Tennant Co (TNC) 2013 Q4 法說會逐字稿

Good morning. At this time I would like to welcome everyone to the Tennant Company's fourth quarter and full year earnings conference call.

This call is being recorded.

(Operator Instructions)

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

Thanks. Good morning everyone and welcome to Tennant Company's fourth quarter 2013 earnings conference call.

I'm Tom Paulson, Senior Vice President and Chief Financial Officer at 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 2013 fourth quarter and full year, and our outlook for 2014. First, Chris will brief you on operations and then I'll cover the financials. After that we'll 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 risks and uncertainties are described in today's news release and the documents we file with the Securities and Exchange Commission. We encourage you to review those documents, particularly our Safe Harbor statement for a description of the 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 non-recurring items. For each non-GAAP measure, we'll also provide the most directly comparable GAAP measure. There were special non-GAAP items in third and fourth quarter of 2012, and the first and fourth quarters of 2013. Our 2013 fourth-quarter earnings release includes a reconciliation of these non-GAAP measures to our GAAP results for the fourth quarter and full year. Our earnings release was issued this morning via business wire and is also posted on the investor section of our website at www.tennantco.com.

At this point I'll turn the call over to Chris.

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

Today I'd like to briefly review our performance and then tell you about our strategic plans going forward. Tom will give you greater detail on our financial results for the quarter and full year.

First let's take a look at Tennant's fourth quarter. The company had solid top-line revenue growth. Our 2013 fourth quarter consolidated net sales of $195.1 million rose 5% organically, compared to the prior year quarter, on higher volume across all of Tennant's product categories.

Contributing to sales was demand for new products, especially the T12 Rider Scrubber, which is the first new product in our redesigned modular large equipment portfolio. It has been a great success for us. We also saw strong sales of industrial equipment, as well as sales to strategic accounts. Additionally, sales of scrubbers equipped with ec-H2O technology rose in the fourth quarter to post their strongest quarterly gains for the year.

We had record sales for our fourth quarter, although they were slightly below our expectations. This impacted our bottom line as we intentionally ramped up key strategic investments during the quarter in order to accelerate long term growth. We were simply not able to pull back spending in time to pace with the lower sales level in the quarter. Going forward we expect our growth initiatives to produce clear benefits in 2014 and beyond. I'll say more about our strategic plans in a moment.

Turning to a few fourth quarter highlights across our geographic regions, contributing to Tennant's revenue in the Americas were sales of industrial products, sales through distribution and continued strong growth in Latin America. As I mentioned last quarter, we are building on our momentum with strategic accounts by duplicating in Brazil the approach that's been successful in North America.

Sales in Europe, the Middle East and Africa, or EMEA, continue to be somewhat constrained due to challenging economic conditions. Despite this, sales to strategic accounts increased in the quarter by 18% and grew 12% for the full year. Further sales of our environmentally friendly Green Machines outdoor sweepers were up for the first time since the 2012 first quarter.

Along with the steady stream of new products we're introducing, we have made significant progress over the last two years in right sizing our EMEA cost structure, and improving our sales and service organization. We believe we are well positioned to take advantage of growth opportunities as the macro environment continues to improve in EMEA.

In the Asia Pacific region organic sales increased due to strong performance in China, which posted about 45% organic sales growth. During the quarter we began manufacturing our first industrial product in China, the T12 Rider Scrubber. We also made further progress on our initiative to expand into the western part of that country, where we expect to open a sales office within the next six months.

Additionally, we plan to roll out our successful North American strategic accounts structure and strategy in China this year. We are confident about our continued growth prospects and expect double-digit sales growth again in China in 2014.

Now for a deeper look at our new products. We continue to execute against one of the most robust new product and technology pipelines in the Company's history. As you know, innovative products and technologies are a significant driver of Tennant's revenues.

To illustrate our new product ramp, in 2012 Tennant introduced 17 new products. In 2013 we launched 20. In the 2013 fourth quarter specifically, Tennant introduced a new canister carpet extractor and grout cleaners with high heat functionality. And Tennant is on track to roll out more than 63 additional new industrial and commercial products by 2016.

In 2014, we plan to launch 16 new products. These include a new line of walk-behind burnishers in the 2014 first quarter, as well as the second product in our redesigned modular large equipment portfolio in our second quarter. The majority of Tennant's new products will be manufactured on modular equipment platforms. Modularity allows us to offer a wider range of possible machine features more efficiently and cost effectively.

To demonstrate the growing momentum of new product sales as we complete our launches and demand accelerates, sales of new product unveiled in late 2012 and 2013 rose steadily from 2% of total equipment sales in the 2013 first quarter, to 8% in the fourth quarter. In addition, our Orbio Technologies Group is developing an exciting new product with Split Stream Technology that will deliver antimicrobial solution, as well as an effective multi-surface cleaner, for use in a wide variety of customer segments. We expect to introduce this new Orbio product in the first half of 2014.

Now, I'd like tell you about our strategic growth plans. As you saw in today's news release, we are shifting our focus to growth with a goal of reaching $1 billion in revenue by 2017. Why growth?

Over the past five years we have built a scalable business model capable of delivering improved efficiency and profitability. To take full advantage of that effort, we are shifting our focus to organic revenue growth in order to increase market share and enhance Tennant's ability to reach a 12% or above operating profit margin.

We have many existing growth levers. Additionally, through a deep analysis of our markets we have identified and validated exciting ways to expand our global market coverage and win over new customers. As a result, we see significant opportunities to grow in key existing global vertical markets, such as the industrial, retail, education, and healthcare sectors where Tennant's value proposition is a strong one.

Why now? Tennant has the right people, strategies and business model in place to take on an ambitious revenue target. The marketing investments that we've made over the last four years are paying off, especially in the area of analytics. We can now identify by geography, vertical market and customer, where we are well represented, underrepresented, and not represented at all.

This allows us to better and cost effectively target our customer acquisition investments, add sales, service, and channel resources against the biggest opportunities, and arm our sales group with detailed information about active opportunities in order to maximize their effectiveness and boost sales. We began ramping up some of these investments in the 2013 second half.

Why target a billion dollars in revenues? This goal is a significant and compelling milestone, and our modeling shows that it's achievable. We plan to meet this goal through strong and sustained new product growth in our core business and in the Orbio Technologies Group, continued significant sales gains in emerging markets, growth in Europe, ongoing focus on strategic accounts, and an enhanced go-to-market strategy designed to meaningfully expand Tennant's global market coverage and customer base.

Our plan to reach $1 billion revenue goal by 2017 includes an assumption of approximately 2% global GDP growth. We anticipate Tennant's targeted 7% compounded annual growth rate to be broken down approximately as follows. Up to 3% from new products, including Orbio. Up to 3% from our enhanced go-to-market strategy, including Europe and strategic accounts. And up to 2% from emerging markets.

Why 2017? We continue to operate in an uncertain economic environment and we recognize that it takes time to ramp our go-to-market initiatives. We will carefully monitor our progress and seek to accelerate our timeline wherever possible.

We are excited about our prospects in 2014 and beyond, as we work to reach our $1 billion revenue growth goal. We will continue to manage our business with a focus on operational excellence and strong cost controls, while investing in direct sales, distribution, and marketing capabilities. And maintaining a strong pipeline of new products in order to deliver long-term growth and improve profitability.

Now I'll ask Tom to take you through Tennant's fourth quarter financial results. Tom.

Thanks Chris.

In my comments today all references that the earnings per share are on a fully diluted basis.

For the fourth quarter ended December 31, 2013, Tennant reported net sales of $195.1 million compared to $187.5 million in the prior year quarter. Organic sales grew approximately 5.1% excluding an unfavorable foreign currency exchange impact of about 1%. As you may recall Tennant's organic sales grew approximately 6.8% in the 2013 third quarter, excluding an unfavorable foreign currency exchange impact of about 1%. We are encouraged by the solid level of organic sales growth in these last two quarters.

For the 2013 full year, Tennant reported net sales of $752 million compared to $739 million in the prior year. Organic sales grew approximately 2.8% excluding an unfavorable foreign currency exchange impact of about 1%. Fourth quarter 2000 (sic - see press release "2013") net earnings as adjusted were $12.2 million, or $0.65 per share. These numbers exclude the restructuring charge of $1.6 million pretax, or $0.10 per share.

In the year-ago quarter, Tennant reported adjusted net earnings of $11.8 million or $0.62 per share. For the 2013 full year net earnings as adjusted were $42.6 million, up 7.3% compared to net earnings as adjusted of $39.7 million in the prior year. 2013 earnings per share as adjusted were $2.26, up 8.7% compared to earnings per share as adjusted of $2.08 in 2012.

Turning now to a more detailed review of the 2013 fourth 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 2013 fourth quarter, organic sales increased approximately 5.6% excluding about 1% of unfavorable foreign currency impact. Record sales for fourth quarter North America were due to strong sales of industrial sweepers, continued high demand for new products, and sales of scrubbers equipped with ec-H2O technology.

Sales in the emerging market of Latin America remained robust with organic sales growth of approximately 20%. In EMEA, organic sales were down about 3.2% excluding a favorable foreign currency impact of approximately 3.5%. Although EMEA sales in the 2013 fourth quarter continue to be somewhat constrained due to challenging economic conditions, sales to strategic accounts increased in the quarter, as did sales of our (technical difficulty) sweepers. As you may recall, we recorded a $1.4 million restructuring charge in the 2013 first quarter that was primarily focused on reducing the size of our European sales and service organization.

We also recorded a $1.6 million restructuring charge in the 2013 fourth quarter to right size our cost structure and enhance our go-to-market approach primarily in Europe. Going forward we anticipate the EMEA sales growth and profit margins will improve as a result of process improvement projects as well as benefits from the restructuring.

In Tennant's Asia Pacific region, organic sales grew approximately 15.1% excluding an unfavorable foreign currency impact of about 6.5%. Organic sales grew for the third consecutive quarter in this region. Growth in the 2013 fourth quarter was due primarily to strong sales performance in China, which had organic sales growth of approximately 45%.

Tennant's gross margin for the 2013 fourth quarter was 42.9% compared to an exceptionally high gross margin of 44.5% in the prior year quarter. Gross margin in the 2013 fourth quarter was adversely affected by selling channel mix with strong sales through distribution, and sales to strategic accounts and also product mix. Sales through distribution and strategic accounts tend to have slightly lower gross margins which are typically more than offset by the lower cost of a more efficient selling process. The 2013 full year gross margin of 43.3% was within our target range of 43% to 44%.

Research and development expense in the 2013 fourth quarter totaled $7.2 million or 3.7% of sales compared to $7.7 million or 4.1% of sales in the prior year quarter. We continue to invest in both our core business and Orbio, which is focused on advancing platform of chemical free and other sustainable water-based cleaning technologies.

Selling and administrative expense as adjusted in 2013 fourth quarter totaled $57.3 million or 29.4% of sales. This compares to S&A in the fourth quarter of last year of $56.8 million or 30.3% of sales. S&A expense was down 90 basis points as percent of sales due to continued operating leverage efficiencies.

As Chris mentioned, to accelerate future growth we're making strategic investments in this area that include additional direct sales, distribution and marketing capabilities. Absent these investments, we would have achieved even greater operating leverage in the 2013 fourth quarter.

Our 2013 fourth quarter operating profit as adjusted totaled $19.2 million or 9.9% of sales compared to 2012 fourth quarter operating profit of $19 million, or 10.1% of sales. Improved S&A leverage and lower R&D spending in the 2013 fourth quarter was offset by lower gross margins due to selling channel and product mix.

We remain committed to our goal of a 12% operating profit margin by successfully executing our strategic priorities and assuming the global economy improves. However, as we've previously stated, achieving this milestone requires a return to organic revenue growth in the mid- to high-single digits.

As we work towards this target we are keenly focused on driving organic revenue growth in 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 lin; and standardizing and simplifying processes globally to improve the scalability of our business model while minimizing any increases in our operating expenses.

Thus far we have made significant process in building a scalable business model capable of delivering improved operational efficiency and profitability. We are now placing a renewed focus on accelerating organic revenue growth. We are encouraged that we achieved our target organic revenue growth in the range of mid- to high-single digits in both the third and fourth quarters of 2013. These past two quarters represented the highest organic sales growth achieved in two years.

We continue to successfully execute our tax strategies. Tennant's overall effective tax rate for the 2013 full year was 32.8%. This includes the $0.6 million tax benefit related to the 2012 R&D tax credit recorded in the 2013 first quarter and the taxes related to the 2013 first quarter and fourth quarter restructuring charges.

Excluding a special items, the 2013 full year overall effective tax rate would have been 32.3%. This is higher than the 2013 first nine months overall as adjusted effective tax rate of 30.8%, due to lower earnings in Europe in the fourth quarter of 2013 than we originally estimated. The unfavorable impact on the fourth quarter to bring the first nine months up to the higher tax rate was approximately $0.3 of earnings per share.

The base tax rate of approximately 33.2%, which excludes the restructuring charge and discrete tax items was at the high end of our targeted range of 31% to 33%. Variability in the base tax rate is primarily due to the mix of full year taxable earnings by country.

Turning now to the balance sheet, again we continue to have a very strong balance sheet. Net receivables at the end of the 2013 fourth quarter were $140.2 million versus $138.1 million a year earlier. Quarterly average accounts receivable days outstanding were 61 days for the fourth quarter compared to 60 days in the 2012 fourth quarter.

Tennant's inventories at the end of the 2013 fourth quarter were $66.9 million versus $58.1 million a year earlier. Quarterly average FIFO days inventory at hand were 81 days for the 2013 fourth quarter, up 3 days compared to 78 days in the year ago quarter. Capital expenditures of $14.8 million in the 2013 full year were comparable to $15.6 million in the prior year period, with planned investments and tooling related new product development, manufacturing equipment, and process improvement projects.

Tennant's cash from operations was $59.8 million in the 2013 full year, an increase of $12.2 million, versus cash from operations of $47.6 million in the prior year. This was primarily due to cash contributions to the US pension plan in 2012 as compared to no cash contributions in 2013.

As you may recall in 2012, Tennant made cash contributions of $16.7 million to our US pension plan of which $15 million was discretionary. This was an economically efficient use of cash as we have previously not made a cash contribution to that pension plan since 1987. We do not expect any additional cash contributions to this plan will be necessary. Note that this pension plan was closed to new purchasements back in 2000.

Cash and cash equivalents totaled $81 million, up $27 million from $53.9 million a year ago. The company's total debt at $31.8 million declined $0.5 million from $32.3 million a year ago. Our debt-to-capital ratio was 10.8% at the end of 2013, versus 12.1% a year ago. Regarding other aspects of our capital structure, Tennant is currently paying a quarterly dividend of $0.18 per share. We paid cash dividends of $13.2 million in the 2013 full year and $12.8 million in the prior year.

Reflecting our commitment to shareholder value, Tennant has increased our annual cash dividend payout for 42 consecutive years. During the 2013 full year we purchased 434,118 shares of Tennant's stock in the open market, at an average price of $51.04 per share for a total cash outlay of $22.2 million. As of December 31, 2013 we had approximately 631,000 shares remaining under our repurchase program.

Moving now to our outlook for 2014, based on our 2013 full year results and expectations of future performance, we estimate 2014 full year net sales in the range of $780 million to $800 million, up 4% to 6%, and earnings in the range of $2.50 to $2.80 per diluted share, an increase of 11% to 24% compared to 2013 as adjusted. For the full year 2013, adjusted earnings per share were $2.26 on sales of $752 million.

Our current 2014 annual financial outlook includes the following expectations: modest economic improvement in North America and Europe, and steady growth in emerging markets; unfavorable foreign currency impact on sales for the full year of approximately 1%; gross margin performance in the range of 43% to 44%; research and development expense of approximately 4% of sales, and capital expenditures in the range of $20 million to $22 million.

We anticipate a base tax rate excluding any special items in the range of 31% to 33%, depending primarily upon the mix of full year taxable earnings by country. Note that our 2014 base tax rate does include 2014 benefit for the Federal R&D tax credit. However, the Federal R&D tax credit program has not yet been re-enacted for 2014, so we're not allowed to include that favorable impact on the 2014 tax rate we record until it is enacted.

While we do not provide quarterly guidance, we do expect our 2014 sales will be stronger in the second half of the year as our investments for growth begin to generate incremental revenues. During the initial ramp up of strategic investments to accelerate future revenue growth, we anticipate our selling and administrative expense will grow at approximately the same rate as our sales. Importantly, we expect to increase our operating profit margin in 2014 with the majority of the improvement expected in the second half.

Now we'd like to open up the call to any questions.

(Operator Instructions)

Your first question comes from the line of Jason Ursaner with CJS securities.

Good morning. Congrats on a very strong finish to the year.

Thanks.

The gross margin was down a percent and a half, year to year despite higher sales -- was the lowest level of any quarter. I just didn't catch what this was primarily attributed to. Obviously not a longer term issue given the guidance on gross margin.

Yes, the two biggest pieces of it were a channel mix and product mix. The biggest of those two is the channel mix, as we had a particularly strong growth in our strategic accounts and through the distribution channel. And both of those channels tend to have modestly lower growth margins. We do make it up through the efficiency and selling expense side. So it's additive to our operating margins. But with the mix we had, it was diluted to our gross margin. It's fair to say we think we will be back within our targeted range for next year as we just got done guiding.

Okay. When you think about the strategic account obviously it's becoming a bigger factor in the overall growth strategy, when you think about that on operating margin leverage -- overall how do you view it and what was the commentary on SG&A inflation relative to sales?

What you'll see on an absolute basis we'll expect our operating expenses to grow in line with our sales revenue. So it'll be dependent upon where our revenue ends up and that will monitor our spending at that level. A predominant amount of the investment will be around sales coverage, service coverage, and also investments in marketing.

And then to your first question around strategic accounts -- and distribution's true also, we do make lower gross margins. But if through the efficiencies, incrementally it's additive to our operating margin structure. We try to negotiate the best prices we can at the gross margin line but we're even more focused on the fact that we've got to incrementally drive operating margins above 12% or we're being diluted to our operating model -- where we want to take it to.

Okay and SG&A increase with sales -- that's I guess due to the actual sales growth in the year or that's reflective of the future growth with investment coming ahead of revenue on the longer term in 2017 billion dollar target?

Yes, reflective of investments ahead of the curb a bit Jason. One of the comments I will make there is we did say that we made some those investments In the back half of the year. We haven't published our K yet but you'll see that our head count from the end of the year 2012 to the end of the year 2013 will be up. Somewhere in north of 100 heads and a vast majority of that's going to be increases that were sales people, service people and marketing folks.

And that's an investment that's in our cost base and in a week we think it will -- is a critical part of driving accelerated revenue growth in the next year. When you come into Q1 at the higher level of investment against our lowest revenue typically in the year. That puts pressure on the profit margins. But we're very comfortable in improving operating margins for the full year.

Okay. And just a last question for me and then I will jump back in the queue. Outside of the cost base from a capitalized investment point of view, the growth strategy is not particularly capital intensive. So just overall you're generating very strong cash. What's the view on capital structure sitting here today?

Well we'll continue to -- we'll explore dividend increase as we have said that. That's underway and we've typically taken our dividend up. It's under exploration at this point. So we will continue to return money to shareholders through dividends.

Also we expect to remain aggressive in our buy back of shares. We've been that way for the last three years and we'll continue to be aggressive. Assuming the right economic circumstances, we'll be going to the market and buy shares on open market.

We'll fund our working capital. We're taking our capital spending up a bit in the upcoming year. And we will continue to look at M&A activity but it is unlikely to be a major investment. Our predominant focus is on organic growth.

Okay. Appreciate it. Thanks guys.

You bet. Thanks Jason.

Your next question comes from the line of Joe Maxa with Dougherty & Company.

Hi, good morning. Thank you. A couple questions.

Back on the gross margin. The channel mix being a bit of an issue in Q3 for the margin -- I understand the sales benefit or lower expenses. But how does that look going forward? Are you still focusing on strategic accounts or are we going to see this gross margin be at the lower end of that range because of it? Or what is your expectation for 2014? Can you get back to higher end?

I sure hope so. That's certainly what we're going to strive for, Joe. But we don't want to be that precise. We're comfortable being above 43. We're certainly not willing to say we can go above 44 at the current point. But we are going to continue to focus on gross margin improvement.

We're working on our discounting. We're going to take price increases. We're managing the heck out of our supply chain.

But if we can continue to accelerate growth in strategic accounts and we can earn operating margins above 12% we're okay with that. And it has been an important part of our growth and will continue to be an important part. I can say some of the investments we're making are outside of the world of strategic accounts, and they're in our direct sales organization, and with our distribution partners also.

Right. On the guidance, second half appears to be a little bit more backend loaded than a typical year based on what I am hearing. Is that --?

A couple comments on that Joe. One is, if you looked at our revenue over the last few years we've been returning to a more normalized skew. If you went back to 2012, we had more revenue in the front half than the back half. That's abnormal.

It used to be about 48% was in the front half. We got closer to that norm in 2013. I think it'll be closer to history in the upcoming year. So higher percent of total revenue in the back half. And then we have made some investments and we feel really good about them.

The other commentary I'd make on Q1 specifically, is we had the opposite effect on our tax rate last year in Q1. We had an abnormally low tax rate in Q1 of last year and an abnormally high in Q4. And that makes for some tough comps.

We don't expect for that very low -- I think it was around 28% tax rate in Q1 -- we don't expect that to repeat itself. So it put some pressure on profitability in the first quarter. And we're focusing again -- we care about our quarters a lot, but we're focusing on the full year and really accelerating our growth profile for the future.

Regarding the tax rate, if you've not taken the R&D credit, what would be that base rate without it?

It's about 50 basis points overall in the R&D tax credit.

Okay, you've got the (multiple speakers) to come in.

We're not saying we can't be within range without it. But it's going to negatively affect our tax rate in the quarter by 50 basis points until it gets enacted.

Right. Then last for me is regarding the Orbio launch coming up this spring. Can you give us a little color on how initial beta tests are going and what the initial outlook may be?

Yes we're really excited about this product. It's called the os3 system. Remember it's a machine that's half the size and half the cost of our 5000-Sc, which is out there now. It provides both an antimicrobial solution as well as a multi-purpose cleaning solution.

The other thing that's a real benefit is that it produces a concentrate that is a diluted on site. And that concentrate we can then store in containers and move about the facilities to other dilution stations. Something we could not do with the 5000-Sc, which gives it a lot more flexibility and allow our customers to -- that way cost effectively clean the entire facility.

The other issue we have with the 5000-Sc was that a lot of our customers said it's great, but it only solves part of our cleaning problem. We still have the sanitizing and disinfecting part. And if we're going to change our cleaning protocol we want do it across the board. They can now do that because we can help them disinfect, sanitize, and clean.

But I would say that we've had prototypes in test for a while now, with extremely strong positive reaction from everyone. The goal is to get this product out in the market commercially in the second quarter this year. It's the product we always thought from the beginning -- that this is the product that had the potential of truly making Orbio a force within the cleaning industry.

We're taking orders as we speak.

Sounds good. Thanks a lot. Great guys. Thank you.

Your next question comes from the line of Daniel Rizzo with Sidoti & Company.

Hi guys. In addition to the new product you just described. I think you said you have 63 new products that you plan on launching in the next couple years. Is that going to be somewhat evenly distributed or is it something we're going to -- look more of those products coming in the back half of the year into 2015? Or just a little color on the timing of --?

I think that it'd be fair to say they'll be relatively evenly distributed across the three years, 2014, 2015 and 2016. We're not ready to get as specific as front half or back half but for each of the three full years they'll be relatively evenly distributed across the three years.

Right. And we said 16 products in 2014. So that gives you an indication that that's the cadence, then it's pretty evenly distributed.

And then with the product you're just describing -- the Split Stream, it sounds kind of revolutionary the way you were describing it. Could it be as big as ec-water was a couple of years ago -- where it's just -- company that completely changes everything?

It's very different from ec-water. Remember when we reported ec-water results it was ec-water module on our scrubbers. So we were reporting the scrubber sales with ec-water. Not just the sales of the technology module that produced the ec-water. So I don't think you're going to see in the short term that we can get to those levels, which are in the vicinity of $140 million in annual sales right now.

But we do think it's revolutionary. What this does is allow our customers to produce on-site and on-demand sanitizing, disinfecting, cleaning solutions that can replace just about everything, if not everything, they currently use.

It is cost effective. It simplifies the cleaning process for their operators dramatically. And it's environmentally friendly in that the on-site, on-demand generation eliminates the very long and significant environmental supply chain of producing or extracting the raw materials, producing the chemicals, packaging the chemicals, transporting them to the facility. So we think, and the feedback we're getting from the beta test is that this could be transformative.

Would that mean that -- I think you said it was half the size, half the cost -- given how great it is or how great it could be that would mean that you could charge more for it and still enjoy higher margins. Am I looking at that the right way?

I think the only comment we can really make there, Dan, is we certainly expect it to be additive to our margin structure. At both the gross margin line and the operating margin line. So we can pass on value to the end user and they can improve the economics of their cleaning process. And we can make nice margins at the same time. So it's exactly the kind of innovative products we want to bring out.

All right. Thank you guys.

Your next question comes from the line of Scott Graham with Jefferies.

Hi. Good morning. A couple questions for you guys. Tom, the first one, it sounded to me as you went through 12% operating margin that there's a bit less confidence in getting there in the fourth quarter of this year. In fact, I don't even think that you said you will.

And I'm just wondering if that is traceable to this mix issue? And if so, why the 43% to 44% gross margin guidance?

The guidance on the 43 to 44 is we really believe we'll be there. We wouldn't give a guidance range if we didn't believe in that. It could be at the lower end. It could be at the higher end. We're comfortable that it will be within the range.

The biggest reason for us not definitively committing to that 12% by the fourth quarter -- we're not saying we're not going to get there, but we've given a pretty broad range in our revenue and it's a $20 million range. The dependence on what revenue level you get and what quarter it falls in could dictate that you're not able to get to that 12% by the fourth quarter.

And we'll acknowledge we're a bit more focused on the long term here, and accelerating, and making the investments to take our growth profile to a different level. We're not going to manage to a quarter to get the 12%. We're looking at getting to a sustainable 12% as quickly as we possibly can, while achieving better than historical revenue growth rates than we've had over the last period of time.

And the beauty with the new growth strategy is it actually enhances our ability to get to 12% and go beyond. Right, because you look back over the last two years, our struggle has been organic growth.

We've kept our R&D spending within the range that we had promised. We actually took our gross margin range up 100 basis points. We exceeded expectations there.

And we made great progress in terms of reducing our operating expenses. So growth has been the culprit in terms of postponing our ability to get to 12%. Now that we're focused on the organic growth, while maintaining the discipline against the three other metrics, it should allow us to get to the 12% and beyond to a much greater extent than before. So we view it as a net positive for both our ability to grow market share, get to $1 billion, and to enhance our operating profit margins.

Okay. That's actually down the path of my third question which, if you don't mind, I'd like to come back to you with -- Chris. The second question is more again for Tom. Let me just ask you this.

I know you don't give quarterly guidance, nor am I asking for that. But if you're saying that the year is going to be more back half loaded, it just seems as if that the range -- the high end of the range is -- would be pretty remarkable second half of the year. What's behind that thinking on the high end?

We obviously think we're going to grow solidly organically in every quarter. We expect to exit the year at our highest level of year-on-year organic growth. And $800 million of revenue would be a good quarter but we wouldn't give guidance of that at the highest end if we didn't believe it was achievable.

So it would be accelerating organic performance. We're going to monitor closely and if we're not achieving the higher growth rates, we'll back off on our spending a bit. But we did give a range and we did that on purpose but we are not saying that the higher end is not achievable.

But the higher end is, what, 6% growth.

Yes, $800 million is 6.4% recorded growth. And that would be 7.4% roughly if we're at the high end.

I was actually talking about earnings per share.

Oh, got you.

Can you refashion your response now that you know I was talking about earnings per share? Again, it's just that it seems that if the first half is, let's say, flat or up slightly.

Yes, and the way to think about that is gross margins should get better during the year. And that tends to be a given. Q1 is always our low point from a gross margins standpoint. We have done pre-investment. Our expectation is that we will make significantly higher incremental margins in the back half of the year as we get to a higher sustained revenue base.

And we've got some of the investments that we've front-end loaded. Part of that was this year. Part of it will be a front year.

And you've seen the power of our business model as we begin to take advantage of the investments and don't further invest and get the kind of incremental margins that we can make as we begin to accelerate our revenue growth. So we are assuming a higher incremental structure in the back part of the year.

Very good.

Again the growth is a key component of --

Key critical part (multiple speakers).

-- because we did plan to maintain the discipline we've established around gross margins and our operating expenses. Yes, we're taking operating expenses up. Especially in the first half to fund some of these strategic investments. Which are going to pay dividends in the second half and help us get to the $800 million. And with the appropriate margin structure and getting to the EPS goal, hopefully on the high side of the range that we've put out there.

And we do think, Scott, we'll get a good read as we've had. We've gotten a read on the ability to get revenue going. We think we'll get a good read in the front part of the year. And that will dictate how we meter spending out.

If we don't get comfortable that we're going to be at the midpoint or higher on our revenue range, we'll meter back some of the spending. We're still very cognizant of the need to keep moving margins in the right direction. We're taking on a little bit more risk in this profile than we have in the past but we're not getting that far ahead of ourselves.

But the reward of getting it right is significant.

Absolutely.

Understood. Chris, last question is more directed to you. The new product pipeline, when you look at this range that you've given which -- I think you guys mentioned that this was a wide range. I actually consider that a fairly narrow range. Which seems to be somewhat indicative of confidence in the placements in the new product pipeline. Well if I'm right in my supposition there, Chris, would you be able to tell us those placements -- is that higher mix channel or is that still same channel mix?

I don't think we're going to see a big a shift in channel mix in terms of where the new products are going. Although the new industrial product we're launching in the second year, is an industrial product. It's going into our industrial product. It's going into our industrial vertical markets which inherently has higher margins and should be a net positive for us.

So that is the one shift. Versus last year where the majority of the products were all commercially oriented with a little bit lower gross margins. So I would say that's a positive. The other thing about new products you've got to remember, all the new products we launched last year we often say that it takes three years to get the peak annual sales on products launched in a specific year.

So we're going to get a lot of incremental benefits from the new products launched last year, this year, plus the benefits of the 2014 new products. And if you look at the T12, which we launched last year, and the success we've had with that. And if -- we anticipate we're going to have similar success with this next product, that's another very nice gain for us in 2014 which gives us the confidence that we can both get to our revenue goals and our margin goals.

Thanks very much.

(Operator Instructions)

Your next question comes from the line of Kevin Sonnett with RK Capital.

Thanks. Hi guys. So along the lines to some degree of what Scott was getting at. Understanding we're much more focused on the year and even more than a year, we're focused on several years and rightfully so -- the last couple years we've seen a pretty similar decline from Q4 to Q1, about 10%, a little over 10%. And I think that would comport with Tom what you were saying about growth increasing as we move through the year. So you start off with something similar to the growth we just saw. 4% growth give or take, and then that ramps to something like 6%, 7%, 8% as we end the year to get us to the middle of that range.

If you did the math by quarter that's not far off.

Okay. And then with the spending you gave a good forecast for us on SG&A. First half should grow about with revenue so that helps a lot. Especially in terms of the initiative you have with new product launches, etc.

On the R&D line, I apologize if I missed that, but the R&D stepped down a lot in dollars. And as a percent of sales this quarter, it had been running closer to $7.5 million to $8 million. Is that just new product work and some shift in timing for that --?

Yes, we were more front-end loaded with our R&D. And we had guided that we would be right around that 4% level for the full year. Which really just had spending down in Q4, not only versus the run rate but versus the prior year. But we were still at just over 4% for the full year last year and we're going to be somewhere up to 4% in R&D next year. It was a planned way -- the way our spending was loaded in R&D.

Yes. Okay. And then as we think about 2014 -- understanding it should be around four, maybe a little bit less, up to four for the year. Is that more first front half or back half loaded? Does it look like last year or just given the timing that the new product work?

It will likely be a bit more front-end loaded, as a percent of revenue.

Okay. So maybe a little over four in the front half, a little under four in the back half.

Could very well be.

Okay. Maybe this is a good time to -- I guess get everyone on the same page since we're on a public call. So if we -- understanding that you don't want to get so specific that you're giving quarterly guidance because I know you're not managing the business that way. And you don't want to get locked into making decisions for a quarter.

Can we still get to the -- let's say the midpoint of your range, give or take? Maybe it's not the high end but we can still get solidly in that range. If the first half was flattish in terms of the planning you have as far as spending? On an EPS basis?

Yes, the answer would be yes. We could very easily have a first quarter that's going to be quite similar at the EPS line that we had in our first quarter of last year. Then Q2 becomes a much bigger revenue quarter typically. Q2 at times has been bigger than Q4.

That's an easier quarter to manage within. Then our expectation is, we begin to create further leverage in the back part of the year. But we can be flattish at the EPS line through the first part of the year to slightly better. And we expect some acceleration on the back part of the year.

Okay. Thanks. That's really helpful. Thanks guys.

You're welcome.

At this time there are no further questions. I'll turn it back over to the speakers for closing remarks.

All right. We are pleased with our progress today and confident that we've laid a strong foundation for our future. By placing a renewed focus on growing Tennant's revenues while continuing to leverage cost structure we expect to generate stronger bottom-line performance. We are committed to reaching $1 billion in revenue by 2017, while achieving a 12% or greater operating profit margin.

Thank you for your time today and for your questions. We look forward to updating you on our 2014 first-quarter results in April. Take care everyone.

I understand there's one more question before we close. Is that possible?

Yes. Your question comes from the line of John Rosenberg.

Thank you so much for taking my question. Sorry to reiterate a lot of the things that you've already said. My focus is more on the operating profit. Of course, as you've said, and as has been discussed in the prior questions -- not really looking for anything quarter to quarter -- you don't want to manage the business and I certainly agree with that on a quarterly basis.

But can you give us a sense of how much of the improvement in operating margins and gross margins might come from not just new product, but also from your moving to a more modular manufacturing process? If you guys don't hit the high end of your range are we likely to still see some -- 8 to 12 is pretty significant improvement. Are we still going to see some significant improvement even if the year does not turn out as good as hoped?

Yes, obviously revenue is a thing that helps gross margin improvements a lot. So the higher you can get your revenue you do generally create a significant amount of leverage. And so it's a hard question to answer. Modularity will -- has begun to and will continue to drive some upside in our gross margins. But you've got to remember we're at the front end of executing modularity. We're only introducing the second industrial product that's modular in nature in 2014.

We've begun to modularize our commercial line. The real benefits of that, both from a margin point of view, and an inventory, and a cost point of view is out in front of us. I think that, that's more of a long term -- two-, three-, four-, five-year benefit than it is going to benefit us significantly in the short term. But it is very beneficial on multiple fronts over the long term.

So ultimately we'll start to see that in more turns, lower DSOs, cash flow, as well as margins then.

We think -- it's one of the efforts that is -- it's beneficial to margin growth, it's beneficial to cash generation, etc. It's a positive on lots of fronts.

Okay. And thank you. Lastly just one quick kind of housekeeping question. I might have missed this. The new Orbio product, what is its particular end use? Are you selling it through the same channels or are you entering an entirely new market?

No. The Orbio product is obviously very different from our core product portfolio. As we've mentioned, it's a product that has both an antimicrobial and a multi-surface cleaning capability that you can generate on-site, on-demand.

It is relevant in our existing customer base across the board, and into some new customer segments maybe where we haven't competed in the past. We have decided with this product that we're not necessarily going to be focusing on our existing sales organization or distributor structure to launch it.

We're putting in place an organization with account specialists who are well versed in the product and the science behind the product. And understand the regulatory environment that we will be competing in. We will be focusing much more on what we think are the early adopter customers who have the ability to take many, many units up front. Versus trying to sell onesies and twosies across many, many different customers.

Because one thing we've learned is that it's one thing to get the product into the customer. You need to hold their hand a little bit up front until they get comfortable using it. And you can only do that if you limit the customer base you go after. But those customers, for example a university campus, that could take upwards of a hundred of these units potentially. Then you focus the resource on that university campus. Hold the hand of the people involved until it is up and running to their satisfaction and then you can move on.

Great. All right. Well thank you very much for that color and of course best of luck. Thanks a lot.

Thanks a lot John. Appreciate it.

Thank you. That concludes the call today. You may now disconnect.