Good morning. My name is Sarah, and I will be your conference operator today. At this time, I would like to welcome everyone to the Tennant Company's Second Quarter 2018 Earnings Conference Call. This line 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 second quarter earnings conference call. Beginning today's meeting is Mr. Tom Paulson, Senior Vice President and Chief Financial Officer for Tennant Company. Mr. Paulson, you may begin.

Thanks, Sarah. Good morning, everyone, and welcome to Tennant Company's second quarter 2018 earnings conference call. I'm Tom Paulson, Senior Vice President and Chief Financial Officer of Tennant Company. Joining me today are Chris Killingstad, Tennant's President and CEO; Tom Stueve, Vice President and Treasurer; Andy Cebulla, Vice President of Finance and Corporate Controller; and Kristin Stokes, Deputy General Counsel. Today, we will review recent progress against our core strategies, our performance during the 2018 second quarter and our updated outlook for 2018. First, Chris will brief you on our operations and then I'll cover the financials. After that, we'll open up the call for questions. We are using slides to accompany this conference call. We hope this makes it easier for you to review our results. A replay of this conference call along with these slides will be available on our Investor Relations website at investors.tennantco.com following this call until August 25, 2018. Now 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. 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 second quarters. Our 2018 second quarter earnings release includes a reconciliation of those 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 this point, I'll turn the call over to Chris.

Thank you, Tom, and thanks to all of you for joining us. During the second quarter, we made solid progress against our core strategies and generated additional momentum across a broad range of performance measures. Overall, we are pleased with our progress to date, and we are confident in the underlying performance of the business. Our first strategy is to diversify our revenue streams by expanding our sales growth drivers across all geographic regions, channels and product categories. During the second quarter, Tennant once again generated organic growth in each of our three geographic regions. This marks the third consecutive quarter of sales expansion across all geographies. Sales grew in each of our different go-to-market channels, direct, distributor and in particular, strategic accounts. We're also excited to see that enhancements we made in our service, parts and consumables business continued to benefit our results in the second quarter. In total, 2018 second quarter consolidated net sales grew 7.9%, or 5.2% organically to approximately $292 million. We are pleased with our sales execution efforts thus far in 2018, and we expect continued positive momentum in the back half of the year. Our second strategy is to fully realize or to realize the full potential of the IPC acquisition by successfully integrating the business. IPC expands and diversifies our revenues by region, product category and sales channel and also broadens our growth platform. Our current focus remains on identifying revenue growth opportunities within our combined organizations, as well as capturing organizational and sourcing efficiencies. We will continue to see integration process as thoughtfully as possible, with the primary goal of enhancing shareholder value. Underlying IPC business performance and integration progress remains solidly on track. Our third strategy is our commitment to operating effectively, which includes the investments we made last year into…

Thanks, Chris. In my comments today, references to earnings per share on a fully diluted basis except for the 2017 GAAP result, which were calculated with the basic weighted average shares outstanding due to the as-reported net loss. However, non-GAAP 2017 earnings per share are calculated on a fully diluted basis. And as a reminder, this is the first quarter that IPC results are embedded in our organic results and regional reporting. As Chris noted, we witnessed improvement in several areas during the quarter. Most notably, in broad-based sales growth, expense leverage, cash flow and EBITDA growth. These all illustrate our discipline and commitment to executing on our core strategies. For the second quarter of 2018, Tennant reported net sales of $292.2 million, roughly 7.9% higher year-over-year with organic sales improving 5.2%. Our organic sales result exclude a favorable currency impact of approximately 2.7%. Looking at the bottom line, second quarter 2018 net income was $12.7 million or $0.69 per diluted share. A reported results on a quarter reflected $3.1 million in pretax expenses or $0.13 per share related to non-operational special items, primarily IPC acquisition, integration costs. Excluding these items, Tennant reported adjusted net earnings of $15.1 million or $0.82 per share. By comparison, Tennant reported adjusted net earnings of 10.6 million or $0.58 per share in the year ago quarter. It's worth mentioning that our results also include pre-tax expense of $5.5 million or $0.23 per share from amortization of the intangible assets related to the IPC acquisition. Our results also reflect two discrete tax benefits totaling $3 million or $0.16 per share. These benefits are the result of two events. The first is a favorable ruling from Italian Tax Authorities related to the deductibility of interest expense in Italy, resulting from the IPC acquisition. This is a…

Thank you, Tom. All right. So before we open the line for Q&A, I'd like to take a moment to acknowledge my colleague and my friend, Tom. Today, we announced Tom's plans to retire in the coming months. Tom joined Tennant in 2006 and in his 12 years with the company, he has contributed significantly to Tennant transformation as a global industry leader, including a major role in the IPC acquisition, the largest in our history. His leadership and personal commitment to advancing Tennant strategic initiatives has positioned us to capitalize on new growth opportunities, enhance value for all of our stakeholders and continue our journey to reinvent how the world cleans. We have initiated a search to identify Tennant's next Chief Financial Officer. As we mentioned in the news release, Tom has agreed to remain with the Company until the search has concluded and the successor has been chosen. So while he still has some time in the chair, I ask that you please join me today and thanking him, and congratulating him as he plans to spend more time on the golf course and spoil his grandchildren. So with that, we'll open it up to Q&A. Sarah?

[Operator Instructions] Our first question will come from the line of Mr. Chris Moore from CJS Securities. Please go ahead.

Hey. Good morning, guys.

Good morning, Chris.

Good morning.

And I'll be the first. Congratulations Tom.

Thanks Chris. Appreciated.

Sure. Absolutely. Maybe just to start with IPC. It looks like IPC derives less of their revenues from parts, consumables and services. First, is that correct? And why is that? And is there an opportunity?

It's a factual statement, and it is an opportunity. And it's predominantly or really two drivers of that. And one is that it is generally in the distribution base business, which is 80% through distribution that is more difficult to give your fair share of the parts and consumables business. Also their product portfolio tends to be smaller equipment, not as industrial based, and the parts and consumables component of the aftermarkets is smaller – on smaller pieces of more renewable equipment. But it presents a real opportunity. It's one of the areas we're very focused against creating leverage with our direct service organization in Europe and other parts of the world in conjunction with the distribution service functions. So I think it really is an opportunity to get more than our fair share, both from a revenue and I think it can also be margin enhancing over time.

Got it. Appreciate it. Obviously, you guys called out the headwinds, tariffs, raw materials, labor, et cetera, that the obvious impact is on the margins. Is there any potential for any of those to impact you on the revenue growth side?

Possibly. I mean, anytime, you start to have supply shortages and it can have some effect on revenue. I'd like to think that the worst that could happen is it would affect timing, not cause us to lose revenue. So that's certainly our desire, and we'll do everything in our power to not – we just want to please customers, we don't want to miss any revenue. And one of the issues we have is, we just not big enough frankly to have the kind of the leverage you might want have with some of your suppliers, and we're a low unit and high-mix business. And so that does make the material supply more difficult at times. But we're doing everything in our power to short up, and we certainly hope it worse that only affects the timing of revenue.

Yes. One of the things we're doing is that operations in sales are working hand-in-hand to figure out the priority orders and the priority customers, where we can't miss deadlines. And then – and also then in the second Tier 1s, where you can maybe – you can delay for a couple of weeks, and that’s fine, and then the third Tier where it’s not as crucial. And I think that's going to help us manage at least in the short-term here through this issue and not have an impact sales, but if this were to continue for an extended period of time, where it get worse than it currently is than it may be more difficult.

It is one of the times we’re having a direct organization really matters. It just the depth of the relationship they have with the customers, we can very actively manage that, but it's a risk.

Got it. Appreciate it. Last one, tax rate. So the guidance going down to 20%. Reasonable to assume that, I know you not there yet, but fiscal 2019 is slightly black closer to the 24% that we started out this year?

I would say that if I – we're not ready to give guidance for next year, but I would be comfortable the range could be 20% or 21%, up to 24%, but I mean I’d like to think that we can permanently keep it in the low 20s, but we certainly not ready to commit. And the reason for that is, there's two things. One, the tax legislation and things are going are still unclear in many cases. And also our mix of business matters enormously above remake our profits and while our tax rates can be. But we certainly don't anticipate going above 24, and we could just – you could stay down in the low 20s also.

Got it. I appreciate guys.

You bet. Thanks Chris.

Thanks Chris.

Sure.

Your next question comes from the line of Marco Rodriguez from Stonegate Capital Management. Please go ahead.

Good morning, guys. Thank you taking my questions, and congratulations on it.

Thank you very much. I appreciate it.

Real quick, I just wanted to maybe dive down a little bit deeper into some of the potential headwinds, if you can maybe provide some more information, some more color, specifically around the tariffs, China. And then the specific raw material is it most just steel and aluminum, or there are other areas that are you're kind of seeing there as well?

Yes. It’s predominantly steel related. But it's – and this is one of the complexities of it at all, it goes beyond just raw steel. Now one of the things that there is tariffs being put in place that affect steel as the part of – a component of other parts. And those tariff being charged in that regard. So we have – there's some impact of what we're getting from China. We have impacts of where resource other steel, which is Canada is on the primary providers. So it is totally unclear about what we have, but we feel that we're adequately covered this year. And we're quickly shifting gears to next year to really determine what kind of flexibility we have and every actions that we can take, if this really does become a full board and start effecting the full 12-month period.

Gotcha, and the tariffs impacts, are there specific impacts to the invoicing that you're doing or other areas where that's impacting?

Say that again, Marco. I didn’t understand that.

I'm trying to get just a little bit better resent on the tariffs headwinds. It made it sound like it was across the sales revenue…

It's a pure tariff on it as we're bringing in as permanently componentry. So it's raw steel or its other components for that steel and we're literally getting the tariff up-charge on the cost of goods that’s coming through. So we're not being affected in pricing. And again, it's important that right now, we aren't making any assumptions that in the tariffs coming, these other areas that we know about that are being either in that or would appear that are likely to happen. We all know that no one really knows for sure what's going happen. But it is goes to cost of goods sold, yes.

Gotcha, okay. And then…

I was going to say one of the good things, as you know, as we tend to produce close to the customers. So a lot of our sourcing for North America comes from North America sourcing and Europe comes from Europe et cetera. So I think the impact on us versus some of the manufactures who already come out and reported earnings in the second quarter is less because of that strategy.

Gotcha. And in terms of the increase in cost that you guys are going to be experiencing here in the second half of the year. Can you maybe talk a little bit about your ability to kind of a push those additional costs through and as far as higher pricing is concern or is that not just too feasible right now?

Yes, I mean one of the things I'd comment on is, we have done a really nice job through the first part of the year that we are certainly covering inflation, and as we’ve seen and we aggressively took price and that was on top of a reasonable pricing last year and we’ve enacted pricing through the first six months of the year and anticipate continuing to get that. We firmly believe that if the market puts tariffs in place the combination of flexibility in our supply chain and our ability to price that we will recover and get our margins back to normal levels or just be a matter of timing. But our customers understand it and we will be able to price and exhibit flexibility to make changes in our supply chain.

Understood. And then switching gears here to your – the North America or the Americas, the strategic accounts, I just want to trying a little bit better of understanding as far as the growth impact that you saw there from strategic accounts versus what you kind of saw in Latin America?

Yes, I mean, we're not going to give precise strategic account numbers, but I mean, it is – it's the most important source of growth from an absolute level. And it didn't matter in Q1, it matter in Q2. And we have solid visibility that the strategic account revenue will positively affect from a revenue standpoint Q3 again, also. But we're calling out from our original expectations for example, to give guidance a quarter ago, we think that the full-year margin impact due to higher strategic accounts will negatively affect our gross margin expectations by about 20 basis points. And it's a good problem to have the more strategic account revenue we can get the more efficient we get but it doesn't directly affect our gross margins but it's one of those problems we want to call it out. But it’s a good problem.

Yes, affects our gross margins remember the cost of sales is also less than that our net margins are not impacted, which is why we're seeing some leverage at the EBITDA line.

It’s part of that we creating the leverage of the EBITDA line I mean if that is objective you want to be in a different due to channel strategies, serve the customers the way they want to be serve and but we got do it efficiently.

Understood. Okay. It’s helpful. Then in terms of the - you reported an adjusted EPS numbers. I just want to kind of confirm discrete tax items that were benefit to the quarter, those were not stripped out of the adjusted EPS reported number of $0.80? Is that correct?

They were not. And the reason for that is, we feel there – in the case of expiring options, that's a normal part of ongoing operations, it does happen sometimes the smaller, sometimes it's nonexistent. And then, the big benefit from the Italian situation. That's a specific action that we took and it was really related to the deductibility last year. So our tax rate was higher. So didn't know we are going to get the favorable ruling, but that's also an ongoing benefit in our tax rate, we’ll get that deductibility as we go forward. But it will move around by quarter.

Understood. And last quick question, I’ll jump back in the queue. Maybe if you can just kind of update us on the field service productivity issues. I know you are starting to make improvements in Q1. Just kind of want to get an update as far as where do you think you stand there?

Yes. We’re actually as painful as last year it was really pleased with the progress that the team has made this year. We are back firmly on track, we're actually ahead of expectations for both the revenue and a margin standpoint. We have completely stabilized the organization. Our open truck levels are back to normal. The strategy of enhancing our commercial service offering is working. And so we're really pleased with where we're at and it will benefit Tennant as we go forward.

And all the people that we brought on board late last year and early this year now for the most part are fully trained and are hitting the productivity levels that we need. That’s a big benefit as well.

Understood. Thanks a lot guys. Appreciate your time.

Our pleasure. Thanks.

[Operator Instructions] Your next question comes from the line of Brett Kearney from Gabelli & Company. Please go ahead.

Hi guys. Thanks for taking the question, and congratulations Tom.

Thanks Brett.

Yes. Just want to ask you guys on capital allocation, as you guys are generating really good cash flow approaching your net leverage target to 2.5 times towards the end of this year. Just want to ask, obviously a lot of great organic new product development capabilities in front of you, but how are you thinking about some of the cash flow of the business will be generating in the back half of this year?

Obviously we're still – are staying consistent on our dividend policy. We have not, although, we have an authorization. We're not buying back shares. We don’t see ourselves doing that anytime soon. But we are getting at a point where we’ve kept our acquisition pipeline active. And we're – we will tell you our focus will remain paying down debt in our organic growth. We love that doing other transaction. And we’ve talked about a few of those overtime, but – with certainly hope that sometime in the not too distant future on the leverage that gets to where it could be that we would close on another smaller transaction, it would be much smaller and we don’t expect to lever back up. But for now we will remain focused on debt paydown, keeping our pipeline live.

Great. Thanks so much.

Yes, thanks Brett.

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

All right. Thanks. Before we conclude, I want to thank the team members of Tennant, who have been so critical to driving the growth, operational improvements and technology leadership for which we are recognized today. The momentum we have is a direct result of their hard work. Tenant remains committed to enhancing long-term shareholder value by divorcing our revenue streams by expanding our sales growth drivers across all geographic regions, channels and product categories. We enforcing our technology leadership and supporting our robust new product pipeline, striving for global operating effectiveness, strengthening our financial position and cash flow characteristics as well as balancing our capital allocation strategy across growth investments, debt reduction, dividends and share repurchases. Successfully completing the integration of IPC and looking holistically at our growth plans both organic and strategically targeted in organic growth opportunities. Growth does not come without challenges. We have some to addresses we move forward, but we have achieved many important milestones in the first half of 2018 and look forward to building on this momentum in the back half of the year. Thank you for your time today and for your questions. Take care, everyone. Bye-bye.

This concludes today’s conference call. Thank you for your participation. You may now disconnect.