Tennant Co (TNC) 2003 Q3 法說會逐字稿

Good morning and welcome to today's Tennant Company's third quarter earnings teleconference. All lines will be on a listen-only until the formal question and answer session. Instructions will be given to you at that time. Today's conference call is being recorded for instant replay purposes. If you have any objection you may disconnect at this time. Thank you for participating in Tennant Company's third-quarter earnings teleconference.

Beginning today's meeting is Ms. Janet Dolan, President and Chief Executive Officer for Tennant Company. The call will now be turned over to Ms. Dolan.

Thank you. Good morning, everyone. This is Janet Dolan and I would like to welcome you to our third-quarter results conference call. With me for this call is Tony Brausen, our Chief Financial Officer. Thank you for joining us this morning. Welcome also to all of you who will be participating on the Webcast of this call. Before we proceed, I'll Tony to provide our safe harbor statement.

Good morning, everyone. Our remarks this morning and our answers to your questions may contain forward-looking statements regarding the company's expectations of future performance. Those statements are subject to risks and uncertainties and our actual results may differ materially from those contained in the statements. The risks and uncertainties include factors that affect all companies operating in global markets, as well as matters specific to our company and 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 uncertainties.

Our news release was issued this morning via PR Newswire and is also posted in the Investor section of our Web site, tennantco.com. The information required to be disclosed about non-GAAP measures discussed during this call is available in the news release, which includes schedules that reconcile our GAAP results with results excluding unusual items. We believe presenting the non-GAAP measures permits a more meaningful comparison of our operating results, and it is consistent with the way we measure the business internally.

Tony will review the financial performance for the quarter in detail in a moment. To begin, let me comment briefly on the quarter's results. While business conditions remain very challenging, we are pleased to be reporting a fourth consecutive quarter of year over year improvement in earnings per share. As we noted in our results announcement, three factors contributed to the improvement in our 2003 third-quarter results compared with the 2002 quarter.

First, our export sales to international markets, particularly Asia, the Middle East and Australia grew significantly compared with the prior period. Second, we saw an improvement in industrial equipment volume in North America, the first such period over period improvement in more than two years. And third, favorable foreign currency exchange effects benefited our top and bottom lines during the quarter. That said, business conditions are still difficult, as we are not yet seeing a meaningful upturn in the industrial sector capital spending.

I'll have more to say about our outlook for the balance of 2003 after Tony provides an overview of the quarter's results.

Thank you, Janet. Our reported results for the 2003 third quarter include earnings of 36 cents per diluted share on net sales of $110.1 million. That compares to earnings of 31 cents per diluted share on net sales of 107.8 million in last year's third quarter. As our news release indicates, there were unusual items affecting our year to date results for both the 2003 and 2002 periods. The financial impact of these impacts is noted in a separate column on the earnings statement we included with our news release.

Also, as noted in our third-quarter results release, we expect no further charges beyond those which we have already recorded related to the previously announced dissolution of the NexGen joint venture. Excluding unusual items, we reported earnings per diluted share of 94 cents on net sales of $327.6 million for the first nine months of 2003, compared with earnings per diluted share of 87 cents on net sales of $310.4 million in the comparable 2002 period.

The rest of my discussion of my income statement will be excluding the unusual items in both the 2003 and 2002 year to date periods. When I discuss our year to date results, I will be referring to the columns excluding unusual items on that consolidated statement of earnings page. Consolidated net sales for the third quarter, totaled, as I mentioned, $110.1 million, which is up 2.1% from the third quarter of last year. Favorable foreign currency exchange effects added about 3% to net sales for the quarter and price increases benefited net sales by about 2%.

For the year to date, consolidated net sales excluding the $6.4 million of deferred revenues that we recognized in the third quarter were $327.6 million, which is up 5.5% from the comparable 2002 period. Favorable foreign currency effects added about 4% to net sales from the year to date. And during the quarter, we saw sales growth outside North America with particularly strong growth in Asia, the Middle East, and Australia. In North America, sales for the 2003 third quarter totaled $78.3 million, which is down 2.2% from the 2002 third quarter.

As Janet noted, we saw a modest increase in North American sales of equipment for industrial cleaning, the first such year over year improvement in more than two years. The growth in that category was offset by a decline in sales of equipment for commercial cleaning compared with the prior year. The decline reflects in part a comparison against a strong year-ago period that included two large orders. In addition, we are seeing a slowdown in orders from customers in state and local governments, including schools, because of budget constraints in the public sector. This slowdown has been more pronounced than we had anticipated earlier this year.

Year to date, sales in North America totaled $237.6 million, excluding the $6.4 million in previously deferred revenues recognized in the first quarter, all of which was in North America. Net sales in North America increased 0.7% year to date. Favorable foreign currency exchange effects have added about 1% to net sales to North America for both the quarter and the year to date.

Turning to Europe, sales for the 2003 third quarter totaled $20.7 million, which is up 12.5%. Favorable foreign exchange effects added about 13% to net sales in the quarter. Our sales volume in Europe and this year's third quarter was about flat with the year-ago level, despite the continued weakness in European economies that has been exacerbated by the strong euro.

We benefited from sales growth in two countries where we have made investments this year in expanding our sales and service coverage. Year to date, sales in Europe totaled $63.4 million, which is up 20.3% over last year. Favorable foreign currency exchange effects have added 19% to net sales in Europe for the year to date. In our other international markets, net sales for the 2003 third quarter totaled $11.2 million, which is up 20.4% from the 2002 third quarter. Year to date, net sales are up 17.4% compared with last year. Favorable foreign exchange currency effects added about 6% to net sales in both the quarter and the year to date.

Following up on a strong second quarter, we continued to see sales growth in Asia, the Middle East and Australia. This growth is primarily attributable to strengthening economies n these regions, as well as attributable to success with new products, including FaST which is our foam scrubbing technology and Sentinel, which is our recently introduced upgrade of our model 830 Outdoor sweeper. Consolidated order backlog at quarter ended and $10 million compared with $12 million at the end of this year's second quarter and $14 million at the end of last year's third quarter. Our gross profit margin for the third quarter was 40.1% that is the same as in last year's third quarter and for the year-to-date our gross margin is 40.1% compared with 40.4 in the comparable 2002 period.

Our R&D spending in the 2003 third quarter total $4.1 million which is down from $4.5 million in last year's third quarter, that reduction reflects the timing of spending and not a change in our commitments in new product development. On year-to-date basis our R&D spending is up slightly at $12.6 million compared to $12.4 for the same period last year.

Certainly administrative expenses total $34.6 million in the third quarter, which is up $1.4 million from last year's third quarter. About $1.1 million of that increase is attributable to foreign currency exchange effects. Excluding exchange effects third quarter selling and administrative expenses are up less than 1% compared with last year's third quarter. Foreign exchange effects overall have increased third quarter EPS by above 11 cents per share and about 17 cents for the year-to-date and as was noted previously there is about a three months lag between changes in the euro exchange rates and its impact on our gross profit or the impact on selling administrative expenses is immediate.

Results overall also benefited from the Canadian and the Australian dollars as well as the Japanese yen, all of which strengthen relative to the U.S. dollar during the quarter. Our operating profit for the 2003 third quarter totaled $5.4 million compared with $5.3 in last year's third quarter and our operating margin in both periods were 12.9%. For the year-to-date operating profit was $14 million up slightly from $13.9 million in the 2002 period. Our year-to-date operating margin is 4.3% compared with 4.5% through the first nine months of last year. Our tax rate for the quarter is 37% and for the year-to-date is 39%. compared with 41% first the nine months for the prior year. For the whole year we are anticipating a tax rate of about 39% compared with 40.2% in the 2002 whole year. The decrease in the expected effective tax rate results from a favorable non-US tax audit settlement.

We are more in previously our effective tax rate can fluctuate with mix of our taxable earning by country. Cash flow from the operation in the year-to-date forward 23.5 million compared with 12.6 million in the comparable 2002 period. This strong improvement is all primarily from lower inventories.

Since last December we have reduced inventory by about 6 million and excluding foreign exchange effects. In compare with September last year our inventory were down by 9 million exclusive of foreign exchange. These declined results from our consolidated efforts to reduce inventory company wide including our part payment inventory held by the third majestic services provider and its locations.

Our capital expenditure year-to-date a total 6.5 million we are currently anticipating four year capital spending and range of 9 to 11 million, we anticipate depreciation, normalization for the year is about 40 million. Touching and receivable for the moment at the quarter end was 79 million that's up 4% from September last year and foreign exchange accounts for almost all that increased.

Our cash equivalent at quarter end total 21.2 million compare with 16.4 million at the end of the 2002 and 13.4 at the last September. Our cash net debt has increased by about 19 million since the end of the last year. Total capital ratio at the end of September was 4% that compared to 11% a year ago. And that concludes my overview at the quarter.

Now I turn it back to Janet to update you our state of the business and our look for the remainder 2003.

Thanks Tony. To conclude our call this morning I will update you on state of the business and our expectation for the rest of the year. As I mentioned at that start of the call we were pleased with our performance in the 2003 third quarter. This is our fourth consecutive quarter of year over year improvement in earnings per share despite the difficult environment.

We saw a number of positive signs in the quarter. First, well we don't want to call one quarter a trend it was certain encouraging to see improvement in North America industrial equipment sales. Those of you from earlier Tennant know that we have the considerable operating leverage in our industrial equipment area. As a result a return to normal levels of volume and flat utilization should have a difficult portion positive impact on our operating results.

In our past two recession we saw about one year recession period followed by a two year recovery of normal level of volume and flat utilization. For the industrial sector the current recession has been much longer and the shape and the pace of the recovery from remained to be seem. Second we continue to generate sales growth outside North America. In Europe our most economies in overall demand remain weak year-to-date, which enable to growth sales slightly despite the unfavorable environment.

Thanks to foreign currency exchange effects our top line in Europe is up 20% year-to-date. In our other International market results were particularly encouraging. We generated true volume growth in the Asia, the Middle East and Australia on the strength of new product in healthier economy.

With the added benefits of this favorable currency exchange effects that volume growth 17% top line growth year-to-date. we continue to benefit from our prior investments in developing breakthrough new products.

Our FaST system provides a particularly good example. This patented system, which improves cleaning crew productivity, consumes less water and leaves the floor -- It is becoming broadly accepted in the market. For example, in Europe where there is generally a greater concern with environment -- about 60% of our scrubbers are now sold equipped with the FaST system.

Beginning in the fourth quarter, we will be offered FaST on some of our scrubbers for the industrial applications as well. We are very pleased to announce that last week, the FaST system received two more industrial awards adding to three prior recognitions as the most innovative product in its category at international trade events. FaST became the first and the only automated cleaning system to receive High-Traction certification from the National Floor Safety Institute.

This High-Traction certification -- to a third party staff of approval for products that offer a slip and fall accident prevention benefit we expect this certification to be a very powerful selling point with customers concerned about the safety of employees and customers in both commercial and industrial settings.

In addition, last week's International Sanitary Supply Association Conference, which is the most significant annual trade show in the commercial sector of our business, the International Custodial Advisor's Network gave FaST its top product innovation award. Off setting these many positive signs, we did see our North American sales of equipment for commercial cleaning slip in the third quarter breaking a long string of period-over-period improvement.

As we noted, the decline reflects in part comparison against a strong 2002 third quarter for commercial cleaning equipment sale that also included two especially large orders. But we are also seeing weaker demands from some commercial equipment customers. This is particularly true among Federal, State, and local units of government and in schools where public sector budget constraints are dampening demand. To adjust with this development, our distributor partners and our Commercial National Counter Sales Team will focus on private sector markets such as retailers to grow the business.

Overall, the signals from the economy and our markets remain mixed. Like others in the manufacturing sector, we are seeing considerable volatility in month-to-month order volume that makes forecasting near term results very difficult. For instance, in our third early September where periods of abnormally low order volume. We experienced a similar sharp drop in order volume in our second quarter during May and early June. Result announcements and research reports and other industrial companies have also noted this kind of volatility.

Given the short cycle nature of our business, our order backlog typically represents less than two weeks of revenue. Sharp swings in order volume will have immaterial impact on our expected results for any one quarter. We only like what we see in our pipeline of prospective orders. The environment is providing little ability to predict with certainty when promising opportunities will become firm orders. This is especially true in the fourth quarter when it is easy for our customers to the first spending into next year's capital spending. As a result, we are remaining guarded about our expectations for the balance of the year. With our third quarter results announcement, we revised our expectations for the whole year earnings per share range of 136 to 156. This range includes the unusual items, Tony covered in his remark excluding those items we are now expecting 2003 earnings per share of 130 to 150. This guidance incorporates several factors.

First, we are not yet seen any meaningful recovery in the industrial sector capital spending. We cautioned earlier that achieving the operand um our initial 2003 earnings guidance would require a strong recovery in the industrial sector capital spending in the year's second half. That recovery has not materialized.

Second at Tenant, a rebound in demand in industrial cleaning equipment has typically laid the onset of our recovery in capital spending by one to two quarters. Because of that lay, even that we see a material, favorable, turn in capital spending of the year end. The resulting rebound in our business is not likely to occur until 2004.

And third, we have a challenging quarter-to-quarter comparison in 2003 fourth quarter. In the prior year, our performance benefited from a large number of Centurion delivers as well as shipments of commercial clinic equipment under the large 2002 third quarter orders we mentioned previously. While Centurion continues to do well in the market place.

We currently expect fewer deliveries in 2003 fourth quarter, then in the comparable period. And as I noted earlier, we have seen recent weakness in demand for commercial cleaning equipment in the public sector. As a result of these factors and the overall order volatility I mentioned earlier. We are being cautious about our expectations for the fourth quarter and adjusting our guidance for the whole year accordingly.

That's it. We remain optimistic about the company's prospect and continue to believe that we are well positioned to benefit from an eventual upturn in the industrial sector capital spending. The actions we have taken to permanently reduce cost improving operating efficiency expand or sales in service coverage and develop superior cleaning solutions should all be rewarded in a more favorable environment.

In the meantime, the actions we have taken have enabled us to remain profitable throughout a prolonged and severe downturn even if we strengthen the company's financial position by generating cash and clearing all our debt.

That includes our remark and we will be very happy to take your questions.

Thank you, If you would like to ask her question, please press '*1', to cancel your question, please press '*2'. Once again that's '*1' to ask the question and "*2" to cancel.

Our first question comes from Gary Giblen of C.L King.

Hello, Good morning

Hello guy.

Good morning.

Just wondering these do you still feel as you are gaining market share in municipal within the context of a week municipal market?

Well, we certainly feels that we are gaining share with our Centurion that would be the first. If we continue to see very broad demand for the Centurion and in terms of the commercial equipment I think there is no indication that it is any kind of share lost it is more an indication of in the public sector. As we could well imagine from all of us reading about the budget difficulties of 43/56. We just believe that it is a slowdown in spending and no indication about positing of any particular competitors in the market place.

OK. Great. And then -- I mean if you peal back the onion of this extraordinary volatility and demand. What is behind that, I mean, is it that half the customers are buying and the other half are not, so that therefore you have uneven patterns or you know are there other aspect of this.

Well, I think you know all of us at each stages -- stock market up or the stock market down and then somebody has got a reason for it. I think there is just a very on going uncertainty and there has been a couple of false starts to a recovery in the last three years and so I think that just adds to the uncertainty.

So you get a little strength and then there will be some events whether it is on the global stage or whether it has to do deficits or whether it means that you get some triggering events that people get cautious and say. We are not having a stronger recovery as you might have thought and so you just you see this sort of pause as people sort of pull back and try to take a temperature check of how serious is this latest piece of news that we are responding to.

So I think it is more the volatility as you see strong months too. So instead of just the steady decline you see one good month then you see an uncertainty and then you see another good month. Then eventually we will pull out of this as the whole economy starts to be more confident that the recovery really does have legs and it is here to stay.

And Gary I will just add, I take a little bit of solace in the fact that I do not believe we are alone in this situation from the volatility stand point I have seen at least a handful of equity research analyst that follow the manufacturing sector. That have talked about this volatility and I have now seen some companies in this reporting season and their tele-conference scripts or transcripts I should say refer to the volatility.

For instances I have heard, at least one or two others talk about August specifically as a very weak month. Well I wish I knew the answer to why that happened and we know we had a hurricane and we had a blackout during that period. But, should those events cause this kind of volatility I do not know. I wish I knew the answer to that.

OK. Final question is the. Yes I guess there is confusion in the market place as to whether Tennant would be a very late cycle recovery like play or mid cycle or early to mid or whatever so Janet I guess what is your -- on that.

Well I think we have tried to indicate at least timing wise we tend to lag one to two quarters, so that would certainly not be a late cycle. I would say it is probably more like a mid cycle. As soon as people go back to work and you start to get any kind of use of the equipment and use of the facility whatever it is, very quickly on that becomes the question of cleanliness and safety and so I would say we do not lag more than a quarter or two.

We have always tried to be candid. So I would say that you know either mid or just late early, but we come very close in the capital spending as soon as any kind of use of the facility recovers because there is great demands on people to maintain clean and healthy and safe environment

OK, great. Well thanks very much

You are welcome.

Our next question comes from of Lord Abbot.

Good morning.

Hello. Bob.

Good morning Bob.

Excuse me

our next question comes from Bob Sledge of Lord Abbot.

Good morning.

Hello Bob

We haven't seen any number of kappa goods market some impact from the tax law, which writes the benefit that works by our next September. Your customers typically sensitive to the same financial benefits as you would expect as others with the and to agree that they are these things we are just going to CI. More likely bulging orders closer to the accommodation point.

Bob I think you probably are referring to the exol rated depreciation available for the capital expenditures and expires next year and certainly our customers would purchase expenses in industrial large any equipment will be available to their net tax benefit that is something - that we have armed are sales force were to be shared. That the focussing with on the daily basis understands that what are that will have an impact on buying in 2004 don't know that benefits available this year as well and as you have seen in our results, we were down on the first year course of industrial sacer now up modestly in the third quarter I certainly can tell you that tax benefit has had a aliquant influence on industrial logic orders so far.

OK

Bob I am just going to say two things, one is the advantage of our drug sales is as Tony said, you know it is a completely automated drug sales what we have the opportunity to have the information from every sales rep for that they reason. And I would guess it is kind of like a hurdle and then an accelerated and tell people it's is hard to betray them to spend the money at all. Once the components start then motivations like the accelerated depreciation can act as kind of an accelerate you know, an extra persuasion point one thing over that rule that they can loose enough the first things in the capital money

OK you talked about the head wind of the economy last cycle and lasting about a year and then a couple of years of recovery, how long you kindly measure this period of weakness that we didn't.

I think Bob from our standpoint began in the fourth quarter of the year 2000.

And

We were talking in it is been about three years.

OK and in that regard have you seen some typical level were created at the replacement cycle that will be in offset some of the economic assets of some point everything else in equal.

I think it is fair to say that you know with creaming equipment in our industrial equipment has a very like stand depending on its use. Well I think it is fair to say obviously in that three-year period, there has been industrial equipment that you know was sold 5-6-7 years ago that leads to now be replaced and I think it is also fair to say we have seen a number of our customers and again back to Janes point of our sales cause we know what are the equipment is and we know about its life stand, we know its use and saw direct to are very much in contact with those customers at replacement time. We also know as many of them has continued the push so they have set lock and ready to place some order, appraise that order in the third quarter, - the third quarter comes, they say I still need the equipment and I have even indicate the modal numbers but yet they cant get the capital free from so they had to push there after, so we continue to see that experience certainly I would say some of some of those customers have had to bite the bullet and buy the equipment, regardless because it just became that necessary, while others have certainly been able to continue to push that purchase of.

Yes now we talked previously about floor space having flunked in the industrial markets but with every thing you had just said and the potential benefit of the FaST systems in to the industrial market as well as the tax code which ought to benefit for at least another year that, so number of factors ought to be coming together that, ultimately ought to get people to move of the dime.

I think that is why Bob Sledge we have said we are some part is new territory here because this has been such a prolong slow down, so that we really do not now yet what the velocity or the slope of the line is going to look like for the recovery, as you said, when there are lot of drivers it may be FaSTer or more significant then it has been in the past.

Thanks, and with that volatility I know, in a number of recent quarters you had production schedules where you did take some down time, can you give us senses to release based on what you are seeing, what schedules may look like over the next three six months.

Yes at this point we did shut down in North America over the Fourth of July holiday, but we have not scheduled or and have no further shut downs in North America. In Europe where obviously there continues to be weakness as well, as Janet talked about earlier in the call, they where looking at from time to time a day or two where we may close the factory, but nothing of a more standard prototype than that.

Can you give us senses to what foreign exchange may look like in the next period or two, obviously its been meaning full benefit when you look at fair reported sales in Europe, more recently, but how long does that benefit last.

Yes that benefit will be worth a little while, just to give you sense again remember the euro on a lag basis, So fourth quarter really for the most part think about, third quarter comparison of the euro. euro averaged this third quarter about a 112.5 last year was at $98 cents in the third quarter other currencies that influenced us would be the Canadian dollar which was sitting at about $64 cents in last years fourth quarter, as you know is above $74 cents and another one will be the Australian dollar that was sitting at about $56 cents a year ago and now that is above $66 cents, so we certainly still continue to except to see some favorable foreign currency benefits in next quarter or two, assuming these rates hold.

Do you have the fourth quarter 02 number handy for the euro

The euro in the fourth quarter 02 was about a dollar even.

OK and I know over the last year or so, lot of work is been done, taking a more of a pan European approach to there business, have you in actuality found any dislocation as you been working through that process

What do you mean by dislocations.

Well any thing surprises that may be did not, at least did not get the immediate benefit, that you had excepted or the cost have been some what higher

No I think we got the productivity gain, that we were looking for, we certainly hit a tougher economy than we anticipated, well I think its more of a vague behind the North American. I think Europe is really sagged in all reports in their industrial sector in Q2 and Q3.

OK, can you talk generally about pricing I noted that was on March 1, I think increase that you had put through that appeared to be holding. did it in fact hold.

Yes.

And was that on both commercial and industrial.

Yes.

And on the Centurion last quarter, you had mentioned that the orders had been above planned up until that point and you had mentioned that one of your competitors was complaining about minuscule spending that apparently was not affecting you folks -- you now think that, that is exactly what is happening, it has caught up to you folks as well.

Well it certainly has caught up to us in the commercial equipment and I think it has certainly a factor in the Centurion order, although Centurion order do continue strong in effect on the interesting part as last year we had fewer orders, but bigger, you know we had some kind of demand as we introduced it last year, we had some municipalities that bought several so we continue to be pleased with what I would call sort of the broad awareness and the broad interest and the broad range of types of customers who are buying.

But clearly the industrial sect or the public sector for big ticket items is really difficult sector to settle into right now.

So would you -- would you characterize this at all that the initial Centurion success was somewhat leveraged off, those folks who are most likely to buy it first and now it really requires little bit harder sales effort to kind of educate or get the word out to those who might be generally slower to move.

I think with any new innovation the early adapters are the first ones that do it and certainly we had interest and early customers in areas of the west what was very high -- very high dust concentration in it -- it was very appealing to them. But I would say that it is more about -- we put a tremendous amount of sales effort into it last year. Obviously you do it with a new product and plus we were in such a slow down with industrial it was easy to -- it was a good decision to put a lot of direct sales effort behind it.

Now as we are starting to see more interest more activity in the industrial market place we will more evenly smooth out, how much sales effort we put into it, because we want all parts of the plant to increase, so we have got perhaps less sales effort going into it, because we have more of a track record now, and we can have specialist focusing on it and they can be just as effective.

OK, and then further on the commercial, then if overall level of business activity may have slowed, for all our participants have any of them --are your finding any meaningful level of price pressure promotion occurring.

I would say -- I think we have already spent candidly -- we have greatest price pressure in the commercial market place and, but it is nothing that is causing us at least right now to take any severe steps or do anything differently. We have gained so much momentum in the commercial market place in the last couple of years. Also in terms of the quantity and quality of distributors we have attracted. So it is very clear that we are the leader and we have a lot of momentum there, so we are finding pricing as big a challenge as you do, when you are -- you know number 3 or number4.

You still characterize the size of the market as staying about three times out of industrial.

Yes.

It is quite clearly as Janet is pointing out, there is more competition and that part of the cleaning business versus the industrial part of the business in North America

OK then

And I would say that is also one of the reasons why you will see a lot of our innovations is in that part of the market place, at least first, because that helps you avoid the price pressure.

OK and then, just within the industrial market, take some of the areas that might have been slow, might have included things like airports, but what -- your know whether it is airports or shopping centers or commercial buildings or accounts, are you seeing some more noticeable activity where you had not seen some in sometime.

That is a good way to put it, that is the kind of the word we are using as activity, we are seeing, not in any you know just single subset or single segment like industrial or like distribution centers, but all across the industrial market place. We are seeing uptake in what I would call activity customers calling saying you know that did -- I or that spec that I had you do for me, where I put it on hold, let us bring it out, let us talk about it again, so it is kind of a, it is really an increase in activity that is leading us to believe that you know we are very pleased with this first quarter of increased revenue from the industrial equipment.

OK good luck.

Thanks Bob. Maggie any other questions.

Next question come from Eric of Associates

Good morning

Hello, Eric.

Hello, Eric.

I tried to hit the buttons on my phone as FaST as I could, but Bob and Gary still beat me out, they covered half my questions. Number 1. I Just wanted to -- can you explain in a little bit more detail, the issue with the tax rate, you know the audit that you referred to, what exactly you know how that came about and why it turned out favorable just a little bit more detail on that.

Sure, it is outside of the United States and we have provided some tax reserves in the past for certain aspects of our tax filings. We were audited by the appropriate authority as you always are on a, you know on a periodic basis, and found that based on the settlements and the results of those audits that we did not need certain of those reserves so we reversed them as part of the tax rate for the current year.

OK, secondly just looking at your -- looking the balance sheet sequentially the increase in tables and in crude expenses can you comment on that?

Yes. Absolutely. The increase in payables and crude expenses, you may skip that in front of me, that is primarily timing, Eric. If I look at it from your end, it is essentially timing of payment, there isn't is not any other major factor influencing that.

But will we see some of that reverse in the forth quarter or some of that third quarter number, kind of?

Yes that is where if you think earnings are tough to predict, you should try to predict accounts payable.

Right.

That is a tough one, So I cannot answer that.

Just that, you know to get a handle on -- you know I mean that obviously bumped up your cash from ops for the quarter so just to be able to -- you know get a gauge or where that is going to come in for the year. I should fact on some of that reversing.

Perhaps yes, -- I am not in the position to forecast, where that will be at year-end, so I really cannot answer that.

OK, and on Capex, you said for the year, you are looking at 9 to $11 million.

Yes.

Two questions -- you know that is -- that is you know fairly below -- you know the trend you run historically so if you can just comment on that and related to that you know what you will be looking at in 2004 and beyond I mean is there going to be some pent-up spending you are going to need to do, what your expectations there

Sure, while first of all one of the reasons that the capital expenditures are down year over year. It is the fact that we now lease our vehicle fleet. So the sales and service forces in the past we had owned their vehicles that they drive the vans and the suburban as an example and we have gone through leasing those for a couple of reasons which I can certainly go into if you are interested and so now appears outside of the capital expenditure ground so that's part of the reason that was running three to five million on an annual basis in the capital expenditure lying in the past that's no longer there.

Another factor influencing reduced capital spending as just now we have got the SAP system installed globally as you probably know and still some of the spending we have had in the last couple of years there is no longer occurring and so now to next year, if at all this mean I would anticipate you level in that same neighborhood, however, next year we do have a reasonably sized project actually couple of them coming that's going to cause their capital expenditure number for next year to be higher than it was this year these two projects are one is a powder paint system, we are converting here in Minneapolis from solid base system to a powder system we are doing that for a couple of reasons one is higher quality paint secondly from an environment standpoint, we need to do that and so that will be incurred primarily this year and then other one is we are looking very seriously for our service force giving them hand-held for instance and automating them a bit from where they operate today and that would be another potential capital expenditure next year of an opportunity nature.

We think that would give us some improved efficiency with that group for those kinds of things I think would cause next year's capital spending to be higher than it was this year questionnaire . Maggi, are you still with us.

Yes you are just out of queue.

OK.

Our next question comes from Gregory of Lord Abbott.

Hi just with regard to the balance sheet, what is the deferred revenue, could you explain that what it was versus last year and what we should expect in that area.

Sir, our revenue was an insignificant part of that account available accrued expenses and that relates primarily in a few instance we sell products through a third party lesser and we are not for various reasons relating to that specific transaction, able to relieve recognized revenue, that revenue gets recognized over that lease term. The lease term being the term being the third party lesser and the end user. So, we collected the cash from the third party lesser immediately upon shipment. The lessor is collecting the cash over time and the economy will require us to correct or to rather record the revenue over that time frame. So it is not a big number, is not a big component in that line.

And that's a normal number and now it is 6 million is about what you normally experience

And the six million is a different item now because that we have deferred as we ended of last year about 6 million that because of our change in the terms of the contract with one of our third party last source one here in North America, because of the change in the terms of the that contract, we were able to in fact require to record all that immediately in the revenue and no longer defer it. So that happened in the first quarter of this year you might recall we retreated that as an unusual item. So that is not influencing the results in the third quarter.

Ok and with regard to the orders in the like you said you have basically two weeks of orders in revenue has that been declining would you say overtime and would you expect that to bottom kind of with the bottom of the economy and shrug along at the bottom when demand is week.

Yes. I would say the order backlog has not swung materially from that two-week time frame on average. No we say on average because for instance we have got Centurions in the order backlog and those have from an 8 to 12 week time frame if you ordered it on September 30 that will be in the backlog for eight to twelve weeks.

So on average it is about two weeks but they are truly arranged within the orders that are in that backlog. But I would say no, there is not, I think trend of a declining backlog or anything like that relative to the economy as that has been relatively constant, it has got a little bit of seasonality to it, but no material trends in that.

But the change in your operation would make it easier for you to get the products through. Correct.

Yes. There is still a two color balancing influence, just because you are absolutely right we have gone on the industrial manufacturing equipment to built to order which that actually causes us to have a bit of an increase to the back log if you will because now we are not building for inventory.

And then the other influence that would cause backlog to go up would be the Centurions as I mentioned which has a longer leap time. But other influences within the operations would cause that backlog a little bit shorter.

Do you have -- do you keep a specific list on the pipeline?

Yes. On the order pipeline?

Fine. In other words orders that are hanging out there -- you know, you watch those.

Yes. We do.

And monitor those every month.

Yes. We do.

OK. With regard to the she has done a lot of restructuring and getting manufacturing in line? What would you say the marginal profitability you know when we see an up turn is for your -- for the incremental dollar sales.

Yes. That is tough to put a number one. I think the restructuring first of all if you look to last years S&A line versus the prior year. I think you will see a decline of about $3 million in that. I think it is reflective of some of the action we had previously taken on the gross margin line and the leverage point. I think you are referring to and Janet also talked about earlier in the call, tough to put a number on that because that is gone to certainly we leverage and when our industrial business in particular picks up.

We expect to realize that leverage with improved gross margin but tough to put a number on that because that obviously is going to depend on the length, the duration of that recovery.

Yes. But if gross margins are a magnitude of 40%. And you have maintained those pretty well. Even with very very modest growth. In fact, perhaps a negative real growth. D&A is about 3 plus percentage of the total. So we ought to be talking something North of 30% for an incremental profit margin.

When you say 30% incremental.

Well on a dollar I mean your gross margin are 40%. You have got D&A of another 3% to 4% in that -- that is excluded from that gross margin I mean if you add those up and then you know -- with some -- there got to be some variable cost and you have some S&A etc. with may be commissions and stuff, I mean I would expect that the gross margin, I mean, the incremental margin on an incremental sale ought to be pretty hefty, I mean, what I am saying is perhaps North of 30%

I am not sure your point on D&A because certainly depreciation is an element of our gross margins, I am not quite sure.

So, you would add that back so it would be 33% or 34% -- 43% or 44% on top of that, that is not D&A in the cost of goods sold.

You are saying that, that does not go up incrementally.

Right.

I now understand your point. Yes, certainly we absolutely believe we got leverage in the gross margin, but I have just not prepared the data, for the number on that.

Is there any other fixed cost beside D&A in there, how much more would you say,

Within our manufacturing operation, yes, I mean, we have got like any plant you got fewer folks in the plant that are fixed cost or you know some call them overhead and so certainly we have got that in our plants as well.

OK and finally with regard to the cash on the balance sheet and it has been raising, is there any use intended for that expected.

Well, we continue with respect to our cash to seek opportunities that would enable us to get a return on investment that would exceed our cost or capital, so that is, we are continuing to seek opportunities to reinvest that cash in high-return opportunities.

And what are the alternatives there, besides acquisitions, any others.

Well, we talked early about the service force automation capital project, will be an example of a capital expenditure where we would be able to get improved efficiency from an investment of cash. Other examples will be new product development which of course ends up in the income statement initially as our re-expense but then once a product goes into production, now you have got tool laying and other costs that are of a capital nature that we think of as opportunity capital spending that have high-return.

So, those would be the types of internal or at least examples of internal opportunities to spend that cash.

And are acquisitions in the list too.

Yes.

OK and what is the cost of capital.

We consider it to be about 11%.

OK. I am sorry, I did not ask too many questions as Bob.

I am sure it is a competition.

OK. Thanks Greg. Maggie, any other questions operator: Our next question comes from Eric Abau of .

Hello, again guys.

Hi there. We lost you.

You lost me, just as you started your answer on Capex, so, I will not ask you to bore everyone else and repeat it, I will touch it basically afterwards.

OK.

I did have one another question. Can you just -- and I apologize if you covered this while I was off the call. Can you touch on just the progress of your third party logistics distribution arrangement, that you know the progress of that , I know you had some delays in getting that, you know, running at the speed you wanted to, what is the status there.

Well, if you know, some of the inventory improvement has come from getting your inventories down there, so, that was one of the very first step. But, we continue to make progress there, we continue to improve in terms of the quality metrics, which to us was the #1 thing we indicated. We were putting more money in order to improve the quality metrics and so we continue to improve the quality metrics there and then right when we were satisfied with this sustainability of that then obviously we are very interested in driving down the cost overall.

OK. So, would you consider you are in the, I mean, if you had estimate in the sixth inning or seventh inning on that or you are pretty far along before you need to be then, in terms of having it up and running in operational where you wanted it to be.

I see we are about half way there.

OK.

Which is that I think will be predictive.

OK. That is it for me. Thank you.

Janet Dolan. You are welcome.

Next question comes from Gary Giblen of C. L. King.

Hello, just a clarification is the FaST and commercial a separate factor from the, I mean that is not the municipal, but it has also relatively FaST commercial sales and likely be driving that, that in the general economy.

One of the biggest factors that I think is that we had the quarter-over-quarter comparison was tough, because we had two big orders last year that were in the base of the comparison, which we did not have this year. So, that is the big factor, so when you take those out, then I would say the second biggest is that we have a lot of demand and we have distributors who are very good at serving schools and other municipal facilities and this is obviously dampening the demands for their products. So they have now got to focus their energies on other markets.

And on that point about the large order as Janet mentioned earlier in the call that orders came in last year in the third quarter and shipped in last year's third and fourth quarters. So we will have a bit of that influence as well in our fourth quarter comparison this year.

OK, so, I mean this commercial x-municipal or x-outdoor or what is they, is that sequentially declining or sequentially fired at?

I do not have that number and I do not know. I can only enter that in intuitively and I do not believe.

We do not believe so.

It has gone

We are more focussed on the impact of the State and local and how to makeup for that by redirecting resources to other types of opportunities.

OK, and there were some distributors in Europe you were gaining, distributors from the other x-competitors taking distributors, I mean what is happening on that floor.

We actually took more distributors in North America from our two largest competitors and in Europe our real sales coverage opportunity is putting more sales reps and service reps. Our own organization expanding our own -- certainly have a dealer network there, but we, because more of the volume from the whole product line in Europe comes from large orders from building service contractors of large orders from, what we would think of is National Council or large retail facilities or whatever, what we really do is we expand our sales and service so we are better able to serve them and then we gain more volume by gaining more of those accounts that we have not been able to win before. So, it is just a little different market place in a little different goal to market strategy there.

OK. That is very helpful. Thanks very much.

You are welcome.

Maggi.

At this time, I see no further questions and like to turn the call back over to Mr. Brausen.

Actually, I think I would be the one Maggi who finishes up and I would like to thank you all for joining us and this does conclude our call and we look forward to reporting to you on our year-end 2003 performance next February.

Thanks much and good-bye.

Thank you very much.