Tennant Co (TNC) 2004 Q3 法說會逐字稿

Good morning, everyone. I'd like to introduce Ms. Janet Dolan, President and Chief Executive Officer of the Tennant Company. Ms. Dolan, you may begin.

Thank you very much. Good morning, everyone. I'm Janet Dolan. Welcome 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, and welcome also to all of you who are participating in the webcast of this call. Before we proceed, I'll ask 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. Such predictions are subject to risks and uncertainties, and our actual results may differ materially from those contained in the statement. 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 filed with the Securities and Exchange Commission. We encourage you to review those documents, particularly our Safe Harbor statement, for a description of risks and uncertainties. Our news release was issued this morning via PR Newswire, and is also posted in the investor section of our website, tennantco.com. The information required to be disclosed about non-GAAP measures discussed during this call is available in the news release, which includes a schedule that reconciles our 2004 third quarter and year-to-date GAAP results and our 2003 year-to-date GAAP results with the results, excluding the usual items. We believe presenting the non-GAAP measures in addition to the GAAP measures permits a more meaningful comparison of our operating results. Janet?

Tony will review our financial performance for the quarter in detail in a moment. To begin, I'll provide an overview of our results. You may recall hearing Federal Reserve Chairman Alan Greenspan talking about the economy hitting a soft patch this summer. That was certainly our experience at Tennant. As a result, the third quarter proved to be a challenging period for us. After strong order growth in our second quarter, activity slowed dramatically in July. For instance, we did not have any particularly large orders in the third quarter like those that had benefited our results in the previous two quarters. By the end of the quarter, however, we began to see real volume growth in most geographies.

The growth we experienced later in the quarter was not enough to fully offset higher costs in several areas, for example, steel costs, which had flattened for a while after spiking earlier this year, but then rose again earlier in this third quarter. In addition, we began to feel the impact of higher oil prices in increased costs for petroleum-based materials, including plastics and resins, rubber and tubing products, and chemicals. We have subsequently put in place another materials selling-price surcharge for North America. It will help us in the fourth quarter, but it was not in place in the third quarter.

In addition, while we've been anticipating higher costs related to Sarbanes-Oxley compliance, the cost for the year and in the third quarter will exceed our initial estimates. We understand from surveys and discussions with other companies that we are not alone. These costs, which include the related external audit costs, represent an ongoing additional burden for us as for all publicly held companies.

As in our second quarter, our expenses also grew because of an increase in accruals for performance-based incentives compensation. For example, our management performance-based plans are based on economic profit which, in addition to profits, also values improvements in cash flow and balance sheet items such as inventories and receivables. We've been making very good progress in these areas, which Tony will cover in his remarks. And the result is an increase in the accruals for our performance-based incentive compensation.

Finally, our third quarter S&A expenses also included higher marketing costs related to a number of new products that we are introducing in the second half of the year. I'll have more to say about these new products after Tony's update on the quarter. Overall, these marketing-related expenses represent investments in our strategy to evolve into a world-class marketer. Our aim is to consistently bring to our customers innovative solution for cleaning and maintenance requirements that capitalize on market knowledge and insight.

As you know, shortly after the close of the third quarter, we announced a workforce reduction that resulted in a 20-cent-per share charge to third quarter earnings. As we discussed in prior quarterly conference calls, one of our four key strategies is to leverage our cost structure. We took the workforce reduction action in the context of that ongoing effort to reduce our cost structure in order to improve our profitability, to invest in growth initiatives, and to have the flexibility to adapt to a more volatile environment for order volumes and material costs. In fact, the workforce reduction wasn't only about reducing head count. We are also reshaping our workforce to ensure that we have the positions and skills needed to support our growth initiatives. Therefore, while we actually eliminated a total of 93 positions, we intend to hire 29 new positions, resulting in a net 64 positions eliminated. The new hires we're looking for will have a different mix of talent, skills, expertise, and experience to serve our operational, marketing, sales and product development needs going forward.

I'll turn the call over to Tony now for a review of our third quarter results.

Thank you, Janet. For our 2004 third quarter, we reported net earnings of 11 cents per diluted share on net sales of $120.5 million. The quarter's results include an after-tax severance charge of $1.8 million, or 20 cents per share, related to the workforce reduction we announced October 8. Excluding this charge, our net earnings for the third quarter were 31 cents per diluted share, down about 14 percent, on a 9 percent increase in third quarter net sales. For the year to date, earnings were 80 cents per diluted share on net sales of $368.3 million. Excluding the charge, net earnings were 99 cents per diluted share. That compares to GAAP net earnings of $1 per share on net sales of $334 million in the comparable 2003 period.

As we have previously reported, our GAAP results for the 2003 year-to-date period included two unusual items from the 2003 first quarter. The first was the recognition of $6.4 million of previously deferred revenues resulting from the amendment of a contract which resulted in a benefit of 20 cents per share. The second was a charge of 14 cents per share related to the dissolution of a joint venture. Excluding the unusual items, the 2003 year-to-date EPS was 94 cents on $327.6 million net sales. The effect of these unusual items on our results are noted in separate columns on the earnings statement we included with our news release. Excluding the unusual items in both years, our net earnings per share for the first 9 months of 2004 increased 5 percent compared with the first 9 months of last year on net sales growth of about 12 percent.

The rest of my discussion of our earnings statement will be excluding the unusual items in all periods. With respect to these periods, I will be discussing the results in the earnings statement schedule in the column labeled "Excluding Unusual Items."

Beginning with consolidated net sales for the third quarter, they totaled $120.5 million. That's up 9.4 percent from the third quarter of last year. Favorable foreign currency effects and price increases, including a surcharge on certain products to offset increased steel costs, each added about 3 percent to net sales for the quarter, with contributions from the Walter-Broadley acquisition making up 2 percent. Other volume growth was about 1-1/2 percent. For the year to date, net sales increased 12.4 percent. Favorable foreign currency exchange and price increases added about 3 percent and 2 percent to net sales, respectively, for the year-to-date period. The Walter-Broadley acquisition added about another 2 percent, and other volume growth added the remaining 5-1/2 percent.

In North America, third quarter net sales increased 6.9 percent over the 2003 third quarter, to $83.7 million. Equipment, service, and after-market parts revenues all increased compared with last year's third quarter. Equipment volume benefited from some new products introduced this year, including a new line of commercial vacuums and new scrubbers equipped with our FaST technology. Net sales for the quarter also benefited from the steel surcharge mentioned previously. For the year-to-date, net sales in North America increased 8.3 percent compared with 2003.

In Europe, sales for this year's third quarter totaled $24.8 million; that's up 19.8 percent. Foreign currency change effects added approximately 10 percent to net sales for the quarter. The balance of the increase came from contributions from the Walter-Broadley acquisition. Excluding foreign exchange and the Walter-Broadley contribution, volume in Europe in the third quarter was about flat with last year's third quarter, as business conditions in Europe remain soft. For the year to date, sales in Europe totaled $82 million; that's up 29.3 percent from the comparable 2003 period. Foreign currency exchange effects added about 12 percent to net sales in Europe for the year to date. The acquisition added about 12 percent, while other volume growth added 5 percent, in part from a large order back in the first quarter.

In our other international markets, net sales for this year's third quarter increased 8.1 percent to $12 million. Favorable foreign currency exchange effects added about 5 percent to net sales, with volume growth in Japan and Latin America making up the majority of the remaining increase. For the year to date, sales to other international markets increased 9.1 percent to $36 million, with foreign currency accounting for about 7 percent of that increase.

Our gross profit margin for the third quarter was 39.3 percent compared with 40.1 percent in last year's third quarter. Almost all of the 80 basis point decline in gross margin is a result of the higher steel- and petroleum-related materials costs we encountered. As Janet mentioned, we have implemented an additional surcharge in North America now in the fourth quarter. For year to date, our gross profit margin was 39.8 percent; that's down 30 basis points from 40.1 percent in the 2003 period.

Our R&D spending in this year's third quarter totaled $4.3 million; that's up 5 percent from $4.1 million in last year's third quarter. The increase results from our investment in new product development and is consistent with our commitment to consistently invest in between 3 and 4 percent of net sales on R&D to solidify our position as an innovation leader in our industry.

Selling and administrative expenses for the third quarter totaled $38.7 million excluding the third quarter severance charge, compared to $34.6 million in last year's third quarter. About $1 million of the increase is the result of foreign current exchange effects, and most of the remaining increase results from higher costs for performance-based incentive compensation, increased marketing spending to support in-depth market research and new product launches, costs related to the Sarbanes-Oxley compliance, and expenses of the acquired Walter-Broadley business. Selling and administrative expenses were 32.1 percent of sales in the third quarter compared with 31.4 percent last year.

Our operating profit for this year's third quarter totaled $4.4 million, down 18.5 percent compared with $5.4 million in last year's third quarter. This decrease resulted from the higher materials, marketing, performance-based incentive, and Sarbanes-Oxley compliance costs previously noted. For the year to date, operating profit increased 8.6 percent, to $15.2 million.

The operating margin for this year's third quarter was 3.7 percent; that's down 120 basis points from 4.9 percent last year. This margin decline results from the higher costs we have been discussing. Year to date, our operating margin was 4.1 percent; that's down 20 basis points from 4.3 percent last year.

Our tax rate in the quarter was 32 percent compared with 37 percent in the year-ago period. The decline in the third quarter tax rate results from the resolution of various state and federal tax matters. For the full year, we expect our tax rate, excluding unusuals, will be between 39 and 40 percent.

The direct financial impact of foreign currency exchange, primarily the weakness of the US dollar compared with the Euro, Yen, and Canadian and Australian dollars, increased earnings per share by about 1 cent for the third quarter and about 19 cents for the year to date.

Turning to cash flows and the balance sheet, for the year-to-date net cash flows from operations totaled $29.8 million; that's up 27 percent from $23.4 million in 2003. Cash and equivalents at the end of the quarter totaled $23.9 million, up from $21.2 million a year ago despite the $9 million acquisition of Walter-Broadley earlier this year. Our inventories at quarter end totaled $55.6 million; that's up less than $1 million from year end despite some buildups to accommodate new products being introduced this quarter, higher sales volume, and the effect of the January 2004 acquisition. Compared with the end of last year's third quarter, inventories are down by about $200,000. Our inventory days on hand are down to 97 in the 2004 third quarter compared to 110 in the 2003 third quarter. We have been pleased with our ability to drive down inventory days on hand.

Net receivables at quarter end are down about $1.2 million from year end and up $5.4 million compared with the end of the 2003 third quarter. The increase resulted primarily from the higher sales volume this year. Accounts receivable days sales outstanding were down to 63 in the 2004 third quarter compared with 68 a year ago.

Our capital expenditures year to date total $14.7 million. For the full year, we expect capital spending to total between $18 and $21 million. Our debt-to-total-capital ratio at September 30, 2004, was 5 percent compared to 3.8 percent a year ago. And that concludes my overview of the quarter. I'll turn the call back to Janet now for her concluding comments.

Thanks, Tony. With the softer volumes and higher costs we encountered in the third quarter, we've lowered our expectations for the full year earnings per share to $1.35 to $1.50, as we have previously reported. That range includes the impact of the third quarter severance charge of 20 cents per share. Excluding that charge, our earnings per share expectations for the full year are $1.55 to $1.70, which represents the lower half of the range we provided earlier in the year.

While we are disappointed in our third quarter results, we remain decidedly optimistic about our outlook for the fourth quarter and into 2005. We continue to make solid progress on our four key strategies. We discussed those with you in our July conference call, but as a reminder, they include -- first, leading the industry with innovation. Second, extending our market coverage, with particular focus on the segment of the market we call "cleaning pros." Third, developing world-class marketing capabilities. And fourth, leveraging our cost structure.

Let me summarize our progress on these core strategies in the year to date, beginning with the last one. The workforce reduction action we announced earlier this month is a part of our ongoing work to leverage our cost structure. We expect that action to yield annualized cost savings of $2 to $3 million pre-tax in 2005, increasing to $4 to $5 million pre-tax in 2006 and beyond.

With respect to extending our market coverage, last quarter I talked about a realignment of our North American sales organization that is making us more agile in addressing our markets with a coordinated sales effort. In Europe, the Walter-Broadley acquisition extends our sales and service coverage in the United Kingdom considerably and strengthens our ability to serve large building service contractors and other customers for commercial cleaning equipment. Those of you who have been following us for a while know that we have also made some changes to the way we are organized in Europe to be more efficient about serving our customers there while also extending our reach in certain markets.

For the balance of my remarks today, I want to turn to our two other key strategies -- developing world-class marketing capabilities and being the industry's leading innovator. The introduction of our FaST technology last year provides a concrete example of how these two strategies interact to help to drive profitable growth for Tennant. With FaST, we translated marketing insight about what customers really need in certain cleaning environments -- namely an automated scrubbing system that leaves clean floors virtually dry to minimize risk of slip-and-fall accidents. We translated that into an industry-leading innovation, our foam-activated scrubbing technology.

We continue to extend FaST to new products. We recently introduced in Europe, and we will be launching next week in North America, the Tennant T-series of automatic scrubbers, incorporating our FaST tech. The T-series includes the T-3, a walk-behind scrubber offered in 17- and 20-inch models; and the T-7 Micro Rider, a riding scrubber compact enough to fit onto standard elevators. We are also extending FaST to a scrubber in our Noble plant, the Noble Speed Scrub Micro Rider, a riding scrubber offered in 26- and 32-inch models.

The process that produced our FaST system is repeatable. It's what world-class marketing organizations and industry innovators do over and over again. It's where we are taking Tennant. For instance, we are taking steps to become the industry leader in commercial carpet care. This effort encompasses the introduction of several new products and a new carpet-cleaning technology that we believe is as significant to carpet care as our FaST technology is to hard-surface floor maintenance. The new products include a line of upright commercial vacuum cleaners, including two models under the Tennant brand and one under the Noble brand. We followed up this product introduction with the launch of two new dual-purpose sweepers that can be used for cleaning both carpeted and hard-floor surfaces.

The centerpiece of our carpet-care offering is an innovation we call "Ready Space Technology." It's a breakthrough, because it solves the most daunting problem, cleaning through the space, when it comes to carpet maintenance. That is drying time. The innovation here is a system that removes the dirt that diminishes the carpet's appearance, luster, and life span. But it does it without spraying the carpet with water. (indiscernible) ReadySpace uses sprayer units to apply water to two counter-rotating fabric rollers that pick up the soil from the carpet. As the rollers turn, they are rinsed with a solution. A built-in vacuum extracts the soil from the rollers. Very little water ever reaches the carpet. As a result, cleaned areas are typically ready for use in 30 minutes. This is very important to customers in markets such as hospitality and retail, where carpet cleaning creates down time for carpeted space and therefore potential loss of revenue. Needless to say, we are very excited about the potential of this new technology, which we are currently offering on two machines -- one in the Tennant family and one under the Nobel brand. We announced our Ready Space offering in late August, so our results from the third quarter do not include any benefits from these new products.

We have aggressive goals for all of these new products. They reflect a new approach to product development at Tennant that is deeply rooted in understanding what our customers truly need and finding innovative means to satisfy those needs. Our experience with FaST demonstrates that our markets value innovation, value it highly enough to pay a premium for it, in fact. That is why being the industry's innovation leader is a core strategy for Tennant. It is also why we are complementing our focus on developing world-class marketing capability and innovative products with an equally diligent emphasis on leveraging our cost structure. We want to continue to have the ability to invest in our marketing capabilities, our R&D effort, and new product development to drive top-line growth and expand our margins.

To sum up, the third quarter was a challenging period as a result of weaker volume in July and the higher costs we encountered. But we are very confident about our prospects going forward. We've taken our costs down and will continue to work on leveraging our cost structure. We are now in the midst of one of the most concentrated periods of new product introductions in the company's history. We'll have more to say about how all these new products are performing when we report to you on fourth quarter and full-year results in February.

This concludes our prepared remarks, and we'll be happy to take your questions now.

[Operator instructions.] Our first question comes from Gary Giblen.

(Greetings) To what extent have you fully passed on the raw materials price increases, or to what extent have you had to absorb it, and how will that evolve?

Well, we have taken two price increases this year. As we said, the second one was October first, so of course it didn't help the third quarter. We had already incurred the expenses in the third quarter. But we have gauged our price increases to our best estimate of the ongoing cost expectations that we have. And now, of course, it's not only for steel, it's for oil as well.

So do you think that basically you can fully recover the materials increases?

Well, I'll tell you what our effort is, Gary, and of course it's never just one effort. First and foremost, we are continually working at improving and being as smart as we can about sourcing to start with -- consortiums and every other way we can to buy as smartly as we can. And then also we are, as we've already indicated, taking steps to reduce our cost structure to offset the increased costs. And then, we add the third arrow in our quiver, which is to pass on price increases, but it'll be a combination of all three.

Okay, I got it. And the-- is there a bulge of marketing expenses now because of the new products, and does that taper off or go away at a certain point?

Yes, and I think we've signaled that earlier in the year -- that we would be anticipating this; that we would have increased marketing expenses in the third quarter as we get ready for this very significant period of new product introductions in the fourth quarter. So yes, they will taper off. They were clearly in anticipation and preparation for Q4.

Janet, you know how Wall Street micromanages to the quarter, so what exact day and hour-- about what quarter do the expenses really taper off?

Certainly, Gary, they will taper off, as Janet mentioned. And we wouldn't expect to see the same kind of year-over-year cost increases coming from the product launch and marketing costs as we did in the third quarter.

Okay, I'll just do one more and get back in queue, but what are your major customers looking to-- I mean, there's no right answer to this, but what do people want to see before they order more robustly? Is it just the resolution of the election, or does it have to be a Bush victory, or is it oil prices coming down to a certain level? I mean, what are the signals that will cause customers to buy more freely?

Well, I think that is a question that calls to more of an art than a science, Gary. First of all, we have seen the recovery side; it started in September. So we had more of-- and I think other industrial companies are reporting the same. It was more of a slowdown or a stall in the summer, and I think nobody can predict with exact precision what caused it, but I think clearly we had a really strong first half of the year, and I think everybody thought the recovery was well on its way. And then suddenly, you had lot of headlines about escalating steel prices, and then you had a real increase in the violence in Iraq, and lots of other things that started to just make businesses and customers nervous that maybe there was going to be an undermining of the recovery. I think that was a temporary pause as people sort of wanted to wait and see, and I think we got beyond that because we certainly saw, in September, a return to the volumes that we'd seen earlier in the year.

And I would just add to that, Gary, that we've seen and talked about this in the past several quarters, and that is, our order levels have experienced more volatility in the last several quarters than they had prior to that. And we think that's being influenced by certainly a couple of major factors, one of which is, our customers are becoming larger, and the national account part through consolidation in the national accounts part of our business -- the large account part of our business -- continues to grow, we have the volatility of large orders. And I think that can be attributed to, in part, what Janet was just describing, which is lumpiness in the economy. We've seen that over the last couple of years for sure. We've seen some ups and some downs, and that up-and-down influence has continued this past year. Janet talked earlier-- you know, we had great second quarter and right away in July, things dropped off, and now they've rebounded, seemingly, again. So we've certainly seen lumpiness from the economy's perspective that we think's driving this. But also just the fact that timing of large orders can influence our results from one quarter to the next as well.

Okay, I understand. Okay, thanks.

Our next question come from Seaver Wang with Sidoti.

(technical difficulty) The chronic-based--

Can I interrupt you for just a minute? You cut off here; we didn't get the beginning of your question.

Oh, okay. Yeah, just an add-on to the last caller. Basically, a little bit more detail on the performance-based compensation. Does that have to do with the realignment in the sales force? And also on the Sarbanes-Oxley, I assume that would be kind of consistent going forward. Can you give me a little bit more detail on that?

Sure. Not, it's not a big influence coming from the alignment of the sales force. The biggest influence is in our management compensation program as well as our profit-sharing, which extends, for instance, to all North American employees. And the driver, as Janet talked about earlier in the call, the driver of that is economic profit for us, and economic profit includes not only revenue growth but margin expansion, cost reduction certainly as drivers, but it also includes cash flow drivers. And some of the success we've achieved that I talked about earlier in terms of reducing receivable days, reducing inventory days, and the influence that that's having on our cash flows and on our balance sheet. All of those things are factored into economic profit and of course, those latter ones I just mentioned don't necessarily improve earnings per share, yet they cause us to have an influence, I think appropriately so, on our incentive compensation and that is the main driver that's pushing up the accruals for performance-based compensation versus a year ago.

On your Sarbanes-Oxley question, absolutely. These are costs that aren't going to be one time and go away. These are significant costs that we're incurring this year as we required-- all companies that are public are required to comply with the Sarbanes-Oxley Section 404 certification of internal controls, which includes the auditor certification. So when we talk about Sarbanes-Oxley costs, from a compliance standpoint we're talking about our costs to document our system of internal controls in the way that it is required under those specific rules. And then to have our auditors audit the internal control system as well. And so those costs are significant. They're occurring this year for the first time, and they will be recurring in future years given the requirements of 404 as they now stand.

I also would like to add that we've spend the last couple of years really building a culture here in which our employees understand that we want to align our reward system with the way shareholders view the company, and that we're very pleased with the improvement in the use of capital. We've made the company much more cognizant about capital, capital charge, and the use of capital and how important it is to move and hit very aggressive targets on that. So we're very pleased with that.

Can you give a dollar amount, maybe, for the actual costs for the Sarbanes-Oxley compliance?

Yes. For the year, we're expecting that to be about $1 million, perhaps even a little bit higher, pre-tax. And in the quarter, it was about half that.

Okay, and one last question. You guys obviously spend a lot of capital on R&D, or investing in R&D. Do you guys have a goal as to how many introductions you want for new products every-- is it every couple of years? I mean, FaST was a few years ago; now you have ReadySpace. Is there kind of a goal for a new kind of technology in, say, 18 months or-- is there a time frame for that?

That's a good question. It's always intriguing how we set metrics for new products. We don't set a metric for a goal of so many per year, but what we do focus on, and what we are changing, is increasing the expectation that more and more of them will be truly innovative. And so, as you say, FaST was a couple of years ago. Now we have ReadySpace. We are expecting that there will be more of them that really are a breakthrough in that they really take an unmet need and create a new innovative solution to it. But a result of increasing our investment in R&D generally is that we also see, as we look forward, a bigger, faster pace of new products generally. I think that's kind of an output from the increased investment in R&D.

And just to add to that, for the baseball fans in the crowd -- we're probably all baseball fans after these two series that are now completed and ongoing. Janet's talking about the innovative new products, which are really the home runs, but not to leave out the singles, doubles, and triples, because we also have an ongoing-- part of our R&D effort fit into that category. The T-series that Janet talked about a short time ago would fit into that camp as well. So it's not just about the home runs, but it's also about the singles and doubles.

Our next question comes from Beth Willey (ph) with Woodward Partners.

I'd like to drill down a little bit more on the S&A expense line. The difference between this quarter and last quarter was, as I see it, like $4.1 million. Okay? I mean, this year and a year ago. Okay? Is that right? "Reported the usual excluding--" Yes, $38.7 versus $34.6, right? So it's $4.1. One million of that is foreign exchange, right?

That is correct.

Okay, so that leave you with $3.1 million. And half a million of that $3.1 million is Sarbanes-Oxley, right?

Yes.

Okay, so $2.6 million then is divided between additional marketing expenses on these new products and then internal comp. Is that right?

Sarbanes-Oxley would be the other one. Yes, you mentioned that.

Yes, Sarbanes Oxley.

And then, the fourth factor would be the Walter-Broadley acquisition, which added to the base of estimated costs as well.

So now, wait. I took out a half-million for Sarbanes-Oxley already.

Oh, I'm sorry. Then the other piece I think you didn't mention is the Walter-Broadley acquisition.

Okay. I guess what I'm trying to get at, Tony, is, how much of that $2.6 million are marketing expenses that are going to, as I understand it-- are they going to go away next quarter?

Yes, that was in the neighborhood of $300,000.

Okay, so $300,000. So then that leaves you with $2.3. and of that $2.3, then there's Walter-Broadley, and then there's the comp plan. Correct?

That's right.

Okay, so $2.3. And can you split that for us in terms of Walter-Broadley and then comps?

Well, Walter-Broadley is now an integrated acquisition, so that's a little bit tougher to do. And the comp piece certainly is a fairly sizable amount. And then, selling expenses would be part of that as well. If you think about it, revenues are up, and so you've got higher commission costs as well that would be a factor on a higher revenue basis. So those are the big pieces -- you've got them all.

Okay. So just so I can understand this -- so what we will see, then, hopefully next quarter, is these marketing expenses going away with these new products, and then we're going to start to see these new products hit the revenue line; correct?

Tony Brausen and Janet Dolan: Correct.

Okay. And I know you don't want to answer this question, but I'm going to ask it anyway. Are you willing to quantify how much in revenue you think these new products are going to generate?

Tony Brausen. No. And the reason we aren't, Beth, is, again, we just don't want to hand that information to our competitors. But we certainly, as Janet described, and with ReadySpace, that is an innovative new product and we have high hopes for its potential. And the other new products as well that she described, we certainly are very excited about them.

Okay. But they'll hopefully start to hit next quarter?

Yes, I believe they will in the fourth quarter.

Yes, they're starting now. Right now.

Right now. Okay. Then my last question has to do with revenue growth in North America. So revenues are up 6.9, and can you split that between what's volume and what's price?

In round numbers I can, Beth. We think that price was about half of that, and volume was the remainder.

Okay. And then, Europe was flat, right?

Europe was flat once you take out foreign exchange and the Walter-Broadley contribution.

Okay. And then, I just want to clarify one other thing. It's fair to say, then, that you have seen a pickup in business after kind of that spurt of not a lot of activity that Greenspan referred to?

Yes.

And is it back to the levels that it was at prior to that?

September was back to the level of second quarter.

Okay, terrific. That's really helpful.

You bet. And I'll get back to that, Beth, just recall the volatility comments we made earlier as well. One month does not necessarily a trend make, but at the same time, certainly the momentum has shifted back; yes.

Okay, that's very helpful. Thank you.

You're welcome.

Our next question comes from Gary Giblen with C. L. King and Associates.

I guess to elaborate on Beth's line of questioning. Would you expect in an average-case scenario, barring any extremes (ph), that sales growth in North America next year would be higher than the sales growth you'll achieve in '04?

I would say-- first of all, Gary, we're not yet ready to provide guidance for 2005; we're in the midst now of our operating planning process for 2005 and we will provide guidance when we report on the fourth quarter results. But I certainly think you've touched on the $64 million question, which is, what's the economy going to do in 2005? Certainly we can all build a case with respect to higher oil prices and potential disruption in Iraq and other things and could lead us to a more negative outcome and perhaps even a derailment to the economy. On the other hand, I've read reports that say the cost of oil at $50-plus a barrel is artificially high, and by the end of 2005, one analyst said, it should be back in the low $30s. So it all depends on which of those scenarios you believe, or perhaps something in the middle. But in any event, certainly that's going to be an influencer of our revenue growth next year, absolutely.

But secondly, as Janet has talked about, we're excited about the new products and despite, perhaps, say a derailment or potential derailment of the recovery, we still have some exciting, innovative products, ReadySpace being at the top of that list for now. And we've got high hopes for those for next year.

That's what I would add, Gary, is that next year we have a full-year effect from the new products that we're introducing fourth quarter. So we certainly are looking at strengthening our growth opportunities in North America and Europe all throughout 2005. In February, we'll be in a much better position to give you a report on how the first quarter of introducing these new products has turned out.

Okay. And a couple of follow-ups. Do you think your customers will care who wins the presidential election? I mean, does it make a big difference in their ordering pattern, or is it kind of a toss-up-- roughly speaking, a toss-up in their minds? I'm not asking you who you're voting for. [Laughter]

Well, I think that the most important thing for our customers is the same as is true for most voters. They want a strong economy; they want to see a strong, stable economy. That's the most important thing for them. So--

Okay. So go, Ralph Nader! Okay. [Laughter]

[Laughs] We're a swing state here, Gary, so one of the only places we're save from campaigning is in the office.

Okay. And how has productivity and morale been since the layoffs? I mean, I realize that you (indiscernible) people and there's a lot of offset, but how is it playing out?

Oh. Well, actually, a very thoughtful question. It's actually gone as well as I had hoped; and I would say it's gone very well. But I would say-- you know, we really planned this, and our goal in planning it was to create as little stress on the organization as possible and I think we have certainly accomplished that.

But part of it is, our whole organization is very well aware of our four strategies, and it's very clear that as we move more and more toward innovation and world-class marketing, we will be reshaping our organization somewhat. And they are all also well aware of our need to reduce our cost structure so we can invest more in innovation and in marketing. So I don't think the action came as a surprise, and that's always what is most helpful in reducing the organizational distress.

Also, Tennant is very generous and committed to helping displaced employees. So not only do we provide severance, but we also provide career counseling and help people get into new jobs. We also have a track record of helping displaced employees find new employment.

And then finally, I think times like this is when having a culture in which open communication as part of the culture really pays off. We have quarterly all-employee meetings -- I'll be leading them next week again. And so, you just have the opportunity to face any issues face to face, and that helps reduce any stress. So I'd say the organization has gone through it very well.

Have you made it clear to the organization that's there's no more cutbacks, layoffs -- I mean, barring another 9/11 or some unbelievable scenario? Or is that still a pending possibility?

Actually, we don't put it that way; we put it the other way, which is, it's very clear what our strategies are and what it's going to take to meet those strategies, and we will continually look for ways to effectively implement those strategies. So everybody needs to be very engaged in being part of the new team and very engaged in supporting the new strategy. So we put it in the positive, which is, "Develop your skills and make yourself very important to the execution of the whole transformation of Tennant."

Okay. And just a quickie. What would be the best thing to use for projecting the '05 tax rate? What kind of number are we looking at?

Yes, we talked about the full year this year in the 39 to 40 percent range, and I would assume it would be in that same neighborhood. Now, there is the pending tax legislation that impacts us with the foreign sales corporation benefit going away, and an additional deduction for manufacturers being phased in. And certainly it's a little bit early to try and predict the implications of that since it's not even been a passed law yet, but our early read on that is, in the short term, that could take the tax rate up a little bit because of the timing of the phasing, at least that we've seen in the early draft proposals of that. So that could have a little bit of a short-term impact on us in the tax rate of 2005.

Okay. Like, half a percent, or--?

Yes, I would say in the neighborhood of 1 to 2 percent. But again, it's early. And our expectation is that if that thing's passed as it is, it could perhaps increase our tax rate long term by up to 1 percent. But there's the phasing, and that's not completely clear. For instance, they'll phase out the foreign sales corporation benefit that we're now receiving, and the question becomes, will they phase in, and will it be a complete offset? And our early conclusion is, it's a net about 1 percent increase to our effective rate.

Okay. Will you accrue that starting from the beginning of the year and then just true it up in the end if you've over-accrued?

Yes, if the tax laws pass we would accrue it and be starting at the beginning of the year.

But if the law is still pending? I mean', you're just going to--?

Yes, if the law's still pending, we wouldn't be able to accrue that yet; we'd have to wait until the law's passed.

Okay, thank you very much. That does it for me.

You're welcome.

Our next question comes from Bob Sachett (ph) with Lord Abbett.

(Greetings) As far as the new products, could you in any way guesstimate how meaningful they might be to total sales next year on a percentage basis so we could have some sense as to what degree they're incremental and to what degree they may be cannibalizing existing products?

Well, certainly there is some cannibalization potentially. In the T-series we talked about, for instance, is a new scrubber product with FaST we have some cannibalization influence. So you're absolutely right, Bob. There is the potential for cannibalization, and we certainly have targets that are net of that for each and every product. But again, we hesitate to provide that information because we would be handing that to our friends who are not in the same position we are, generally speaking. They're not public in the US and they do listen to these conference calls. So we're very hesitant to do that.

Okay. Future picture question, then, to address some of the topical items here today. If you look back over the last two years, what you've really been doing is positioning the company to serve a wider marketplace, one that was traditionally solely in the industrial area and now addressing the commercial market as well. What do you think the size of the serve market is today versus what it was alone in the past?

Well, we estimate that the serve market that we target is about 5 billion, Bob. We actually sub-segment that into some meaningful areas for that. And the industrial, which is kind of a term for the big equipment used in industrial applications, but what we really call the large equipment, is about 800 million of that. The outdoors, about another 800 million of that. And then the rest is commercial. So you can see why big or small equipment, you could see that's why a greater opportunity for us.

Okay. That being said, then, what we're I guess looking at this year would be a sales level that would be approximately 10 to 15 percent higher than was achieved in the last peak in 2000. Does that suggest we're just still in the very early stages from a penetration standpoint of addressing the wider marketplace?

Yes. Well, we indicate that we have about a 10 percent share worldwide of the total market. So we have low penetration of the total market. Or, the reverse is, yes, we have great opportunity to grow.

Then, by implication, when do you view your share at in the industrial market?

It varies from market to market, but we are as high in the 40s and 50 percent share in certain of the product parts of the segment, and down more in 25 to 30 percent in the broader product lines like the walk-behind. As you can imagine from the history of the company, we have much stronger and bigger shares in that marketplace, but the marketplace itself is not growing, and it gets more difficult to gain share, the bigger share you get.

Understood. So that in the newer markets where you have lesser share today, do you feel you have largely addressed the product needs required to penetrate those markets? And are we at the point where it is principally, at the moment, anyhow, a distribution and marketing issue that's going to drive the degree of performance in the next few years?

It depends upon the market, Bob. I would say in North America in the last three years, we have focused significantly on expanding our market coverage. That is, reaching the customers. In Europe, we still have significant opportunity to continue to add market coverage there. In terms of the products, while many of us who are competing in the marketplace have a similar range of products -- so I think each of the major competitors feels like we have a good or adequate range of the products --- what we are focused on is getting out of the business where all of our products are alike and we're competing on price.

And we're getting into the segment of the marketplace where we create innovative new products that perform much better than what the old product used to. So for instance, FaST is a walk-behind and rider scrubber. Scrubber is traditional technology, but we did it totally differently, and therefore we gained share because customers want to buy a better mousetrap. It's the same way now with the ReadySpace. We have had carpet extraction before, but now we're creating a new way to clean much more frequently, and so it's a new product that's never been in that space before. The need has been there -- to clean the carpet -- but this product, taking it to a much higher, more innovative, level has not been there. So we still have many opportunities to create brand new products in the space. And we also have the need to gain more market coverage, more so in Europe and outside North America than in North America.

Okay. You've talked in the past about that your customers, especially as you get into some of the more commercial areas, are interested not just in having a clean workspace, but maintaining an acceptable environment, which also includes, I guess, in the health care area, minimizing issues relating to molds and other factors. Are you finding that that is beginning to take hold as a meaningful sales driver, and something that is significantly favoring the marketing position that you're in currently?

Yes. I'll tell you why. The way we are gaining that market is that we are really targeting a particular group of customers. They are cleaning pros, and often they are the experts who those institutions are relying on. Either they're internal staff or outsiders who would be contract cleaners. So we are finding that our strategy of wanting to work with them and create a range of products to meet those kinds of health and safety needs are resonating because they're the ones who are expected to provide that. So they're the ones who help us, through market insight, to figure out that there's a future for being able to guarantee how clean a facility is, there's a future in being able to give a certification of how clean; that there's a future in begin able to go off the floor and provide the same level of cleaning capability to other kinds of surfaces in those applications such as health care, hospitality, and others in which it's very important that they present to the public a clean and safe environment.

And do any of these products incorporate the sensor technology that you may have hoped to bring to the market that would actually help the provider to determine how clean the surface actually is?

That is a science that we expect to be incorporating into products going forward. I will tell you, like many, we already are looking at sort of the GPS sort of e-intelligence in the product. But we also are looking at-- and that's part of why we're bringing some new talent into the company. When you go into R&D, you go into areas like electronics and sensors. That is an opportunity going forward, is to make better and smarter products, not only that work better and more efficiently on their own, but give a lot of data back to the customer on what they're getting for their cleaning process. It may be measuring certain materials in the water or the air; it may be other ways in which the sensor feeds back information. So information becomes as important a part of the solution as the cleaning process.

Okay. The other part of the income picture, besides the discussion regarding sales and the markets served, is on the operating margin side. You have a different mix of products than you clearly once did. You were able to generate, almost consistently, operating margins close to the mid-teens. We're in the mid-single digits right now. Can you talk about, first of all, what you might think ought to be normal going forward with your mix of products? And what are the remaining issues that ought to close that gap between where you are now and where you ought to be?

I can tell you what some of the remaining issues are. In that bigger market called "commercial," there are more competitors. And so we have more price competition on the products than we have had in the industrial, where we have our large equipment. So first and foremost is the opportunity to get our large equipment sales back. That is, getting the continual recovery of the percentage of our sales that come from the larger equipment as we get a stronger and stronger recovery here. But the second is, then, to create innovative products that carry a higher margin, even though they're in commercial applications. And then the third is to continue to take down our cost structure. We are building a culture here at Tennant around lean enterprise, similar to what we did in the quality movement, which is to really build a culture around that so that we can continually drive down our costs.

Well, on the cost structure -- is it more in the manufacturing area at this stage, or is it more on the marketing and administrative?

Well, it is both. And obviously, as a manufacturer-- and it isn't on what I'm calling the operations side. When you're really looking at how orders are entered, you're looking at how you package your products, you're looking at the size of the orders, you're looking at the manufacturing processes, you're looking at your sourcing. So there's a great deal of opportunity on the operating side. But also, a big expense for us is our sales. And service component is a huge part of our success, but it's also a big cost driver. So we will bring the same concept of tearing-down the processes, looking at them, and finding more efficient ways to do the same thing. We'll bring it to that side of the cost structure as well.

I know you have the economic value-add as an incentive, but is there a supportive normal margin that is a meaningful target that the employees are focused on as well?

I'll take that one, Bob. Certainly, as Janet mentioned, we're absolutely relentlessly pursuing opportunities to reduce our cost structure and ultimately that would improve the operating margin. But you're pointing out, correctly, our overall objectives are called EPR -- we call it "economic profit and return on capital" -- which we feel are important to shareholders, and you tell me if we're wrong about that. And those are not necessarily operating-margin dependent. So I'll give you an example. If we've got the opportunity to significantly grow our economic profit with business that would have a 7 percent operating margin, even though once peaked at 9-1/2 percent, if that has a high return on capital, we should and would pursue that opportunity. So again, our objectives are not necessarily operating margin-dependent, although we will tell you, we have not taken our eye off the fact that we once had a 9-1/2 percent operating margin. But I would just reemphasize that it is about economic profit, growth, and return on capital, and those are not always operating margin-dependent.

And the fact, though, that you had those margins, or you once did, and even adjusting for the fact that the commercial world has more competitors, does that still suggest by implication you're not getting paid enough for differentiated products?

Well, I'd like to perhaps-- it's harder to get paid for undifferentiated. That is, there's too much, perhaps too many competitors and too much me-too products. And so, our real strength is in creating more truly differentiated products. And we find that we do get paid for differentiated products. As we've introduced newer, more differentiated, products, we can command the margins on those that we want to in order to build our operating margins.

Okay, and two last questions. One is now on the supplies and chemicals sales. With these newer products, should that be a higher proportion of your sales mix? Do you drive more of those sales per product dollar on a going-forward basis?

Yes. For instance, in FaST, we actually developed our own chemicals. And so in that case we were able to. It is a factor, I will tell you, we look at when we design new products -- what will be the downstream impact for consumables for the product?

So the dollars-per-product sales from a supply standpoint should increase and I imagine, or I would hope, that they're higher-margin dollars?

Yes. The answer to both those questions is yes.

Okay. And then, in regards to Europe, can you just elaborate a little bit further on what you feel still needs to be done and where the greatest opportunity is in light of the facts-- some of the comments you've had in the past that markets like Germany have kind of viewed yourself as a nonlocal brand, where in some of the other markets you're viewed locally? As well as some of the outsourcing you were doing in Eastern Europe?

Yes. Well, let me address Europe and say, as you say, what more needs to be done. First of all, I'm very glad to report that a lot of the internal heavy lifting that we had to do is behind us. So that is terrific in terms of creating an integrated pan-European operation. What lies ahead now-- we are a smaller player there than we are here. And so what lies ahead is having products that put you at the table, particularly with building service contractors, who are a bigger and more significant part of the market there. And with large customers. And these two new products that we are introducing, our T-3 and our T-7, were in fact designed for the European market. So this has been a very important part of our growth and European strategy, to get products really designed for the market. And I think, being candid, that is an important part of doing business in other markets, is being sensitive to the differences between products. And so this is a very important building block of that.

Also, it is getting more sales and service coverage. We are building our direct sales and our direct service organization there, but we do not yet have the concentration of coverage that we have here in the United States, even though they have an economy as big as ours. And we know over time, that's been part of our relentless growth in the United States. So those two things -- having products that really are designed for Europe and can get you at the table. And then the second is sales and service coverage so you can provide the after care for the customers so that you can win the big orders because you've got enough concentration of service to support them.

So it sounds, then, just based on those comments, you would expect a sales lift in Europe that ought to be at least as good as it is here, if you're going to be introducing products that will allow you to compete in, say, a more level playing-field basis than you've had heretofore?

We are looking for lift coming in Europe from the new products. We would like to see a strengthening of the European economies to match what we have seen here in the United States. So far, the economies seem to have lagged the recovery here in the United States. That would help significantly.

In Europe, will the products be exported or locally manufactured?

Janet Dolan; Locally manufactured. We certainly do export some products, but these two new products will be built in Europe. And of course, that adds significantly to our ability to have quick turnaround and otherwise better serve our European customers.

Thanks. Good luck.

Thank you, Bob.

At this time, I'm showing no further questions.

Okay. Well, thank you all for calling in today. That concludes our call. We look forward to speaking with you in February, when we report to you our fourth quarter results. Take care.