extent at all in terms of material costs. It did, however, impact us in, I will call it the S&A line in terms of fuel costs for our service and our sales fleet. And then also from a freight standpoint, I'll call it freight in when we purchase materials and then we pay the freight to get them to us, there would have been an unfavorable influence there. But the materials impact itself, no real impact through the end of the second quarter.

You expect to see an impact there in the next two quarters or so?

We definitely expect to see some impact in the second half of the year.

Do you have any idea of what that -- can you quantify that at all, percentage of --?

I would probably put it the up to 50 basis point range in terms of the impact on gross margins.

Thank you. And I wanted to just ask about -- obviously your new products that you introduced at the end of '04 had a good impact on your revenue this year. And I just wanted to ask about future new products in the pipeline. How full is your pipeline? When do you think you might be introducing some newer products?

We don't announce them publicly until we're ready to release them, but we have committed that innovation and creating innovative new products and consistently delivering new product over time is one of our four key strategies. So you can assume that we have a good, healthy pipeline, and we will be having a steady introduction of new products for some time to come.

Great. And then I guess last question that I wanted to ask was about the e-commerce (ph) capabilities in getting your service force wired. I know you have been talking about that for a bit. How far along are you in that process? Is it still in the initial early stages? And once that is up and running, what kind of impact do you think that will have on your performance? Will that reduce S&A expenses, and can you quantify that?

We're well into the development and have already had it tested in the field. And we're into -- this year into the rolling out phase (multiple speakers) service organization. You're right, we have been committed to that for some time. And because the service organization and its performance is so important to our business, we really spent a lot of time developing a system that we thought would really be effective for them.

And the impact is -- it comes in a number of ways. First of all, it comes in our service force being just more effective with the customers. It comes with them having the ability to invoice and otherwise conduct their transaction in real-time. It comes in improving our knowledge of any product issues in the field instantaneously because we have better, much quicker turnaround in terms of information. It really does start to touch several areas of our business that -- it improves inventory level. It just provides a lot of real-time information that then drives real-time processes in the Company.

Great. Thank you so much. That's it for me.

(OPERATOR INSTRUCTIONS) Ma'am, at this time I show no further questions.

Well, that concludes our call. Thank you all for dialing in. We appreciate your interest in Tennant Company and we will see you for our third-quarter earnings release.

At this time that does conclude today's conference call. All parties may disconnect.