Tennant Co (TNC) 2006 Q4 法說會逐字稿

Thank you for participating in Tennant Company's fourth-quarter teleconference. All lines have been placed on listen-only until the question-and-answer session. (OPERATOR INSTRUCTIONS). Today's conference is being recorded. If you have any objections, you may disconnect at this time.

Beginning today's meeting is Mr. Tom Paulson, Vice President and Chief Financial Officer. Mr. Paulson, you may begin.

Thanks, Barb. Good morning, everyone, and welcome to Tennant Company's fourth-quarter 2006 earnings conference call. I am Tom Paulson, Vice President and Chief Financial Officer of Tennant Co.

With me on the call today are Chris Killingstad, Tennant's President and CEO, and Pat O'Neill, our Treasurer.

Our agenda for this morning is to review Tennant's performance during the quarter and full year and discuss our outlook for 2007. After that we'll open up the call for your questions.

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, uncertainties, and our actual results may differ materially from those contained in the statements.

These risks and uncertainties are described in today's news release and the documents we file with the Securities and Exchange Commission. We encourage you to review these documents, particularly our Safe Harbor statement, for a description of the risks and uncertainties that may affect our results.

Our news release was issued this morning via business wire and is also posted in the investors section of our Web site at Tennantco.com.

At this time I will turn the call over to Chris.

Thanks, Tom, and good morning, all. Let me start by saying that we are very pleased with the Company's continued strong growth in the quarter. We achieved record fourth-quarter revenues and posted our ninth consecutive quarter of double-digit earnings gains. As a result, the Company's full-year revenues and earnings increased substantially over last year, with 2006 revenues up 8% and net earnings that grew 30%.

I should also point out that, despite raising our full-year guidance place during 2006, we still exceeded our own expectations for the year. We are pleased that we have consistently met or surpassed the goals that we have set for ourselves and communicated to our investors. The momentum we have generated is a continuation of our success over the past two years.

At this point, I will let Tom review our financials in detail. After that I will cover the highlights of the quarter and then we will provide a preliminary outlook for 2007. Tom? double take

Thanks, Chris. In my comments today all references to earnings per share are on a fully diluted basis.

For the 2006 fourth quarter ended December 31, 2006 we reported net earnings of $0.43 per diluted share, an increase of 23% compared with $0.35 per diluted share in the 2005 fourth quarter. The 2006 earnings include $0.01 per diluted share for the non-cash expense of stock options in accordance with our adoption of FAS 123. The 2006 earnings also include a one-time tax benefit of $0.04 per diluted share. For the year, net earnings per diluted share totaled $1.57, up 25% from $1.26 per share in 2005. The 2006 full earnings include $0.03 per share for the non-cash expense of stock options in accordance with FAS 123.

In 2006, Tennant increased its cash dividends for the 35th consecutive year. Dividends totaled $0.46 per share. The company also declared a two-for-one stock split in the second quarter.

Consolidated net sales for the quarter totaled $166.9 million, up 9.8% from 2005's strong $152 million. The Company again increased sales for the quarter in all three of our geographic regions, fueled by new product sales. Favorable foreign currency exchange effects added approximately 3% to consolidated net sales for the quarter.

Full-year consolidated net sales grew 8.3% to $599 million. Favorable foreign currency exchange effects added approximately 1% to full-year consolidated net sales.

In North America, fourth-quarter net sales rose 4.3% to $105.3 million. This surpassed strong sales in the fourth quarter of 2005, and excluding the discontinued Centurion line, the year-on-year growth was 6.1%.

For the full year, net sales in North America increased 5.7% to $391.3 million. Foreign currency exchange effects added less than 1% to net sales for both the quarter and year.

Europe generated particularly strong results in the quarter. Fourth-quarter sales in Europe grew 23.6% to $44.5 million. As in the third quarter, our Hofmans acquisition was a strong contributor, adding approximately 5% to sales. Favorable foreign currency exchange effect added approximately 10% to sales in Europe for the quarter.

Full-year net sales in Europe increased 16.4% to $147.7 million compared to last year. Hofmans contributed approximately 3% to sales in 2006. Favorable foreign currency exchange effects increased net sales in Europe by approximately 2% for the full year.

In our other international markets, net sales for the fourth quarter rose 14% to $17.1 million compared with the prior-year quarter, led by increased contributions from Australia and China. Favorable foreign currency exchange effects benefited net sales by approximately 1%.

For the year, net sales in other international markets totaled $60 million, a 7.3% gain versus 2005. Unfavorable foreign currency exchange effects lowered net sales in other international markets by roughly 1%.

Tennant's gross margin for the 2006 fourth quarter decreased slightly to 41% versus 41.6% in the same quarter a year ago. Cost reductions and price increases taken early in the year were not large enough to offset significantly higher costs for materials, the China startup and manufacturing footprint consolidation. Similarly, for the 2006 full year, the gross profit margin was 42% versus 42.5% in 2005. Our R&D spending in the fourth quarter 2006 totaled $5.8 million, compared with $5.4 million in the 2005 fourth quarter. R&D spending at 3.5% of net sales remains in the Company's targeted range.

Selling and administrative expenses for the 2006 fourth quarter totaled $51.8 million compared with $48.5 million in the prior-year quarter. The 6.8% increase for the quarter is higher than we'd like. On a percent of sales basis, sales and administrative expenses improved 31% of sales versus 31.9% of sales in the year-ago quarter.

For the 2006 full year, selling and administrative expenses were up 5%. Our goal is to limit S&A to half the rate of sales growth, which would have meant a 4% increase. We have renewed our efforts here and fully expect to achieve this goal going forward. As a percent of net sales in 2006, estimated decline 1 percentage point to 31.7% versus 32.7% for 2005.

Our fourth-quarter operating profit this year was up 14.9% to $10.8 million compared with the 2005 fourth quarter. This increased operating profit stems from sales growth across all product categories and geography. The quarter's operating profit includes startup expenses for China and the manufacturing footprint consolidation, which together exceeded $1.7 million pretax or $0.07 per diluted share. China accounted for the majority of the expense and is a key part of our long-term strategy to reduce the Company's manufacturing and product sourcing costs. For the 2006 year, our operating profit rose 14.6% to $40 million.

Operating margin for the fourth quarter of 2006 was 6.5% versus 6.2% in the fourth quarter of last year. For the 2006 year, operating profit improved to 6.7% versus 6.3% in 2005 and up from 4.2% in 2004. We have succeeded in raising our operating margins by 2.5 percentage points over the past two years. As we have previously stated, our objective is to reach an operating margin of 9.5% by the end of 2008 and we remain committed to achieving this goal.

In the 2006 fourth quarter, as required, Tennant adopted Statement of Financial Accounting Standards No. 158, employers accounting for defined benefit pension and other post-retirement plans. The new standard requires that the net funded position of the Company's plans be recognized as an asset or liability on the employer's balance sheet. The effect of adopting this new standard was a net increase to stockholders' equity of $600,000.

Tenant company tax rate in the quarter was 28.4% compared with 32.6% in the prior-year quarter. For the year, the effective tax rate was 31.2%. The decline chiefly relates to a refund from a state tax protective claim and the release of tax reserves accrued in prior years.

Turning to the balance sheet, we continue to maintain a strong financial position. Net receivables at quarter end total $116.3 million compared with $105.9 million at the end of the 2005 fourth quarter, due to higher fourth-quarter sales volumes. Account receivable days outstanding remain flat at 61 at the end of the quarter versus the prior-year period.

Our inventories at year end totaled $61 million, up from $52.7 million at the end of 2005, primarily due to foreign currency exchange effects, the Hofmans acquisition, ramp-up for new products and establishing a manufacturing base in China.

FIFO days inventory on hand remained at 82 days in 2006 compared to 2005 as inventory grew at the same pace as demand during the year.

Our capital expenditures for 2006 totaled $23.9 million versus $20.9 million in 2005. We expect our investment in 2007 to be between $23 million and $28 million, primarily related to our global expanse initiative and footprint consolidation. The Company's cash, cash equivalents and short-term investments increased to $45.3 million compared with $41.3 million at the end of 2005. Shareholders' equity rose almost 19% to $229.7 million.

With that I'd like to hand the call back to Chris for an update on our strategy and progress.

Thanks, Tom. As I mentioned earlier, we are very pleased with our fourth-quarter and full-year performance, which comes on top of last year's record results. The business is performing well and on plan. Our focus in 2006 on new products, market expansion and leveraging our cost structure is delivering significant top and bottom-line increases. And with our new management team in place, I am confident that we can continue to build on the growth momentum and efficiencies that we are generating.

As in previous quarters, we have made further progress on our five corporate priorities. First, China. Our initiative to establish a manufacturing base in Shanghai continues to exceed our expectations and timetable. In just one year, we succeeded in getting our facility up and running. Our first walk-behind scrubbers and sweepers manufactured in China rolled off the production line during the third quarter, on schedule. And in the fourth quarter we continued to rapidly expand our market coverage and add distributors to our China organization. We remain very pleased with our progress there.

China is also a key element in another corporate priority to build Tennant's low-cost global sourcing capabilities. Let me give you an example of this opportunity. Currently, 70% of our cost of goods come from parts and components. But less than 8% of our parts and components are now sourced from low-cost regions. Our goal is to drive that percentage higher. To do this, we have begun implementing a worldwide material sourcing strategy designed to deliver substantial savings in 2007 and beyond. Under the direction of Steve [Olvy], our Vice President of Global Procurement, we have reorganized around global teams that include all the necessary staff to rapidly seek, test, qualify, and implement parts and components from low-cost regions.

The teams are methodically viewing all procurement categories to determine the right sequence of opportunities. We are taking a disciplined approach to implementing low-cost sourcing. This strategy will help drive long-term gains in the Company's profitability.

Establishing a lean enterprise, which includes the consolidation of our manufacturing footprint, is another key initiative. Let me give you an update on our manufacturing footprint consolidation project.

Our plans are on track to move all processes out of our Maple Grove, Minnesota facility, where we do mostly machining and fabrication and sell this location by the end of 2007. We have finished transferring certain production lines from Minneapolis to Holland, Michigan. In a related move, we have completed the expansion of our distribution center in Louisville in order to handle the brush operation that we are moving from Maple Grove to Louisville. This action will generate immediate efficiencies, as 90% of all of our brushes are currently shipped out of Louisville.

As part of our footprint consolidation, we are also integrating other Maple Grove operations into our largest plant in Golden Valley, Minnesota and consolidating two existing Golden Valley plants into one. All of these moves will help us realize the significant opportunities we have to further improve our efficiency.

We also remain focused on growing our top-line revenues through new product and service offerings, and through continued international market expansion. In 2006 we were very successful on both fronts. New products drove our fourth-quarter performance as we experienced sales gains for both large and small equipment. As planned, we launched several new Tennant and Nobles-branded products at the end of the third quarter, and sales began to ramp up in the fourth quarter. These products included new walk-behind scrubbers for both of the Company's core brands, the Tennant T5, and the Nobles Speed Scrub, also called the SS5; address a wide range of applications and environments, such as retail, hospitality, and light industrial markets. In addition, both of these products extend the use of our successful FaST floor cleaning technology.

We also extended our ReadySpace carpet cleaning line into our popular micro-rider platform, launching two new rider machines under the Tennant and Nobles brands. These are the Tennant R14 and the Nobles Strive machine, both of which are dual technology carpet cleaners that offer two distinct cleaning functions -- ReadySpace and deep extraction in a single machine. We are very pleased with the initial market acceptance of these new products.

Our other major new products launched in 2006 include the M20, which is the cleaning industry's first integrated single system Scrubber-Sweeper. The M20 was introduced in the second quarter in North America, our largest market. Sharing the same design platform as the M20 is the new T20 Rider Scrubber, which also has been received very positively.

New products were the biggest contributor to increased sales in North America, led by sales of the M20, T20, G5 and SS5. New products were also a factor in our international growth, primarily due to demand for the T3, T7 and ReadySpace. In fact, sales of new products introduced over the past three years generated almost 30% of our total sales during 2006.

I also want to note that by the end of year we have sold all of our discontinuous Centurion chassis-mounted street sweepers. As we announced midyear, we decided to exit this product in ordered to devote Tennant's resources to stronger growth opportunities in other areas of our business.

Looking ahead, we have an exciting and robust new product pipeline for 2007 and beyond. We introduced six major new products during 2006 and plan to launch an equal number in 2007. We just held our annual sales meeting, where we previewed our new product plans and our sales organization is very excited about the upcoming products. Our efforts will continue to emphasize shared platforms across product families in order to fully leverage our manufacturing efficiencies.

In addition, we remain committed to offering an expanding number of environmentally-friendly products and solutions. Tennant already is becoming a leader in offering green floor cleaning technologies. Our efforts include products that recycle water and reduce water usage, as well as use of environmentally-friendly cleaning agents. We are proud of the initial environmental steps we have taken to date and we firmly believe it makes good business sense to become even better environmental stewards.

Turning to our market expansion efforts, we continue to be pleased with our acquisitions of Hofmans Machinefabriek, which made significant contributions to our sales growth in Europe during the fourth quarter and full year, as Tom mentioned.

As you will recall, the Hofmans line of compact outdoor street cleaning products complements our current suite of products in the European market and, we believe, offers global growth potential. The integration of Hofmans into our business continues to proceed smoothly.

We also recently announced that Tennant completed the acquisition of Floorep Limited, which is a cleaning equipment distributor based in Scotland with annual sales of approximately $5.6 million. This small transaction continues our strategy to expand Tennant's sales and service coverage in key European markets. And the acquisition should increase Tennant's customer base in the United Kingdom by approximately 25%.

Before we wrap up with our outlook, I would also like to acknowledge our announcement this month that William Austen has joined Tennant's Board of Directors. Bill is currently the vice president of operations at Bemis Company, and he brings tremendous experience with global expansion, innovation and best practices in operations. We look forward to benefiting from his insights. With his addition, Tennant now has 10 board members.

Going forward we believe we have significant growth opportunities, the biggest being outside of North America, where our market share has tremendous room to grow, both in Europe and in our other international markets. As we have outlined, Tennant has made considerable progress over the past two years and we believe even greater growth and efficiency lie ahead.

In 2007, we expect consolidated sales growth in the range of 5% to 9%. We also anticipate another year of solid double-digit earnings gains despite continued expenses related to our China expansion and manufacturing footprint consolidation. We will continue to drive revenue growth by offering innovative new products, services, and solutions.

All of this makes us confident in our ability to maintain our growth momentum and to further leverage our operating efficiencies going forward. And we remain committed to attaining our goal of a 9.5% operating margin by the end of 2008.

Now I will turn it over to Tom to add some specifics to our outlook for 2007. Tom?

Thanks, Chris. As you know, we provide annual but not quarterly guidance. For 2007 our outlook anticipates that we will continue building on our success with further top and bottom-line gains. The Company expects 2007 earnings per diluted share to be in the range of $1.72 to $1.80. This outlook includes approximately $3.5 million to $4 million pretax or $0.15 to $0.17 per diluted share of expenses related to the Company's China expansion and manufacturing footprint consolidation initiative. We expect continued pressure on margins due to cost hikes for raw materials and other purchase components. We are very focused on offsetting these increases through pricing actions and ongoing cost reduction initiatives. We expect continued operating margin improvements in 2007 and assume a tax rate of approximately 36%.

In connection with the manufacturing footprint consolidation Tennant continues to anticipate selling its Maple Grove, Minnesota facility. While the Company cannot estimate the impact of this sale on its results because of the uncertainty of the transaction price and timing, the Company does anticipate a substantial gain on the sale. The forecasted gain on the sale is not included in Tennant's earnings guidance for 2007.

At this point, I would like to open up the call to any questions. I will turn it back to Barb.

(OPERATOR INSTRUCTIONS). Andrea Sharkey, Sidoti & Co.

I guess looking at the sales growth, my first question is North American was a little bit more modest; international was very strong. I was wondering if maybe you could just talk a little bit more specifically about your end markets maybe where you see strength or weakness? And what is driving your growth -- is it more market share gains versus just end market growth?

Let me address the North America point first. We achieved 4.3% sales growth in North America in the fourth quarter. But if you back out Centurion from both 2005 and 2006 because it was a discontinued product line, the growth in our base business was 6.1%, which is pretty solid.

Again, we have said over time that our industry is probably growing at about GDP, all right, so 2, 2.5, to 3%. So if we are growing the underlying business at over 6%, we estimate that we are indeed taking market share.

In terms of international, I think it's such a big opportunity for us -- so much low-hanging fruit -- that we are just starting to execute better. We now have a new leader in place in international, Karel Huijser, been onboard now for three months. So we expect further acceleration of our growth in the future. But in international markets I think most of the end markets look pretty stable. We don't see any changes since last quarter. I think it's really more of a matter of our executing better.

In North America, again, we had some issues in some industrial markets like automobile manufacturers, which are weak, as we all know. But the rest of our markets remain fairly robust. So I would say the economy right now for us is neutral. It is not hurting our business, and it is not being a substantial benefit, either.

That makes sense. I guess just to follow up on that, any sense that you can give us in terms of further market penetration in the commercial environment with the building service contract or is there any color you can give us there?

All I will say on that is, we have a very low share in the commercial business, especially in North America. We estimate our share of the commercial marketplace at around 7%. Our total market share in North America is 15%. The reason it is that much higher is because of our strength in our traditional and core industrial markets.

We are viewed as an emerging leader in the commercial marketplace. One of the issues we had in the early 2000's is we didn't have the right product portfolio to go after building service contractors and retail hospitality, education, and the fast-growing markets within commercial. Now with our FaST technology, and our ReadySpace technology being implemented on a broader set of machines, we are beginning to see our growth accelerate. I think today we are viewed as an emerging leader in that part of the market. We are not the established later, but we are an emerging leader.

And I think as we go forward -- we are working very hard on ensuring that our go-to-market strategy and the way we cover the market in North America is in line with the way the commercial marketplace is structured, and also focusing on the sectors where we are seeing the most growth going forward. So this is still a little bit work in progress, but we are happy with the results to date.

Okay, great. And then just to talk about the China and Maple Grove expenses, I was just wondering if you had any sense of how it might be spread out through the year. Kind of going to be evenly or maybe more front-end loaded? What are your thoughts on that?

We have not commented on that historically, Andrea, but a couple comments. One is, we do feel those expenses will be skewed more towards a higher portion of the spending being against footprint versus being against China. And we would anticipate that more of the expenses will be front-end loaded than back and loaded. So they will certainly be skewed towards the front half of the year versus the back half of the year and would expect a vast majority of the spend to be done before the fourth quarter.

And then just last question is -- can you give us a sense of how much sales growth you've gotten out of China? I know that was something that you mentioned in the press release on the other international side -- that Australia and China were strong regions for you. Maybe could you quantify that a little bit?

We haven't previously commented on our sales in China. All I will say is that they are growing. They were on plan. As a matter of fact, they exceeded plan by a little bit in 2006 and we are very happy with the progress we are making there. But for competitive reasons right now I don't think it's appropriate for us to say more.

Sure, fair enough. And then anything that you could update us on the sales office you opened in Brazil that you mentioned last quarter?

Again, South America is a huge untapped market for us. We have very little sales in South America today. The office there gives us feet on the street to help build a network of distributors in key markets like Brazil, Chile, and Argentina. I think we have, since the office opened, we have signed up two very significant distributors in Brazil that should help accelerate our growth there. But early days, still. And we're still putting the plans and the strategy together for really accessing fully the South America markets over the next three to five years.

Any sense of what that market opportunity represents in aggregate?

Again, for competitive reasons we haven't commented on that in the past and don't plan to do so now. We are there because it is significant to our overall business.

One more quick follow-up on that -- are your competitors already in Brazil and in China? What does that competitive landscape look like?

They are, but in very small ways. It is still a very open market in Chile, Argentina, Brazil and other markets in South America are still very open. Nobody has established a very strong foothold. I think that we are the first to actually establish a regional office down there, if I am not mistaken, which I think will help us advance our business there more aggressively than some of our competitors.

(OPERATOR INSTRUCTIONS). Kevin [Sonnett], RK Capital Management.

I have two if I could. The first is just on the seasonality of the business, understanding you don't want to give specifics on quarters. Just looking back to last year, to '06 was really Q2 and Q4, we saw very significant revenue growth in the quarter prior. And Q2 in particular was the quarter where you saw real nice leverage and had real nice operating margins. Would you expect a similar trend in '07?

I can comment on that, Kevin. The data point that I think is the biggest piece to fix on it is we would continue to expect our fourth quarter to generally be our highest quarter as a percent of the total year. And the first quarter is going to tend to be a little bit lighter. But I mean second quarter last year was somewhat of an aberration in the total context of that quarter as a percent of the total. So I think the thing we can really hang our hat on is Q1 tends to be a little bit lighter, Q4 is stronger. And in all honesty, our objective is to try to flatten out and have less seasonality just from a manufacturing efficiency standpoint. But there's only so much we can do to control demand.

But also to add to what Tom said, increasingly our business is becoming national account and big deal-oriented. Right, and it is often difficult to anticipate when a big deal is going to hit. So year-to-year you may see some variation by quarter depending on when the big deals hit and the next year, we're not certain it is going to hit the same way and so you are going to see a different quarter potentially being stronger than it was in the previous year.

Understood. So just so we have the context as we go forward for the next few quarters, as we look back at last year, is it fair to say then that Q2, which grew 10% year-to-year and 11% from Q1, Q2 is a little bit better than internal expectations? And maybe Q1 and Q3 were a little weaker? So in Q1 and Q3 you have maybe a little bit of an easier comparison and Q2 is a tougher comparison?

That is a reasonable way to think about it.

And I guess from that the margins sort of follow -- the margin comparison to Q2 is a real tough year-to-year operating margin comparison and Q1 and Q3 a little easier. So in terms of getting that leverage over the course of the year I know you don't expect to see it similar every quarter, but it would be easier comparisons in Q1 and Q3?

I am hesitant to comment on the margin side. There's so many things that can impact that, particularly as we see things like sourcing start to kick in. The part that we are comfortable to at least comment to, because people can work their way through the numbers is -- we are comfortable that we are going to see more improvement in our operating margins on a percentage basis than we saw this year.

We would characterize this year as modest improvement. We expect to see some further improvements on a percentage basis with the bigger improvement, as we've commented on previously, come in, in '08 in order to exit at that 9.5% level. But I'm hesitant to comment on a quarter-by-quarter basis.

And then the second line of questions just as it relates to the margins is the target to grow the SG&A at about half the rate of revenue growth. In '06 you had a really slight tail wind I think with just 1% from FX. But I would think that tail wind of slightly higher revenue growth makes it a little easier to hit your goal of growing SG&A at half the rate. Assuming there is now FX tail wind in '07, it is maybe even a little bit tougher to hit it. You said in the opening remarks that you missed your goal this year but you would expect to hit it in '07. What can you do differently as it relates to that couple hundred million in spending at the SG&A line to grow that at more of a rate in line with your goal?

A few comments. One is, we have started to implement process improvements within leveraging our -- call it our people expense. And we expect to start to see ay further benefits from those process changes. That is one element.

The other element is just a renewed focus against it. And people have some targets in their incentive structure. So we are incenting people to ensure that we appropriately manage in that expense. Because it is a critical part of our operating profit growth and creating leverage until we hit our targets going forward.

So we're -- part of it is process improvement, part of it is we are going to be more focused against it.

(OPERATOR INSTRUCTIONS). And I'm showing no further questions at this time.

Okay, so no further questions, let me just take a moment to thank you all for your time today and for your questions. And to let you know we are excited about Tennant's strong performance in 2006 in the fourth quarter and for the full year, and we have high expectations and great momentum heading into 2007. And we look forward to updating you on our progress next quarter.

Take care, everybody, thank you.

And that concludes today's conference. Please disconnect your line at this time.