Tennant Co (TNC) 2017 Q3 法說會逐字稿

Good morning, my name is Chris, and I will be your conference operator today. At this time, I would like to welcome everyone to Tennant Company's Third Quarter 2017 Earnings Conference Call. This call is being recorded. There will be time for Q&A at the end of the call. (Operator Instructions) Thank you for participating in Tennant Company's Third Quarter 2017 Earnings Conference Call.

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

Thanks, Chris. Good morning, everyone, and welcome to Tennant Company's Third Quarter 2017 Earnings Conference Call. I'm Tom Paulson, Senior Vice President and Chief Financial Officer of Tennant Company. Joining me today are Chris Killingstad, Tennant's President and CEO; Jim Stoffel, Vice President of Global Planning and Analysis; and Tom Stueve, Vice President and Treasurer.

I also want to take a moment to welcome 2 very talented additions to our team; Andy Cebulla, who is with us today on the call, joins us from MTS Systems as Vice President of Finance and Corporate Controller. We also want to welcome Jeff Cotter, who joins us from G&K Services as Senior Vice President, General Counsel and Corporate Secretary. We appreciate the breadth of experience and knowledge they bring to our team.

Today we will review progress on our core strategies, Tennant's performance during the 2017 third quarter and our outlook for the full year. First, Chris will brief you on our operations and then I'll cover the financials. After that, we'll open it up for questions. We are using slides to accompany this conference call. We hope this makes it easier for your review our results. A tape 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 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 filed with the Securities and Exchange Commission. We encourage you to review those documents, particularly our Safe Harbor statement for a description of the risks and uncertainties that may affect our results.

Additionally on this conference call, we will discuss non-GAAP measures that include or exclude special or nonrecurring items. For each non-GAAP measure, we also provide the most directly comparable GAAP measure. There were special non-GAAP items in the third quarter and first 9 months of 2017. There were no special non-GAAP items in 2016. Our 2017 third quarter earnings release includes a reconciliation of these non-GAAP measures to our GAAP results. Our earnings release was issued this morning via Business Wire and is also posted on 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. Tennant Company is still in an important period of transition and I'd like to take the opportunity to expand on how we're continuing to strengthen Tennant as we move into the fourth quarter. Tennant Company has been pursuing a strategic framework for the last several quarters, intended to further strengthen our organization, so it can continually deliver value for our customers and shareholders, as well as remain stable amidst challenging end markets. This quarter is no different and I want to walk you through the goals we're pursuing and the progress we've made.

Our multiple overlapping initiatives include maintaining a robust new product and technology pipeline that meets customer needs, both existing and new; promoting revenue diversification and improving Tennant's scale in a low-growth environment; minimizing expenses to optimize operating efficiency; and improving our financial strength through solid cash flow and debt reduction, which better allows us to invest for growth. Within this framework, we are pursuing specific strategies that have resulted in important progress against goals.

First, we have pursued expansion through acquisition, building on our other recent acquisitions. Acquiring IPC has further build out our geographic reach and our ability to address a broader cross section of the market through a greater penetration of key customer segments, a wider product platform and improved go-to-market capabilities. Overall, I am very pleased with our efforts to improve in these strategic areas through acquisition.

Last quarter, we detailed our restructuring efforts to better utilize and align our resources for growth and efficiency. While this was the right thing to do, it has resulted in some gross margin pressure in the near term. We anticipate progress on gross margin recovery in the fourth quarter on a sequential basis, but we clearly have more to do.

Finally, our new product introductions continued to be successful. Innovation has always been an area of intense focus at Tennant and we continue to perform here. As we continue to work through this transitional period for Tennant, we remain confident that we are creating the foundation for long-term success.

Turning to the quarter. For the 2017 third quarter, our overall consolidated net sales grew 30.9% to $261.9 million, reflecting the contribution from IPC. On an organic basis, sales grew 1.3%. Adjusted net earnings totaled $0.32 per share. Please keep in mind that both our reported and adjusted EPS in the quarter reflect the impact of accelerated amortization for IPC intangible assets. Tom will explain more about this noncash adjustment a bit later.

As you saw in today's earnings release, Tennant just concluded a quarter with mixed results. We returned to organic revenue growth, but continue to face gross margin challenges. On the positive side, this is our first full quarter with IPC, and IPC's strong performance from the second quarter continued with sales growing 5% organically year-over-year. Our integration efforts are on track and I'm pleased to say that we're doing at the right way with respect for IPC's culture and prioritizing synergies that are mutually beneficial. I recently traveled to several of our IPC facilities to get to know the people and the culture and there is considerable enthusiasm for being part of the Tennant family. I am impressed with the people and IPC's management team and pleased with our ability to retain all key players. We believe these factors have provided and will continue to provide positive momentum in the business. As a reminder, Tennant and IPC are highly complementary and attractively differentiated in terms of our geographies, products and go-to-market approach.

Geographically, 80% of IPC's sales are in Europe, which significantly expands our market presence in EMEA and enhances our scale. We are particularly pleased with our ability to stay focused on broad sales execution in EMEA on the heels of this transaction. Our core Tennant business in the region posted a 14.6% organic growth rate during the third quarter. In terms of products, IPC offers a strong mid-tier value proposition and its brands are known for quality and performance. Together with Tennant's premium brand, we are address a larger portion of the overall market. In terms of go-to-market approach, IPC sells through distributors while Tennant sells direct. This combination of channels and compatible product categories gives us more opportunities for cross selling.

Our forecast of $10 million in run rate synergies across our cost of sales and selling and administrative expenses is unchanged and we remain committed to achieving these in 2019 in the categories of sourcing, improved sales and service capabilities and operating scale benefits. In fact, we believe there may be more than $10 million in obtainable run rate synergies. We also believe that there are potential tax synergies to be realized through tax planning and entity reorganization activities. Please keep in mind that we expect to incur $10 million of costs to achieve these synergies.

Moving on to some of our challenges in the third quarter. Sales in the Americas region saw continued softness, which we attribute to the timing of key strategic account orders. We are optimistic about our pipeline here and expect the timing of sales and this important customer category to correct itself in the near term. In addition, we saw some ongoing gross margin headwinds as a result of our restructuring, manufacturing automation efforts and material cost inflation. The temporary inefficiencies that we are seeing in our service organization and our plants continue to impact our gross margins. While we are seeing early signs of improvement, particularly in service as we reduce open trucks and get back to the right staffing levels, manufacturing inefficiencies and material cost inflation will take longer to work through, as we stabilize our staffing levels in U.S. plants, ramp up benefits from our manufacturing automation initiatives and offset inflation with price increases and the cost of goods reduction initiatives. We are eager to move past these challenges, and we believe our gross margin improvement initiatives will get Tennant back to a more normalized gross margin profile of 42% to 43% by the end of the second quarter 2018.

Turning now to new products. Innovation and a regular cadence of new product introductions are essential to our success. We remained on track with our product launches in the third quarter and our vitality index is at 47%, which far exceeds our target of 30% and indicates that our customers are excited about and engaged with our products. We had one major product launch in the third quarter, the T350 Stand-On Commercial Scrubber. This scrubber is an ideal choice for large or obstructed spaces because of its high-productivity rates and excellent maneuverability. It is exciting to enter the stand-on scrubber product category with an offering like the T350 that we believe is best-in-class and that will drive significant incremental sales. The same is true for the i-Mop. The i-Mop is a micro scrubber that is ideal for small spaces in market segments like convenience stores and quick service restaurants. Portions of the market with Tennant has historically been underrepresented. We introduced the i-Mop in the second quarter and it has been well received, winning praise from industry associations, and thus far, we have been pleased with the sales performance of this new offering. Both the i-Mop and T350 are excellent examples of how Tennant is moving into promising new market segments and product categories with offerings that we believe will set performance standards.

As we move forward with our integration of IPC group, we intend to share more about their new product releases and pace. We are optimistic about our new product pipeline as we head toward 2018 and the ability of our development team to keep Tennant and our customers on the forefront of the innovation. As we move toward the end of 2017, we remain confident that we are moving down the right strategic path and have the right focus. We continue to concentrate on our integration with IPC which is ahead of plan. Our emphasis on new product innovation remains at the forefront. Operationally, we believe our efficiency initiatives will ultimately return us to our historical margin profile and we remain dedicated to building our financial strength through continued solid cash flow and debt reduction.

We are also committed to benchmarking ourselves based on metrics that are more relevant in light of our current earnings profile. We intend to move from operating income as a key performance metric to EBITDA. We believe this will provide a more normalized and appropriately lens through which to evaluate our operating performance. We currently anticipate we will provide near-term and long-term revenue and EBITDA targets in conjunction with our 2018 guidance.

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

Thanks, Chris. My comments today references the earnings per share are on a fully diluted basis except for the 2017 year-to-date results, which were calculated with the basic weighted average shares outstanding due to the as reported net loss. Note that our financial results in 2017 include the financial performance of IPC Group , which was acquired at the beginning of April 2017.

For the third quarter ended September 30, 2017, Tennant reported net sales of $261.9 million, increased 30.9% compared to sales of $200.1 million in the 2016 third quarter. Organic sales increased approximately 1.3% excluding a favorable foreign currency exchange impact about 1.2% and the impact of the August 2016 Florock acquisition and the April 2017 IPC acquisition that increased net sales by 28.4%.

The third quarter 2017 net income was $3.6 million or $0.20 per share. Tennant reported adjusted net earnings of $5.8 million or $0.32 per share. The as adjusted results in the 2017 third quarter excluded 2 special items the total the charge of $3.1 million pretax or $0.12 per share. Both the as reported and as adjusted earnings reflect $7.3 million or $0.29 per share of amortization expenses related to the IPC intangible assets. The special items were $0.9 million pretax or $0.03 per share for acquisition costs related to the IPC acquisition and $2.2 million pretax or $0.09 per share for the IPC acquisition related inventory step-up flow through. In the year-ago quarter, Tennant reported net earnings of $11. 5 million or $0.64 per share.

Turning now to more detailed review of the 2017 third quarter. Our sales are categorized in the 3 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, 2017 third quarter sales increased 5.7%, but declined 0.2% organically, excluding the 5.5% impact of the Florock and IPC acquisitions and the favorable 0.4% foreign currency exchange impact. Sales in the Americas reflect in organic sales decline due to softness and strategic accounts, which we attribute to timing of deals. However, we were encouraged by sales in our direct and distribution channels and demand for new products, particularly the M17 Sweeper-Scrubber. Organic sales in Latin America also grew in the 2017 third quarter, as we continue to have strong sales growth in Mexico. In September of 2016, we acquired our long-time distributor of Mexico. However, the incremental revenue impact in the quarter was not material. This is an important emerging market for us and we remain confident about its long-term growth prospects.

In EMEA, sales in the 2017 third quarter increased 169% and increased approximately 14.6% organically, excluding the favorable foreign currency impact of about 5.7% and the impact of the IPC acquisition of 148.7%. Solid sales performance in the Western European countries offset softer sales in the Central Eastern Europe, Middle East and Africa markets.

In the Asia-Pacific region, sales increased 18.9%; however, declined 8.5% organically, excluding a favorable foreign currency impact of about 0.4% and the impact of the IPC acquisition of 27%. Softer sales in China, Korea and Southeast Asia were partially offset by sales gains in Australia. Tennant's gross margin for the 2017 third quarter was 39.9% and the as adjusted gross margin excluding the $2.2 million IPC acquisition-related inventory step-up flow-through was 40.8% compared to 42.6% in the prior year quarter. The as adjusted 180 basis point decrease includes the 68 basis point dilutive impact of the IPC acquisition and the remaining decline in gross margins primarily reflects 32 basis points from a higher mix of the EMEA region sales, raw material inflation, which reduced gross margin by 26 basis points and continued field service productivity challenges related to organizational changes from the restructuring, the near-term unfavorable impact from investments and manufacturing automation initiatives, which combined and negatively impacted gross margins by 54 basis points.

As Chris mentioned, we are anticipating improvements in these factors and we are committing to improving our gross margins. We expect to see the initial stages of recovery in the fourth quarter with gross margin improving approximately 40 basis points above third quarter margin rates and back into our 2017 full year gross margin rate guidance range of 41% the 42%.

Research and development expense in the 2017 third quarter totaled $7.9 million or 3% of sales, versus $8.4 million or 4.2% of sales in the prior year quarter. We continue to invest in developing the robust pipeline of innovative new products and technologies that Chris noted.

Selling and administrative expenses in the 2017 third quarter were $85.7 million or 32.7% of sales and as adjusted was $84.8 million or 32.4% of sales. S&A in the third quarter of 2016 was $60.6 million or 30.3% of sales. The 2017 third quarter S&A expense also included $23.4 million of IPC and S&A expenses, including $7.3 million of noncash amortization costs. In our second quarter results, we had a preliminary purchase price allocation and apply a straight-line method of amortization. During the third quarter, we made significant progress towards the finalization of intangibles created through the acquisition. Although the valuation on the intangible assets are still preliminary, we do not anticipate any significant changes. In addition, as we made this progress, we also revisited the method of amortization and have determined that an accelerated amortization method is more appropriate. The impact of this change was to record a catch-up adjustment in the third quarter of $2 million and record higher levels and amortization of third quarter of $5.3 million for a total of $7.3 million in the quarter. Excluding IPC, Tennant's expenses as a percent of sales would have been 30.2% or 10 basis points below last year. We continue to balance discipline spending control with investments in key growth initiatives.

Given the adjustments in our 2017 third quarter, I'd like to discuss our operating margin from a few different perspectives to help of clarity. On a GAAP basis, our 2017 third quarter operating profit was $11 million or 4.2% of sales. When adjusted to exclude both the IPC acquisition related inventory step-up flow-through in cost of goods sold and the one-time acquisition costs and S&A expense, our operating profit was $14.2 million or 5.4% of sales. Looking at the core Tennant business, excluding the operating profit or loss related to IPC, Tennant's operating profit was $16.7 million or 8.1% of sales, compared to an operating profit of $16.3 million or 8.1% of sales in the year ago quarter. Included in 2017 third quarter results, our amortization costs related to the IPC acquisition that I previously mentioned, the additional noncash amortization expense in the quarter negatively impacted operating profit margin by 280 basis points.

Amortizing the noncash IPC intangible assets more rapidly does not change our positive outlook on the acquisition. IPC continues to perform well and we remain on track with respect to the integration efforts. It does however require us to revisit timing of accretion. Our prior guidance indicated that the acquisition would be accretive to earnings in 2018. However, with the incremental annual amortization costs of approximately $12 million in 2018, we now believe that it will be accretive in earnings in 2019. Excluding the amortization costs, we believe the acquisition will be accretive in 2018 and is ahead of our original acquisition model from a return perspective.

As we mentioned in the last quarter, we are now providing an EBITDA calculation on our non-GAAP financial table. Our 2017 third quarter adjusted EBITDA was $28 million or 10.7% of sales. Adjusted EBITDA in the prior year quarter was $20.7 million or 10.3% of sales. We believe that EBITDA as a better measure of our performance, particularly with the high amount of noncash amortization expense and we'll remain committed to expanding our operating profit margin by successfully executing our strategic priorities and assuming the global economy improves. In order to see this target, we need to drive organic revenue growth in the mid-to-high single digits, hold the fixed cost essentially flat in our manufacturing areas as volume rises, strive for 0 net inflation at the gross profit line, standardize and simplify processes globally to continue to improve the scalability of our business model, while minimizing any increases in operating expenses.

We continue to successfully execute our tax strategies. Tennant's overall effective tax rate for the 2016 full year was 29.9%. The overall effective tax rate for the first 9 months of 2017 was 26.9%, excluding the special items. Capital expenditures totaled $7.1 million in the third quarter of 2017, compared to $7.7 million in the third quarter of 2016. Given our current results, we are tightly managing capital spending. The spending reflects our continued planned investments in information technology projects, tooling related to new product development and manufacturing equipment.

Tennant's cash from operations for the third quarter was strong at $34.6 million, compared to $20.8 million in the third quarter of 2016. In the third quarter, we repaid $22.8 million of our debt, reducing the total to $388.5 million as we focused on cash generation from the business and reducing outstanding debt. The $388.5 million of outstanding debt at the end of the third quarter was comprised of $300 million of senior unsecured notes, $75 million outstanding of $100 million term loan, $20 million outstanding under the revolving credit facility, $0.6 million related to capital leases and an offsetting $7.1 million of debt issuance costs yet to be amortized. The overall weighted average cost of debt net of a related cross-currency swap instrument is approximately 4.2%.

Regarding other aspects of our capital structure. Tennant increased the quarterly dividend to $0.21 per share, effective December 2016. We paid cash dividends of $14.3 million in the 2016 full year and $11.2 million in the first 9 months of 2017. Reflecting our commitment to shareholder return, we're proud to say that Tennant has increased the annual cash dividend payout for 45 consecutive years.

Moving to our outlook for full year 2017. As Chris stated, the global macroeconomic environment still merits caution. Further, the combination of slower-than-anticipated progress on field service and manufacturing challenges we face and the acceleration of amortization expense for the IPC acquisition, will place continued pressure on earnings in 2017. Therefore, we are reaffirming our full year sales guidance range and lowering our full year earnings guidance. We continue to estimate 2017 full year net sales in the range of $960 million to $990 million, up 18.7% to 22.4% or up approximately 1% to 2% organically for the full year, assuming an unfavorable foreign currency exchange impact on sales of approximately 0% to 1% and additional 16.7% to 20.4% in organic growth from acquisitions. We now expect 2017 full year reported GAAP earnings in the range of $0.05 to $0.25 per share and expect 2017 full year adjusted earnings in the range of $1.50 to $1.70 per share.

The 2017 full year adjusted earnings exclude the following nonrecurring costs totaling $33.4 million pretax or $1.45 per share; $8 million restructuring charge or $0.32 per share; $9.4 million IPC acquisition costs or $0.52 per share, which includes anticipated additional spending in the fourth quarter; $7.4 million IPC-related financing costs or $0.26 per share; $8.4 million IPC acquisition inventory step-up or $0.34 per share; and $0.2 million pension plan settlement charge or $0.01 per share.

Previously, we expected 2017 full year GAAP earnings in the range of $0.85 to $1.05 per share and full year adjusted earnings in the range of $2.20 to $2.40 per share. As we stated earlier, the change in guidance is primarily related to the operational challenges that we continue to face, particularly the gross margin headwinds from our restructuring and manufacturing automation efforts, inefficiency in our service organization, and raw material costs, which accounted for approximately $0.37 per share of the decrease. The higher noncash amortization expenses also causing our guided range to decrease by approximately $0.33 per share.

Foreign currency exchange in 2017 is estimated to negatively impact operating profit by a range of approximately $0 million to $2.5 million or a negative impact of $0.00 to $0.10 per share. This is relatively consistent with our previous guidance. Our 2017 annual financial outlook includes the following additional assumptions; continued stable economy in North America, modest improvement in Europe and a challenging business environment in APAC, gross margin performance in the range of 41% to 42%, R&D expense in the range of 3% to 4% of sales, capital expenditures in the range of $20 million to $25 million and an effective tax rate of approximately 29%. Our objective is to continue to build our business for sustained success, both through organic sales growth and through acquisitions.

And now we'd like to open up the call to any questions, Chris?

(Operator Instructions) Your first question comes from Chris Moore of CJS Securities.

Obviously lots of moving pieces. Maybe could you just -- if you look at where you are now versus say mid 2018, I know -- trying to understand kind of what issues are likely to be resolved between now and then which were still going to be ongoing -- you mentioned by the end of Q2, you'd like to get the gross margins back to 43% to 44% range. What else can happen between now and then, is the IPC integration done, can you kind of might help to compare...

Yes, what I would say, Chris, is that our anticipation -- first of all, we hope we're being conservative as we are adjusting guidance, but we originally felt that we might get all the way back on track with our gross margin performance before we exited the year, but we thought it could very well go into Q1. Based on the progress we've made, we determined it's prudent to be more conservative, but we do feel that as we exit Q2, we will be back totally on track from a gross margin point of view and that the initiatives that we've executed will be firmly in place and we'll be back performing within our guidance range of 42% to 43%, which is adjusted for lower gross margins on the IPC business. We also believe that -- we'd hope the demand starts to improve, as we're starting to see some signs of that. IPC continues to perform really nicely and is ahead of target and we will begin to start to see a modest level of our integration benefits beginning to flow through the P&L as we get the halfway point of the next year.

And the other thing I would add, if you look at our service organization, I think we're making the best early progress there and our hope is that by the end of the year that they're back on stable ground in delivering the results that we expect from the restructured service organization and they deliver enhanced performance. On the -- in our plants, I think what we have now is that we've completely stabilized the automation initiatives, remember there are warehouse management system in our European facility and robotic welding in our Minneapolis facility and so they are now fully implemented, stable and we're starting to get the benefits, but it takes a while to ramp up before benefits of both of those, but they're in place, the problems are behind us, benefits are ramping up.

The other issue we have in our U.S. plants is that, and it's not just us, but most manufacturers are struggling to find qualified labor, and once again in the third quarter, we struggled mightily. If you look at the third quarter, I would say, we had on average probably 10% open positions throughout the quarter and we had over 30% turnover of the people that we did bring in. So what we've done there is that we have changed our compensation policies, our training policies and the way we're going to reward people once they come on board and gain skills. And we're already seeing that we are closing the open position gap and that open -- and that the turnover is way down, as a matter of fact, right now, it's less 10%. But there it takes some time for the new employees to ramp up and get to the productivity levels that we need for the factories to be running really well.

And then the final one is on material inflation, there we have a price increase, a significant price increase we're taking at January 1 and we're also aggressively pursuing a cost of goods reduction initiatives. Those those are in the early phases and I think we'll ramp up as we go through Q1 and Q2 of next year. So that's why we believe -- so, it's not just -- we're hoping that all happens. We have very specific initiatives under each of the areas that we're executing against that to deliver those kind of results.

The price increases, that's normally only done on an annual basis or just timing on...

Yes, that's typical, Chris. We would normally execute pricing around January and at times that will modestly change from that, but we intend to execute early right on time and so far we've just begun that process, it's actually going fine. In reality, in the environment we're in, it's far easier to justify price increases as people are seeing inflation in many instances, and while we're not -- we consider taking pricing early, we made the decision that it was better to wait and let things fully develop and we are comfortable that we'll be able to execute global pricing that will be more than adequate to cover the inflation that we're seeing in our business. So early days, but we feel good about the ability to take price.

Can you just -- you guys are in good shape, but in terms of the debt covenants coverage rates, where you are now and you don't anticipate any challenges in those in the future, do you?

We don't, and I mean, I'll let Tom add, if he wants to add anything, but we're actually ahead of target. We paid down over -- we're pleased we could pay down over $20 million in debt in Q3. We anticipate the opportunity to pay down even further as we are in the quarter that we're in. And as we look out to next year, we don't see anything out in front of us, it's not going to allow us to continue to be on target or ahead of target. So we are well within any kind of any -- we have no issues in any covenants or any issues at all on the debt side. So we're -- [it's not very close attention], we're still very focused on paying it down. We're in really solid shape.

Your next question comes from Marco Rodriguez of Stonegate Capital.

I was wondering if we could talk a little bit more about the, I guess, the gross margin impacts here, specifically on the manufacturing inefficiencies side from the automation aspects. So can you talk a little bit more about what sort of has changed from last quarter when we discussed this to today that caused the rather different changes, if you will?

Actually there is really -- really no change. And I mean in that -- we haven't seen any new issues come on board during Q3 that we didn't experience in Q2. We just didn't make as much progress really in all 3 areas in the issue of servicing efficiencies, we made progress, but not as much as that you would like to have. To your specific question, in 2 factories we've done major automation initiatives, and while we're stabilizing and we're beginning to see improvement, we didn't make anywhere near the level of improvement that we anticipated in Q2 -- Q3. We do expect we will be fully back on track as we get into the Q2 next year. And then the only thing that was really -- other than we were a bit slower making progress, we did see more inflation than we anticipated in the quarter. And we clearly -- we considered it, we determine not to take pricing early, but we did see more inflation, but other than that, no new issues came on board and we still feel we're doing the right things and we will get back into our normalized gross margin range.

And so in terms of just not making enough progress or not making the progress you guys had expect. I mean, what were the challenges there that caused that issue?

Marco, I mentioned the labor situation in our U.S. plants and they're the 2 biggest plants by far have a material impact on our results. And I said, we are running 10% open positions over the whole of Q3. We did not anticipate that would happen and we had over 30% turnover. So it wasn't until the end of Q3 that we initiated these new compensation policies, training policies and ability to reward people who come on board and gain skills. And we're seeing a dramatic improvement in our ability to attract and retain. And our hope is in Q4, we stabilize the workforce, we reduce the turnover and then it takes a while to really ramp them up and get them to the productivity levels that we anticipate. So that's one example. The other one is the robotic welders in plant 1. We have 2 state-of-the-art robotic welders. I think it took -- it is taking us longer to get all the parts kind of qualified on those robots. And so we're hoping that we will be fully staffed and up and running for -- in the second -- on a second shift in the third quarter and we didn't. We kind of stabilized our first shift operation on robots. I think as we go into Q4, second shift is now stabilized, but we also have to have them running 24x7, so a third shift is absolutely required. And until we do that, what happens is we need to outsource some of our fabrication, like as we don't have the capacity internally to handle it and that costs us a lot more money. So that's also driving some of the negative variances that's impacting our gross margins. As Tom said and as I said before, we are making good progress in all of these. We hope we're being conservative and how long it's going to take to ramp up and get back to the full benefits we expect and that's why we're saying the end of Q2 is when we feel very comfortable, but we're going to do everything in our power to get there earlier.

And just a clarification on the comments about the 30% turnover, is that the new employees that you're bringing on or is that 30% turnover you saw when you started to do the new efficiency project?

That's a new -- it's new and then we just set up, they would come in and you spend a week trying to train them and then [they're gone] because they went some place that offered them another buck and a half. And so you have a lot of disruption to the factories when that happens.

And then I was wondering if you could maybe talk about the accelerated amortization, not to get too far deep into the weeds, but just kind of what drove that process? What made the change? And then obviously that had a pretty big impact on your EPS guidance.

Yes. We made a simplified assumption. As you know, you do have 12 months to finalize your balance sheet and finalize your amortization methodologies. We took a simplifying approach in the second quarter and just assume that we amortize on a straight-line basis, so equal amount every quarter across the period of time. And we knew there was a chance, we might have to change for an accelerated methodology and when we went deep into the analysis of that, which is pretty complicated, it really lined up that we needed to accelerate and amortize faster. And it's important to note that it has absolutely no impact on the economics of the transaction, it's completely noncash, it has no impact on taxes, it's just -- it makes GAAP earnings look unusual and that's why we're going to talk a lot more about EBITDA. So it's completely timing related and it has no impact on the cash flow of the business whatsoever. But it is -- we would have never anticipated that it would be that big of a difference from straight line, but in reality, as we did the analysis it was and we needed to move forward on that basis.

And maybe if you could talk a little bit more just kind of come back here to the price increases that you guys are going to be taking a look at implementing in fiscal '18, maybe if you could talk a little bit about the decision making process there as to why not to go ahead a little bit -- ahead of time like in this quarter.

Yes, what we -- we made a determination that -- we had taken pricing at the beginning of the year already. And we felt that it was -- to try to implement a mid-year price increase and it wasn't the normal timing. And also we want to let things play out and be able to have a better sense of what was driving the inflation, which I think was a good decision in reality. Now we saw more inflation in Q3. We have better clarity. We've been able to do a far better job [front of customer now to] justify the level of price that will take in January (inaudible) sales organization to show that the pricing is justifiable. And so we think it was really a matter of having everybody be more educated and be smarter and execute on our normal timing and so that was really the thinking. And we stand by our decision on that regard to be honest with you.

Right. And there's really no historical precedence for players in this industry taking more than one annual price increase. And we monitor the competition facing the same issues that we are pretty much, did not take a price increase. What we do periodically is take, add a surcharge on for a specific item, for example, batteries this year, because of the led being expensive. So we took surcharges on batteries to help cover those costs. So when we think something has gone up high enough on a specific component, we do sometimes do that, but we've never taken a price increase outside of our normal schedule.

And last question, I'll jump back in queue. You guys had called out some of strategic accounts as far as having some I guess timing issues in the quarter. Can you maybe talk a little bit about that as far as how you obtained that sort of I guess data? And then also, you're kind of like your level of confidence that those are going to actually to return?

I say that if you look back at the last 5 years, one of our key growth drivers has been strategic accounts. We reorganized against strategic accounts in North America and has been extremely successful. We haven't really not lost a major strategic account deal for a long time now. Now what we know is, is that were strategic accounts tend to order on 2- to 3- to 4-year intervals in other cycles and we're getting at this point now where there is a lot of the contracts that are coming due. So we have great visibility to what they are, who they are and what the amount of business that can be generated from them. But what we've also learned is that with the big ones and the ones we're looking at now are some of our biggest; the bid or the confirmation of the bid can be pushed out a month or 2 and has been pushed out of the third quarter into the fourth quarter, we do still anticipate that we will learn of winning of these bids in this quarter. But the fact is, is that we had built volumes in the third quarter into the fourth quarter that we no longer will see, so we're going to start ramping these deals up in the first quarter of next year most likely. But they are significant, which is why we are confident that we'll get back on track with strategic accounts. And the pipeline beyond just those also looks pretty good.

It's also important to note that the strategic accounts at times will exhibit more patience than we would like, because it might be a 2- or 3-year time frame that they're ordering against. So they want to get it right, they're willing to negotiate a bit longer. We're a bit more inpatient, but we also want to make sure we get through the right price, but winning these bids it does matter to the business over as long as a 2- to 3-year time frame. So it's important to get at the right price and we're willing to sacrifice a little lower revenue in a quarter to get to the right place with our most important customers.

(Operator Instructions). Your next question comes from Jon Fischer of Dougherty.

Just couple of questions on some topics that have already been touched on, I'll start with price. Just given the negative organic growth in Asia and the negative trends in the Americas and kind of soft trends last fiscal year, is the demand environment such that you can actually go to I think as you described at significant price increase through, especially -- and you can correct me if I'm wrong, but I think you also said that your competition did not take price this year, so...

The whole industry did take pricing this year, Jon. So we were similarly pricing and we've actually gotten some level of pricing benefit in a relatively low inflationary environment the 3 years prior to 2016 and we did get, I would say, adequate levels of pricing this year for the first part of the year and in the back half, which we were a bit higher, but when I say meaningful price increases to, I don't want to overstate it. I mean, we would hope that we would get price stick in the 1.5% to 2% range and in a lower inflationary environment you might only get a price stick of 0.5% to slightly over 1%. So it's not -- we would say it's very justifiable, but getting 1.5% to 2% in our industry to stick is, that's higher than normal, but I do think you really do need to price in an environment where there is inflation, you combine that with running your factories well, it presents opportunities ideally to not only keep margins flat, but actually to expand margins over a period of time.

So what you're saying is that the competition didn't take another price increase out of sequence, they'll also be...

We believe and you never know until it happens that the industry will likely take pricing together, but until it happens, you don't know for sure.

But you are comfortable that the demand environment overall just based on the quarterly organic growth rates that I'm seeing from the company support getting 1.5% to 2% instead of 0.5% to 1% or maybe 0% to 0.5%?

We believe so and we'll be very conscious of where we take pricing. It does vary by component of our business, by geography, by the type of equipment, by the strength of our market position. So it's not unified across the board, I mean, it can change in various areas.

And then just kind of dovetails, just looking at organic growth, I just -- everything going on here domestically in the industrial world would just -- would indicate that the demand environment is good, strong and you've put up 2 quarters of negative organic growth; Asia, you've put up multiple quarters of negative organic growth and I can't help, but look at the big organic growth numbers that you -- that the company generated in fiscal '14 and at least in the Americas in fiscal '15. And I'm just wondering, how do you counter the argument that maybe in fiscal '14 and '15 you pulled demand forward to get those big organic sales growth here and if you've got a product that lasts 5, 6 years, I mean, it could be fiscal '19 of fiscal '20 before that product technically needs to be replaced in these organic growth issues could persist for another year, year and a half?

There are definitely these cycles, but 2 things, one, if you look at our direct business and our distribution business, which in many ways is more tied to GDP, they are performing really well. So the piece that is underperforming right now is strategic accounts, but what we're saying is, it's a delay in the orders from some very big potential deals and once those play out, then we should see, as Tom said, 2 to 3 years of consistent sales coming from those contracts to get us back on track. So the underlying direct and distribution is oftentimes the key indicator if we have a problem with demand in the marketplace, because that's where it shows up first. But the strategic accounts is more timing related, but we're actually coming into a pretty robust strategic account period here over the next year or so. So we're feeling good in the Americas.

You mentioned Asia-Pacific, there it's a completely different issue. It means that I think the demand is there in most of the key countries except maybe Korea right now, but we have and we've talked about this, reorganized our management team almost across the board in all the key countries over the last 2 years. That has now stabilized. We have new leaders and new leadership teams in place in places like China and Australia and we feel much stronger where we now have the ability to start driving organic growth and get to a more sustained trend in that regard. So 2 very different issues. There is not a market demand problem in Asia-Pacific, it's just the way I think we were led and the way we were structured, but those things have been resolved and should yield benefits going forward.

And then, one last question, can you tell me the split in the Americas between -- from a revenue standpoint between strategic accounts and direct distribution?

We have not historically provided that, Jon, and for competitive reasons, we would prefer not to go there. What we can say is it has meaningfully shifted and has been our largest source of growth over the last 5 years, but it's also -- and one of the reasons and has been is, the definition of a strategic account is -- it's not purely defined, it's just large customers and some one can move easily from being a normalized customer to a strategic account based on that way we penetrate them. So it's -- we're hesitant to do that for a few reasons.

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

Alright, thanks, Chris. Today, we believe Tennant is well positioned strategically and operationally, despite our quarterly challenges. As we close the quarter, we are looking ahead to continued revenue growth from both our core Tennant business and IPC. We are also focused on initiatives that will get gross margins back to our stated range of 42% to 43% by the end of the second quarter in 2018. Lastly, we are creating an outstanding relevant product portfolio for our customers and continuing to drive strong cash flow and debt management that will deliver improved value to our shareholders. We look forward to further updating you on our strategic progress and our 2017 year-end results in February. Thank you for your time today and for your questions. Take care everybody.

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