Tennant (NYSE:TNC) Q4 2018 Earnings Call

0:00 Good morning. My name is Tiffany, and I will be your conference operator today. At this time, I would like to welcome everyone to the Tenant Company's 2018 Fourth Quarter and Full Year Earnings Conference Call. This call is being recorded. There will be time for Q&A at the end of the call. Please press star 1 if you would like to ask a question. After the Q&A, please stay on the line for closing remarks from management. If you have joined our call today via telephone and logged into the conference call presentation on your computer, please mute the audio on your computer to avoid potential quality issues during the call. Thank you for participating in Tenant Company's 2018 Fourth Quarter and Full Year Earnings Conference Call. Beginning today's meeting is Mr. William Pratt, Director of Global Financial Planning and Analysis and Investor Relations for Tenant Company.

0:54 Mr. Pratt, you may begin.

0:57 Thank you, Tiffany. Good morning, everyone, and welcome to Tenant Company's fourth quarter 2018 earnings conference call. I'm William Prate, Director of Global Financial Planning and Analysis and Investor Relations. Joining me today are Chris Killingstad, Tenant's President and CEO, Keith Woodward, Senior Vice President and CFO, Tom Stueve, Vice President and Treasurer, Andy Sabula, Vice President of Finance and Corporate Controller, and Mary Talbot, Senior Vice President and General Counsel. Today we will review our ongoing progress against our core strategies, our performance during the recent fourth quarter, 2018 full-year results, and our outlook for 2019. Chris will first brief you on our operations, and Keith will cover the financials.

1:42 After our remarks, we will open the call 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.tenantco.com until March 21, 2019. 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 the statements. These risks and uncertainties are described in today's news release and the documents we file with the Securities and Exchange Commission.

2:28 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 will discuss non-GAAP measures that include or exclude certain items. For each non-GAAP measure, we also provide the most directly comparable GAAP measure. There were non-GAAP items in both the 2018 and 2017 fourth quarters. Our 2018 fourth quarter earnings 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 our Investor Relations website. Now I will turn the call over to Chris.

3:14 Thank you, William, and thanks to all of you for joining us. But before I begin, I first want to welcome two very important additions to our leadership team who are joining us for their first tenant earnings conference call. First, Mary Talbot. Mary joined us at the end of January as our new general counsel. She brings the tenant more than two decades of experience as a trusted legal and business advisor to boards of directors and multi-billion dollar global companies such as General Cable Corporation, Macy's, E.W. Scripps Company and Scripps Networks Interactive Inc. And second, Keith Woodward. Keith joined us at the beginning of December as our CFO. Keith brings more than 30 years of finance and corporate leadership experience to Tenant The last 26 years with General Mills.

4:12 Both Mary and Keith are bringing fresh perspectives to our leadership team and challenging our organization to think differently as we move forward. We are grateful to have them as part of the tenant team. Before I speak to our fourth quarter results, I wanted to reflect on our full year performance. Our full year 2018 results illustrate a strong top line growth. Disciplined expense management and improved financial strength, areas we deem critical to delivering shareholder value. Specifically, our full year results reflect net sales of over $1.1 billion, organic growth across all geographies, which is the first time since 2014, strong improvements in our cash flow, improved S&A leverage, and adjusted EBITDA growth of 19% and expansion of 70 basis points compared to last year, 2017.

5:17 While we are certainly affected by headwinds in the form of tariffs, raw material price inflation, higher freight costs, and tight labor markets, our ability to execute on our core strategies is creating a stronger tenant. I believe 2018 created strong momentum for the company. and we are well positioned for profitable growth in 2019 and beyond. Now, shifting to tenants' fourth quarter results. On a consolidated basis, net sales rose 2.1% or 4.3% organically. It's important to note that our 2018 fourth quarter was the sixth consecutive quarter of organic growth. In the Americas, organic sales were up 5.7%.

6:06 reflecting strength in both North America and Latin America regions. In the EMEA region, our organic sales expanded 4.3%. Our continued growth in the EMEA region demonstrates the multi-channel and dual-brand strength that we are building as an organization, while at the same time continuing to make progress integrating IPC. I am proud of our ability to unify the tenant and IPC teams while preserving the stability and growth profile of our business in the region. Our integration efforts to date have played a significant role in our regional success here.

6:51 Now looking at Asia Pacific, organic sales were down 3.4%. As Keith will address, this primarily reflects an unusually difficult year-over-year sales comparison. Continuing with our revenue diversification strategy, in early January of 2019, we closed on the acquisition of Gaomei Cleaning Equipment Company in China. Gaomei manufactures a broad spectrum of cleaning machines and equipment, including single disc scrubbing machines, vacuum cleaners, carpet extractors, blowers, high pressure washers, and sweepers. Importantly, Gaume is also recognized for the strength of its innovation, which compliments tenants own historical leadership in this area.

7:44 Like IPC, Gaume is an excellent example of our efforts to expand both our mid-tier product platform and geographic reach in critical markets. Technological leadership is also a central focus at Tenant. And among our various areas of innovation, we are particularly pleased with the recent commercialization of our T7 autonomous cleaning machines. As we have previously mentioned, we set a goal to commercialize this technology in the fourth quarter, and we achieved that goal. We now have autonomous T7s deployed across all geographies. They are operating in high traffic environments such as large retail centers and major airports.

8:35 And the response to these deployments has thus far been highly positive. Naturally, we are very encouraged by this early adoption, the impact these units can have on our customer experience, and the promising role we believe they will play in helping us achieve our financial objectives. The autonomous T7 represents just one example of our ongoing commitment to industry-leading technology and innovative solution across our product portfolios in order to help address our customers' biggest cleaning issues. Turning now to gross margin and expense management, both of which are areas of intense emphasis at Tenant and where we are committed to improving. In terms of gross margins, like many industrial companies, tenant continues to be impacted by raw material inflation, tight labor markets, which impact productivity, higher freight costs, and the ongoing impact of tariffs.

9:40 These have combined to meaningfully reduce gross margins by 110 basis points in the fourth quarter. In order to offset these challenges, we continue to explore different initiatives to reduce costs and David Zay. These are important levers as we seek to offset challenges and grow profitability. Moving to expense management. During the fourth quarter we improved our expense leverage while still investing in areas critical to our growth. While we are pleased with our progress in the fourth quarter, and Full Year 2018, it's important to note that this will continue to be a critical area of focus in 2019 and beyond.

10:36 Our ability to balance and prioritize investments is another important aspect of improving our profitability. Now, I'll ask Keith to take you through Tendon's fourth quarter and full year financial results. Keith.

10:53 Thank you, Chris, and greetings to everyone. Before I walk through the results, I wanted to share some personal observations I've gathered since joining Tenet in December. I came to Tenet for many reasons, including great brands and products, culture of innovation, leading market positions, a diverse geographical footprint, a strong selling and service model, and a very proud history with talented leaders. I have not been disappointed. It's inspiring to be part of an organization where people are so committed to prosperous growth. I'm fortunate to be entering the company at a unique time where we are developing our future strategic framework and where I believe my background and experiences can help the team to drive even more shareholder value.

11:41 I look forward to the journey ahead. Now turning to our financial performance. In my comments today, references to earnings per share, both GAAP and non-GAAP, are on a fully diluted basis. As Chris highlighted, we achieved broad-based improvement in several areas during the quarter and full year 2018, most notably in organic revenue, expense leverage, EBITDA growth and expansion, cash flow, and debt reduction. These all illustrate our discipline and commitment to executing on our core strategies and pursuing a balanced approach to value creation. For the fourth quarter of 2018, tenant reported net sales of $285.2 million, roughly 2.1% higher year over year, with organic sales improving 4.3%.

12:37 Our organic sales results exclude an unfavorable currency impact of approximately 2%. Looking at the bottom line, fourth quarter 2018 reported net income was $7.7 million, or 42 cents per diluted share. Our reported results in the quarter reflected the impact of non-operational items that reduced earnings by approximately $2.3 million or 12 cents per diluted share. Excluding these items, tenant reported adjusted net earnings of $10 million or 54 cents per diluted share and reflect an increase of more than 62% and 59% year over year respectively. Now let's examine our sales results.

13:26 As you may know, we group sales into three geographies. The Americas, which encompasses 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. In the Americas, 2018 fourth quarter sales rose 4.2%, up 5.7% organically. We are pleased with the breadth of performance in this region during the period, which reflects a combination of expansion in both our strategic account and distributor channels, continued sales strength in our service, parts, and consumables business, and improved sales performance across Latin America, specifically in Mexico.

14:17 Turning to AMEA, reported sales were up 1% or 4.3% organically. Again, sales in this region were driven by strength across all channels with notable performance in both Germany and France. As Chris mentioned, our team's ability to continue to meet our integration milestones for IPC has been an important contributor of our sales performance in EMEA. Looking at the Asia Pacific region, Sales were down 6.8% or 3.4% organically. The lower sales in the region primarily reflected difficult year-over-year sales comparison. You may recall that during the 2017 fourth quarter, this region reported an organic sales growth of 8.4%, driven by strength in Australia, Japan, and China.

15:11 As we enter 2019, we will continue to focus on top-line growth opportunities and look forward to the contributions from Galmay in this region. Before turning to our margin discussion, I want to briefly note an accounting adjustment reflected in our gross margins and S&A expenses we made during the fourth quarter that resulted in a reclassification of certain expenses in our P&L. The impact of the reclassification in the fourth quarter 2017 had the effect of reducing the gross margin rate by approximately 60 basis points and reducing the selling and administrative expenses as a percent of sales by approximately 60 basis points. I want to emphasize that these adjustments are simply reclassifications related to our IPC acquisition and had no impact on operating profit or adjusted EBIT docs.

16:09 Tenant's gross margin in the 2018 fourth quarter was 39.3% compared to 40.8% in last year's fourth quarter. On an adjusted basis, excluding an acquisition-related adjustment in 2017, our gross margins in the fourth quarter 2018 and 2017 were 39.3% and 40.3% respectively. The margin rate decline from the prior year was driven by higher raw material costs increased freight and logistics expenses, tariffs that were implemented during the year, and the negative impact from the mix of our sales channels, specifically from the robust growth in our strategic accounts channel. As Chris stated, we continue our efforts to aggressively tackle the margin drivers within our control and explore ways to navigate the macro factors that are impacting our results.

17:06 Research and development expense in the 2018 fourth quarter totaled $7.3 million. In addition to our sales growth goals and margin and expense management, our commitment to investing in R&D at levels that allow us to be the innovation leader is unwavering, and it continues to support a robust new product pipeline. Selling and administrative expense in the 2018 fourth quarter, adjusting for one-time costs, was $87.5 million or 30.7% of sales compared to the prior year quarter of $86.5 million or 31% of sales. This resulted in an adjusted expense leverage of improvement of 30 basis points from continued type management of controllable expenses, which is a discipline we plan to carry forward.

18:00 Moving on to EBITDA, which is an important measure for tenant given the impact of non-cash amortization expense and our increased level of interest expense as a result of the IPC acquisition. We also believe this to be a key driver in creating shareholder value. Our 2018 fourth quarter adjusted EBITDA was $30.3 million or 10.6% of sales. We are committed to continually driving EBITDA growth and leverage, even with the headwinds we're facing related to gross margins. EBITDA improvement can vary from quarter to quarter, so expanding our view to the full year better illustrates our overall progress.

18:46 For the full year, Tenants EBITDA grew 19% and delivered 70 basis points of expansion compared to 2017 full year results. We continue to focus on the initiatives that can help us improve our EBITDA performance. These include driving organic revenue growth across all geographies, continuing to control fixed costs in our manufacturing areas as volume rises, working to offset inflation, tariffs, and other cost of goods pressures, and standardizing and simplifying our processes globally to continue to improve the scalability of our business model while tightly managing our expenses. Turning now to efforts to build our financial strength, flexibility, and returns for our shareholders, tenants' cash from operations for the fourth quarter was $36.5 million compared to $22.1 million in the same period last year, a jump of 65%.

19:50 In terms of debt reduction, tenant reduced our outstanding debt by $8 million during the quarter. The company also paid $4 million in cash dividends to our shareholders. As I mentioned earlier, our full year results may better illustrate the broad-based strength we are trying to create. In addition to strong EBITDA expansion, cash flow rose by 48% to $80 million and we paid down $38.3 million in debt. These collective achievements are supporting our ability to both invest for growth in multiple ways and deliver cash returns for our shareholders. Before turning the call back to Chris, I'll share our outlook for 2019.

20:37 First, this outlook is based on our focus on the elements I just mentioned, an emphasis on driving profitable growth, improving our financial strength and flexibility, and supporting cash return for shareholders. Our 2019 financial outlook is as follows. Net sales of $1.15 billion to $1.17 billion with organic sales growth in the range of 2% to 3%. Full year reported gap earnings of $2.05 to $2.25 per diluted share. Adjusted EPS of $2.30 to $2.50 per diluted share. Adjusted EBITDA of $129 million to $133 million. Capital expenditures of approximately 40 to 45 million dollars and an effective tax rate of approximately 20%.

21:37 I will now turn the call back over to Chris.

21:40 Thank you, Keith. For the past couple of quarters, we have mentioned that we are in the process of developing a new strategic plan to guide our next phase of growth and performance. So before we open the line for Q&A, I want to take a moment to talk about this process, the progress that we have made, and what you can expect from tenants in 2019. We have been operating under our current strategic plan for five years now. As I discussed toward the beginning of this call, that strategy has supported several critical objectives, such as diversifying our revenue streams by geography, channel, and product building on our technology leadership and improving our financial strength. The progress we have made on our current strategic plan is clear. From investments in manufacturing automation to the IPC and Gaume acquisitions to aggressively moving into new areas of technology such as autonomous cleaners and exceeding the $1 billion mark in revenue.

22:50 We carefully contemplated how to approach the development of our next strategic plan and had to choose whether to be iterative of our current strategy or take a more fundamental approach and examine our business and opportunities more deeply. We chose the latter to examine our business more deeply. We are engaged with a leading global consulting firm to help us map our path forward. We have made significant progress on refining our strategy, and we have been working closely with our board to gather feedback and support, as well as with new members of our leadership team who will be critical to informing, guiding, and executing these efforts.

23:37 Realizing there has certainly been a longer development tail for our strategic plan, we now plan to share specifics with our stakeholders at some point during the second half of 2019. We plan on providing insight into our expected long-term revenue growth targets, EBITDA expectations, and specific strategies to expand our global footprint with an emphasis on profitable growth. We appreciate your patience on this journey and look forward to sharing our strategic plan in the coming months. Now, let's open the call up to your questions. Tiffany.

24:23 At this time, I would like to remind everyone in order to ask a question, please press star followed by the number one on your telephone keypad. Your first question comes from a line of Chris Moore with CJS Securities. Your line is open.

24:39 Hey, good morning, guys. Thanks for taking a few questions. Hi, Chris. Hi, Chris. Good morning. Good morning. Yeah, maybe we could start with the... and more. Chris, what I'd say is we again are pricing aggressively in 2019 to offset a lot of the headwinds we're facing. There's a bit of just being cautious about the impact of that on top line.

25:14 but the other big driver for us as we look at the top line is really around strategic accounts and we had a very strong year with strategic accounts in 2018 and you know that can be a bit cyclical so we're just proceeding cautiously there we're still going to grow in strategic accounts but it's really trying to say what's the appropriate level for us to plan going forward and I would also say to Chris I think it's important for us to make sure that we're going after the The highest return growth that we can get and not all growth is created equal. We're just being very disciplined about that as we look forward.

25:52 Got it. That helps. Maybe jump to gross margin. So, you know, trying to get a little further into the future, just get a better sense as to what the, you know, kind of new normal gross margin could be. And I realize it's, you have kind of, you know, all these Current headwinds there that we need to get past. But I'm trying to get a sense as to, you know, a couple years out, is 42% kind of the new place that we should be looking? Or just kind of your overall thoughts on the progression that we should be looking for?

26:31 Again, what I'd say, Chris, is I know historically we've talked to you about kind of a level of 43% to 44%. with an impact of IPC of some kind of negative 100 basis points. I think in terms of that long range, it's probably still in the right zone. We still continue to look at our portfolio and figure out what makes sense. And one of the reasons we're so focused on EBITDA is because we have different business models around the globe that that metric really brings kind of that holistic P&L into play. and we go to market in different ways. And so gross margin will continue to be an area of focus, but EBITDA is our primary. And we will be smart about working all levers of the P&L as we go forward.

27:20 Got it. One more, just in terms of CapEx, it looks quite a bit higher this year than it had been historically. Can you talk to that a little bit in terms of the areas that you're looking to spend and should we think of CapEx moving after 2019 continuing to be at these levels or drop back kind of closer to more recent historical?

27:49 Yeah, so there are two things going on with that in 2019, Chris. Number one, our CapEx levels were pretty low in 2018. We just had due to timing, et cetera, and project timing We ended some kind of $10 million lower than historical norms. So there's a carryover impact of that moving into 2019. And then the other thing that we have going on is we're actually in the process of evaluating and updating expanded office space and how to optimize Plant 1 as we think about the future. And so we're really right in the middle of that, but we're putting it out there in terms of a one-off expense associated with that. So it's the combination of those two things. But I think the historical norm of kind of what we've guided to historically in that 25 to 30 million is really more of our normalized range.

28:43 Got it. That helps.

28:44 Let me jump back in line. I appreciate it, guys.

28:47 Thanks, Chris. Again, as a reminder, to ask a question, please press star or fold by the number one on your telephone keypad. Your next question comes from a line of Marco Rodriguez with Stonegate Capital. Your line is open.

29:03 Good morning, guys. Thank you for taking my questions. I was wondering if we could circle back around on gross margins to follow up on the prior question. If I heard you correctly, there was about a 100 basis point impact in the quarter from various headwinds. If we add that back, we're still looking at roughly that 40% range, low 40%. and the target is kind of a 42 to 43% range. So I'm just trying to figure out what the delta is from the Q4 number to where your target is. What's sort of driving that number there?

29:50 Well, what I'd say, you know, again, Marco, what we're trying to do is to move the dialogue to EBITDA discussion and our EBITDA guidance and expansion is in that 40 to 60 basis point improvement. And gross margin, to your point, we have some pressures we're facing there. But long term, we're going to work gross margins very diligently, and it's a combination of pricing, productivity, mix. And mix is a combination of a lot of things. Customer, product, channel, et cetera. We will continue to work on that, but we're really moving our dialogue to overall EBITDA and making sure we're making good decisions holistically from net sales through gross margin, S&A, and finally down to EBITDA.

30:41 Gotcha. And I know that you guys are going to provide more detail here in terms of a new strategic plan in the second half of 2019, but if I might I'll try and ask the question here ahead of this time. In the past, you guys have talked about a 12% operating margin. Looking at some of your guidance here, at the midpoint, your EBITDA margin is a little over 11%. If I assume DNA remains relatively the same, that kind of implies roughly a 7% operating margin. Maybe you can kind of talk about how you're thinking about those particular numbers, those margins, and how they progress through the year. and what might be more kind of a realistic target, if you will, in the next couple of years?

31:24 Marco, what I'd say is we are on a journey to continue to improve our profitability as an organization. And we are very committed to doing that. That's part of the EBITDA change and dialogue we're creating in the organization. It's part of our incentive metrics as well in the organization. And so what you'll start to hear from us is range of growth as it relates to EBITDA and EBITDA margins. And we will lay that out as we talk to you further about our long-term strategy. But we feel very confident about our plan to get there, as Chris talked about working kind of in formulating our strategy. So more details to be shared on that. But what we're looking for is sustained sequential improvement going forward. versus an absolute target by an absolute year. It is all about the journey we're on to keep instilling discipline and rigor as part of that management and leadership going forward.

32:26 Fair enough. And then last question here, if I could just pop back up to the guidance in terms of revenue growth. Just kind of trying to get a sense as far as your expectations by geographies, where you're expecting some strength, maybe some weakness, and then how you kind of foresee the cadence of the quarters moving through the year?

32:49 Well, this is Chris. I mean, we're looking for organic growth in all three geographies in 2019. And, you know, we're not going to break out which geography is going to grow more quickly and others more slowly, but we are expecting that. And then in terms of the cadence, Keith, you have a

33:13 Thanks, Marco. Thanks, Marco. Since there are no further questions at this time, I would like to turn the call over to management for closing remarks.

33:54 Thanks, Tiffany. Before we conclude, I again want to thank our global tenant team members who are central to creating the broad-based momentum that we are experiencing and our leadership position in our industry. We are excited as we move into 2019, and we're committed to delivering on our guidance and driving shareholder value. Thank you for your time today and for your questions. We wish you well. Take care. This concludes today's conference call. You may now disconnect.