Tennant Company
Q2 2021 Earnings Call Transcript

Published: 6 Aug 2021

[Operator:]

Good morning. My name is Debra, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Tennant Company's 2021 Second Quarter Earnings Conference call. This call is being recorded. Thank you for participating in Tennant Company's 2021 Second Quarter Earnings Conference Call. Beginning today's meeting is Mr. William Prate, Senior Director of Global Financing -- Financial Planning and Analysis and Investor Relations for Tennant Company. Mr. Prate, you may begin your conference.

[William Prate:]

Thank you. Good morning, everyone, and welcome to Tennant Company's second quarter 2021 earnings conference call. I'm William Prate, Senior Director of Global Financial Planning and Analysis and Investor Relations. Joining me today are Dave Huml, Tennant's President and CEO; Fay West, our Senior Vice President and CFO; and Dan Glusick, our Senior Vice President of Global Operations. On today's call, we will update you regarding our second quarter performance and guidance for 2021. 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 2021 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 will now turn the call over to Dave.

[Dave Huml:]

Thanks, William, and thank you, everyone for joining us today. Our second quarter results reflected the overall business recovery we saw across our geographic markets despite widespread global supply chain constraints and commodity inflation that cut across a number of industries and which impacted our ability to fully meet the Q2 increase in customer demand. While the demand increase exceeded our initial expectations for Q2, the impact of macro level headwinds such as parts availability, material inflation, freight costs, and labor shortages was also greater than we had expected. In response, we've taken steps wherever possible to help minimize the effects of these challenges to our customers. In most cases, these actions build upon or otherwise benefit from the strategic improvements we have made to our operating model as part of our enterprise strategy. I will now walk you through some of the actions our teams have and will continue to take to mitigate some of the macro challenges in the current environment, while serving the needs of our customers. To address the issue of parts availability, which is the result of our suppliers managing their own production, labor, and logistical challenges our supply chain teams are leveraging our strategic partnerships to manage component and material availability. We are also developing design alternatives and identifying additional sources to keep our manufacturing lines running, all while maintaining strict product quality controls. To ensure a smoother process in securing parts in the second half of the year, our teams have developed more robust sales and inventory operations plans to better align our supply and demand. These plans not only help our manufacturing plants develop smarter strategies to meet increased customer demand, but also allow us to provide longer term demand forecast to our suppliers to secure the parts fully. To address material inflation, our teams are working diligently to find additional partners and, where possible, consolidating vendors to drive leverage and scale. At the same time, we continue to use value engineering to help reduce the parts and material that go into each machine. Our R&D and operations teams are regularly finding ways to help address material inflation, while maintaining our value proposition of quality and innovation. Today's pressures in the steel, resin, and lead markets represent a significant challenge that is felt by industrial manufacturers around the world and one that we expect will persist for the foreseeable future. To minimize the impact of higher freight costs, we are fortunate that as part of our enterprise strategy, we had already started to prioritize local-for-local supply chain and region-for-region manufacturing. This allows us to manufacture our products closer to our customers, which helps to reduce freight costs. This does not entirely offset current headwinds given the constrained transportation market, but we are making every effort to ensure that our manufacturing lines remain up and running and that we can deliver products with appropriate lead times. Regarding labor shortages, specifically in our manufacturing areas, we are staying competitive in the market by adjusting wages and making every effort to attract new talent by providing a safe, rewarding and fulfilling work environment. We are also investing in our equipment, processes, and systems to drive the increased productivity. With respect to the overall challenges we are facing in our cost of goods sold, we are also carefully and thoughtfully managing our S&A to a level that allows us to invest in the business, serve the needs of our customers, and deliver on our enterprise strategy, while also maintaining our ability to meet our full year financial targets. At the same time, we are implementing price increases where appropriate that will benefit the fourth quarter of this year and help offset some of the costs that we are not able to absorb internally. While a price increase at this time of the year is not a normal practice for Tennant, we are compelled to take this action in response to the current macro market challenges. The key improvements we’ve made internally as part of our enterprise strategy have helped facilitate our response to current market dynamics. These improvements include

[Fay West:]

Thank you, Dave, and hello, everyone. For the second quarter of 2021, Tennant reported net sales of $279.1 million, up 30.4% year-over-year, including a favorable foreign currency effect of 5.4% and a divestiture impact related to the sale of the company's coatings business of negative 2.5%. Organic sales, which exclude the impact of currency effects and divestitures, increased 27.5%. Tennant Group sales into the three geographies

[Operator:]

Your first question comes from the line of Chris Moore with CJS Securities.

[Chris Moore:]

Good morning, guys. Thanks for taking a few questions. Maybe just big picture. I think at the beginning of fiscal '21, the expectation was that revenue could approach pre-pandemic levels by the end of 2022. Most recently, you felt that you could get there perhaps by the middle of '22. I just want to get your kind of take on that. Is that still the case point?

[Dave Huml:]

We are -- we drew some optimism from our Q2 experience. Our demand snapped back in a fairly dramatic fashion across our geographic markets, across channels, and across our product categories. So we feel really good about the demand coming in above expectations within the quarter. Having said that, it's still short of 2019 within the quarter. And so when you look at it from a trajectory perspective, we are still anticipating the first half of '22 being the position where we cross -- crossed over into pre-pandemic demand level.

[Chris Moore:]

Got it. I appreciate that. Understanding no crystal ball, but how would you characterize the current visibility on the -- both the supply chain and the input costs. I mean, for example, at this stage, do you expect improvement late in Q3? Or it's still going to likely continue to get more challenging into Q4?

[Dave Huml:]

Yes, listen, it's a great question. That's one that we think about on a daily basis. I will tell you the actions we’ve taken relative to our guidance. So we are very close to our supply chain and working closely with our supply partners to understand what challenges they are trying to overcome. We’ve got our best forward-looking forecast for demand as well as a backlog that we are very interested in working down as quickly as possible. We are acknowledging the reality of the constraints that we have in our supply chain and operations, and that’s reflected in our guidance. So the forward-looking view on when sort of recovery could occur, we don't see recovery in the foreseeable future. And so I don't want to get into projecting a quarter when things will improve, it's always difficult to tell. I will just tell you that we have fully acknowledged the reality of the challenges we see today in our forward-looking guidance. And I’m really proud of the actions the team has taken to address the issues that we are aware of and can anticipate being a challenge for us as we go forward.

[Chris Moore:]

Got it. Appreciate that. And maybe just in terms of kind of the overall enterprise strategy, obviously, standardization of products is a huge focus, made a lot of progress there. Can you maybe just talk to kind of where you are in terms of reduction on the SKUs? And what really -- what’s the longer term goal there?

[Dave Huml:]

Yes. So we’ve made fantastic progress across our enterprise strategy, and you're highlighting one of the components which is optimizing our portfolios. You look at some of the moves we’ve made at the enterprise level to exit businesses, divest businesses that were non-core and not accretive to where we are going to business. From a standardization process, we're standardizing across two facets, both in our models, but then also standardizing across our model portfolio and the individual products themselves, where we value engineering the products to use, harmonize and use more common components. We’ve made fantastic progress. We’ve got some internal targets that we are striving to achieve. We’ve not pegged an end to that process and I’m not sure if you're ever done with that process. We've made significant progress over the last 18 months, and we've been public about the progress we've made. It will continue to be a focus for us as we go-forward. We’ve mentioned that we had a 35% reduction in our models within our product portfolio. We are proud of that. That was a step change in our product portfolio, and we continue to refine that offering. At the same time, I think it's important to note, we are launching new innovative products, which represents new SKUs into our product portfolio. So, really, it's a balance of the life cycle of our product, the new innovative products we are launching, and then enhancing our portfolio by pruning those and streamlining our offering in the existing portfolio.

[Chris Moore:]

Got it. Very helpful. I will jump back in line. I appreciate it, guys.

[Dave Huml:]

Thanks, Chris.

[Operator:]

Your next question comes from the line of Steve Ferazani with Sidoti & Company.

[Steve Ferazani:]

Good morning, everyone. You talked about the supply chain -- supply chain challenges you're dealing with. Can you quantify that in any way in terms of sales you didn't generate in the quarter because of those supply chain challenge? So are you pushing everything to the right of this year? Or how do we need to think about that?

[Dave Huml:]

Yes. It's a tough one to quantify. I will tell you this, that obviously in a quarter where our demand snapped back above expectations, and we are experiencing significant supply chain and operational challenges, our backlog has grown. And so just -- I will try to dimensionalize that. Our backlog is about 2x normal levels. And so you think about that, that's a dramatic increase and that's the number of customers that we would have hoped to have service in the quarter that we were not able to due to the constraints on the supply chain and the other challenges that we spoke to in the script.

[Steve Ferazani:]

Okay. That’s helpful. And then in terms of -- I know you haven't wanted to raise prices, you're kind of hesitant to do so. Now it sounds like that’s something you will move forward with. Can you talk about the timing on that the response from customers and what that might do to margins by Q4?

[Dave Huml:]

Yes. Let me take that. It's not that we haven't wanted to raise price, we are very respectful about raising price because price, there's a couple of things. One, it impacts your customer relationship. It takes your selling organization or selling organizations time away from doing other activities like selling in new and innovative products. And so it's -- price is a great thing from a financial perspective. But we’ve to make sure that the price increases we put through, we are able to command that premium. We are a premium-based product, and we’ve a fantastic value proposition. We’ve to make sure that we can command the premium that we publish. So it's not that we are hesitant to put in price. We want to make sure that we can sell it in and make it stick with our customers. So having said that, we’ve implemented a price increase, we’ve announced it. We just recently announced, and so it's obviously early to gauge customer feedback about that increase. I would tell you, this is just my opinion. I don't think that anyone will be surprised. The challenge is that we are facing within our business are macro market challenges. So the market and our customers are broadly aware of these challenges. So I think they'll -- if they weren't expecting it, I don't think they'll be surprised we have in the conversation with this about the price increases. And I will just add, I’m really proud of our customer-facing sales and service organization that have to carry this message. They do a fantastic job of selling in the price increase, demonstrating the value that we can deliver and having to stick with our customers.

[Fay West:]

The one thing I would add is that, while we just recently announced these price increases due to the current backlog, we don't really expect a meaningful impact until the fourth quarter.

[Steve Ferazani:]

Right. So you are not repricing the backlog?

[Fay West:]

Correct.

[Steve Ferazani:]

Okay. Fair enough. To switch topics a little bit. Obviously, the balance sheet keeps improving given the environment, how are you thinking about uses of cash over the next couple of quarters?

[Fay West:]

So our capital allocation priorities really remain the same, haven't changed dramatically. And first and foremost is reinvesting in our business to drive growth and to execute against our enterprise strategy. So that's priority number 1. We are also managing our balance sheet and we want to be with the stated leverage target of 1.5x to 2.5x because of the financial flexibility that we need that we would like to maintain as well as optionality. We are always in support of our quarterly dividend. And we have a history of our dividends, and we will continue to return capital to shareholders by way of dividend and potentially opportunistically share repurchases as we evaluate cash flow. And then lastly, is opportunistically evaluating what our opportunities are to enhance shareholder value through M&A. So those are our priorities.

[Steve Ferazani:]

one last one in terms of I know that you were lapping the big sales in the autonomous product for your first launch, given that in the last year, you’ve launched two more of the autonomous products. Can you provide any kind of color in terms of marketing sales, the two more recent autonomous products?

[Dave Huml:]

Let me put some color around that for you. So we are lapping a significant order with the world's largest retailers last year, we are very proud of that order. That took the majority of our capacity, frankly, our time to make sure that, that sold in really well and was deployed to the level our customers expected. I think it's worth noting that the large customers that -- the large customer orders were lapping since reordered. I think that's an important proof point that the early adopters of the technology have seen the benefits and have bought back in. They're doubling down on the technology. So it gives us confidence that we are on the right track. We since launched two additional products that you've noticed T380AMR and we are just in the process of launching our T16AMR. I would say the customer feedback for both of those products has been fantastic. The volumes they are talking about don't approach the levels of the orders we lapped last year, but we still have a significant customer interest in both of those products. I think the power of having a three product portfolio is that we can now address an extremely broad range of vertical market applications. We've trained up our global selling organization and have demonstration units that are deployed on a global basis. So we can now engage customers in virtually all of our important verticals in the robotics discussion and especially important -- I’m especially excited about the T16AMR because it gives us an entree into the industrial verticals. And when you think about robotics in an industrial vertical, it solves a very important compelling business problem for those customers as being labor shortage, while helping them keep it playing a keen and say, operating environment. And then industrial setting, typically you don't have the dynamic of having to worry about retail customers walking through your facility. Industrial customers tend to be more at depth at adopting automation and they have robots elsewhere in their facilities. So it's a really friendly environment to try to sell in robotics. We are getting fantastic customer feedback about all the products, especially the T16AMR. So we are very bullish on AMR. We are really proud of the fact that we had a couple of large customers and kudos to our selling organizations for landing in a couple of large customers right out of the gate, and now we are pursuing other customers on a global basis, still very bullish about AMR potential for the future.

[Steve Ferazani:]

Great. Thanks, Dave. Thanks, Fay. I appreciate the time.

[Dave Huml:]

Thank you.

[Operator:]

And you have a follow-up question from the line of Chris Moore with CJS Securities. It appears that question was withdrawn. Since there are no further questions at this time, I would like to turn the call over to management for closing remarks.

[Dave Huml:]

Thank you. Thank you again for joining us and for your interest in Tennant. I want to thank our global Tennant teams for all of their hard work and dedication in this extremely challenging environment. I couldn't be more proud of the team and how we are performing. This concludes our earnings call. Have a nice day.

[Operator:]

Ladies and gentlemen, you may now disconnect your lines.