Tennant Co (TNC) 2010 Q3 法說會逐字稿

Good morning, and thank you for participating in Tennant Company's Third Quarter Earnings Conference Call. This call is being recorded. If you do not wish to participate, you may disconnect at this time. (Operator instructions).

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

Thanks, Christopher. Good morning, everyone, and welcome to Tennant Company's third quarter 2010 earnings conference call. I'm Tom Paulson, Vice President and Chief Financial Officer of Tennant Company. With me on the call today are Chris Killingstad, Tennant's President and CEO, Pat O'Neill, our Treasurer, and Karen Durant, our Corporate Controller.

Our agenda today is to review Tennant's performance during the third quarter and our outlook for the remainder of 2010. First, Chris will brief you on our operations, and then I'll cover the financials. 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 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 file with the Securities and Exchange Commission. We encourage you to review those documents; particularly, our safe harbor statement for a description of the risks and uncertainties that may affect our results.

Additionally, on this conference call we'll discuss non-GAAP measures that include or exclude special or nonrecurring items. For each non-GAAP measure, we'll also provide the most directly comparable GAAP measure. Our 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 the Investor section of our Website at TennantCo.com.

At this point, I'll turn the call over to Chris.

Thank you, Tom, and thanks to all of you for joining us this morning. Today I will cover highlights of the 2010 third quarter and update you on a few of our strategic initiatives.

We are very pleased with Tennant's quarterly and year-to-date performance. As you saw in today's earnings announcement, the Company has now posted three consecutive quarters of sequential sales and earnings gains. In addition, the business has reported three quarters in a row of double-digit, organic sales growth, which excludes the impact of foreign currency. We are encouraged by these positive trends, especially in light of this year's pervasive economic uncertainties. As a result of Tennant's strong sales and earnings through the first nine months, we have increased our full-year guidance for the third straight quarter.

Taking a closer look at the Company's financial performance, net sales in the third quarter rose 9.2%, with our business maintaining its strong growth in the Americas and in Asia; particularly, in China and Australia. Notably, Tennant's organic net sales grew approximately 11% in the third quarter. And we also had double-digit, organic growth of about 12% in both the first and second quarters of this year.

Looking at Tennant's sales by geographic region, organic sales rose approximately 16% in the Americas and 29% in the Asia-Pacific region. Contributing to these results were strong sales of rider scrubbers and sweepers to the industrial market and walk-behind models for the commercial market. However, we saw organic sales decline nearly 6% in EMEA, as weak economic conditions in Europe led to lower purchases of Tennant's outdoor city cleaning equipment by municipal governments. Excluding the impact of city cleaning sales, EMEA grew organically by about 4.5%.

The quarter's higher sales volume, coupled with our continued emphasis on controlling and improving our cost structure led to improved gross margins and higher earnings per share versus the prior year quarter. Gross margins were up 60 basis points to 42.6% versus 42% in the year-earlier quarter. And third quarter earnings per share totaled $0.39, up from $0.31 in the third quarter last year.

The Company generated $30.2 million in cash from operations during the first nine months. We ended the third quarter with total cash of $33.7 million, compared to $13.9 million a year ago. And total debt fell to $31.8 million from $43.4 million in the year-ago period.

All in all, we are pleased with Tennant's robust results during the 2010 third quarter.

Now I'll share with you some of the factors that are contributing to our success.

First and foremost, we've seen further marketplace momentum for our proprietary ec-H2O technology. As in recent quarters, Tennant's sales gains were chiefly driven by continued demand for scrubbers equipped with ec-H2O. Those of you who are familiar with Tennant know that our environmentally friendly ec-H2O platform converts plain tap water into a powerful cleaning agent without any added chemicals. In addition to being eco-friendly, it offers customers significant cost savings and benefits, including greater productivity and worker safety. We extended ec-H2O to three industry rider scrubbers in the first half of 2010, as planned. We now have six walk-behind and nine rider scrubbers equipped with this technology.

As we anticipated, ec-H2O is proving to be a complete game-changer in our industry. After 28 months on the market, no comparable alternative exists. In just over two years, we have achieved significant sales traction on scrubbers equipped with this technology. As a reminder, in its first year, ec-H2O contributed $17 million to 2008 sales. The second year, ec-H2O sales grew to $50 million. Year to date, ec-H2O has generated $63 million in sales, which is ahead of our nine-month estimated sales for the technology. Given our progress and after a record third quarter, we are on track for 2010 full-year sales of scrubbers with ec-H2O to reach a range of $90 million to $100 million. Clearly, ec-H2O technology offers significant revenue and market share potential.

Since we first introduced it, we have learned a great deal about the capabilities of electrolyzed water cleaning technologies. We are in the process of leveraging our ec-H2O technology platform under the Orbio brand in three phases. We have completed the first phase by extending ec-H2O to all of our relevant, existing scrubber equipment. We continue to realize the benefits of this strategy. Year to date, ec-H2O has helped accelerate Tennant's sales and market share gains. This technology has been the primary contributor to our increased percentage of sales from new products introduced in the past three years. New products accounted for approximately 46% of equipment sales during the 2010 third quarter and 40% year to date. This compares favorably to our goal of 30% of sales from new products. Additionally, we continue to attract new customers because of ec-H2O, another testament to the powers of this innovative technology.

The second phase involves cleaning more of Tennant's customer spaces in more environmentally friendly ways. We are making progress in this endeavor. We currently have research studies and tests underway with key customers in North America and Europe. This includes pursuing the development of new cleaning devices that will be capable of delivering chemical-free cleaning in environments beyond floors. We anticipate launching our first Orbio new product from this initiative in the first half of 2011.

The third phase is to develop new markets and applications. To assist us here, Tennant has engaged an outside consulting firm that specializes in opportunity evaluation and commercialization of disruptive technologies. We are excited about the initial strides our Orbio Technologies Group is making to further enhance and expand our electrically converted water technology platform and build a robust, chemical-free cleaning business.

Our plans require a higher level of R&D investment this year. As we've previously stated, Tennant's R&D spending levels for 2010 will be around 4% of sales.

Moving forward, we continue to remain focused on efficiently running the business, as well as capitalizing on our exciting growth opportunities. We are directing resources against three strategic priorities to leverage our IT systems and drive process improvements and operational efficiencies - strengthen the large equipment portfolio to leverage our IT systems and drive process improvements and operational efficiencies; strengthen the large equipment portfolio by developing a new and innovative, high-performance and lower-cost modular design architecture; and build a sizeable, robust, chemical-free cleaning business.

Now I'll ask Tom to review Tennant's financial results and our outlook.

Thank you, Chris. In my comments today, all references to earnings per share are on a fully diluted basis. Also, please note as I go through the results I will generally not comment on the year-to-date financials, as those were detailed in the earnings release.

As Chris noted, we are pleased with the Company's performance in the first nine months of this year, which represented a significant turnaround from a year ago. For the third quarter ended September 30, 2010, Tennant reported net earnings of $7.5 million, or $0.39 per diluted share, on third quarter net sales of $168.6 million. In the year-ago quarter, Tennant reported net earnings of $5.8 million, or $0.31 per diluted share, on net sales of $154.4 million.

Turning now to a more detailed review of the 2010 third quarter, Tennant's consolidated net sales of $168.6 million increased 9.2% over the prior-year third quarter. For the 2010 third quarter, consolidated net sales were unfavorably affected by a foreign currency exchange impact of approximately 1.5%. Organic sales, which exclude the foreign currency impact, grew approximately 10.7%. The growth was primarily driven by sales of industrial equipment in the Americas and continued strong sales of scrubbers equipped with ec-H2O technology. Once again we had year-over-year increases in large sweeper sales in the third quarter, with growth in the first nine months of approximately 50%. We estimate this is still about 10% to 15% below the pre-recession level of large sweeper sales. But it is encouraging to have three consecutive quarters of year-over-year sales growth.

As you may recall, our organic sales rose approximately 2% in the 2009 fourth quarter, which was the first quarter-over-quarter sales growth we posted since the third quarter of 2008. And now we've had double-digit, organic sales growth in the range of 11% to 12% in the past three quarters.

As I take you through our sales by geographic region, please, remember that we have re-categorized our three regions to cover - the Americas, which now encompasses all of North America and Latin America; EMEA, which still covers Europe, the Middle East, and Africa; and, lastly, Asia Pacific, which includes China and other Asian markets, Japan, and Australia. For your reference, we have a provided a table of the 2009 sales by quarter for this new geographic categorization on the Investor portion of Tennant's Website.

In the Americas, we reported a third quarter year-over-year sales gain of 16.5%. Excluding a favorable foreign currency impact of approximately 0.5%, organic sales was roughly 16%. The growth in the Americas was driven by sales in industrial products, especially large sweepers, and continued strong sales of scrubbers equipped with ec-H2O technology.

In EMEA, sales declined 14.3%. The approximate impact from foreign currency flipped over from favorable in the first half to an unfavorable 8.5% in the third quarter, primarily related to fluctuations in the exchange rates between the euro and the dollar. Excluding this unfavorable foreign currency impact of approximately 8.5%, organic sales declined roughly 5.8%, as weak economic conditions in Europe led to lower sales of outdoor city cleaning equipment to municipalities. Excluding these city cleaning sales, EMEA grew organically in the third quarter by approximately 4.5%.

In Tennant's Asia-Pacific region, sales rose 36.6%. Excluding a favorable foreign currency impact of approximately 7.5%, organic sales growth was approximately 29.1%, fueled by continued strong sales in China and Australia.

Tennant's gross profit margin for the 2010 third quarter was 42.6%, up 60 basis points versus 42% a year earlier. However, gross margin was down 50 basis points sequentially, from 43.1% in the 2010 second quarter. This was primarily due to higher prices of some commodities and unfavorable manufacturing cost variances related to lower production levels of city cleaning equipment in Europe.

We have seen some commodity price increases in select areas, such as lead, copper, steel, and resins, which is negatively impacting the cost of our batteries, motors, and coatings. However, we still expect to hit our goal of saving $20 million from global sourcing in 2010, a year earlier than planned, despite some commodity price pressures and lower volumes than originally anticipated, due to the economic slowdown.

Research and development expense in the third quarter totaled $7.1 million versus $5.5 million in the prior-year quarter. R&D expense as a percent of sales was 4.2% in the third quarter of 2010, compared to 3.5% in the third quarter last year.

Selling and administrative expense in the third quarter of 2010 totaled $54.2 million, or 32.2% of net sales, compared with $51.8 million, or 33.5% of net sales, a year earlier. The third quarter [2000] expense level on a dollar basis increased 4.7% versus the prior year, primarily due to variable selling expenses on significantly higher 2010 sales. We are gaining operating expense efficiencies in 2010, with selling and administrative expense as a percent of net sales decreasing from 34.5% in the first quarter to 32.8% in the second quarter and, now, 32.2% in the third quarter.

Our third quarter operating profit was $10.5 million, or 6.2% of sales, versus operating profit of $7.6 million, or 4.9% of sales, a year ago. Our medium-term goal is to achieve an operating profit margin of at least 9.5% when revenues return to pre-recession levels, and our longer-term goal is a 12% operating profit margin.

In the 2010 third quarter, Tennant's overall effective tax rate was 27.4%. Our base tax rate was 37.9%, which included a retrospective adjustment to increase the base tax rate from 36.5% to 37%, due primarily to the mix of earnings by country. We had discrete net favorable tax items of about $1.1 million, of which $224,000, or $0.01 a share, related to the release of our China valuation allowance, which was a special or unusual item. Our base tax rate does not yet include any benefit for federal R&D tax credits, as we are not allowed to consider these credits in our tax rate until they're formally reenacted.

Turning now to the balance sheet, again, we are pleased with the Company's progress. Net receivables at the end of the 2010 third quarter decreased to $114.6 million versus $114.7 million a year earlier, despite higher sales compared to the prior-year quarter.

Accounts receivable days outstanding was 62 at quarter end, down from 66 at the end of the 2009 third quarter. We continue to proactively manage our receivables, both by enforcing tighter credit limits and successfully collecting past-due balances.

Tennant's inventories at the end of the [2000] third quarter increased to $68.5 million from $60.8 million in the third quarter last year. FIFO days inventory on hand declined to 91 days at the end of the quarter, compared to 94 days in the year-ago quarter. The improvement in days is due to higher sales levels and the continued strides we are making in managing our inventory.

Accounts payable totaled $44.5 million at the end of the third quarter, up from $37.7 million in the year-ago quarter, due to the lengthening of payable terms and higher sales volume. With our increased focus on conservative cash management, we have worked closely with our suppliers to extend payment terms while retaining the flexibility to revert back to taking cash discounts when economic conditions warrant.

Capital expenditures totaled $6.7 million in the first nine months of 2010 versus $0.8 million in the prior-year period. We continue to tightly control capital spending, and we implemented a rigorous prioritization process earlier this year to ensure we are approving projects that best align with our strategies and our design to offer an attractive return on investment.

Our strong cost controls continued to yield benefits. We saved more than $15 million in 2009 from our restructuring actions, and we anticipate incremental savings of another $5 million from these actions in 2010 for a total of $20 million in savings in 2010. Please note that, by leveraging our existing workforce, we have continued to hold our employee count to 2,800, which is flat with when we completed the restructuring. That is down 11% from Tennant's pre-recession peak.

Tennant generated $30.2 million in cash from operations in the first nine months of 2010, compared to $58.4 million in the prior-year period. Total cash and cash equivalents at the end of the 2010 third quarter was $33.7 million, compared with $13.9 million a year ago. The Company's total debt of $31.8 million is $11.6 million lower than $43.4 million a year ago. The debt reduction was a result of our ongoing focus on cash optimization, lower capital spending, and improved working capital management. Our debt to capital ratio is now down to 13.7% at the end of the 2010 third quarter versus 19.5% at the end of the 2009 third quarter.

Moving now to our outlook, we saw continued improvement in the Company's performance in the 2010 third quarter, but we will continue to manage the business conservatively, with a focus on operational excellence and rigorous cost controls while making selective investments in key strategic priorities. For the remainder of 2010, we anticipate steady recovery in North America, strong growth in emerging markets, and continued sluggish conditions in Europe. Additionally, our 2010 full-year financial outlook include the following expectations - minimal foreign currency impact on sales for the full year, with a favorable, first-half impact being offset by an unfavorable second-half impact; a gross margin in the range of 42% to 43%; research and development expense of approximately 4% of sales; and capital expenditures in the range of $10 million to $12 million.

Also, as you may recall, we had ESOP income in 2009 of about $1 million. However, on December 31, 2009, our ESOP program ended, so we will no longer have ESOP income this year.

We continue to anticipate a base tax rate in 2010 in the range of 34% to 36%, depending primarily upon the mix of full-year taxable earnings by country. However, the revised earnings guidance excludes the impact of an anticipated one-time tax benefit in the 2010 fourth quarter, resulting from a reorganization and realignment of international operations to provide commercial benefits and reporting efficiencies. The reorganization is also expected to provide a more tax-efficient international legal structure that will positively affect-- positively impact the effective tax rate in 2011 and beyond. We will not know the exact amount of the one-time tax benefit until the reorganization closes in the fourth quarter, but we expect it to be significant.

Based on our financial results in the first nine months of 2010, we now estimate net sales for the full year in the range of $655 million to $665 million, which is a more narrow range than our previous guidance of $645 million to $665 million. We anticipate earnings for the full year 2010 in the range of $1.25 to $1.35 per diluted share, which is higher than our previous guidance of $1 to $1.30 per diluted share. Our revised, full-year guidance includes Tennant's strong first nine months' results and assumes performance consistent with our 2010 third quarter for the remainder of the year. Again, this revised guidance excludes the anticipated one-time tax benefit related to the international business reorganization that I just mentioned. We anticipate another solid quarter of year-over-year increased sales and earnings in the 2010 fourth quarter. Long term, we remain committed to profitably growing our traditional business and expanding our global footprint in chemical-free cleaning.

And now we'd like to open up the call to any questions.

(Operator instructions). Ted Kundtz, Needham.

Could you cover a little bit-- Maybe, Chris, you could talk a little bit about Europe or, Tom - either one of you-- just what you see there. You indicated that you expect to still remain weak. Are you seeing any kind of a pickup over in Europe yet, or is it still looking like the performance in the Q4 could be kind of equivalent to Q3?

We're basically saying that we anticipate performance in Q4 being similar to the performance in Q3. We're not seeing any pickup. If you look at the macroeconomic indicators, they aren't improving at all over the near future either. So, if you look-- In EMEA, most of the issues are in Europe, and most of those issues are in western Europe. Our two biggest countries are the UK and France. And we anticipate that they will remain sluggish for the foreseeable future.

And I would just add one piece. We want to make sure everybody recognizes we feel it's really an economically driven poor performance. But we, as Chris said, we do expect similar performance in Q4 to Q3.

Yes. That was my next question - whether you feel like you're losing market share there, and you don't feel you are. Have you guys completed your market share study that you were working on? Do you have any kind of update as to what your market share is globally?

We have not completed it yet, Ted. We're going a fair amount deeper than we've historically gone. So it's taken us a bit longer than we would expect. But we certainly expect to be providing some insights into that next year as we release our full-year earnings.

Okay. And your margin outlook was for pretty much in the same range. What do you look for longer-term in terms of gross margins. Do you feel like there is upside to those margins as you-- perhaps the mix changes a little bit more favorably, as it has towards the ec-H2O technology?

You know, we're going to be cautious about not providing any forward-looking guidance at all at this point. But I would say we continue to expect to be able to manage our gross margins in that 42% to 43% range and would hope that's conservative. And, assuming that we return to-- assuming that we continued revenue growth and a return to a more normalized pricing environment without any big upticks in commodities, we might actually get some upside out of that. But I wouldn't count on anything above 43% at the current time.

Okay. Just on pricing, are you seeing any ability to raise prices to reflect some of these commodity increases?

Not yet - not in any major way. We still view it as a tough pricing environment. We experienced our third quarter was really similar to the rest of the year, which, you know, varies dramatically by geography, by product line, et cetera. But, overall, we saw less than 1% of pricing benefit across the world in the third quarter, just like we saw in the first half of the year.

Okay. Great. Thank you.

(Operator instructions). Joe Maxa, Dougherty & Company.

Tom, can you give us thoughts on the tax rate for next year, given what you put in the press release here (inaudible)?

We're not prepared to do that, Joe. I'd give you a little bit of color in-- First, I'd remind you that we did say it would be significantly positive. We will not incur any one-time costs to execute this. And we've talked about a tax range of, today, 34% to 36%. The lower end of that range assumes that the R&D tax credit gets reenacted. As we execute this tax strategy, assuming closure in Q4, we'll see a meaningful reduction to our ongoing tax rate. So we're really excited about implementing this change. But we're not prepared to give any further specifics. We'll get into great detail when we release earnings for the full year.

Okay. And I wanted to ask on the traction from the newer products - the 500 ZE and the Scrub-N-Go. If you can give us a little color--

I would say that, in both cases, the going has been slower than what we initially anticipated. And our sense is most of that is driven by the economy. So, with the 500 ZE, as we told you, our city cleaning business, in general, is struggling because municipalities do not have the budgets to buy the traditional stuff, much less an innovative, new product at a significant price premium like the 500 ZE. We continue to test the product in multiple European cities. We've sold a handful of them, and they're performing well. We believe strongly that this product is going to be very successful in the medium to long term. But, for the time being, it's pretty much wait and see until the economy recovers.

On the Scrub-N-Go, I think, as we've told you in the last couple of quarters, it's taking longer to get traction than we would like. But both we and Ecolab are very bullish on this product medium term. We have approvals from McDonald's and from Burger King and from Yum! brands. The franchisees that have purchased a unit-- we're seeing that many of them are beginning to purchase multiple units, which means it's working. So I think it's just a matter of time, and I think as word of mouth spreads that this product actually cleans really well and improves their productivity, we're going to see this thing ramp up. It's still not material to our overall results, so we're not divulging publicly how many we've sold so far.

Okay. Thank you. And, lastly, I know you're not giving guidance for next year. But should we be thinking about-- Are you seeing a typical seasonality, would you expect, Q4 to Q1? Or does your increase in traction with ec-H2O kind of smooth that out a little bit?

We would expect more of a general to return to normalized seasonality this year. The abnormal piece we had this year was Q3 was above Q2, modestly. That's unusual. And, certainly, a part of that was ec-H2O and the economical recovery. But, for modeling purposes, for now anyway, I would assume normal seasonality next year.

Right. Okay. Thanks, guys.

And there are no further questions at this time.

All right. If there are no further questions, let me come with the closing remarks. We are very pleased with our financial performance in the third quarter and the first nine months of 2010. We made further progress across our operations that resulted in significant top and bottom line gains. We also invested in new products that we believe will fuel Tennant's future revenue growth. We remain excited in committing to achieving our strategic vision to become a global leader in chemical-free cleaning. We believe that our strategic direction, coupled with strong cost controls, improved operating efficiency and new products will further enhance Tennant's long-term value creation potential.

Thank you for your time today and for your questions. We look forward to updating you on our 2010 full-year results in February. Bye-bye.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.