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Good morning. My name is Jason, and I will be your conference operator today. At this time, I would like to welcome everyone to Tennant Company's 2019 First Quarter Earnings Conference Call. This call is being recorded. There will be time for Q&A at the end of the call. [Operator Instructions] Thank you for participating in Tennant Company's 2019 First 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, Jason. Good morning, everyone, and welcome to Tennant Company's First Quarter 2019 Earnings Conference Call. I am 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 review our ongoing progress against our core strategies, our performance during the recent first quarter and our full year guidance. Chris will first brief you on our 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, until May 30, 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. We encourage you to review those documents, particularly our safe harbor statement, for a description of the risk 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. Our 2019 first 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.
Now I will turn the call over to Chris.
Thank you, William, and thanks to all of you for joining us. Tennant Company is a business undergoing an important transition. The core strategies we have been pursuing for the past several years have unquestionably been focused on growth, expanding and diversifying our geographic reach, broadening our go-to-market channels, strengthening our ability to address the mid-tier market and building a robust and innovative new product pipeline. We have had a lot of success in each of these areas, but that success has not translated into the EBITDA growth as rapidly as we would've liked.
As we move into 2019, our focus is turning much more deliberately toward a balance between reasonable growth and enhancing our EBITDA expansion activities. These efforts are in full swing and are beginning to show progress. They are a central component of our new strategic plan that, as we mentioned on our last call, we intend to share with you in more detail later this year.
During our first quarter, Tennant posted mixed results but results that began to reflect a more intense focus on profitable growth.
Looking at sales performance. Tennant posted a decline in net sales during the first quarter, which was a combination of negative organic sales and negative impact due to currency. Our organic results primarily reflect a couple of factors. The first is a challenging sales comparison due to the large level of strategic account sales in the prior period. Industry market softness was also a contributing factor, specifically in the United Kingdom.
Looking at earnings performance. As I previously noted, our focus on EBITDA expansion is playing a more significant role in our decision-making at Tennant. Increasingly, we are focused on prioritizing sales efforts where our value proposition is strongest, optimizing our operations and supply chain and mitigating external factors impacting our margins. Our early efforts positively impacted both our gross margin and EBITDA performance this quarter.
Gross margin in the 2019 first quarter jumped 120 basis points year-over-year. Like many industrial companies, we continue to face macro-driven factors, including tariffs, tight skilled labor markets, material inflation and higher freight costs. Our gross margin performance in the quarter benefited from Tennant's positive impact from pricing actions, favorable channel mix and our efforts to mitigate those prevailing headwinds. As a result, our gross margin performance along with disciplined expense management, we improved EBITDA by 17% or 200 basis points over last year.
All in all, we are pleased with the progress we made this quarter on profitability improvement and fully intend to build on this momentum.
As you may know, Tennant has built its reputation on innovation and finding creative ways to bring new, compelling solutions to our customers. Earlier this month, Tennant announced an agreement to supply our autonomous T7 AMR solution to Walmart. This is just one example of Tennant's position as a leader, developing innovations that can help all our customers, and in this case, a large, strategic customer with sophisticated needs, run their businesses more safely, efficiently and profitably. The application of robotic cleaning technology is a promising emerging trend, and the advantages for our customers will be substantial. This relationship with Walmart represents an important first step towards broader adoption of autonomous cleaning equipment in the marketplace. We are pleased by how our T7 AMRs are being received, and we are very excited by the promising role robotics will play in our future. We believe we have the first mover advantage at large-scale commercialization of this technology, and we intend to fully capitalize on it. During the first quarter, we also announced our decision to relocate our corporate headquarters to neighboring Eden Prairie, Minnesota. This move will give Tennant several advantages by allowing us to repurpose our current headquarters to optimize our manufacturing operations and drive efficiencies at this location, adding space to accommodate additional growth, helping attract and retain talent and allowing for better collaboration by bringing together the roughly 500 employees who are currently spread among separate buildings around our current headquarters location. Ultimately, this move underscores our commitment to strengthening Tennant for the future. We intend to complete the move in the first half of 2020.
Now I'll ask Keith to take you through Tennant's first quarter financial results. Keith?
Thank you, Chris. In my comments today, references to earnings per share, both GAAP and non-GAAP, are on a fully diluted basis. As Chris stated, we are committed to building strength across our entire enterprise with a particular emphasis on EBITDA dollar growth and expansion. Our performance in the first quarter illustrates progress along these lines as well as some challenges. Most of those challenges took the form of tougher sales comparisons as we lacked strong growth in strategic accounts last year.
For the first quarter of 2019, Tennant reported net sales of $262.5 million. That was down 3.8%, which included a 3.4% reduction from currency translation, a reduction of 0.8% on an organic basis and a positive plus 0.4% impact from our Gaomei acquisition.
Turning to the bottom line. Our first quarter 2019 reported net earnings grew 64% to $5.4 million or $0.29 per share. On an adjusted basis, net earnings grew 82% to $9.1 million or $0.49 per share. As I will explain more in a moment, we are encouraged by our margin and EBITDA improvement in the quarter and continue to strive for more progress.
Now let's examine our sales results. We group sales into three 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 declined 1.1% but actually increased 0.3% on an organic basis. The increase reflects strong Latin America sales with strength in Mexico and was partially offset by a challenging comparison to last year's strong strategic account activity in the region. It's important to note, sales contributions from our recently announced partnership with Walmart for our autonomous cleaners did not contribute significantly to the quarter. We expect this contribution to gradually ramp up over the course of the year and into 2020.
Onto EMEA. Reported sales in this region were down 12% or 5% organically and were primarily impacted by two factors. The first, like the Americas, EMEA sales also reflected the comparison to last year's strong strategic account and distributed channel activity, and secondly, EMEA sales during the period also reflect some general industry market softness in the United Kingdom. Looking at the Asia-Pacific region, we are pleased with the sales performance in this geography during Q1. Reported sales were up 10.3% or 8.4% organically, reflecting broad strength across the region. We were also happy to finalize the closing of the acquisition of Gaomei this January and look forward to them becoming a solid contributor to this region as we move forward.
Now turning to margins and expenses. As Chris pointed out, our focus on EBITDA growth, in addition to renovation, is increasingly guiding our decision-making, and we are pursuing broad-based initiatives designed to address this. While we still have more progress to make, we are encouraged by our gross margin and EBITDA improvements during the 2019 first quarter. Gross margin improved to 41.2%, up 120 basis points year-over-year. The improvement was led by a favorable channel mix and positive pricing actions as well as our ongoing efforts to mitigate the impacts of prevailing macro headwinds such as tariffs, raw material price inflations and higher freight costs.
Taking a look at R&D and S&A expense levels. R&D spend as a percentage of sales decreased 20 basis points year-over-year. As we've stated before, we are committed to investing in R&D at levels that allow us to remain competitive, meet our customer needs and sustain our leadership position as a top innovator in the industry. We also continued our practice of proactive S&A discipline. During the quarter, adjusted S&A expenses were down 3.7% on an absolute basis and roughly flat as a percentage of sales. EBITDA remains an important profitability measure for Tennant.
We are pleased with our EBITDA dollar growth and expansion during the quarter, growing 17% or up 200 basis points to 11.2%. This reflects our holistic focus on the entire P&L and balancing top line initiatives while managing costs with strategic growth investments. As we look ahead, we will continue to focus on the activities that can help us improve our EBITDA performance, including expanding organic revenue, driving operational cost leverage, working to offset macro headwinds such as inflation, tariffs and other cost of goods pressures and tightly managing controllable expense.
Turning now to cash flow, capital allocation and balance sheet items. Tennant used $11.6 million in cash for operations for the first quarter, primarily for inventory expansion to support future sales and employee compensation and benefit-related payments. During the quarter, the company paid down an additional $8 million in outstanding debt and paid another $4 million in cash dividends to shareholders. As stated in today's earnings announcement, we are reaffirming our 2019 guidance, which 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 GAAP 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 million to $45 million and an effective tax rate of approximately 20%.
With that, we will open the call to your questions.
[Operator Instructions] Your first question comes from the line of Chris Moore from CJS Securities. Your line is open.
Hey good morning guys. Thanks for taking some questions. Good morning. Maybe just kind of bigger picture, obviously, when you think of Tennant, you think of -- first thing you think of is equipment sales, but that said, it seems like kind of a service model approach is becoming increasingly important. Can you talk to that a little bit and kind of how that model's evolving?
I can talk to that. No, I mean service -- I'd actually refer to service as our secret sauce. I mean, if you look at a market like North America where we really have the only national both direct sales and service footprint, it is an important competitive advantage. And I think it's one of the reasons that we actually won the Walmart business as well. So service and then -- and the P&C business collectively have always been around 30% of sales. They hover in that direction. But I think as we go forward with a new strategic plan, one of the emphasis areas is going to be to see how we can further leverage our service model to drive more equipment business but also to drive more parts and consumables business. As we've said, the margins on the service labor are not all that interesting, but the margins on our P&C business are extremely attractive. And today we're not getting our fair share. That's our judgment, and we're going to strive to grow that much more aggressively as we go forward.
Helpful. Does the -- on the autonomous scrubber side of things, does that change anything? Is that the kind of service component of that? Is that more important, less important? Or maybe talk to that kind of whole revenue model a bit more.
Right. Well, I think with Walmart, it's still evolving, but I -- our judgment is that it's going to become increasingly more important because not only are we having to service the machine and all the cleaning components, but you have all the robotic component as well and the software updating that used to take place on a regular basis. And so the coordination between us and Brain, which is our partner on that front, is going to be crucial as part of our service model. So I would say that service in the autonomous space is an even more important component of our value proposition going forward.
Got it. Thank you. Gross margins were obviously quite strong this quarter. You talked about the different pieces that were driving that. So looking at it from more of a perhaps a fiscal '19 perspective, is that the new normal? Or is it likely to -- especially, with that strategic accounts become more important up and down, is it -- is that 41.2% likely to slide back a little bit?
Chris, this is Keith. I would say, it's likely to slide back a little bit. What we've said about autonomous cleaning and the autonomous T7 is that it's slightly below from a gross margin standpoint versus our company average, but it's accretive from an EBITDA percentage. So as we start to ramp that up here in the back half, we would expect to see a little bit of pressure there as well as just the ongoing tariffs and inflation that we expect to hit us. So probably we'll slide back a bit.
Got it. Last question. Just maybe talk about IPC a little bit. I mean the acquisition was almost two years ago. It still feels like there is some integration taking place. Is that accurate? And if it is, kind of which areas are still a bit of work in process?
Yes. I mean, I think, as we've said, the IPC acquisition has and continues to exceed our expectations. But we're in the middle of doing a lot of the heavy lifting on the integration of the key countries, the U.K., Germany, France and Spain, bringing the two teams together, the Tennant team and the IPC team together and basically creating a new operating model. So I would say here over the last three, four, five months, maybe we've been a little bit more internally focused as we have tried to get that right, but we are kind of at the later stages of all that effort. And our belief is that once in place, and we turn outward again, the benefits of the integration are going to be significant.
[Operator instructions] Your next question come from the line of Marco Rodriguez from Stonegate Capital.
I was wondering if maybe you could talk a little bit more about the organic growth expectations. Obviously, you have the guidance of 2% to 3% for fiscal '19. Maybe if you could just talk a little bit about how you, kind of, expect that organic growth to fold out through the remaining three quarters? Just kind of given the fact that you had real strong strategic account growth last year.
Yes. No, we're lapping very strong strategic account growth, one of the strongest year-over-year we've ever had. So that's a challenge. But the fact is, we're sticking to our revenue guidance. A little bit behind in the first quarter, but if you look at our backlog and you look at the visibility we have to the pipeline going forward, we're confident that we can get to those numbers. And we will be accretive on the base business without Walmart AMR.
I'd also add to that, Marco, just to say, we're going to be very focused on getting out the profitability that makes sense for us and the returns that we want. So we're just going to be disciplined about that as we go forward and managing it accordingly. So you'll see us just continue, and that's incorporated in our 2% to 3% guidance.
Got you. Okay. And then if you could talk a little bit here about your expectations just on the geographies and your expectations in terms of the organic growth rates there?
Well, we said we should have organic growth in all three geographies again this year. That is our expectation. Good news is that Asia Pacific is, which we've struggled with that part of the business for a while, had extremely strong results in the first quarter. I'm not sure we can maintain it at quite that level, but we should have robust organic growth there for the rest of the year. If you look at EMEA, we've grown in the mid-single digits in the last 2 years. Expect to maintain that kind of growth in EMEA. And the North America has been our growth engine for many, many years now. So it's a pretty consistent track record of delivering decent organic sales growth, and that is our expectation going forward.
The other thing I'd add to that too, Marco, is North America, keep in mind, the ramp-up of Walmart AMR is coming in the second, third and fourth quarter. So that will help us as well as we go forward in the Americas region.
Got you. Then kind of shifting gears here to the operating expense side. I heard the commentary you had on R&D. The growth rate has been kind of on the downside here for the last couple of years, and you've had a pretty significant year-over-year decline. Can you maybe just help frame a little bit more the R&D? It seems to be a bit of a change in strategic direction. I understand, obviously, you want to spend to make sure that you're competitive consistently in the marketplace, but just kind of help us understand a little bit more as far as where that sort of kind of levels out?
The first thing that we look at is how robust is our new product pipeline in terms of meeting the greatest needs in the marketplace. And right now, we find that we basically are able to fully fund all the major programs, including AMR, with the budget that we have in place. Yes. I mean, as a percent of sales, it's been under 3% on a number of occasions, but also remember that we're a much bigger business now, so the number of dollars we're spending against R&D are higher as a percent of sales when you're a $1.1 billion, $1.2 billion business. I think that over time, they gradually decline little bit. But we, as the innovation leader, are single-mindedly focused on this, and we will never allow our innovation agenda, our R&D agenda to be anything less than optimal to serve the needs of our customers and drive our growth.
And I would build on it, Marco, as well, to say we're just getting smarter about our spend. We're much more focused on where we're really addressing operator needs and spending on those areas versus maybe exploring areas where it's not truly differentiated innovation. And to Chris' point, the absolute level of our R&D spending has been fairly consistent. We peaked in 2016, and that was largely behind a lot of the automation with robotics, and when we partnered with Brain, that basically took us back down to that $30 million, $31 million, $32 million level from kind of that $34 million, $35 million level. So we feel good about where we're at, and the team is very focused on the right spending and getting the right returns.
Got you. And then on the SG&A line, the adjusted number around $88 million or so in change. So you, obviously, that, there was restructuring charge as well there that stripped out. Just kind of want to get a better feel. Is that $88.5 million, is that kind of a new run rate, or should we be expecting additional restructuring type costs in the next couple of quarters?
We have a little bit more restructuring to come for the rest of the year, Marco, but [Technical Difficulty] attention is focused on 2 markets that are the biggest. It's China and Australia. We have placed new management teams in both of those geographies over the last year or so. They're kind of getting their feet on the ground and starting to operate to our expectations, and the results are reflecting that. The other thing we're doing is that in China, for example, most of our sales were driven through our distribution network, and that was a little more volatile, and so we've begun to shift more and more of our effort to a direct model, especially in the major metropolitan centers, because that, again, is where we are advantaged in geographies like Europe and the U.S. And that's also helping us drive sales. And you're going to see more of that as we go forward.
And then Gaomei is such a critical strategic play for us too in figuring out how we continue to grow that in the mid-tier piece of that market. So we're excited about that.
Yes. So it's not material to our results yet, but remember, what we're trying to do with Gaomei in China is what we are doing with IPC in EMEA, right? We have not traditionally had access to the mid-tier markets either in EMEA or in China. And in China, it's by far, the biggest part of the market. So the opportunity through Gaomei and China is very significant.
Since there are no further questions at this time, I would like to turn the call over to management for closing remarks.
All right. Well, before we conclude, I again want to thank our global Tennant team members who are pushing forward on initiatives to deliver innovation to our customers and value to our shareholders. We are excited as we move further into 2019 and are committed to delivering on our guidance and driving shareholder value. Thank you for your time today and for your questions. Take care, everybody.
That concludes today's conference call. You may now disconnect.