Tennant Co (TNC) 2012 Q3 法說會逐字稿

Good morning and thank you for participating in Tennant Company's third-quarter 2012 earnings conference call. This call is being recorded. If you do not wish to participate you may disconnect at this time.

After the speakers' remarks there will be a question-and-answer session. (Operator Instructions) We ask that you remain on the line for closing remarks by management after the question-and-answer session.

Beginning today's meeting is Tom Paulson, Vice President and Chief Financial Officer for Tennant Company. Mr. Paulson, you may begin.

Good morning, everyone, and welcome to Tennant Company's third-quarter 2012 earnings conference call. I am Tom Paulson, Vice President, Chief Financial Officer of Tennant Company. With me on the call today are Chris Killingstad, Tennant's President and CEO; Pat O'Neill, our Treasurer; and Karen Durant, our Vice President and Controller.

Our agenda today is to review Tennant's performance during the 2012 third quarter and first nine months and our outlook for the remainder of 2012. First, Chris will brief you on our operations and then I will cover the financials. After that we will open up the call for your questions.

Before we begin, please be advised that our remarks this morning and our answers to questions may contain forward-looking statements regarding the Company's expectations of future performance. Such statements are subject to risks and uncertainties and our actual results may differ materially from those contained in the statements.

These risk and uncertainties are described in today's news release and the documents we file with the Securities and Exchange Commission. We encourage you to review those documents, particularly our Safe Harbor statement, for a description of the risks and uncertainties that may affect our results.

Additionally on this conference call, we will discuss non-GAAP measures that include or exclude special or nonrecurring items. For each non-GAAP measure we also provide the most directly comparable GAAP measure. There were special non-GAAP items in the 2011 second quarter and in the 2012 third quarter.

Our 2012 third-quarter earnings release also includes a reconciliation of full year 2011 non-GAAP diluted earnings per share to our 2011 GAAP diluted earnings per share. Our earnings release was issued this morning via Business Wire and is also posted on the Investors section of our website at TennantCo.com.

At this point I will turn the call over to Chris.

Thank you, Tom, and thanks to all of you for joining us this morning.

Back in July you may recall that we characterized the economic environment as challenging for our business, but we anticipated an improving economy in North America in the third quarter. However, after rising 4.7% in the 2012 first half Tennant sales in North America, our largest geography, declined 3.3% in the third quarter. We had expected to see an improving North American economy in the third quarter, but instead the sales cycle slowed and some customers delayed capital equipment purchases.

Tennant sales in the 2012 third quarter in our strategic accounts and distributor channels met our expectations. The shortfall was from lower sales of large industrial equipment through our direct channel and government business, which were both adversely impacted by economic uncertainty in the 2012 third quarter. The slowdown in these two areas led to the decline in Tennant's third-quarter sales in North America.

Despite this, we anticipate that our North America region will return to organic growth in the 2012 fourth quarter.

While we can't control the macroeconomic climate, we can continue to execute well and I am very pleased with our progress in this regard. We had many third-quarter accomplishments. Among the highlights, sales in China and Latin America remained robust, growing organically approximately 10% and 30%, respectively, in the 2012 third quarter.

Our strategic accounts business is a key revenue driver for Tennant and we continue to make good progress expanding our relationships with key customers around the world. Notably, we expanded our business with Sodexo to Europe.

Sodexo is a global leader in providing facilities services to a broad array of industries. Tennant already was an approved supplier for Sodexo in North America where they were an early supporter of ec-H20 technology. We are delighted that Sodexo has selected Tennant and our ec-H2O technology to help their customers throughout North America and now Europe.

Regarding ec-H20, sales of scrubbers equipped with ec-H20 technology positively benefited results in the 2012 third quarter growing approximately 9%. Importantly, the percentage of scrubbers sold with ec-H20 on board, which we call the attachment rate, rose again in all geographies in the 2012 third quarter. As you may already know, Tennant's ec-H20 technology converts water into an innovative cleaning solution that cleans effectively, saves money, improves safety, and reduces environmental impact compared to daily cleaning floor chemicals.

Sales of new products introduced in the last three years generated approximately 28% of equipment sales year-to-date. This is slightly lower than our goal of 30% and is primarily due to all of our 2008 and early 2009 ec-H20 equipped scrubber launches falling out of the calculation of new products. Being slightly under our goal of 30% is temporary as we are starting to execute against one of the most robust new product and technology pipelines in Tennant's history.

We anticipate launching 17 new products in the 2012 fourth quarter and an additional 25 in 2013. Just last week we showcased many of these new products at the cleaning industry's ISSA trade show. I will talk about a few of them.

We previewed our new T12 rider scrubber, which is the first new product in Tennant's redesigned modular large equipment portfolio. The T3 orbital scrubber provides a chemical free way to clean and strip floors. The B10 rider burnisher is our first rider burnisher offering. It enables rapid cleaning and polishing of large areas.

Another new introduction is IRIS, which stands for intelligent remote information system. IRIS remotely collects and transmits machine usage activity using machine-to-machine cellular technology. Knowing actual machine use improves service efficiency and reduces the risk of breakdowns by servicing machines and changing parts when needed, which helps maintain optimal machine performance.

In addition, we demonstrated a versatile line of new walk-behind sweepers that clean multiple surfaces in both indoor and outdoor environments, as well as a suite of commercial grade vacuums including lightweight backpack and dry canister models.

We also recently announced that we will feature the HydroLink battery watering system from Trojan Battery on a variety of Tennant's floor scrubbers and rider sweepers. The HydroLink design helps extend battery life on scrubbers and sweepers and reduces the frequency of battery replacement. These innovative, new, core equipment offerings are engineered to be durable, lowering operating costs, improve operator safety, and reduce environmental impact.

Turning to our sustainable water-based technologies, you will recall that the first product under our Orbio technologies brand is the Orbio 5000-Sc. It is a self-contained unit that creates, stores, and dispenses an effective, ready-to-use multipurpose cleaning solution that works with most existing cleaning equipment and methods. Introduced in 2010, the Orbio 5000-Sc uses split screen technology to automatically generate a cleaning solution that is always at the right dilution, so there is no more need to mix concentrated cleaning chemicals.

In the 2012 third quarter we continued the Orbio 5000-Sc rollout in North America, Europe, and Australia according to plan and we also began offering it as a capital purchase in addition to the rental model. During the quarter, the Orbio 5000-Sc also received the top honor for product innovation from the Australian Business Awards.

Our Orbio technology group continues to make progress on their product and technology roadmap. Currently under development for release in 2014 is an exciting new product with split-screen technology that will deliver an anti-microbial solution as well as an effective multi-surface cleaner for use on hard surface floors, carpet, and spray-and-wipe applications.

With our ongoing pursuit of innovative technologies, we are thrilled to welcome Tennant's newest Board member who brings extensive experience in helping multinational companies develop and commercialize disruptive technologies. Azita Arvani currently serves as Head of Partnering and Alliances at Nokia Siemens Networks where she leads strategic and global partnerships for their collaborative innovations. Azita has also served as Head of Innovation Strategy for Nokia Siemens where she defined the mission of its innovation center in Silicon Valley and the innovation team, developing and implementing strategies to commercialize innovations with a focus on rapid experimentation, partnerships, and fast time to market.

Previously, Azita founded Arvani Group Strategy Consulting where she worked in close collaboration with global companies around disruptive innovation in the mobile and wireless, multimedia, and technology markets. Prior to that she held senior positions at Xerox Corporation, including Director of Corporate Business Strategy both at Xerox's Palo Alto research center, known as PARC, and at company headquarters.

We look forward to benefiting from Azita's insights as we evolve our portfolio of Orbio water-based and other sustainable cleaning technologies. With the addition of Azita, Tennant now has 10 Board members, nine of whom are independent directors.

Moving on to our operational initiatives. As I have previously mentioned, we are doing everything in our control to increase Tennant's profitability. Given the current volatile economic environment, our continuing cost control, and process improvement efforts are now all the more timely and beneficial to our bottom-line performance.

As a result of Tennant's ongoing focus on operational excellence initiatives, the Company again produced higher gross margins in the quarter versus a year ago. We are pleased that the third-quarter gross margin rose to 43.5%, up from 42.9% in the prior-year quarter and above our targeted range of 42% to 43%. All geographies contributed to the improvement.

Tennant remains capable of attaining our ambitious long-term goal to reach a 12% operating profit in the fourth quarter of 2013, assuming that the global economy improves. However, as we have stated before, achieving this milestone requires a return to organic revenue growth in the mid to high single digits for the 2013 full year.

Tennant is in strong financial shape. At the 2012 third-quarter end the Company had $63 million in cash on the balance sheet. As announced earlier today, the Company's quarterly cash dividend is being raised to $0.18 per share, up 6% from $0.17 per share. This marks the 41st consecutive year that Tennant has increased the annual cash dividend payout, and we are pleased to be able to continue this long-standing record for our shareholders.

Moving forward, we remain focused on growing Tennant's revenues through continued market penetration with our sustainable cleaning technologies, including scrubbers equipped with ec-H20 and the Orbio 5000-Sc. Expanding our strategic account business with particular emphasis on global customers. Increasing our share in new or underserved markets through channel partners. The introduction of new products and ongoing penetration of emerging markets.

Tennant has industry-leading products and technologies and more in the pipeline. We believe our future remains bright and full of potential.

Now I will ask Tom to take you through Tennant's third-quarter financial results. Tom?

Thanks, Chris. In my comments today all references to earnings per share are on a fully diluted basis. Also please note, as I go through the results I will generally not comment on the year-to-date financials as those were detailed in the earnings release.

In reviewing our 2012 third-quarter results, I think it will be helpful to put them in context. As we recover from the recession throughout 2010 and the first half of 2011 Tennant had achieved on average organic sales growth of about 13% in each of those six quarters. We estimated at the beginning of the 2011 third quarter that we were back to pre-recession sales levels and we anticipated organic revenue growth going forward would return to our traditional range of mid to high single digits as we lapped those very high growth quarters.

That was the case in the second half of 2011 with organic sales growth of approximately 7.4% in the 2011 third quarter and 5.7% in the 2011 fourth quarter. The organic sales growth of approximately 1.6% in the 2012 first quarter was lower than anticipated, primarily due to order timing in the Americas as well as the impact from increased tightening of credit in Europe.

In the 2012 second quarter organic sales growth was approximately 2.6% with about 6.8% growth in the Americas, which more than offset the declines in EMEA and Asia Pacific. Now in the 2012 third quarter organic sales declined approximately 1.7% with Americas down about 0.7% and EMEA down about 5.5%. Sales in Asia Pacific grew organically by approximately 1.3%.

Based on the increased economic uncertainty in Europe and now also North America, we are lowering our 2012 full-year net sales to a range of $735 million to $745 million. This is expected to result in organic sales growth for the 2012 full year of about 0% to 2%, which is below our traditional range of mid to high single digits.

As Chris mentioned, sales of scrubbers equipped with our ec-H20 technology grew 9%, increasing from $34 million in the 2011 third quarter to $37 million in the 2012 third quarter. Sales in the first nine months of 2012 totaled $104 million, an increase of 3% compared to the prior year.

Due to the uncertain economic conditions and an unfavorable foreign exchange impact, primarily in Europe, full-year sales growth for scrubbers equipped with ec-H20 are now expected to be in the range of 2% to 5%. We remain very confident about the continued success of this innovative technology.

Turning now to a more detailed review of the 2012 third quarter, our sales are categorized into three geographic regions which are the Americas, which encompasses all of North America and Latin America; EMEA, which covers Europe, the Middle East, and Africa; and lastly, Asia Pacific, which includes China and other Asian markets, Japan, and Australia.

In the Americas 2012 third-quarter organic sales declined approximately 0.7%, excluding about 1.5% of unfavorable foreign currency impact. In North America, 2012 third-quarter organic sales declined approximately 3.3%. The decline in North America was primarily due to lower sales of industrial equipment through our direct sales channel and government business due to economic uncertainty.

The sales cycle slowed down and some of our customers delayed their capital equipment purchases. We had not anticipated this shift in buying patterns. Growth in sales through distribution and to strategic accounts was in line with our expectations.

Sales in the emerging market of Latin America remained robust with organic sales growth of approximately 30%.

In EMEA, organic sales were down about 5.5% excluding a large, unfavorable foreign currency impact of approximately 8.5%. EMEA's sales of indoor equipment were adversely affected by the European economic conditions and a continued tight credit environment that made it difficult for Tennant customers to obtain financing. We have continued to work diligently to identify additional leasing companies to help our customers secure third-party financing.

Third-quarter 2012 outdoor city cleaning equipment sales were also lower compared to the prior-year quarter. Sales of Green Machines did not offset the lack of Hofmans products that we continued in the second quarter of last year.

We had record sales of the Green Machines 500ze environmentally-friendly city cleaning sweeper in the first half of 2012 as we worked down the backlog of open orders. Sales of 500ze in the 2012 third quarter were on par with the prior year quarter; however, sales of other Green Machines products were lower due to decreased demand from municipalities.

We had two special items in EMEA in the 2012 third quarter. First, we had a $784,000 pretax gain on the sale of a business as Tennant transitioned to a master distributor business in the Central Eastern European Middle East and Africa markets. A number of Tennant employees also transitioned to the master distributor, which reduces our selling and back office infrastructure costs. We are confident this new go-to-market approach will enable us to grow more aggressively in these important markets.

Second, we recorded a $760,000 pretax restructuring charge to align workforce levels in our European factories with current production demand, thereby reducing wages and benefits by approximately $150,000 in the 2012 fourth quarter and $1 million for the 2013 full year.

In Tennant's Asia Pacific region organic sales were approximately 1.3%, excluding an unfavorable foreign currency impact of about 0.5%. Higher third-quarter 2012 sales in most markets were partially offset by lower sales in Japan. In the third quarter last year Japan had double-digit organic sales growth due primarily to increased demand to support cleanup efforts related to the earthquake and tsunami.

China is a key market for us. We achieved organic sales growth of approximately 15% in the 2012 first quarter, 30% in the 2012 second quarter, and 10% in the 2012 third quarter. We remain very positive about the future growth potential in this region.

Tennant's gross margin for the 2012 third quarter of 43.5% was up 60 basis points from 42.9% in the prior-year quarter. Gross margins improved in all geographies due to product mix, stable commodity costs, and production efficiencies. Despite the lower year-over-year sales level in the 2012 third quarter, Tennant was able to perform above the high end of our target gross margin range of 42% to 43%.

Research and development expense in the 2012 third quarter totaled $7.4 million versus $7.2 million in the prior-year quarter. R&D expense as a percent of sales was 4.1% in the third quarter of 2012 compared to 3.9% in the prior-year quarter. We are continuing to invest in our core business, most particularly in preparation for the early 2013 launch of the first new product in our redesigned modular large equipment portfolio.

Selling and administrative expense in the 2012 third quarter totaled $57.2 million or $56.4 million as adjusted, excluding the restructuring charge, compared to $57.3 million in the third quarter of last year. As a percent of sales, S&A was 32.1%, or 31.7% as adjusted in the third quarter compared to 30.6% in the same quarter last year. S&A spending, as adjusted, decreased 1.4% on a dollar basis but was up 110 basis points as a percent of sales due to lower sales volume.

We continue to invest in our process improvement projects during the 2012 third quarter. These initiatives are designed to standardize and simplify our global processes in the areas of pricing, invoicing and collections, and machine configuration. These efforts will help us build a scalable business model, reduce costs, and make it easier for our customers worldwide to do business with Tennant. We are continuing to tightly control our spending to improve operating efficiencies.

Our 2012 third-quarter operating profit totaled $13.8 million, or 7.7% of sales, compared to operating profit of $15.8 million, or 8.4% of sales, in the 2011 third quarter. Operating profit margin was affected by higher S&A expense as a percent of sales and increased R&D investments somewhat offset by improved gross margins.

Our goal is to reach a 12% operate profit margin in the 2013 fourth quarter. We believe that Tennant is capable of attaining this ambitious long-term goal by successfully executing our strategic priorities and assuming the global economy improves. However, as we previously stated, achieving this milestone requires a return to organic revenue growth in the mid to high single digits for the 2013 full year.

As we work towards this target, we are keenly focused on driving organic revenue growth in the mid to high single digits; holding fixed costs essentially flat in our manufacturing areas as volume rises; striving for zero net inflation at the gross profit line; and standardizing and simplifying processes globally to enable the building of a scalable business model while minimizing any increases in our operating expenses.

If the economy continues to adversely impact our ability to reach targeted organic revenue growth in the range of mid to high single digits, the achievement of our 12% operate profit margin goal will likely take a bit longer.

We have been successful in leveraging our existing workforce and have continued to hold our employee count to about 2,800. This number is essentially flat with when we completed the restructuring effort that began in the 2008 fourth quarter and is down about 10% from Tennant's pre-recession peak, yet we have been able to grow sales from $596 million in 2009 to a record $754 million in 2011.

We continue to successfully execute our tax strategies. The 2010 fourth-quarter restructuring and realignment of Tennant's international operations continues to provide commercial benefits and financial reporting efficiencies, as well as a more tax efficient capital and legal entity ownership structure. As anticipated, there is a positive impact to our 2012 tax rate as well as to our long-term expected tax rate.

Tennant's overall effective tax rate was 32.8% in the 2012 first nine months. The base tax rate, excluding special items and routine favorable discrete tax items was 32.7% which was in line with our targeted range of 31% to 33%. Note that the federal R&D tax credit has still not yet been re-enacted for 2012, so we are not allowed to include the favorable impact from that in our tax base.

Turning now to the balance sheet, again we are pleased with the Company's progress. Net receivables at the end of the 2012 third quarter were $124.1 million versus $128.8 million a year earlier. Quarterly average accounts receivable days outstanding were 63 days in the third quarter compared to 63 days in the 2011 third quarter.

Tennant's inventories at the end of the 2012 third quarter were 61 million versus $77.4 million a year earlier. Quarterly average FIFO days inventory on hand were 86 days for the 2012 third quarter compared to 92 days in the year-ago quarter. Capital expenditures of $11.1 million in the 2012 first nine months are higher than the $7.7 million in the 2011 first nine months due to planned investments in tooling related to new product development and process improvement projects.

Tennant's cash from operations was $43.3 million in the 2012 first nine months, an increase of 20.2% versus $36 million in the 2011 first nine months. Cash and cash equivalents totaled $62.7 million, an increase of $18.4 million compared to $44.3 million a year ago.

The Company's total debt of $33.6 million declined $3.3 million from $36.9 million a year ago. Our debt to capital ratio was 12.8% at the end of the 2012 third quarter versus 14.5% a year ago.

Regarding other aspects of our capital structure, Tennant is currently paying a quarterly dividend of $0.17 per share. We paid cash dividends of $12.9 million during 2011 and $9.5 million during the 2012 first nine months. Today we announced a 6% increase in our quarterly dividend to $0.18 per share. Reflecting our commitment to shareholder value, Tennant has increased our annual cash dividend payout for 41 consecutive years.

During 2011 we purchased approximately 469,000 shares at an average price of $37.51 per share for a total cash outlay of $17.6 million. During the first nine months of 2012 we purchased approximately 437,500 shares at an average price of $42.44 per share for a total cash outlay of $18.6 million.

In April 2012, our Board of Directors authorized the repurchase of an additional 1 million shares of our common stock. In total we now have approximately 1.3 million shares remaining under our repurchase agreement. As of September 30, 2012, we had about 18.6 million shares outstanding.

Moving now to our outlook. Based on the 2012 first nine months financial results and our forecast for the remainder of 2012, we are lowering our full-year sales and earnings guidance for 2012. We now anticipate net sales of $735 million to $745 million and estimate 2012 full-year earnings in the range of $2 to $2.15 per diluted share.

Previously we estimated 2012 full-year earnings in the range of $2.30 to $2.45 per diluted share on net sales of $770 million to $785 million. The lower net sales range reflects the ongoing economic uncertainty, primarily in Europe, and the lower than anticipated 2012 third quarter sales in North America. For the full year 2011, adjusted earnings per share were $1.95 on net sales of $754 million.

Our current 2012 full-year financial outlook includes the following expectations -- modest economic improvement in North America, continued uncertainty in Europe, and steady growth in emerging markets; unfavorable foreign currency impact on sales for the full year in the range of 2% to 3%; a gross margin above the targeted range of 42% to 43%; research and development expense of approximately 4% of sales; and capital expenditures in the range of $15 million to $17 million.

We anticipate a base tax rate, including any special items, in the range of 31% to 33% depending primarily upon the mix of full-year taxable earnings by country. While we do not provide detailed quarterly guidance, we do expect sales in the fourth quarter of 2012 to be sequentially higher than the third quarter of 2012. Further, we also anticipate improving our operating profit margin in the fourth quarter of 2012 compared to the fourth quarter of 2011.

Now we would like to open up the call to any questions.

(Operator Instructions) Andrew Gadlin, CJS Securities.

Good morning. Could you talk a little bit about the progression through the quarter by month what you saw in some of your key markets?

Sure, I will talk broadly. First, I would remind people, and we've talked about this in the past, that the third quarter is generally our toughest quarter to forecast in.

Reasons for that being is that summer has a big impact on our business in North America and August is a pretty tough quarter in Europe, as everyone is aware of. Therefore, the quarter really happens in September. That is the make or break month in our quarter, which is -- typically we don't have as much skewed to the last month in a quarter.

What we saw from a trend standpoint is we were a bit behind in July and August with where our expectations were, but not meaningfully, not at a meaningful level. What we did not see at all was the rebound that we would expect to see in September. And so it was a matter of we saw enough -- we saw some signs during the quarter; September did not come back with the way we expected and it was really substantially below our expectation, which was what drove the miss relative to expectations in the quarter.

But it is also important to note that all other parts of our business, other than our direct channel in North America and the [permanent] business in North America, exhibited the same trends that they had for the first half of the year. So this is really kind of an issue in one discrete part of our business, but unfortunately it's a fairly significant part of our business in our largest geography -- direct sales, large equipment, and our government business.

Got it. Can you talk a little bit about some of the pricing improvements you put in earlier this year? Have those stuck?

We have seen a pricing benefit so far this year of about 1.5% in total, and we did begin to see that pricing benefit weighing a little bit in Q3. Our pricing benefit in Q3 was more in the 0.5% range, which has brought our pricing benefit down a bit on a year-to-date basis. We still expect to end the full year at about 1.5% pricing benefit, which was at the lower end of what we would have hoped, but we did see a bit of weakening in the quarter.

Was that because of mix or pushback?

It was not mix driven.

Okay. Then you cited in your comments, as well as in the press release, kind of a slowdown of the purchasing process. Have you seen any pickup or has there been any slide from September into October? Have you seen any of that so far?

Yes, what I would comment there is we have seen improvement in our order patterns in October and so this really -- of particular note in North America, in the areas that we saw weakness we are now seeing order patterns that reflect an ability to have organic growth in the quarter. So there has been a difference and is one of the key reasons why we have some level of optimism about our ability to grow organically in the fourth quarter.

And how important is October to the fourth quarter?

We don't have the same kind of skew as we have in Q3, but I would also tell you that December is the most important month in the quarter. But it is still always encouraging to get off to a start that is very much in line with what you would expect, whereas I would say we trailed a little bit in the third quarter.

Okay, thanks. Just final question on the share buyback; it looks like you have slowed down a little bit in the quarter. Can you comment on that as well as what you think you will be doing going forward?

Part of it we are obviously always affected a bit by the level of low trading activity in our stock. It is tough to get back into the market. What we continue to -- are going to continue to look for buying opportunities as we look forward. So we expect to continue to use our buyback authorization to buy back shares and we will certainly expect to finish the year above where we ended last year, which we are modestly above so far.

Okay, thank you very much.

Scott Graham, Jefferies.

Good morning. So I just wanted to understand, we have a fourth-quarter implied guidance where it looks like kind of at the midpoint you are still expecting a year-over-year rise in earnings. Is that -- and if my math is wrong on that please tell me, but is that because you are expecting North American growth? Is that going to be the leader in this?

It is certainly -- it is our largest geography. It is the most important element in any of our financial forecasting and we do anticipate a return to organic growth in our guidance numbers.

At the lower end, I mean that is a different story. At the lower end you would see in the quarter that our organic declines -- we would have organic declines. We would also have reported declines also. At the higher end our organic growth is between 1% and 2% at the higher end and would drive modest fiscal year organic growth for the full year. But a return to growth in the quarter for North America is very important.

Okay. So then if we were -- let's assume we do edge out some organic growth in the fourth quarter, but it would still, I assume, be below what your target range is. As you head into 2013 are you guys contemplating anything to help you get to the 12% margin, even if it is pushed back a little bit? But do you need to contemplate anything else structurally on the cost side to get to that level of margin in, let's say, a prolonged weaker environment?

I will answer that a couple different ways, Scott. In order to get to that 12% by the fourth quarter the key thing that we would like to see is a return to organic growth for the full year in the 5% to 9% range. And that is what we are very focused against.

We certainly recognize that given the growth rates we are seeing today we can't count on that. We hope we see it. We hope our new products and all the other things that are working for in our business that allow us to return to that, but it is very economically dependent.

The area that we will continue to monitor is -- as well as the entire world, but with particular focus is Europe. We have gone through now four quarters of organic declines. We have taken some actions to right-size our factories and we will need to continue to evaluate if we need to take additional actions in that geography if we continue to see organic declines.

So it is something that -- it is just prudent. We have to monitor our business and you can't sustain organic declines over an extended period without taking some level of action to shore up profitability.

Right, right, okay. Thought so. Last question is this; you guys have an enormous new product pipeline and launches over the next four or five quarters here.

I was just kind of wondering if we are -- I understand that we are only a couple weeks into the fourth quarter, but any news you can give us on the sell-in of some of these new products, customer enthusiasm, maybe what you are seeing out there? Even if it is anecdotally from customers that are about to take shipments in the next two months would be helpful.

Scott, this is Chris. We don't start really introducing them till later in the fourth quarter, so the impact is really going to start in the first quarter of 2013.

Anecdotally, what I can tell you is that we just had our annual industry trade show in Chicago where we presented many of the new products. I think that the feedback we got was that we have many more new product launches than any of our competitors going into 2013. It is the most, especially our commercial customer base, has seen from us in a long, long time so there was a lot of excitement. So that bodes well, I think, for next year.

Also, remember that we had no new product launches this year and so that is going to be a big change.

So as we look into 2013 new products could be a significant driver of growth. We have some early signs that our strategic accounts business could be more robust next year than it was this year. Remember, this year we did not have very many new, big deals in strategic accounts which we did in 2011 and our hope is that we return to some more big deals. There are some prospects out there that we are working on right now.

So really what I think it comes down to is that we only really -- we succeed in strategic accounts and with our new products based on the strength of the underlying business, which is influenced by the economy. So if we have a modestly improving economy next year with strategic account growth and with new product growth, we could see a relatively decent year from a top-line growth perspective. But we just don't have visibility to that now.

Understood. That is all I had, thank you.

Joe Maxa, Dougherty & Company.

Thank you. Along the lines of the new product introductions, how should we be thinking about the operating expenses as you roll these out through the year?

We will continue us to create leverage in our operating expenses if we see revenue growth. Obviously the level of leverage is impacted by our growth rates, but if we return to what we would call normalized growth rates of 5% organic or higher, we will see meaningful expense leverage all through the year would be our expectations. But there is a growth dependence to it.

And remember that we have a philosophy at Tennant that all new products will have higher gross margins than the products they replace. And we should be able to achieve that, too, next year.

So if I look at your OpEx line, should we be looking at it relatively flat year over year assuming really no growth? And if we assume a 5% growth, how does that OpEx line grow from there?

Joe, I would say it is just too early to be speculating on operating expense levels for next year at this time. We are going to -- I wish we could give people some deeper prospective on next year, but we are really -- given the economic circumstances, we are going to have to wait till our typical time in February when we release earnings to give people a more solid sense of what we expect in 2013.

Okay. Wanted to talk a little bit about what you are seeing here in October. Are you seeing an improvement in the large industrial equipment sales as well as the government channel? Is this part of what you are seeing here in October?

Yes, let me comment first on the government channel. It is a bit of a strange one in that it's -- because of the end of the fiscal year in the government at the end of September, the third quarter is really a critical quarter. So I couldn't comment at all about whether the first quarter is having any change in what is going on in the government side. It is just we were surprised by the magnitude of what happened in the third quarter.

But we are seeing some improvement in our large equipment order patterns in October. Not just -- so that is part of why we are able to say that we feel that we have the ability to grow organically in the fourth quarter.

On the government side, Joe, it is important to note that the vast majority of our government sales hit in the third quarter. So the government sales in total is not all that material to our overall business, but it is very material to our third-quarter results because that is when it all comes. And it didn't materialize in accordance with our expectations this year.

I see. Okay, that is helpful. I wanted just a brief, maybe, update on the Orbio; what you are seeing out there in the market. I know there is a new competing product out there. Just give us some thoughts.

We are still not talking about unit placements yet for competitive reasons, so I think you can expect us to maybe come out with a report on that front early in 2013. But as we said, the roll out in North America, Europe, and Australia continues on plan. Customers who have been using the technology for at least six months absolutely love it and we have had no returns.

And you mentioned that a competitive product has been launched, it is the Hydris from Ecolab. We actually think this is a really good thing for us. It validates the technology.

Here you have a major cleaning chemicals supplier in our industry coming out with a technology that is similar to what we have. Our sense is that this is not something that they want to push aggressively; this is more of a defensive strategy on their part. While for us the technology is priority number one and we are pushing it aggressively.

But most importantly, I think it validates the technology and gets people to say if Ecolab is in this game too then Tennant must be on to something. I am a believer that any industry segment that is interesting will eventually attract multiple competitors and we are beginning to see that happen. But remember this is a huge market opportunity, very diverse market opportunity and there is room for both Tennant, Ecolab, and others to play very successfully.

Very good, that is all I had. Thank you.

[John Rosenberg], [Lawtham & Water Partners].

Good morning. Most of my questions actually were covered, but if you could expound a little bit on two things that I might have missed or that I likely missed.

Your confidence in this quarter, in fourth quarter for this year is based primarily on -- I am sorry, could you give me some color in terms of are you seeing that as -- were some sales pull off in September that have fallen into the fourth quarter? Is that your sense or do you just see another source of recovery in the fourth quarter?

A couple comments, I would also say we have given a pretty broad range for the quarter, so I'm not going to -- we have a confidence in our ability to grow organically. We also recognize that there is lots of things that we can't control.

I wouldn't say that we consciously saw orders shift between the month of September and October. I can't really get into the details of that. What we can say is our order patterns that we have seen -- and, again, we are not that -- we are getting close to being done with the month here, so we are relying on not a ton of data. But based in what we are seeing, the order patterns do reflect an ability to grow in the quarter relative to history.

Great. Additionally, just a little bit more color on some of these new product offerings.

Chris, you mentioned that you guys hadn't rolled out a new product this year and that you are very excited or that a lot of your customers, having seen these products, are very excited. As someone who is not in your industry, could you give me more of a sense of like how quickly are the adoption rates for these things?

Well, I think the adoption rates on the products we just talked about, because they are all part of our core equipment portfolio and it is not new technology, it is not new cleaning applications. These are new and improved products from Tennant and a couple of them we haven't ever had before in our portfolio, so they should be completely incremental.

So we have customers who buy scrubbers from Tennant but haven't been buying walk-behind sweepers and vacuums because we didn't have offerings in that category that met their needs. We now do. So we have the relationships with customers. They will then say, okay, these products are great; we are going to buy those from you as well.

Then you have the Orbio scrubber, which is the chemical-free cleaning and stripping machine, and the ride on burnisher, those are new to the portfolio. Those are actually very interesting and growing categories.

Our competitors have products in those markets so they actually have made some inroads into some of our customers where we still own the majority share because they were the only ones offering them. Now our customers will revert to us so that they have a one-stop shop supplier, which is Tennant, because we can fill those needs with equivalent or, in most cases, better products than what they have today.

Okay, I see. Thank you, that is very helpful. I understand it a little bit better now. Thanks.

Scott Graham, Jefferies.

Just one question about Europe. We are reading, like I am sure you guys are, the press that continues to come out from your large competitor over there. I don't what it is going to take to verify the technology more than what you have it seems.

I am just wondering, do you think that their press is hurting your business there? And if so, what further can you do about that? I am sure it is frustrating for you.

I don't think it is so frustrating anymore. Matter of fact, this has gone from a front burner issue for us to a back burner issue at this point. We see no impact on our business. We don't see our customers talking about it anymore, so I think that the press that is out there is actually being projected into a void from what we can tell.

There is still some court cases, especially the German court case that is pending, and hopefully that gets resolved here in the reasonable future. So we remain positive.

But the point is that our competitors have yet again, because if they were going to launch a new technology, a new product to compete with ec-H20 they would have done it at the ISSA tradeshow last week. They didn't. So all they have been able to do is to attack ec-H20 through the courts and other avenues, and so far unsuccessfully. So I think it is pretty much in our minds right now a nonissue, and as I said, we are not hearing anything from our competitors anymore.

Very good, thank you.

(Operator Instructions) Zahid Siddique, Gabelli Funds.

Good morning. Just a couple more follow-up type questions, one on the 12% margin goal by 2013. Should it really be independent of the macro, of the organic growth assumptions? Because I mean if you have those assumptions we might never get to that goal of 12%. Shouldn't it be 12% that is our goal?

I don't agree with that, Zahid, to be really straightforward about my response. It would be different if we didn't believe in our business model and our ability to grow under normal economical times. We firmly believe that in a more normal economic environment that we will grow very firmly within our 5% to 9% range. And, therefore, it is not the sole reason or not the sole way we create an operating margin at the 12% level.

But growth is important to us and we would not recommend running the business on a basis to hit a 12% target at the given time if we are not seeing the kind of growth we expect. So we are not going to just hit a target in the quarter for the sake of hitting a target. We still -- if we don't make it by the fourth quarter 2013, we firmly believe that we will see a return to normal growth and we will hit it in some relatively reasonable period of time after that.

But I would reiterate that if we do experience growth in range next year, we still believe we can hit the 12% by the fourth quarter. We just recognize that there is a heck of a lot of uncertainty out there.

Okay. The other question I have is on ec-H20. Did you say that you expect the sales to be up low single to mid single for the full year?

Yes, 2% to 5% for the full year. So we are disappointed in that on an absolute basis, but couple things going on. I mean, Europe is important to ec-H20 and we are seeing organic declines in Europe and ec-H20 is not growing organically in that market. But, overall, we firmly believe in the future of the business.

Exchange is affecting us right now too, but we do believe that we can see a significant growth into the future. We are a bit below our expectations this year, but we feel it is related to the economy.

Right, but we look at it -- we have the declining sales base. We tend to look at attachment rates because that tells you about the robustness of the technology. And the attachment rate, meaning the percent of scrubbers that have ec-H20 available on them that are sold with ec-H20, continues to increase across all of our geographies. I think that bodes extremely well for when we start to get some economic tailwind in our sales recovery.

Okay. And what percent of your portfolio, product portfolio actually has ec-H20 versus does not have ec-H20?

I will just comment directionally on that, Zahid. If you look at our equipment business, scrubbers are close to 60% of our equipment business now where that was more -- that has increased our scrubber business as a percent of our overall equipment. But we have never commented specifically on the number of scrubbers that we sell, what percent of those have ec-H20.

What I can say is there is 15 machines that we have openly stated that are in the market today that have ec-H20 on them, but we haven't talked about what percent of our portfolio that is.

Okay. Thank you so much.

We have no further questions. I turn the call back to the presenters for any closing remarks.

Thank you, Martina. We remain confident in Tennant's future. Our commitment to deliver enhanced growth and profitability is unchanged, although we are mindful that global economic conditions currently pose a challenge. We will continue to pursue growth, innovation in our core equipment business demonstrated by our upcoming launch of 42 new products in the 2012 fourth quarter and 2013 full year. And advancing our water-based technologies.

We remain focused on improving profitability through ongoing operational excellence, cost controls, and standardized global processes.

Thank you for your time today and for your questions. We look forward to updating you on our 2012 fourth-quarter results in February. Take care, everybody.

This concludes today's conference call. You may now disconnect.