Tom Paulson - Senior Vice President and Chief Financial Officer Chris Killingstad - President and CEO Jim Stoffel - VP of Global Planning & Analysis Thomas Stueve - VP and Treasurer Andy Cebulla - Vice President, Finance and Corporate Controller Jeff Cotter - Senior Vice President and General Counsel.

Chris Moore - CJS Securities Marco Rodriguez - Stonegate Capital Jon Fisher - Dougherty.

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..

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 will cover the financials. After that, we will open it up for questions. We are 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 three 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 non-recurring 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 nine 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..

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 pursed expansion through acquisition.

Building on our other recent acquisitions, acquiring IPC has further built 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 products 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 continued to perform here.

As we continue to work through this transitional period for Tennant, we remain confident that we are creating the foundation for a long term success. Turning to the quarter. For the 2017 third quarter, 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 that both our reported and adjusted EPS in the quarter reflect the impact of accelerated amortization for IPC in tangible assets. Tom will explain more about this non-cash 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 continued 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 it the right way with respect for IPC's culture and prioritizing synergies that are mutually beneficial.

I recently travelled 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 address a larger portion of the overall market.

In terms of go-to-market approach IPC sells to distributors while Tennant sells direct. This combination of channels and compatible products 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 cost to achieve these synergies.

Moving on to some of our challenges in the third quarter. Sales in the Americas region saw a 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 in 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 backed 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 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 of 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 as true for the i-mop.

The i-mop is a micro-scrubber that is ideal for small spaces in market segments like convenient stores and quick-service restaurants, portions of the market where Tennant has historically been under-represented.

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 the T350 are excellent examples of how Tennant is moving into promising new market segments and product categories with offerings that we believe will set the performance standards. As we move forward with our integration of IPC Group, we intend to share more about their new product release and pace.

We are optimistic about our new product pipeline as we head toward 2018 and the ability of our development team to keep Tenant and our customers on the forefront of 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 our sales 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 appropriate 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.

Tom?.

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 would like to open up the call for any questions. Chris..

[Operator Instructions] Your first question comes from Chris Moore of CJS Securities. Your line is open..

Obviously lots of moving pieces. Maybe you could do this. 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 and which are still kind of be ongoing. You mentioned by the end of Q2 you'd like to get the gross margin back to 43% to 44% range.

What else it can happen between now and then? Is the IPC integration done? Can you kind of – just you might help to compare and contrast..

Yes, what I would say, Chris, is that our anticipation is -- first of all, we hope for being conservative as we're 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 as the initiatives that we've executed will be firmly in place and will be back performing within our guidance range of 42% to 43%, which is adjusted for lower gross margin in the IPC business.

We also believe that we 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 to the half way point of next year..

And the other thing that I would add is just 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 and 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 completely stabilized the automation initiatives. Remember there is a 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 the full benefits of both of those. But they are 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 of manufacturers are struggling to find qualified labor, and once again in the third quarter, we struggled mildly.

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 or training policies in the way we are going to reward people once they come onboard 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. Right now it's less than 10%.

But there it takes some time for the new employees to ramp up and get to the productivity levels that 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 are taking at January 1, and we are also aggressively pursuing a cost of goods reduction initiatives. And those are in the early phases and I think will 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 this al happened.

We have very specific initiatives under each of the areas that we are executing against that should deliver those kind of results..

Price increases, that's normally only done on an annual basis or it’s 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 up fine.

In reality, in the environment we are in, it's far easier to justify price increases as people are seeing inflation in many instances. And while we are not -- we consider taking pricing early.

We made the decision that was better to wait and let things fully develop and we are comfortable 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 our early days, but we feel good about the ability to take price..

Can you just -- you guys are in good shape.

In terms of the debt covenants covered rate, 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 were actually ahead of target. We paid down all -- we can 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 are in.

And as we look out to next year, we don’t see anything out in front of us that’s not going to allow us to continue to be on target or ahead of target. So we are well within any kind of -- we have no issues and any covenants or any issues at all on the debt side.

So we are – it’s not to be a core attention, we're still very focused on payment down, we are in the really solid shape..

Our next question comes from Marco Rodriguez of Stonegate Capital. Your line is open..

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, aside from the automation aspects.

So can you talk a little bit more about what sort of has changed from the last quarter when we discussed it to today that caused the rather different changes, if you will?.

Actually there is really no change. And I mean, in that we haven't seen any new issues come onboard during Q3 that we didn’t experienced in Q2. We just didn’t make as much progress really in all three areas. In the issue of servicing efficiencies we made progress, but not as much that we'd like to have.

To your specific question, in two factor 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 levels of improvement that we anticipated in Q3. We do expect we will be fully back on track as we get into 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 determined not to take pricing early, but we did see more inflation.

But other than that no new issues came onboard and we still feel we're doing the right things and we will get back into our normalized gross margin range..

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

Mark, I mentioned the labor situation in our U.S. plants, and they are the two biggest plants by far have material impact on our results. As I said, we're 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 onboard 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 two robotic welders.

I think it took us -- taken 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 in the second -- on the second shift in the third quarter. And we didn't -- we kind of stabilized our first shift operational robots.

I think as we go into the Q4, second shift has now stabilized, but we also have to have them running 24/7, 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 cost us a lot more money.

So that's also driving some of the negative variants that’s impacting our gross margins. As Tom said and as I said before, we're making good progress in all these. We hope we're being conservative in 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 end of Q2 is when we feel very comfortable, but we're going to do everything in our priority to get there earlier..

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

It's the new. And then we decided -- they would come in and you spend a week trying to train them and then if you are gone because they went at some place that offered them another buck and a half. So you have a lot of disruption to the factories when that happens..

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

We made a simplifying assumption. As you know, 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 to assume that we amortize on a straight line basis, so an equal amount every quarter across the period of time.

And we knew there was a chance, we might have to change from 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 transactions.

It's completely non-cash. It has no impact on taxes. It's just -- it just looks – it makes GAAP earnings look unusual and that's why we are going to – yes, that's why we are going to talk a lot more about EBITDA. So it's completely timing related and that has no impacts on the cash flow of the business, what so ever.

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 coming 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 the why not to go ahead of little bit -- ahead of time like in this quarter?.

Yes, what we made a determination that -- we have taken pricing at the beginning of the year already, and we felt that it was just try to implement a midyear price increase when it wasn’t been in the normal timing.

And also we wanted 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 as we are in front of a customer now to justify the level of price that we’ll take in January and then lastly you armor sales organization to show that the pricing is just viable. 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 in that regard, to be honest with you..

And there’s really no historical precedents for this – for players in this industry taking more than one annual price increase, not only monitor the competition facing the same issues than 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 lead being expensive. So we took surcharges on batteries to help cover those cost.

So even we think something has gone up high enough on a specific component, we do sometimes do that, but we have never taken a price increase outside of our normal schedule. .

And last quick question and I'll jump back in queue. You guys have called out some of the 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 obtain that sort of, I guess, data? And then also your kind of like your level of confidence that those are going to actually start to return?.

I'd say that if you look back at the last five years, one of our key growth drivers has been strategic accounts. We reorganized against strategic accounts in North America and it's 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 strategic accounts tend to order on two to three to four year intervals. They have that cycles, and we're getting -- and we're at this point now where there's 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 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 two. And it's been pushed out of the third quarter into the fourth quarter. We do still anticipate that we will learn of winning these bids in this quarter.

But the fact is is that we have built volume to the third quarter into the fourth quarter that we no longer will see, so we're going to start ramping these ones -- these deals up in the first quarter of next year most likely. But they're 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'd like because it might be a two- or three-year timeframe that they're ordering against. The way we want to get it right, they're willing to negotiate a bit longer. We're a bit more impatient, but we also want to make sure we get to the right price.

But winning these bids is, it does matter to the business over as long as a two- to three-year timeframe. So it's important to get it at the right price and we’re will 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 Fisher of Dougherty. Your line is open..

A couple of questions on some topics that have already been touched on, we'll start with price.

Just given the negative organic growth in Asia and the negative trends in the Americas and just kind of soft trends last fiscal year, is the demand environment such that you can actually get -- I think as you described it significant price increase through, especially if -- and you can correct me if I am wrong, but I think you also said that your competition did not take price this year, so…..

No, they – yes, the whole industry did take pricing this year, John, so we were similarly pricing.

And we've actually gotten some level of pricing benefit in a relatively low inflationary environment in the three 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 we -- in the back half I wish we were bit higher.

But when I say meaningful price increase, 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 at it presents opportunities ideally to not only keep margins flat but actually to expand margins over a period of time..

Yes, but what we were saying is that the competitions didn’t take another price increase out of sequence, they will also be….

We believe and you never known until it happens that the industry will likely take pricing together. But until that happens, you don’t 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 supports getting 1.5% to 2% instead of 0.5% to 1% or maybe 0 to 0.5%?.

We believe so and we will 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 ducktails. Just looking at organic growth and 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 two quarters of negative organic growth. Asia, you’ve put a 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 recently Americas in fiscal '15, and I'm just wondering how do you counter the argument that maybe in fiscal '14 and '15 you fold demand forward to get those big organic sales growth years.

And if you've got product that lasts five to six years, I mean it could be fiscal '19 or fiscal '20 before that product technically needed to be replaced in these organic growth issues could persist for another year or year and a half?.

There are definitely cycles, but the two 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 are 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, two to three years of consistent sales coming from those contracts to get us back on track. So the underlying direct and distribution is often times the key indicator if they have a problem, the demand in the marketplace because that's where it shows up first.

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 totally different issue.

I think the demand is there in most of their key countries, accept maybe Koreas right now, but we have, and we've talked about this, reorganized our management team almost across the board all of the key countries over the last two 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 whether you now have the ability to start driving organic growth and get to a more sustained trend in that regard. So two very different issues.

There is not a market demand problem in Asia Pacific, it's just the way I think we were lead and the way we were structured. But those things have been resolved and should deal 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 prefer not to go there. What we can say is it.

It has meaningfully shifted and has been our largest source of growth over the last five years, but it's also -- and I one of the reasons I'm hesitant is the definition of a strategic account is -- it's not purely defined, it's just large customers and somewhere we can move easily from been a normalized customer to a strategic account based on the way we penetrate.

So it's a -- 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..

All right. 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 the continued revenue growth from both our core Tennant business and IPC.

We are also focused on initiatives that will get gross margins back to a 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. So thank you for your time today and for your questions. Take care, everybody..

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