Tennant Co (TNC) 2016 Q3 法說會逐字稿

Good morning. My name is Sean, and I'll be your conference operator today. At this time, I'd like to welcome everyone to Tennant Company's third-quarter 2016 earnings conference call. This call is being recorded.

(Operator Instructions)

Thank you for participating in Tennant Company's third-quarter 2016 earnings conference call. Speaking on today's meeting is Chris Killingstad, President and Chief Executive Officer, and Mr. Tom Paulson, Senior Vice President and Chief Financial Officer for Tennant Company.

Mr. Paulson, you may begin.

Thanks, Sean.

Good morning, everyone, and welcome to Tennant Company's third-quarter 2016 earnings conference call. I'm Tom Paulson, Senior Vice President and Chief Financial Officer of Tennant Company. With me on the call today are Chris Killingstad, Tennant's President and CEO, and Karen Durant, Vice President and Controller.

Our agenda today is to review Tennant's performance during the 2016 third quarter and our outlook for the 2016 full year. First, Chris will brief you on our operations; and then I'll cover the financials. After that we'll open up the call for your questions.

We're using slides to accompany this conference call. We hope this makes it easier for you to review our results. A taped replay of this conference call, along with these slides, will be available on our Investor Relations website at: investors.tennantco.com, for approximately 3 months after this call.

Now, before we begin, please be advised 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 also provide the most directly comparable GAAP measure.

There were no special non-GAAP items in 2016. There were special non-GAAP items in the third quarter of 2015. Our 2016 third-quarter earnings release includes a reconciliation of those non-GAAP measures to our GAAP results for the 2015 third quarter and also EPS for 2015 full year. Our earnings release was issued this morning via Business Wire, and is also posted our Investor Relations website.

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

Thank you, Tom.

And thanks to all of you for joining us this morning.

We've previously discussed the uncertain global economy, and we saw continued economic volatility in the 2016 third quarter. The sluggish environment for industrial manufacturers led to lower 2016 third-quarter sales in our EMEA and Asia-Pacific regions. But our Americas region posted record revenues for a third quarter.

Once again, sales through strategic accounts, and sales of new products drove our results in the Americas. Tennant's 2016 third-quarter consolidated net sales were $200.1 million, with net earnings of $0.64 per diluted share. Overall, Tennant remains competitively well-positioned; and we are excited about our growth prospects. We expect return to organic sales growth in the 2016 fourth quarter based, in part, on a larger than normal order backlog at quarter end.

Taking a look at our 2016 third-quarter highlights.

Part of our growth strategy has been to pursue add-on acquisitions that provide access to interesting products or broaden our global sales and service coverage. We completed two small acquisitions with this profile, recently.

Our acquisition of the Florock Brand in Chicago, expands our commercial floor-coatings business. Florock offers a range of floor coating systems across a wide variety of industries, and is a recognized leader in developing and installing flooring systems for commercial, industrial, and institutional applications. The combination of Tennant coatings and Florock opens new markets for Tennant's coatings business and strengthens our value proposition to more customers.

We also acquired the assets of the Dofesa Barrido Mecanizado, which has been a long time distributor of Tennant equipment based in central Mexico. This acquisition represents a key investment for growth in Latin America, and enhances Tennant's sales and service capabilities in this important region. Combined with our other distributors in Mexico, the Dofesa acquisition will enable Tennant Mexico to have broad and deep representation in pivotal markets such as Mexico City, Monterey, Guadalajara, and Puebla. With the addition of Dofesa's distribution facilities, Tennant Mexico will be able to more quickly and efficiently deliver equipment, parts, and service directly to our customers.

Turning to other priority initiatives. We continue to focus on driving top- and bottom-line results through innovative products and technologies. We've discussed on previous calls the importance of innovation to Tennant's revenue growth. In the first nine months of 2016, 37% of our equipment sales came from products introduced within the last three years. We are pleased that this metric remains well above our target of 30%.

We invest approximately 4% of sales annually in research and development to ensure competitive advantage and future growth. And we continue to execute against the strongest new product and technology pipeline in Tennant's history. We plan to introduce at least 10 new products this year, including large industrial cleaning machines.

Among Tennant's key new product launches in 2016 are three large next-generation cleaning machines for the industrial market. As we've previously mentioned, these are the M20 and M30 Integrated Sweeper-Scrubbers, and the T20 Heavy-Duty Industrial Rider Scrubber, which incorporate Tennant's latest technologies, including our Pro-Panel intuitive touch-screen.

We've also introduced the M17, which is Tennant's largest Battery-Powered Sweeper-Scrubber. This versatile machine allows operators to choose between dry sweeping, scrubbing, or simultaneously doing both. The fume- free Sweeper-Scrubber is engineered to be easy to operate and maintain, while providing big productivity gains through industry-leading innovations. These new products have been well received by our customers.

We also continue to be pleased with the growth of our sustainable cleaning technologies. Our ec-Water NanoClean is available on all of our applicable commercial scrubbers, and we continue to roll out the sustainable cleaning technology on new products as they are introduced. The name NanoClean refers to the creation of nanoscale bubbles that are an important part of the cleaning mechanism. Like the original ec-Water, the next-generation ec-Water NanoClean technology electrically converts water into an innovative solution that offers the same benefits as the original, but cleans better, cleans more soils, and is effective in more applications.

Since the 2008 introduction of Scrubbers equipped with ec-Water technology, we have sold over 85,000 Scrubbers. And cumulative sales through the 2016 third quarter have now reached $1 billion.

Further, as I've mentioned, we are focused on creating entirely new growth avenues for Tennant through our advanced product development efforts. These initiatives go beyond trying to improve cleaning performance. We are looking at our customer's needs holistically to address a broad array of issues such as, managing labor costs, productivity, and machine maintenance information. We plan to expand out business through telemetry, with new and enhanced offerings for our IRIS Asset Manager, as well as robotics, battery technology, and water recycling. We expect these innovations to have a positive impact on Tennant's future.

In the area of telemetry, which involves automated remote data collection and transmission, we introduced the IRIS Asset Manager in late 2015. IRIS is an intelligent command center that tracks machine productivity and maintenance needs, including, ec-Water usage. This technology helps customers with large fleets of equipment make informed decisions and reduce their overall cost to clean, which is a very attractive proposition. IRIS continues to exceed our expectations and generate strong interest from customers. As we have previously discussed, we have already won a number of deals due to our telemetry capabilities.

Robotics is another exciting area that Tennant has been working to develop. With advances in robotics technology and our customers desire to lower labor costs and turnover, we are exploring autonomous navigation technology. This would enable a machine to operate unmanned, or with reduced labor.

Robotics technology is potentially highly attractive, since 70% of our customers' cleaning costs today are labor related. Only 10% of their costs are related to machines. As this technology is more widely adopted in various industries and the costs decline, it may become more practical for our customers applications.

We've been partnering for some time with an industry-leading autonomous guided vehicle company to help us develop our product roadmap. Our development partner has been rated one of the top 50 robotics companies by the Robotics Business Review. Their demonstrated success with commercializing autonomous guided vehicles makes them a unique partner.

The reality is that many companies are able to come out with a very impressive demo, but may lack proven experience in commercializing products. Our partner has over 1000 units in operation across warehousing, mining, agriculture, and security applications. There is a broad spectrum of sophistication when it comes to AGB technology, and we are very comfortable with where we will land on that sector.

A third advanced product development area for Tennant involves battery technologies. Battery life and machine up-time are among our customer's greatest pain points. We are actively evaluating lithium-ion, hydrogen fuel-cell, and other emerging battery technologies. We are committed to offering our customers industry-leading battery options that enhance productivity.

Regarding water recycling, we are engineering solutions that offer measurable environmental improvements. On board water recycling, using advanced filtration technologies, is an example. We see opportunities to help customers conserve water and improve operator productivity by significantly reducing the time-consuming activity of dumping and refilling.

These examples give you a sense of how we are working to create exciting future growth pathways for Tennant. And they demonstrate the myriad ways that we are committed to being an industry innovation leader and raising the standards for sustainable cleaning around the world.

Let me now turn to another important growth endeavor. It involves our investment in a digital platform. Our goal here is to build the Company's e-business capabilities in order to meet customers' changing needs and enhance our long-term sales growth and further improve Tennant's operating efficiency.

To date -- to update you on our digital e-business initiatives, on our last earnings call, I mentioned that we have implemented our new Customer Relationship Management, or CRM, Marketing and Sales Management Solution in North America, EMEA and Australia. This system helps us identify new customers, grow our existing business, and improve the overall Tennant customer experience. We are benefiting from its improved sales analytical capabilities. We expect to complete the global rollout to Japan, China and other regions in the coming months.

Another digital initiative is e-commerce, which continues to grow as an important sales platform and customer interface for Tennant. We estimate that more than 70% of our customers start their buying journey online and, increasingly, they purchase parts and consumables this way. By the end of this year, we anticipate launching a more robust e-commerce platform in the US that offers expanded functionality to purchase parts and products, enhances lead generation, and enables cost-effective sales. And, in a few years, we anticipate being able to report e-commerce as another significant revenue channel, along with our existing direct distribution and strategic account channels.

Looking ahead, we are confident in our growth platform. We believe that Tennant is competitively advantaged, and we will continue to pursue our strategies to accelerate organic sales in 2017. We have a diverse portfolio of initiatives and are creating value through new product and technology introductions, expanding our global sales and marketing initiatives to increase our global market share, and building Tennant's e-business capabilities.

Concurrently, we are applying lean principles and running a more efficient business to raise productivity. We are well-positioned to leverage our operating efficiency as economic conditions improve.

We anticipate that global economic uncertainty will continue for the remainder of 2016. We are narrowing our full-year revenue and earnings guidance ranges, based on the Company's performance to date and our expectation for a return to organic growth in the 2016 fourth quarter.

Now I'll 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'll generally not comment on the year-to-date financials, as those were detailed in the earnings release.

For the third quarter ended September 30, 2016, Tennant reported net sales of $200.1 million compared to sales of $204.8 million in the 2015 third quarter. The impact of foreign currency exchange on sales was neutral in the third quarter. And the net impact of the August 2016 Florock acquisition and the January 2016 Green Machines divestiture decreased net sales by 0.1%. As a result, organic sales decreased approximately 2.2%.

Third-quarter 2016 net earnings were $11.5 million or $0.64 per share. In the year-ago quarter, Tennant reported adjusted net earnings of $12.1 million or $0.68 per share. The as-adjusted results from the 2015 third quarter excluded two special items that total the charge of $13.1 million after tax, or a loss of $0.73 per share.

Turning now to a more detailed review of the 2016 third quarter.

Our sales or are categorized into three geographic regions, which are: the Americas, which encompasses all 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, 2016 third-quarter sales increased 2.2%, or grew 1.2% organically, excluding the impact of the Florock acquisition. The foreign currency impact on sales was neutral. As Chris said, record sales for third quarter in the Americas were once again fueled by sales to strategic accounts and sales of new products. This record was achieved despite lapping the strong Americas' organic sales growth of approximately 8.3% in the prior-year quarter.

Organic sales growth in Latin America was approximately 10% in the 2016 third quarter, despite continued economic headwinds. In September, we acquired our long-time distributor in Mexico; however, the incremental revenue impact is not material. This is an important emerging market for us, and we remain confident about its long-term growth prospects.

Sales in the 2016 third quarter were negatively impacted by productivity challenges in North America. As Chris mentioned, this resulted in a larger-than-normal order backlog at quarter end.

In EMEA, our organic sales in the 2016 third quarter, decreased approximately 7.6%, excluding the impact of the Green Machines divestiture of 5% and an unfavorable foreign currency impact of about 2.5%. Positive organic sales growth through distribution in Western Europe was more than offset by organic sales declines elsewhere, particularly in the UK where Brexit's negative impact on the economy and the related devaluation of the British pound was larger than anticipated.

As you'll recall, at the end of January, 2016, we sold the Green Machines' Outdoor City Cleaning line to our master distributor for Central/Eastern Europe, Middle East and Africa, or CEMEA region. Tennant retained the opportunity to generate revenue in two ways: by continuing to sell Green Machines in certain regions as a distributor and by serving as the exclusive service provider for Green Machines. The impact of the sale of anticipated reduced Tennant's annual revenues by approximately $10 million, or about 1%, with an immaterial impact on earnings.

In the Asia-Pacific region, organic sales in the 2016 third quarter decreased approximately 15.1%, versus strong year-ago sales, excluding a favorable foreign currency impact of about 2%. In the prior-year quarter, organic sales in the Asia-Pacific region grew 21.3%, and organic sales increased in all countries within this region.

Tennant's gross margin for the 2016 third quarter was 42.6% compared to 43.3% in the prior-year quarter. The 70-basis-point decline was primarily due to productivity challenges in North America related to a skilled labor shortage. We anticipate the 2016 full-year gross margin will be in our target range of 43% to 44%.

Research and development expense in the 2016 third quarter totaled $8.4 million, or 4.2% of sales, versus $8.2 million, or 4% of sales, in the prior-year quarter. We continue to invest in developing a robust pipeline of innovative new products and technologies that Chris described for you.

Selling and administrative expense in the 2016 third quarter decreased to $60.6 million, or 30.3% of sales. We continue to tightly control spending, while investing our high priority growth initiatives. S&A in the third quarter 2015 was $64.7 million, or 31.6% of sales, and $62.9 million, or 30.7% of sales, as adjusted.

Our 2016, third-quarter operating profit totaled $16.3 million, or 8.1% of sales, versus an operating profit of $4.6 million, or 2.2% of sales, and $17.5 million, or a 8.6% of sales, as adjusted.

We have routinely discussed the impact of foreign currency exchange on our sales. But with the significant change in foreign currency exchange rates during 2005, and also to a lesser extent in 2016, we believe it's helpful to provide additional information. As many of you know, in a global Company such as Tennant, isolating the impact of foreign currency exchange is complicated. We have calculated an estimated Constant Currency Income Statement, which assumes no change in exchange rates from the prior year. In so doing, we are then able to compare that to our actual financial results to isolate the estimated impact of foreign currency exchange.

Here's a recap of the estimated foreign currency exchange impact on our 2016 third-quarter financial results. Immaterial impact to sales. Favorable impact to gross margin of 20 basis points. Using a constant currency, our gross margin would've been about 42.4% compared to 42.6%, as reported.

Favorable impact to operating profit of approximately $0.5 million. Using a constant currency, our operating profit margin would have been about 7.9%, compared to 8.1%, as reported. Favorable impact to earnings per share of approximately $0.02. Using a constant currency, our earnings per share would've been about $0.62 compared to $0.64, as reported.

Despite external circumstances beyond our control, we remain committed to our goal of a 12% or higher operating profit margin by successfully executing our strategic priorities and assuming the global economy improves. In order to achieve this target, we need to drive organic revenue growth in the mid to high single digits, hold fixed costs essentially flat in our manufacturing areas as volume rises, strive for zero net inflation at the gross profit line, and standardize and simplify processes globally to continue to improve the scalability of our business model, while minimizing any increases in our operating expenses.

We continue to successfully execute our tax strategies. Tennant's overall effective tax rate for the 2016 first nine months was 30.6%, which was lower than the 32.1% for the 2016 first half, due primarily to routine favorable discrete tax items in the 2016 third quarter. The overall effective tax rate for the prior-year first nine months was 30.7%, excluding the special items. The base tax rate for the 2016 first nine months was 31.7%, which excludes the routine discrete tax items.

The Federal R&D tax credit was re-enacted before the start of 2016, so the benefit of that is included in our 2016 tax rate.

Turning now to the balance sheet.

Again, this continues to be very strong. Net receivables at the end of the 2016 third quarter were $135.5 million versus $137.2 million a year earlier. Quarterly average accounts receivable days outstanding was 64 days for the third quarter compared to 63 days in the prior-year quarter.

Tennant's inventories at the end of the 2016 third quarter were $87.3 million versus $83.3 million a year earlier. Quarterly average FIFO days inventory on hand were 94 days, for the 2016 third quarter compared to 93 days in the year-ago quarter.

Capital expenditures totaled $22.5 million in the 2016 first nine months. That is $7.9 million higher than the $14.6 million in the prior year and reflects planned investments in information technology projects, tooling related to new product development, and manufacturing equipment.

Tennant's cash from operations totaled $33.3 million in 2016 first nine months compared to $30.9 million in the prior-year period. Cash and cash equivalents totaled $42.3 million at the end of the 2016 third quarter versus $56.8 million at the end of the prior-year quarter. The decrease in cash of $14.5 million was primarily due to the higher-than-typical level of share repurchases in the back half of 2015 and a higher level of capital expenditures in 2016.

Total debt was $36.2 million, up from $24.6 million at the end of the prior-year quarter, chiefly due to incurring long-term debt related to our recent acquisitions. Our debt to capital ratio was 11.7% at the end of the 2016 third-quarter compared to 9.1% a year ago.

Regarding other aspects of our capital structure, Tennant is currently paying a quarterly dividend of $0.20 per share. We paid cash dividends of $10.6 million in the 2016 first nine months. Reflecting our commitment to shareholder return, we're proud to say that Tennant has increased the annual cash dividend payout for 44 consecutive years.

Share repurchases are also part of how we seek to enhance stockholder value. During the 2015 full-year, we purchased 764,000 shares of Tennant stock for a total cash outlay of $46 million. During the 2016 first nine months, we purchased 246,000 shares for a total cash outlay of $12.8 million. As of September 30, 2016, we had approximately 395,000 shares remaining under our repurchase program, which aims to provide the financial flexibility to offset any dilutive effect of stock-based compensation programs and to consider repurchases to create value based on overall market conditions. Assuming the stock market continues to be volatile, we expect to be active in buying back Tennant shares.

Moving now to our outlook. As Chris mentioned, we are adjusting our guidance for the 2016 full year to narrow our revenue and earnings ranges based on three factors: our performance through the 2016 third quarter, the expectation for return to organic sales growth in the 2016 fourth quarter, and a slightly less adverse foreign currency exchange environment than we previously anticipated.

We now estimate 2016 full-year net sales in the range of $805 million to $815 million. This is down 0.8% to up 0.4%, or up approximately 0.2% to 1.4% organically, excluding an unfavorable foreign currency impact, a sales decline in the Green Machines divestiture, and a sales increase from the Florock acquisition. Previously we anticipated 2016 full-year net sales in the range of $800 million to $820 million.

We now estimate 2016 full-year earnings in the range of $2.40 to $2.60 per share. Previously, we anticipated a range of $2.35 to $2.60 per share.

Foreign currency exchange headwinds in 2016 are estimated to negatively impact operating profit in the range of $2 million to $3 million, or a negative impact of approximately $0.08 to $0.12 per share. On a constant currency basis, we expect 2016 full-year earnings to be in the range of $2.52 to $2.68 per share.

The estimated, slightly higher, effective tax rate in 2016 is also anticipated to reduce earnings per share by approximately $0.05. For the 2015 full year, adjusted earnings per share totalled $2.49 on net sales of $811.8 million.

Our 2016 Annual Financial Outlook includes the following expectations: continued slow economic growth in North America, modest improvements in Europe, and growth in emerging markets. Unfavorable foreign currency impact on sales for the full year of approximately 1%, with a $2 million to $3 million negative effect on operating profit. Decline in sales of approximately 1% from the Green Machines divestiture with an immaterial impact on earnings.

Increase in sales of approximately 1% from the Florock acquisition, with an immaterial impact on earnings. Gross-margin performance in the range of 43% to 44%. Research and development expense of approximately 4% of sales. Capital expenditures in the range of $25 million to $30 million. And an effective tax rate of approximately 31%.

We do expect to return to organic sales growth in the 2016 of fourth quarter. Our objective is continue to build our business for sustained success.

And now we'd like to open up the call to questions.

Sean?

(Operator Instructions)

Joe Maxa, Dougherty & Company

Thank you, and good morning.

Good morning, Joe.

I wanted to ask a little bit more about the productivity challenges you've seen. Does it suggest you've had, or maybe lost, a few of these skilled laborers? And if so, have you rectified that?

We are in the process of rectifying. It's not an uncommon issue. The ability to attract skilled labor as fast as you need to, and not lose them due to competition, has frankly become tougher, particularly in our factory here in Minneapolis. We have taken measures to shore things up, and we are in the process of putting in additional robotics in the factory, to take the place of some of the issues that we're having with staffing up to the levels that we need to be staffed at.

But, we think we saw stabilization as we exited September. We're seeing our performance improving in October. We need a little bit of improvement, but we do think we're going to turn to a more normalized gross margin level in the quarter. But, it's necessitated some change.

Okay, that's helpful. And, then regarding the strong backlog to start the quarter-- so that looks, obviously good for Q4. How has the order trends been compared to last year, given that last year was a little bit weaker than expected, if I recall?

What we are seeing, Joe, to put a little bit of added flavor, on that back order position. The open order position we exited with was about 24% above prior-year. That's really substantial, and meaningful. It certainly doesn't guarantee you're going to have growth in the upcoming quarter, but it increases your odds for sure. It's also important to note that the order patterns that we're seeing so far in the quarter, and we're about 22% or 23% through the quarter, is we're seeing organic growth versus the prior year and it supports the guidance range that we've been given for the fourth quarter.

Okay and then I'll ask one more. This is on the Brexit impact, can you quantify that somehow or what have you seen over there regarding, just Brexit in general, versus

(multiple speakers)

I wish I could, all I can really say, Joe, is we did see -- the UK surprised us. We thought we'd see more stabilization, but it's clearly having an impact on how people are ordering, and customers demand. There could be some additional rub-off effect, but broadly speaking, what we're seeing is -- we really do believe that we're going to see a return to growth in the fourth quarter. We don't believe we are going to see it in EMEA, we don't think we're going to see it in the UK, and we're not counting on it. But, we do believe we're going to see improvements in other areas

Joe, it's important to remember, that the part of the impact is due to just a general slow-down, and the other part is due to the currency devaluation, which is pretty significant.

Of course, yes. Okay, thank you.

You bet.

Chris Moore, CJS Securities

Alright, thanks guys. Can we talk a little bit about the SG&A level that was in Q3? Trying to get a feel for if that's sustainable on a percentage basis moving forward, and where some of that savings came from?

Yes. It is -- the absolute level is not sustainable. We did really manage expenses pretty aggressively in the quarter, while still investing behind the things that really matter for the long-term. But, on a percent-of-revenue basis, I think that it is sustainable. And, in fact, as you know, our objective is, we really want to see, us, as we go forward, begin to create leverage relative to the prior-year, as we look at our operating expenses as a percent of revenue.

So, that's our expectation. You will see the absolute level of spending go up. It will, more than likely, be closer to what you saw in Q2 environment. We won't be able to maintain spending as low as we did in Q3 on an absolute basis.

Okay. That's helpful.

(multiple speakers) Go ahead, Chris.

The other important to note though, so sure, we basically had to take our expenses down, but we in no way, have compromised any of our most important investments. Whether it be in products and technology, building an e-commerce platform, or expanding our sales and service coverage around the world. So, we've had to cut back a little bit, but the most important investments, in those areas -- the integrity of those have been maintained, despite the S&G -- SG&A decline in third quarter

And we're really doing all the classical things that you'd expect, Chris. We're reducing travel to travel that's absolutely necessary or revenue-generating. We're much slower to replace -- fill jobs that are vacant. We still are filling them in key jobs. We're not adding new positions, discretionary spending is being deferred. It's all the typical things that you need to do in an environment that's slower growth.

Got you. Okay.

With respect to Florock, it sounds like, increased revenue is 1% this year, no impact on earnings. 2017? Do you expect the same? Perhaps a little bit of accretion to earnings from Florock?

Yes. We would expect accretion earnings. We're not prepared to give you a specific number, but we expect revenue growth out of that acquisition. We expect it to be accretive to our earnings. So it's early days, but we're really pleased with both Florock and Dofesa.

Got you. Okay. Last question, on the ec-H2O Scrubbers, obviously still growing. 2015 was a big year, $157 million. Are you able to match that number in 2016? Is it still growing? Slightly declining? Just trying to get a sense.

Yes. We still hope that we'd see some modest level of growth on an organic basis. We're not seeing, as you know -- it's not as strong from a growth standpoint, as last year. But it remains -- having nice traction. It's making a difference with our sales guys to go back to customers that didn't buy the technology in the past. So it's mattering overall.

But, the thing that's important, is, if you look at our equipment sales, it's performing better than our overall equipment sales. The other thing is, is that there are a lot of products where we still have not installed ec-H2O NanoClean. And so, that's going to continue to happen over the next two or three years. So you'll continue to see growth with this technology

Got it. Thanks much guys

You're welcome.

Bhupender Bohra, Jefferies.

Good morning, guys.

(multiple speakers)

So, just checking on the Europe and Middle East and Asia PAC. Asia PAC, you guys had difficult comp, that's understandable. On the EMEA, why was that below expectation, and the weakness over there?

In EMEA?

Yes.

In each of them -- EMEA really was -- we did have a much more negative impact on Brexit than we anticipated. I would say that the rest of Western Europe in general, other than distribution, didn't perform quite as well. And in our CEMEA region, we see coming back in Q4 and we expect growth out of it.

So overall, we don't see anything that's not working strategically. The only things that are affecting us, we believe, are the things that we can't control. I can't say we're as confident in the ability of EMEA to grow organically, as we are in the Americas, but we do expect some modest level of growth in Q4. But again, importantly, strategically, we don't see any weaknesses in our operating.

In the case of Asia-Pacific, we do expect to see improvement in Q4. We hope we see a modest level of growth. It's been tough economically, there. And it's pretty broad-based. There's really only one meaningful bright spot, and that's the performance of Japan in Asia Pacific. And in the other areas, we expect improvement in Q4. But it just might be not until next year that we see a return to organic growth.

But we are, in the short-term. There's only so many things we can do the short-term. But we are adjusting our sales approach and what were focusing on. Because there are some vertical markets that are more robust than others, and we're trying to adjust, so we go after the sales that are available.

The other thing we've realized in situations like this, is that we still don't have broad-based coverage, whether the in China or in the Southeast Asian market. So we've historically been very dependent on big deals, and when those big deals don't happen, then you do see a sales decline. And of course, that's happening, also, in a poor economic environment.

So, this is not something that we're going to solve overnight, but our strategy is to continue to improve our sales coverage across the board in APAC, so we have a more broad-based and stable business and should see the fluctuations that we have recently.

That's good.

Tom, you mentioned about EMEA, the Brexit impact. No, how big is the UK for you and.

It's actually less than 5% of total revenue. So it's an important market, but, globally, it's not overly material to our business.

But it's the second biggest business for us in EMEA.

Okay. And, did we see deferred orders over there? Or was it pure cancellations? Or what actually happened with the?

It's more deferrals than anything else. I can't say that we didn't see any cancellations, but it is still more about uncertainty and deferrals than it is about outright cancellations.

Okay. And a second question on pricing. You have mentioned previously that it will be difficult in (inaudible) pricing in 2016. Are we talking about organic growth here in the fourth quarter? How should we think about pricing and what actually happened with pricing in the third quarter?

No. We would say that we did not get measurable pricing benefits in Q3 or Q4. As a reminder, we got about 0.5% through the first half, roughly.

We do think that will change as we go into next year. I can't say that we've announced pricing yet. But we are starting to feel little bit of inflation, and we think that, given the fact that we held the line this year -- did not price -- we weren't overly aggressive in the prior three years, we think there will be an opportunity to price in the upcoming year. We're not prepared to put numbers on it, but expectation will be, we'll take price.

And, lastly, just broadly, on your customers, with the industrial environment where we are right now, and you can see all the major reportings out there on sluggish environment. What are your customers thinking? And how does that look for 2017 as we go into the first half next year?

There's still uncertainty. And, particularly in a few verticals around oil and gas, and agriculture, and some manufacturing, particularly if you look at the middle of the US. We're doing things to offset that. I think we're having some success. And we still believe, based on what we're seeing from our sales, and the order patterns that we're seeing in the pipeline that exists in Q4, that at the current time, we're not ready to give guidance for next year, but we expect some modest level of organic growth in the upcoming year.

And it's not going to be in our normal range, right now. But it's what our expectations are, and we're not ready to guide. And there are some areas that really do matter: education, healthcare are two verticals that matter to us, and they remain pretty solid. So they're examples of things that are very different than some of the areas of the economy.

Since we are, at least our base business is, very tied to GDP. Global GDP estimates for next year are improved versus this year, which should give us a little bit of bump, too.

You can see, Bhupender, our range around Q4 organic is pretty broad. It's 1% to 5%, and there's a reason for that. We do expect growth, and that will certainly have an impact on what our thoughts are as we give -- we typically would give guidance for next year later in February. But how we finish, and the way next year starts is going to matter to next year

I think one of the important things for all of you to notice, as I said before, we have no compromised of our growth initiatives, right? So if we get a little bit of economic tailwind, all of those things are in place, and we will take full advantage of them, and they should give us nice leverage. We feel that everything within our control is working just fine, and we just need a little bit of economic tailwind.

Right. Okay that's good.

Just one more, last question here, on Walmart, that's one of your biggest customers. They recently announced, I don't know if you saw, their capital spending plan, about $11 billion, and they talked about closing retail stores, and putting some more efforts on the e-commerce side, so they would be opening more distribution stores. How do you think about that? When these brick-and-mortars -- they want to compete with companies like Amazon, opening distribution. I think it's a good thing for Tennant, right?

Yes. Certainly the closing of retail spaces, we have to do things to off-set it. It's one of those times where you're glad you're diversified in many different vertical markets. And we do pretty darn good in the distribution world. So, as the world goes more online, I can't say we can offset every dollar of concern in retail sites, but we sell a lot of equipment into the distribution world, and that's a nice vertical for us, and always has been, and continues to be.

The thing is, they may not have as many distribution centers, but it would be large facilities, and they also by the higher-end industrial equipment that we sell. So, from a price-point, selling into them, it does benefits us.

Okay. Thank you guys.

You're welcome.

(Operator Instructions)

Marco Rodriguez, Stonegate Capital Markets

Good morning, everybody. Thank you for taking my questions.

Our pleasure, Marco.

I wanted to follow up on one of the prior questions, on the productivity issues with the skilled labor here in the quarter. I'm not sure I fully understood. Were those laborers poached, if you will, from a competitor? Or, need a little more color on what happened.

Marco, our business model in the factors, is that we flex the factories with temporary labor. So we have a baseline of permanence, and then during certain times of the year we flex with temporary labor, and have been very successful with that business model overtime.

This is really the first time it has not worked the way we anticipated, in two ways. One, it was difficult to find the number of temporary people that we needed. And what we're finding, is that the quality is lower than what we have experienced in the past. So they come on board, we try to train them, they are just not up to snuff.

So it was a double whammy. Fewer people we'd bring in, and then for every 10 people that we did bring in, we had a slower or a lower hit rate than we had historically.

We hadn't anticipated those things. We now realize this is probably going to be an ongoing issue --it's not going away. Everything we read says other manufacturers are experiencing the same. So we are revamping how we go after this temporary labor and how we train them. And as Tom mentioned, I think, that we are being much more proactive and aggressive in bringing robotics into the plants.

We are already beginning to install robotic welders, because that's a key skill area that is in short supply. And we have our first two robotic welders in the plants now. They're not fully up to speed, they should be soon. And we may have to bring on a few more in the future. But that's another thing that's going to help us mitigate the problems regarding labor in the years to come.

Got you. Very helpful. And in this any way you might quantify the impact to the quarter from a revenue standpoint? And how much of that bleeds into Q4?

Yes. To give you a directional piece of it. We did comment on the productivity issue, but so far as the revenue impact, what I would say is, if we would have finished the quarter, in Q3, at a normal kind of open order position, we would've seen modest organic growth in the quarter. So it was material. And it's why we have a 24% increase in our open order position as we enter the quarter.

So, it did have a material impact. Some of that was productivity related, and some of the lower gross margins was lower revenue, too. But it's mainly around productivity, and we expect to be back in range in Q4. And, as we said, we do expect organic growth to return.

Got you. Helpful. And I was wondering if you could talk a little bit more about the Dofesa acquisition? Maybe if you could compare and contrast that with the acquisition that you made to enter Brazil?

Sure. There are some similarities. One of the differences in Dofesa is, we've been partners for over 40 years, so we have a deeper, longer relationship. In this case, though, we really were buying the distributorship. We're buying the people, predominately sales people and service folks. And the brand, certainly is important.

In Alfa, we primarily did the acquisition to get sales and service coverage, but along with it, we also got a great management team. We got a brand, in Alfa, that we continue to operate, both the Alfa brand and the Tennant brand on our equipment.

And we got a factory. So it's a bit different. We're buying a peer distributor. But we do believe that we're bringing in really good people and it's a nice platform. That we're going to be far more aggressive in investing to drive off of that platform. So similarities, but some key differences.

One of the real beauties, is the person that came with the Alfa business that was a general manager there, now runs our entire Latin American operation, as he was integral in bringing on the team of Dofesa, and is instrumental in bringing that deal on board. And we're really thrilled to have Sandro running the whole Latin America business for us.

Got you. Last quick question, we'll jump back in the queue. Just an update here on your guys' thinking on capital allocation. I know you kind of mentioned it in your prepared remarks. Maybe you could just talk about, given what your stock price is now, ranking your R&D spend, additional acquisitions, and stock buyback?

What I would say is, we won't compromise our R&D spending. Expect us to continue to spend a rate of around 4% of revenue. We will protect our growth initiatives, and the components of R&D are critical to that. Our dividend is protected -- we're going to protect our dividend. You might expect to see a dividend increase here in the future. Can't commit to that.

And we will buy back stock at the prices that make sense. We will continue to evaluate, while we remain organically focused, we will continue to evaluate acquisitions. Don't expect anything real soon, we're digesting the two that we did. But we do have a pipeline, and we are evaluating. So we would love to do some future deals after we've digested and had success with the two that we have

Got you. Thank you guys -- very helpful.

Are pleasure.

You're welcome

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

Thanks, Sean.

We remain committed to investing for growth, but with disciplined spending. We continue to believe that Tennant is competitively advantaged with attractive growth prospects, in a stronger global economy. In the short-term, we remain vigilant on controlling costs and enhancing productivity across the organization, while making targeted investments to reach our goal of $1 billion in organic sales, and a 12% operating profit margin.

We look forward to updating you on our 2016 fourth-quarter and full-year results in February of 2017. Thank you for your time today and for your questions. Take care everybody.

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