Tennant Co (TNC) 2019 Q3 法說會逐字稿

Good morning. My name is Jessie, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Tennant Company's 2019 Third Quarter Earnings Conference Call. This call is being recorded. (Operator Instructions)

Thank you for participating in Tennant Company's 2019 Third Quarter Earnings Conference Call. Beginning today's meeting is Mr. William Prate, Director of Global Financial Planning and Analysis and Investor Relations for Tennant Company. Mr. Prate, you may begin.

Thank you, Jessie. Good morning, everyone, and welcome to Tennant Company's Third Quarter 2019 Earnings Conference Call. I'm William Prate, Director of Global Financial Planning and Analysis and Investor Relations. Joining me today are Chris Killingstad, Tennant's President and CEO; Keith Woodward, Senior Vice President and CFO; Tom Stueve, Vice President and Treasurer; Andy Cebulla, Vice President of Finance and Corporate Controller; and Mary Talbott, Senior Vice President and General Counsel.

Today, we will update you regarding our progress against our core strategies, our third quarter performance and our full year guidance. Chris will first brief you on our strategies and operations, and Keith will cover the financials. After our remarks, we will open the call up for questions.

We are using slides to accompany this conference call. These slides, along with a replay of today's call, will be available on our Investor Relations website at investors.tennantco.com.

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 risk and uncertainties, and our actual results may differ materially from those contained in these 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 affect our results.

Additionally, on this call, we will discuss non-GAAP measures that include or exclude certain items. Our 2019 third quarter earnings release include a reconciliation of these non-GAAP measures to our GAAP results. Our earnings release was issued this morning via Business Wire and is also posted on our Investor Relations website at investors.tennantco.com.

Now I'll turn the call over to Chris.

Thank you, William, and thanks to all of you for joining us today. Our third quarter results reflect our commitment to delivering consistent profitable growth in order to create long-term shareholder value. During the quarter, we, once again, delivered positive organic growth and EBITDA expansion, while navigating mixed economic and market conditions worldwide. Specifically, our organic growth was 2.8%, and we expanded EBITDA margins by 50 basis points over the prior year quarter to 11.2%.

As we've shared with you in previous quarters, Tennant Company is moving from a period of strategic expansion, during which we extended our geographic footprint and addressable market, and we are now focused on unlocking the value and profitable growth potential of our broader platform. This will involve balancing -- the balancing of reasonable growth with stronger EBITDA performance, which represents the core of the strategy we've been implementing. And we're encouraged that the initial results of that strategy can be seen in our performance thus far in 2019. And our year-to-date and third quarter results signal that we are on the right track as we move forward in improving our operating model.

As you may recall from our last earnings call, our strategy is based on 3 pillars in support of profitable growth. The first strategic pillar is winning where we have competitive advantage. We are evaluating all aspects of our business portfolio, including our products, geographies, channels and customers to truly understand where we have the strongest competitive advantage.

Tennant is a much larger and more diversified organization than it was 3 years ago. This gives us many strengths and advantages, but also underscores the importance of refining our business portfolio to optimize its capabilities. The second strategic pillar is reducing complexity and building scale across our products and operational and business processes. By focusing on the most popular machine configurations and the highest demand options, we will create efficiencies that flow through our plants and supply chain and help simplify our selling processes. Equally important is our effort to simplify and standardize key business process across the entire organization to enhance the quality, speed and efficiency of our decision-making. These actions are designed to increase the overall profitability of our business and are completely within our control. The third pillar is building on our position as an innovation leader by finding creative ways to bring new compelling solutions to our customers, as they face challenges associated with labor pressures, health and cleanliness standards and sustainability goals.

Our 3 strategic pillars are highly interconnected and mutually reinforcing. In implementing our overarching strategy, we are identifying where we have the strongest competitive advantage, simplifying our product offerings and adjusting our go-to-market strategy accordingly. Doing so, will enable us to further innovate in the areas where we can generate the greatest value for our customers and shareholders.

With that in mind, similar to last quarter, we are announcing additional product discontinuations in the industrial category that tie directly to our first strategic pillar. Specifically, we are discontinuing our ATLV, all-terrain outdoor vacuum, and the Sentinel, a ride-on outdoor vacuum sweeper. Both products have experienced declines in customers, unit volumes and margins and have required operational support and investment that detract from Tennant's growth plans. Winning with these products would require significant investment that does not fit within our profitable growth strategy. These changes are customer-centric and are about optimizing our portfolio and allowing us to refocus our investments in order to deliver the greatest differentiated value.

In doing so, we are executing on our second strategic pillar. By eliminating overlapping products, older models and reducing machine configurations, we're simplifying the decision-making process for our sales team and customers. That same simplification will also reduce manufacturing lead times and make us a more agile manufacturer that remains ready to meet the dynamic and evolving needs of our customers.

Simplification can also drive innovation, our third strategic pillar. Optimizing our product portfolio will enable us to increase our efforts in bringing new high-value products to market. To that end, we're investing in technology that directly addresses the biggest pain points for our customers.

As we highlighted last quarter, a great example of our industry-leading innovation is our T7 AMR, our autonomous robot, which directly addresses the labor challenges faced by an increasing number of customers. This time last year, we were excited to announce the commercialization of this new product in North America. We are equally excited to introduce this innovative product to our customers in the EMEA region starting this month.

In all, this is just scratching the surface of where we are going as a company and what we can accomplish. We look forward to sharing more with you in the months ahead.

Now with that, I will turn the call over to Keith.

Thank you, Chris, and good morning, everyone.

Please note that in my comments today, references to earnings per share, both GAAP and non-GAAP, are on a fully diluted basis.

Tennant's third quarter results reflect a number of factors from mixed end-market conditions to our ongoing efforts to better balance our growth goals with profit-enhancing initiatives. For the third quarter of 2019, Tennant reported net sales of $280.7 million, up 2.7% year-over-year. Organic sales, which exclude the impact of recent acquisitions and currency effects, rose 2.8%. Our total organic sales growth demonstrates the value of diversifying our revenue streams. This growth is especially encouraging in light of the tough comparison to strong organic sales growth in Q3 of last year, which rose 6.1% last -- versus last year as well as softness across the European and Asia Pacific markets this quarter.

On the bottom line, we reported net earnings of $14.6 million or $0.79 per diluted share. On an adjusted basis, net earnings grew 15.8% to $11.7 million or $0.63 per diluted share. We are encouraged by our results for the quarter, which we believe reflect our ongoing operating model improvement efforts to expand our profitability.

We'll now take a closer look at our sales results. We group sales into 3 geographies: the Americas, which includes all of North America and Latin America; EMEA, which covers Europe, the Middle East and Africa; and Asia Pacific, which includes China, Japan, Australia and other Asian markets. Sales in the Americas region were up 6.2% or 6.7% on an organic basis reflecting strong performance in North America and Latin America. The growth in North America was driven by demand for Tennant's autonomous cleaning machine, strength in the direct channel related to industrial equipment and continued growth in the Service and Parts and Consumables businesses. In Latin America, strength in demand for industrial equipment in Mexico and South America drove what was the ninth consecutive quarter of year-over-year organic growth for the region.

Sales in EMEA declined 6.2% or down 2.8% organically. This was the result of persistent market weakness across the region with notable sales weakness in the United Kingdom and CEMEA regions. While this continued weakness is industry-wide, spurred by general market uncertainty and purchasing delays by customers, our long-term plans for the region remain on track.

For the Asia Pacific region, reported sales were up 5.1%, but declined 9.4% organically. This was primarily due to significant softening in China, combined with a difficult comparison with Q3 2018, when we reported 10.6% organic growth in APAC.

Now on to margins. Our strategic pillars are focused on EBITDA-enhancing growth. We are still in the earliest stages of implementing key changes, but we believe our third quarter performance demonstrates that we are on the right path. Adjusted gross margin in the third quarter improved 180 basis points year-over-year to 40.8% as a result of pricing actions, favorable geographic and channel mix, lower freight costs and cost-reduction efforts that more than offset the impact of material inflation and tariffs.

Turning to expenses. During the 2019 third quarter, our adjusted S&A expenses were 31.2% of net sales compared with 30.3% in the year ago period. The increase was the result of higher compensation and benefits costs, given the stronger anticipated 2019 performance.

In total, our profitability enhancement initiatives continued to drive improvement in the quarter. Our adjusted EBITDA increased 7.2% to $31.4 million or 11.2% of sales, an improvement of 50 basis points.

As for our tax rate, during the third quarter, Tennant had an adjusted effective tax rate of 16.1% compared to 5.6% in the year ago quarter. The increase is primarily due to the mix in expected full year taxable earnings by country and a decrease in discrete favorable tax items.

Turning now to cash flow, capital allocation and balance sheet items. Tennant generated $35.3 million in cash from operations for the quarter, primarily with improved collections of outstanding accounts receivable on top of strong overall operating performance. During the same period, the company reduced its outstanding debt by $12 million and paid $4 million in cash dividends to shareholders.

Lastly, as included in today's earnings announcement, we have revised our full year 2019 guidance, which is as follows: net sales of $1.135 billion to $1.145 billion, with organic sales growth in the range of 1.8% to 2.6%; GAAP earnings of $2.40 to $2.50 per diluted share; adjusted EPS of $2.8 to $2.90 per diluted share; adjusted EBITDA of $134 million to $136 million; capital expenditures in the range of $30 million to $35 million; and an effective tax rate of approximately 16%.

We expect Q4 sales growth to be consistent with Q3 growth rates. This lowers our top line expectations due to softening global market conditions. However, given the success of our operating model improvements, we've raised our EPS and EBITDA guidance ranges. As a reminder, and as Chris noted, our goals are to deliver reasonable top line growth and to improve EBITDA margin in order to drive shareholder value. Overall, we believe our guidance reflects this commitment and the progress we are making in executing on our growth strategy.

With that, we will open the call to questions. Operator, please go ahead.

(Operator Instructions) Your first question comes from Chris Moore with CG -- CJS Securities.

Just to start with the AMR. I know Walmart had talked about 1,500 autonomous scrubbers by the end of January 2020. Does that -- from your perspective, does that still look like that you might be a little bit aggressive for kind of the pace that you're seeing?

No, I think we're on track with both Walmart and our expectations regarding the rollout of AMR for this year and moving into next year. Good news is that we're also beginning to sell AMR units to other customers in North America, and interest continues to build. We've commercialized in Japan and are looking at expanding in other parts of Asia Pacific. And as we said in the call today, we are introducing AMR in Europe this month. So we are extremely pleased with the progress we're making so far with AMR, and we think we are in a leadership position.

Got it. And is it reasonable to think that there's additional sales to Walmart coming in 2020 or too early for that to know of that?

Chris, we don't comment on customer orders. That was a fairly unique situation with Walmart when they announced their initiative. So we -- as a general rule, we do not comment on that.

Got it. R&D, it's been roughly $8 million a quarter or so. Is that kind of the level that we'll be at moving forward? Or is there kind of additional expenditure coming there?

Yes. It's a bit of timing, Chris, and it's related to just kind of the ramp-up on a lot of our innovation efforts, which have been more back-end loaded this year. I will tell you, it's in the areas we want to continue to innovate on. A lot of work in the whole robotics space, and we continue to like that space and invest accordingly.

Got it. The 2 products that you talked about discontinuing, the ATLV and Sentinel, did they contribute significantly to revenue for the first 9 months of this year?

Yes, it's -- it will -- it's not a huge amount for us, Chris. It's in the $15 million to $20 million range on an annual basis. We will still be in the market with those partially through 2020, and out of these businesses really in the back half of 2020.

Got it. That's helpful. And we've been through this a little bit. But -- so if the -- my understanding is longer-term EBITDA target, let's just say, that's 15%. Gross margins were improved this quarter. I'm still trying to get a sense, even though I know EBITDA is the focus. Is there kind of that mix between improved gross margin, improved -- better absorption, better on the operating expense side. Is there a level on the gross margin that you're targeting as well?

I've talked about this before, Chris. We have to get it in all parts of the P&L. So in terms of our focus on efficiency efforts and kind of our cost out making sure we're handling any increases that come at us in the way of tariffs, inflation, et cetera, we have to make sure our gross margins are right. And we'll continue to focus on that, but also all the way through the P&L. So it's safe to assume it's going to come from both areas, and we like the performance that we're seeing on gross margins for the year, and we're going to keep focused on that as well as our S&A costs going forward. So it will be a combination of both.

(Operator Instructions) Your next question comes from Marco Rodriguez with Stonegate Capital Market.

I was wondering if you could maybe talk a little bit more about the Americas and the growth you saw there, pretty strong organic growth of just shy of 7%, and you had a pretty nice organic growth rate in the prior year quarter as well. You've kind of pulled out the T7, the direct channel services, maybe if you can kind of rank where the strength was that kind of drove that organic comp there would be helpful.

Yes. No, I would say that it's across all those categories. I mean, we've said that the T7 AMR that was a significant contributor to sales in the third quarter, and most of it -- all of it is still in North America, but we were pleased to see kind of strength in the industrial direct channel, which is our historical sweet spot and also has the highest margins. That part of the business also tends to draw the most parts and consumables, which also are high-margin businesses. And that came through as well. What I'd say about North America, it has been the most robust market for us through all quarters this year. You saw the declines in EMEA and in APAC. So those markets, I think, just holistically across all markets in Europe are fairly weak right now. Whether it's short term or long term, I think that's anybody's guess. We have seen a significant drop-off in activity in China. In North America, it's remained robust, but I think we are signaling that there is a little bit of a slowdown that we're seeing in the North American market too. Again, based on what's happened over the last 2, 3 years, we've seen slowdowns and then they ramp back up. So there's no way for us to tell at this point if it's just a lull in the action or a more sustained step down in business activity as we move into 2020.

What I'd add to that, too, Marco, is just innovation continues to be the driver, and the demand for innovation and robotics is a very positive initiative, certainly in North America, but certainly globally as well. So that will continue to be a big support and focus for us.

Yes. And I think that's been a differentiator for us versus our competition. You may have seen -- the only company in our industry that publishes results publicly is Nilfisk. And they're struggling in all geographies, including North America. And I think that puts our performance in a much more favorable light. We like our position.

Got it. That's very helpful. Just wondering as well though, and I know that obviously nobody has -- no one has a perfect crystal ball, but from what you're hearing from your clients in North America and in Asia, specific to China, I think this is the first time you guys have called out China as far as starting to see some weakness there, and you're obviously saying that the Americas seem to be kind of softening a bit. I mean, what is the feedback that you're receiving for the sort of change in outlook, if you will?

Well, in China, we -- our business is split into 2. We have an extensive dealer network, and we have an emerging kind of a direct sales and service business. And the 2 parts of it performed differently. But the dealer business is still by far the biggest. That's where we saw the slowdown where dealers felt they had enough inventory and really, pretty much stopped ordering in the third quarter to draw down that inventory in these more uncertain conditions. So whether that's to be sustained or not, I don't know. But the good news is, that the direct sales and service channel we're building is growing and continues to gain momentum. So that's a positive sign for us going forward, and we very much like to see that be a bigger and bigger part of our sales mix in China over time. Now having been at Tennant since 2002 and seeing a lot of ups and downs and recessions and all of that, for us, the key signal historically has been when our U.S. customers start to delay their orders, meaning that they place them, and then they keep delaying them. We are not yet seeing that. One of the things we're facing is that we are coming off a period of a lot of really big deals, right, that have positively impacted our sales. So I think that what it is, is that there are customers out there that are being a little more cautious in deciding when is the right time to pull the trigger on replacement of large fleets, big deals that could come to us. So that's the 1 piece we're watching carefully. But the kind of day-to-day, up and down the street business, so far, we're not seeing the traditional signals that precede past market downturns.

Got it. Very helpful. Then shifting down here to the gross margins, you guys brought out positive pricing mix, lower freight costs and overall reductions of manufacturing expenses. Can you talk a little bit about the pricing aspects? I think you kind of touched on the mix, maybe with the direct channel being a higher percentage of your overall sales. But did you push through some significant increases in prices across the board? Or can you guys kind of help us think through these different buckets?

Yes. I mean, we took pricing this year, Marco. And what I'd say is we got ahead of it at the beginning of the year, where if you go back to 2018, we were a little bit behind. We didn't see the tariffs coming, we didn't see the inflation, the freight costs that were going to hit us in 2018. So we took midyear pricing in 2018. And I would tell you that we got ahead of it and took it in January for 2019. So that's carrying through that first half of the year, which really helped our gross margins, and we're sustaining that in the back half. And on a relative basis, pricing a little bit more in 2019 than 2018.

Got it. Helpful. And then last quick question here. Just trying to understand a little bit more on the SG&A side and your comments earlier to an earlier question. Obviously, you need to take actions here on your gross margin level and then your OpEx side to hit those EBITDA margin targets. With the add-back of the continued consideration, you're running around $88 million, in the prior 2 quarters, you're $90 million and $92 million. Just trying to get a sense of how much more can you take out of the SG&A line assuming, obviously, you don't want to take too much away from R&D, given the innovation part of your strategy?

Yes. It's -- like I said before, Marco, I just tell you, I think there are continued opportunities in all parts of the P&L. I like what we're doing on our cost-out and just kind of productivity initiatives and cleaning up our portfolio and really getting focused on the gross margin side. And then I'd tell you on S&A, I think, as Chris said in his earlier comments, that will start to streamline our processes and feeds through. So I think there are additional opportunities there to continue to just -- how do we grow into being kind of this larger organization and getting more efficient processes across the organization, really getting focused on where things matter and taking more of a disciplined approach to a lot of our professional services, et cetera. So I still see opportunities for us in that space, and we'll continue to focus on it and get after it.

But I would also say that to get after that and to actually get to the efficiency levels that we think are possible, it's going to take some short-term investments in areas like service and IT to ensure we have the appropriate enablers to make that happen.

And the way we're going about that is we're just being very thoughtful about as we see that kind of appear, if you will, throughout the P&L, then we earn the right to invest in those things and do it in a disciplined fashion.

Since there are no further questions at this time, I would like to turn the call over to management for closing remarks.

All right. Thanks, Jessie. So thanks, again, for joining us today. So as a final note, we will be hosting an Investor Day on March 10, 2020 in New York City. We're looking forward to providing investors with an in-depth and comprehensive look at our strategy, operations and goals, and we look forward to seeing many of you there. So this concludes our third quarter earnings call. Thank you, and have a nice day.

This concludes today's conference call. You may now disconnect.