Tennant Company (TNC) CEO David Huml on Q2 2022 Results - Earnings Call Transcript

Aug. 09, 2022 10:45 PM ETTennant Company (TNC)
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Tennant Company (NYSE:TNC) Q2 2022 Earnings Conference Call August 9, 2022 11:00 AM ET

Company Participants

Lorenzo Bassi - VP of Finance

David Huml - President and CEO

Fay West - SVP and CFO

Conference Call Participants

Chris Moore - CJS Securities

Steve Ferazani - Sidoti & Company

Operator

Good morning. My name is Rex, and I will be your conference operator today. At this time, I would like to welcome everyone to the Tennant Company's 2022 Second Quarter Earnings Conference Call. This call is being recorded. [Operator Instructions] Thank you for participating in Tennant Company's 2022 second quarter earnings conference call.

Beginning today's meeting is Lorenzo Bassi, Vice President of Finance.

Lorenzo Bassi

Good morning, and welcome to Tennant Company's Second Quarter 2022 Earnings Conference Call. I'm Lorenzo Bassi, Vice President of Finance. Joining me today are David Huml, Tennant's President and CEO; and Fay West, our Senior Vice President and CFO.

On today's call, we will update you regarding our second quarter performance and guidance for 2022. Dave will brief you on our operations and enterprise strategy, and Fay will cover the financials. After their remarks, we will open the call to questions. Please note, a slide presentation accompanies this conference call and is 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 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 filed 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 will discuss non-GAAP measures that include or exclude certain items. Our 2022 second quarter earnings release includes the comparable GAAP measures and 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.

I'll now turn the call over to Dave.

David Huml

Thank you, Lorenzo, and thank you all for joining the call today.

We are pleased with our second quarter performance, which was in line with our expectations. We continue to deliver solid results despite a challenging supply chain and evolving geopolitical environment. We see robust demand for our innovative products and services as well as growth in many of our end markets, but supply chain challenges and specifically parts availability have constrained our ability to increase production.

As a result, our backlog remains at record levels and despite the many actions we have taken that have increased and will continue to increase production, we expect that backlog will remain elevated for the balance of the year.

Our second quarter results benefited from increased price realization and an increased contribution from aftermarket service, parts and consumables. We have taken several meaningful pricing actions to offset the impact of record inflation, and we anticipate that the impact of these pricing actions will provide an increasing benefit over the next two quarters.

While inflationary pressures, constrained production volumes and foreign currency headwinds have impacted second quarter margins, our adjusted EBITDA and EBITDA margins are stabilizing and the actions we are taking to increase production provide a foundation for further improvement in the balance of the year.

We are maintaining our full year EBITDA guidance range and are confident in our ability to deliver adjusted EBITDA between $140 million and $155 million. We now expect, however, to be at the lower end of this range as we factor in foreign currency headwinds and evolving market conditions. Our people have demonstrated terrific agility and creativity in tackling the current operating conditions and remain focused on executing our enterprise strategy.

In support of their efforts, we continue to make strategic investments to drive short-term improvement while continuing to invest in innovative products to deliver long-term growth, including AMR. We launched our AMR program in 2019. And since that time, we've expanded the product offering and have created a comprehensive robotics portfolio to meet our customers' needs across a broad array of vertical market applications.

Our AMR portfolio continues to be well received by a growing number of customers. We have already sold to over 200 individual customers globally with significant repeat business and have generated over $150 million in sales during that time period.

And while inflation and supply chain volatility will continue, we remain focused on what we can control, including stabilizing our supply chain to unlock production and reduce product lead times to safeguard our customer experience and executing on pricing strategies and maintaining strict cost discipline.

With respect to our first area of focus, our supply chain team undertook significant countermeasures to mitigate interruptions and expand capacity, which resulted in a sequential increase in production in the second quarter. Some of these actions include increased supplier purchase commitments and safety stock inventory, extended visibility of production forecasts, expanded dual sourcing supply options and continued spot buy activity. We are making incremental investments in internal resources and software as well as engaging with external resources to augment our global procurement capabilities.

We continue to work closely with our Tier 1 suppliers, including integrating into their supply chains and directly procuring difficult-to-source Tier 2 subcomponent parts. In addition, we tasked our technology and engineering resources to design and produce equipment that reduces the reliance on constrained parts.

We recently launched a walk-behind scrubber with fewer features that does not require a master control board, and it will provide customers a product option with a shorter lead time. In addition to meet customer demand and to maximize revenue, we are also optimizing our global manufacturing capacity and product platforms to increase production in EMEA and APAC.

For example, we have leveraged an existing platform manufactured in Italy to launch new mid-tier Tennant branded products in North America. This also provides our customers with a shorter lead time alternative. We believe these actions will result in increased production in the back half of the year, mostly in the fourth quarter.

With regard to our secondary of focus, pricing strategies and cost discipline, we have successfully executed pricing increases over the last 12 months that will drive sequential improvement in net sales and gross margin over the next two quarters. We believe our significant pricing actions are sufficient to cover inflation on a full year basis, and we will continue to monitor market conditions and take the necessary actions.

At the same time, we are continuing our cost-out efforts and are tightly managing discretionary spending. We remain diligent in pursuing opportunities to optimize our cost structure. For instance, we are investing in solar panels to generate electricity in EMEA that will help mitigate increasing energy costs and provide increased reliability.

We anticipate that this project will be completed in the fourth quarter of 2022. Investments like this also align and support our sustainability goals as outlined in our recently published 2021 sustainability report that is available on our website. Above all, we remain relentlessly focused on providing our customers with high-quality products and exceptional service as we work toward increasing production and executing on our enterprise strategy.

We will continue to take decisive and appropriate actions to improve our customer experience, while remaining focused on delivering our business objectives. Moreover, we are confident about our outlook given the actions we have outlined combined with our record level backlog, innovative product pipeline and demonstrated commitment to price and cost discipline.

With that, I'll turn the call over to Fay for a discussion of our financials.

Fay West

Thank you, Dave.

Second quarter net income was $16.6 million compared to $9.8 million in the year ago period. Comparisons between periods were impacted by nonrecurring items, specifically expenses related to the extinguishment of debt in the prior year quarter as well as a gain on the sale of assets in the current quarter.

Excluding these items as well as other noncomparable items such as amortization and restructuring charges, adjusted EPS for the second quarter was $0.92 per diluted share compared to $1.18 per diluted share in the prior year period. Lower gross profit and higher income tax expense were the primary drivers of the year-over-year decrease. Gross margins were impacted by inflationary headwinds, the timing and realization of pricing actions as well as lower production volume.

Certain discrete tax items were favorable in the prior year period and nonrecurring in 2022. Lower S&A costs as well as lower interest expense due to the refinancing of debt in the second quarter of 2021 partially offset this decrease.

For the second quarter of 2022, Tennant reported net sales of $280.2 million, a 0.4% increase compared to the prior year. The increase in consolidated net sales was driven by an organic sales increase of 4.4% on a constant currency basis, with a net unfavorable impact from foreign currency exchange of 4%.

Tennant groups its sales into three geographies; the Americas, which includes all of North America and Latin America; EMEA, which includes Europe, the Middle East and Africa; and Asia Pacific, which includes China, Japan, Australia and other Asian markets. Organic sales in the Americas and EMEA increased 6.5% and 3%, respectively, versus the prior year period. The increase was primarily due to the impact of higher selling prices as well as growth in services, parts and consumables.

APAC organic sales declined 4.5%, primarily due to volume declines in China as local shutdowns related to the COVID-19 pandemic continued to impact demand. As Dave highlighted, we have successfully executed several meaningful price increases over the last four quarters, which have favorably impacted net sales. Although the effect was somewhat muted, given our existing backlog.

Overall demand remains strong, except for China, as previously noted, but the limited availability of certain parts constrain our ability to meet volume demands. The actions that are in flight and plans for the balance of the year will allow us to increase production in the third and fourth quarters of 2022.

Moving to adjusted EBITDA. Adjusted EBITDA for Q2 was $30.3 million or 10.8% of sales compared to $35.1 million or 12.6% of sales in 2021. The decrease in adjusted EBITDA was due in part to lower production volumes, which were constrained by parts availability as well as lower margins, which were impacted by inflationary pressures across all production inputs. These impacts were partially offset by pricing actions and favorable S&A expenses as we continue to actively manage costs.

Foreign currency also unfavorably affected adjusted EBITDA by $3 million as compared to the prior year period. Turning to cash flow and capital deployment. For the first six months of 2022, net cash used in operating activities was $23.6 million compared to net cash provided by operating activities of $37.8 million in the prior year period. The increase in cash used was primarily driven by an increase in working capital attributable to investments in inventory to support a ramp in production.

We anticipate that inventory levels will begin to decrease and normalize in the back half of the year as production increases. The company continues to deploy cash flow towards operational capital needs and to return capital to shareholders in line with its capital allocation priorities. Capital expenditures of $10.5 million were in line with our overall expected CapEx for the full year.

Liquidity remained strong with a cash balance of $73.8 million and was $279.1 million of unused borrowing capacity on our revolving credit facility. Our net leverage remains within our guided range and was 1.3x based on the midpoint of our 2022 adjusted EBITDA guidance range.

Turning to guidance. We anticipate that supply chain constraints, specifically component availability will continue to impact our ability to produce and deliver products in the near future. However, we are confident that the actions that we have outlined will materialize at our operational results toward the end of the third quarter and into the fourth quarter and that we will deliver results within our guided range.

As we factor in foreign currency headwinds and evolving market conditions, we now expect our results to be towards the lower end of our guidance range. Net sales of $1.125 billion to $1.17 billion, reflecting organic sales growth of 6% to 10%. Full year GAAP earnings in the range of $3.65 to $4.25 per diluted share.

Adjusted EPS of $4.15 to $4.75 per diluted share, which excludes certain nonoperational items and amortization expense. Adjusted EBITDA of $140 million to $155 million, capital expenditures of $25 million to $30 million and an adjusted effective tax rate of 20% to 25%, which excludes the amortization expense adjustment.

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

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Chris Moore. Your line is open.

ChrisMoore

Good morning, guys. Thanks for taking a few questions.

David Huml

Hi, Chris.

Fay West

Good morning.

ChrisMoore

Good morning. Maybe we'll just start with backlog. I know you don't give a specific number. Post Q1, you talked about backlog being 5x normal. Sequentially during Q2, will the backlog go up further? Did it come back a little bit or where are you at there?

David Huml

Yes. Thanks for asking the question. It's obviously top of mind for us because backlog represents unsatisfied Tennant customers. And so the entire organization is wholly focused on serving our backlog and getting product to the customers in a timeframe that they would expect. Sequentially speaking, Q2 to Q1, our orders did increase and our backlog did increase as well.

Now we did increase our planned output sequentially between Q2 and Q1, but it was not enough to overcome the incoming order rate. We've also - I've adjusted for constant currency in that remark as well as excluding what we would call large orders or future orders in the order base. So the takeaway is that the backlog is growing and it's due in large part to a robust demand pattern as well as our inability to ramp production at the pace we would like.

To further dimensionalize the backlog, just to give you a picture of the aging, about 80% of our backlog has been booked in the first half of 2022. And the reason that's an important data point is that it gives you an idea of how long our customers are having to wait. It's an inordinate amount of time, but it's been within the first half of the year for 80% of them. And about 50% of our backlog has been booked in the second quarter.

And so those customers have been waiting a shorter unacceptable - still unacceptable, but a shorter time for their product from Tennant. The other reason those data points are important is you know that the backlog is sitting at - primarily at our most current pricing with 80% of that being booked in the first half. The backlog would have gone in at the - reflecting the price increases from prior year.

And we've had a price increase in Q2 that would have been reflected in the bookings at about the half of the backlog that went into Q2. So the backlog is sitting at most current price. We're getting strong price realization on our published increases. And as it works its way through backlog, we get to realize that impact on the financials.

ChrisMoore

Got it. Extremely helpful as where I was headed to on the kind of backlog pricing. So 80% was booked in the first half of the year, 50% in Q2, you increased prices a little bit further in Q2. So if you look at kind of where you cycle through the older backlog and get to the point where the margins start to increase, it's towards the end of Q3? Or kind of how should I look at that?

David Huml

Yes. I think you're right on, Chris. We're seeing about one quarter, 1.5 quarter delay in the impact of price increases as they move through the backlog. Obviously, it varies by product line and by geography. But your statement is correct. We published in the majority of our markets, we published mid-Q2 with a price increase. So we would expect to read out the benefit of that increase as it moves to the backlog later in Q3, but certainly in Q4.

ChrisMoore

Got it. So margins will kind of follow that sequence. So very helpful. You also said orders were continued to go up in Q2? I know that you had some kind of preordering early in the year, customers saw the long lead times gotten line earlier than normal. But the - anything else you can say in terms of kind of the orders that you saw in Q2 and heading into Q3?

David Huml

Yes. You're right, Chris. We do see some buying ahead specifically large customers that have chosen Tennant as their primary or sole supplier are working with us very closely to establish their needs for the future and give us a secure place in production by giving us a full year's order for products. That helps them because they get to lock in the price as well as have a continuity of supply and a share of supply. They know that by getting in queue, we get line of sight to their production needs and we can better secure inventory and production slots to support them. So it's really a really win-win scenario. Just to dimensionalize that kind of future orders, large customers buying ahead that accounts for about - we think about 1x of our backlog. So our backlog is 3x to 5x normal and you could think about 1x of that on top of the 3x to 5x normal backlog.

ChrisMoore

Got it. Very helpful. Just maybe one more. Supply chain visibility now, say, versus Q1, is it much improved? I know it's - you're still at the challenges there, but in terms of what you're seeing and the improvements coming. Is there much of a difference now than, say, in April?

David Huml

Yes. I think it would be an overstatement to call it an improvement. I would say that there's been a moderate change in our visibility and predictability. What I mean by that is the lead times are still extended, but suppliers are increasingly meeting those extended lead times. So maybe we're getting a little better predictability, but I wouldn't say it's an overall improvement in supply chain.

And that was one of the big reasons why we decided to take a very intentional move and secure Tier 1 components for - or Tier 2 components for our suppliers, specifically in the space of electronics. We decided to invest the capital in inventory so that those parts are available for our suppliers to build circuit boards and eliminate what is and reduce the risk of what has been one of most of our persistent parts availability challenge.

So we have challenges across the rest of the product line, but we took that decisive action and you saw it in our inventory as well as our working capital. We took that decisive action to try to put ourselves in the best position as possible here in the second half.

ChrisMoore

Got it. Very helpful. I'll leave it there. Thanks guys.

David Huml

Thanks Chris.

Fay West

Thank you.

Operator

Your next question comes from the line of Steve Ferazani. Your line is open.

SteveFerazani

Good morning, Faye. Good morning, Dave.

Fay West

Good morning.

SteveFerazani

So given the guidance was established before we saw these very, very strong FX headwinds. Component availability, talking to other companies remains very, very challenging as you just mentioned, and you're still seeing a lot of material price volatility. Hopefully, it's starting to come down here. But confidence in the guidance, given you've got an awful lot of moving parts out there, some not moving in your favor.

David Huml

Yes, absolutely. And the uncertainty and the moving parts has certainly been a reality we've been operating in since Q2 of 2021. And so when we considered our guidance, we took all the factors into consideration, but we also thought about what elements of the - inputs to the guidance that we can control, and we've taken specific decisive action to mitigate the risks that are known and set ourselves up for having to take action in the second half if needed. You'll notice in the commentary that we did guide towards the lower end of the range, and that's largely due, as you noted, to the FX impact on our overall business. But Fay, anything to add from a guidance perspective.

Fay West

I was just going to say, FX certainly has been a headwind for us versus first quarter and that's considered in our current guidance range.

David Huml

Yes, Steve, I would just add, there are a lot of moving parts and a lot of what is going on in our business is beyond our control. We're not spending an inordinate amount of time sitting around complaining about it nor are we waiting for the situation to improve.

We're focusing on the items that we can control, taking control and taking action to try to improve our position. And while there's no guarantee of success, we feel much better about that posture, not only for our company, but for our customers' sake and also versus our competitors. And we'll see how it pans out. But with what is within our control, we have taken action to put ourselves in a position to win. And we're confident we can deliver on the second half guidance - our full year guidance.

SteveFerazani

Very fair. When I think about - I mean, your pricing isn't trailing inflation that much this quarter. And we didn't see any of the - I'm assuming we didn't see any of the spring price hike in the quarter. So theoretically, if taking the other side of that where the guidance is too cautious, the flip side would be you're going to see significant pricing impact some in third quarter, significantly theoretically in fourth quarter if material prices stabilize. And then you're thinking volume picks up. The second half could look very good if component availability comes into your favor, right?

David Huml

With that set of assumptions in the second half could look really good. And listen, I'm optimistic by nature. So that's a scenario that could very well pan off. But the way we're thinking about inflation is, inflation really came in heavier than we had planned in the first half. We've taken a number of pricing actions. Our realization is strong. As it reads through the backlog into our financials, we feel like we can accurately predict when we realize the benefit, all else being equal.

Our full year guidance really assumes that inflation moderates in the second half of 2022, at least these normalizes. But we have to continue to monitor and take whatever action we need to offset it. So I think the scenario you articulated is possible, but we just need - we need inflation to moderate in the second half as our pricing actions read through. And then we'll see what signals we get from the business and take the appropriate actions to deliver on guidance.

SteveFerazani

Okay. And then on - you discussed this a bit in terms of working capital. And as expected, inventory is still very high given supply chain issues. How quickly do you think that can start coming down? And how much is that - are you're expecting positive cash flow in the second half. Is that correct?

David Huml

Yes. Short answer is yes. Really, we'll consume our inventory as we can increase our plant output. And that's the simplistic answer. We don't want to recover our back - we don't want to cover from our backlog by a drop in demand. And so it relates about increasing plant output so that we can serve our customers that have their Tennant machines sitting in our backlog and work the inventory back down.

But we're confident that we can reverse it - reverse it here in the second half and consume that inventory. Much of that inventory investment was around critically constrained components in the area of electronics. And so we're really confident that as we get those into our suppliers' hands here in the quarter and convert those into finished goods parts that we can put in machines that will help everyone. That will help reduce our inventory. That will help reduce our backlog, and that will help service our customers.

SteveFerazani

Great. If I could just get one more in, in terms of you sounded fairly bullish on - in your commentary on AMR. Are you getting more on-site demonstrations going now? And then how do we think about introduced three years ago, we should start seeing replacement on that product? Is that correct? Are we getting closer to that point where we start seeing that turnover?

David Huml

Yes. So you read my comments correctly. I'm very bullish on AMR as a technology. And I think it's our opportunity to rightfully disrupt our own business. We've got the capabilities. We've got the products. We've got the service ecosystem to go satisfy our customers' need. And I remind you with AMR, we are solving one of our customers' biggest and most pressing business challenges and that is the lack of availability and the cost of labor. So I'm extremely bullish on the potential.

When you look at our AMR journey, we did launch in 2019 - our results in 2019 and 2020 were largely related, almost entirely related, to our deployment with Walmart. And that was a fantastic flagship win, kudos to the team that won it, it's been a great experience for us not only from a financial perspective, but also from a learning perspective, everything we've learned as a result of that relationship and that deployment about how to successfully deploy AMR has served us very, very well.

Following up on that, in '21 and '22, we got into more smaller account penetration. We deployed - we expanded the portfolio. So we now have three models in the portfolio. We deployed the product globally so that we're able to sell it outside of the U.S. And we've seen a pickup. And we noted over 200 individual customers and $150 million in sales since launch.

And we've seen a pickup in demand from other customers as we move beyond our initial win. We have seen a high percentage of reorders from individual customers, but that's not to get to your question, that's not to replace units they bought initially. If you think about the Walmart deployment in 2019, 2020, these are T7. These are high-end commercial, low-end industrial products that have a 5- to 7- to 10-year life on them, and especially in a protected environment where they're not being run into things and have the use and abuse of human interaction.

So to think that they'll be replacing them, it'd be awfully early in the replacement cycle right now for them to consider replacing. But we see reorders from customers that bought an initial amount of AMR as kind of a pilot, maybe they put it in a few stores to prove the technology themselves. We see reorder - high percentage of preorders from those customers, a positional data point.

Thus far in 2022, we have surpassed in units and dollars our full year of 2021 in AMR. So if I take the large success we had right out of the gate and just look at the trend line, we're actually really proud of what we've accomplished, and we think there's upside beyond here.

SteveFerazani

That's great. Thanks Dave. Thanks Faye.

Fay West

Thank you.

David Huml

Thanks Steve.

Operator

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

David Huml

I want to personally thank every Tennant employee globally for their hard work, collaboration and customer commitment as we work together to create a cleaner, safer, healthier world. I would also like to welcome Andrew Hider to Tennant's Board of Directors. Andrew is the Chief Executive Officer of ATS Automation and industry-leading automation solutions provider to many of the world's most successful companies.

We are excited to have him aboard and to be able to tap into his expertise as we introduce focused and innovative solutions that will solve some of our customers' toughest challenges. Lastly, please note that we will be presenting at the following conferences; Sidoti & Company's Virtual Conference on August 18; and Seaport Global's Annual Industrials Conference on August 23.

This concludes our earnings call. Thank you for your time, and have a nice day.

Operator

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

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