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Executives

Tom Paulson – VP and CFO

Chris Killingstad – President and CEO

Analysts

Ted Kundtz – Needham & Company

Joe Maxa – Dougherty & Company

Tennant Co. (TNC) Q2 2010 Earnings Call Transcript July 30, 2010 11:00 AM ET

Operator

Good morning and thank you for participating in Tennant Company's second quarter earnings conference call. This call is being recorded. If you do not wish to participate, you may disconnect at this time. After the speakers' remarks, there will be a question-and-answer session. (Operator instructions)

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

Tom Paulson

Thanks, Amanda. Good morning, everyone and welcome to Tennant Company's second quarter 2010 earnings conference call. I'm Tom Paulson, Vice President and Chief Financial Officer of Tennant Company. With me on the call today are Chris Killingstad, Tennant's President and CEO; Pat O'Neill our Treasurer and Karen Durant, our Corporate Controller.

Our agenda today is to review Tennant's performance during the second quarter and our outlook for 2010. 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.

Before we begin, please be advised that our remarks this morning and our answers to questions may contain forward-looking statements regarding the company's expectations of future performance. Such statements are subject to risks and uncertainties and our actual results may differ materially from those contained in the statements. These risks and uncertainties are described in today's news release and the documents we file with the Securities and Exchange Commission. We encourage you to review those documents, particularly our Safe Harbor statement for a description of the risks and uncertainties that may affect our results.

Additionally, on this conference call, we will discuss non-GAAP measures that include or exclude special or nonrecurring items. For each non-GAAP measure, we also provide the most directly comparable GAAP measure. Our release includes a reconciliation of those non-GAAP measures to our first half 2009 GAAP results. We have no special items thus far in 2010.

Our earnings release was issued this morning via business wire and is also posted on the Investors section of our website at tennantco.com.

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

Chris Killingstad

Thank you, Tom. And thanks to all of you for joining us this morning. Today, I want to cover highlights of the 2010 second quarter and update you on our strategic priorities.

As you saw in today's release, Tennant is off to a good start in the first half of 2010. We were very pleased to see favorable trends in the first quarter continue into the second quarter. As a result of the company's strong sales and earnings in the first two quarters, we are increasing our full year guidance again, after raising it in the first quarter as well. Tom will provide more detail on our outlook in just a moment.

In the second quarter, net sales increased 11.8% with our business maintaining its strong growth in the Americas and in Asia, most notably China and Australia. As in the 2010 first quarter, the double-digit sales gains were led by demand for scrubbers equipped with our proprietary ec-H2O technology platform and sales to strategic accounts in the Americas.

Many of our strategic account customers have designated Tennant as a preferred supplier, largely due to ec-H2O's proven chemical free cleaning capabilities. Importantly, Tennant's organic net sales, which exclude the impact of foreign currency, grew approximately 12% this was the third consecutive quarter of organic net sales growth overall and the second consecutive quarter that we have posted year-over-year organic growth of 12%.

The quarter's higher sales volume, coupled with our continued emphasis on controlling and improving our cost structure, again led to increased gross margins and earnings per share. Gross margins rose 270 basis points to 43.1% versus 40.4% in the year earlier quarter. And our second quarter earnings per share doubled to $0.32 up from $0.16 in the prior year quarter.

Marketplace momentum for ec-H2O remains very encouraging. I've said many times that our breakthrough ec-H2O technology has significant revenue and market share potential. As an industry innovation leader, we are aggressively pursuing the development of electrically activated water into a chemical free cleaning platform. To that end, we established our Orbio Technologies Group in 2009. This group is dedicated to developing and marketing environmentally friendly cleaning technologies under the ORBIO brand name.

We intend for ORBIO to set the standard for sustainable cleaning around the world. Leveraging our proprietary and award winning ec-H2O technology, the Orbio Technologies Group is focused on creating and delivering sustainable cleaning solutions to Tennant's existing and new markets.

We think ec-H2O is potentially relevant in a vast array of applications. The platform has two equally important benefits. The first is scalability. As you know, we have created an electrolyzed water cell large enough to be used on our scrubbers and we have figured out how to miniaturize it so that it fits into the head of a spray bottle, we now believe that we can package the technology and adapt it to a wide variety of cleaning devices.

The second platform benefit is performance. We know that our scrubbers equipped with ec-H2O deliver great cleaning results without chemicals and we know that ec-H2O technology on Activeion's handheld spray devices cleans and sanitizes hard surfaces, again without chemicals. We are continuing to explore the possibility that our chemical-free, electrically activated cleaning technologies can be further developed to act as a disinfectant and we have made important progress.

In the second quarter, our Orbio Technologies Group and Activeion, which is our exclusive licensee of ec-H2O technology for handheld spray applications, announced a key discovery, a new method to kill bacterial cells and inactivate pathogenic viruses without using chemicals. The technology, which is based on a process called electroporation, is known as Orbio-E. Electroporation has long been an effective and important tool in molecular and cellular biology for medical and pharmaceutical research. Here's a little background on how it works.

Electroporation uses a low level, externally applied electric field to temporarily disrupt cell membranes, allowing small molecules to pass directly into the cells. If the applied electric field is below a certain threshold, the disrupted area or pores, formed in the cellular wall simply heal after the electric field is turned off, allowing the modified cells to survive.

Orbio-E technology is different in that it causes irreversible electroporation going beyond the effects of typical temporary cellporation. On hard surfaces and used as directed, Orbio-E disrupts and kills more than 99.9% of bacterial cells which may cause harmful infections, including E. coli, salmonella and Staph.

Quantitative laboratory tests also showed that Orbio-E inactivates important pathogenic viruses like influenza and H1N1. Using only water and very small amounts of electrical energy, Orbio-E delivers impressive antimicrobial performance. Additional important benefits of this first mover technology include improved sustainability, a smaller environmental footprint and reduced hazards from potential misuse of chemical cleaning products.

Tennant has filed a number of preliminary patents. In fact, our electrically activated water technology platform now encompasses more than 30 U.S. and global patent applications. Our Orbio Technologies Group is conducting detailed studies to optimize this promising technology and identify market opportunities.

As a result, of our Orbio-E discovery, this technology is now available on Activeion's Ionator EXP and Ionator HOM handheld spray devices. Since, we first introduced ec-H2O, we have learned a great deal about the capabilities of water cleaning technologies and we plan to leverage our learning’s under our new ORBIO brand in three phases.

First, we are extending ec-H2O technology to all of our existing equipment, during all of our relevant existing equipment – excuse me. During the 2010 second quarter, we added ec-H2O to three large rider scrubbers as planned. This completes the roll-out of ec-H2O onto all 14 of our applicable scrubbers.

Our goal here is to accelerate sales and market share gains. The opportunity is clear when you consider that our 2010 second quarter sales of ec-H2O equipped products rose 28% sequentially over the first quarter, while Tennant's overall equipment portfolio was up 15% in the same period. As a pioneering technology, ec-H2O clearly gives Tennant a significant competitive advantage and the ability to build a sizable and robust chemical free cleaning business.

The second phase involves cleaning more of Tennant's customer spaces in more environmentally friendly ways. Tennant currently has research studies and tests underway with key customers in North America and in Europe to determine how to best leverage ec-H2O throughout their cleaning applications. The company also is pursuing the development of new cleaning devices that will be able – that will be capable of delivering chemical free cleaning in environments beyond floors.

Several independent studies have proven the effectiveness of ec-H2O. Most recently in May, we announced the results of an independent study by Elliott Affiliates, which is a leader in janitorial performance evaluation. This study was designed to assess ec-H2O's performance under challenging, grimy, real world cleaning conditions. So it was tested in a soft drink bottling plant that operates 24/7 with sugary syrup and other tough residue on the floor.

The Elliott study reconfirmed that ec-H2O outperformed automated scrubbers that use traditional chemicals in four key categories, cleanliness, hygienic safety, appearance and sustainability. Among the specific findings, ec-H2O was better at reducing bacteria. It also provided superior environmental, economic and social benefits by consuming 70% less water, releasing no used detergent into water systems, eliminating chemical residue, enhancing worker safety and cutting out the cost for purchasing and disposing of chemicals. These are compelling results and they are consistent with the results of our own tests and other independent studies.

The third phase is to develop new markets and applications. The company is exploring partnerships to capitalize on strategic opportunities in various market segments, including but not limited to, consumer products, food processing and healthcare. We are excited with the initial strides our Orbio Technologies Group is making to further enhance and expand our electrically activated water technology platform and build a robust chemical free cleaning business.

I also want to briefly mention another area in which Tennant is innovating in sustainable cleaning. During the second quarter, we continue to demonstrate our Green Machine 500ZE all electric vacuum street sweeper in major European cities. This compact, zero-emission machine is intended for use in crowded urban areas. It is virtually silent, operating on a lithium ion powered battery pack that eliminates carbon emission and reduces noise levels and offers an environmentally sensitive solution for urban street cleaning.

Lastly, I'd like to update you on our partnership with Ecolab, which illustrates Tennant's commitment to pursuing long term revenue growth opportunities through alliances that help us expand beyond our traditional markets. As you may recall, last October, we announced that Tennant would be manufacturing and servicing the Scrub-N-Go floor scrubber vac system and that Ecolab would sell it through their sales and distribution channel.

The Scrub-N-Go is a lithium ion battery powered cordless cleaning machine, initially designed for the quick serve restaurant market segment. The product cleans floors up to 63% faster and more thoroughly than using a traditional mop and bucket and it represents a huge labor savings for restaurant operators.

The Scrub-N-Go was previously approved by McDonald's, Taco Bell, KFC, Pizza Hut and Long John Silvers and now it has also been approved by Burger King. This product's U.S. introduction is progressing and there are now sales of additional machines to multiple store franchise owners who had initially placed a trial order of one machine.

To put this in context, Tennant has never participated in the quick serve restaurant market and Ecolab currently does business with approximately 100,000 of these restaurants across the country. Moreover, we anticipate that Scrub-N-Go will also have international appeal.

Before I turn the call over to Tom to review the financials, I also want to take a moment to welcome our new Vice President of Global Marketing, Rusty Zay. Rusty joined Tennant in June. He brings outstanding product and brand management expertise from leading consumer equipment companies, including Whirlpool and Maytag. We look forward to having him help us achieve Tennant's vision of becoming a global leader in chemical free cleaning and other technologies that help our customers create a cleaner and healthier world.

Moving forward, we continue to remain focused on efficiently running the business as well as capitalizing on our exciting growth opportunities. We are directing resources against three strategic priorities to drive process improvements and operational efficiencies; strengthen the large equipment portfolio by developing a new and innovative modular design architecture and build a sizable, robust, chemical free cleaning business.

Our business is performing very well and we are confident we have the growth strategies and innovative products to continue to drive sales gains. I look forward to keeping you apprised of our progress.

Now at this point, I'll ask Tom to review Tennant's financial results and outlook. Tom?

Tom Paulson

Thank you, 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.

As Chris noted, we are pleased with the company's performance in both the first and second quarters of this year, which represented a significant turnaround from a year ago. For the second quarter ended June 30, 2010, Tennant reported net earnings of 6.2 million or $0.32 per diluted share on second quarter net sales of 166.1 million. In the year-ago quarter, Tennant reported net earnings of 3 million or $0.16 per diluted share on net sales of 148.6 million.

Now I'll turn to a more detailed review of the 2010 second quarter. Tennant's consolidated net sales of 166.1 million increased 11.8% over the prior-year second quarter. For the 2010 second quarter, consolidated net sales were unfavorably affected from a foreign currency exchange impact of approximately 0.5%.

Organic sales, which exclude the foreign currency impact, grew approximately 12.3%. Our organic sales grew 2% in the 2009 fourth quarter, which was the first quarter-over-quarter sales growth we posted since the third quarter of 2008 and now we've had organic sales growth of approximately 12% in both the first and second quarters of 2010, as Chris mentioned.

As I take you through our sales by geographic regions, please note that we have re-categorized our three regions to cover the Americas, which now encompasses all of North America and Latin America; EMEA, which still covers Europe, the Middle East and Africa and lastly, Asia Pacific, which includes China and other Asian markets, Japan and Australia. For your reference, we've provided a table with the 2009 sales by quarter for this new geographic re-categorization on the Investor portion of Tennant's website.

In the Americas, we reported a second quarter year-over-year sales gain of 17%. Excluding a favorable foreign currency impact of approximately 1% organic sales growth was approximately 16%. The growth in the Americas was driven by sales to strategic account customers with sales of Tennant scrubbers once again leading the way.

On a consolidated Tennant level, we had year-over-year gains in large sweeper sales, primarily in North America, in both the first and second quarters of 2010 with growth in the first half of approximately 40%. While we estimate this is still about 20% below the pre-recession large sweeper sales levels, it is encouraging to have two consecutive quarters of year-over-year sales growth.

In EMEA, sales declined 8.7%. The approximate impact from foreign currency flipped over from a favorable 7% in the first quarter to an unfavorable 6.5% in the second quarter, primarily related to the fluctuations in the exchange rates between the euro and the dollar.

Excluding this unfavorable foreign currency impact of approximately 6.5%, organic sales declined roughly 2.2%, due to ongoing weakness in the European economy. This is consistent with the approximately 2% organic sales decline in EMEA in the first quarter.

In Tennant's Asia Pacific region, sales rose 53%, excluding a favorable foreign currency impact of approximately 11.5%, organic sales growth was roughly 41.5%, fueled by continued strong sales in China and Australia.

Tennant's gross profit margin for the 2010 second quarter was 43.1%, up 270 basis points versus 40.4% a year earlier and up 60 basis points from 42.5% –excuse me – in the 2010 first quarter. This was primarily as a result of higher sales volume, continued tight spending controls and flexible production management.

We have seen some commodity price increases in select areas such as lead, copper, steel and resins, which is negatively impacting the cost of our batteries, motors and coatings. This was more than offset by the solid performance from our operations team, especially as they continue to work very efficiently to meet the increased demand for our large scrubbers and sweepers.

Research and development expense in the second quarter totaled 6.4 million versus 5.7 million in the prior year quarter. R&D expense as a percent of sales was 3.9% in the second quarter of 2010 compared to 3.8% in the second quarter last year.

Selling and administrative expense in the second quarter of 2010 totaled 54.5 million or 32.8% of net sales compared with 49 million or 33% of net sales a year earlier. The second quarter 2010 higher expense level on a dollar basis stem from several factors, variable selling expenses on the significantly stronger sales volume; new product launch activity and other investments in chemical free cleaning.

Our second quarter operating profit was 10.6 million or 6.4% of sales versus operating profit of 5.4 million or 3.6% of sales in a year ago. Our goal is to achieve an operating profit margin of at least 9.5% when revenues return to pre-economic downturn levels.

In the 2010 second quarter, Tennant's overall effective tax rate was 37.9%. Our base tax rate was 36.7% and we had discreet net unfavorable tax items of about $125,000. Our base tax rate does not yet include any benefit from federal R&D tax credit, as we're not allowed to consider these credits in our tax rate until they're formally reenacted. Our base tax rate in any given year is chiefly due to the mix of earnings by country.

Turning now to the balance sheet. Again, we are pleased with the company's progress. Net receivables at the end of the 2010 second quarter increased to 112.4 million versus 109 million a year earlier, due to higher sales compared to the prior-year quarter. Accounts Receivable days outstanding was 62 at quarter end, down from 66 at the end of the 2009 second quarter. We have proactively managed our receivables both by enforcing tighter credit limits and successfully collecting past due balances.

Tennant's inventories at the end of the 2010 second quarter increased to 62.4 million from 59.2 million in the second quarter last year. FIFO day’s inventory in hand declined to 87 days at the end of the quarter compared to 98 days in the year-ago quarter. The improvement in days is due to higher sales levels and the continued progress we are making with our inventory reduction initiatives.

Accounts Payable totaled 49.9 million at the end of the second quarter, up from 33.7 million in the year-ago quarter, due to the lengthening of payable terms and higher sales volumes. With our increased focus on conservative cash management, we have worked closely with our suppliers to extend payment terms, while retaining the flexibility to revert back to taking cash discounts when economic conditions warrant.

Capital expenditures totaled 4.2 million in the 2010 first half versus 6.7 million in the 2009 first half. We continue to tightly control capital spending and recently implemented a rigorous prioritization process to ensure we are improving the projects that best align with our strategies and are designed to an offer attractive return on investment.

Our strong cost controls continue to yield benefits. We saved more than $15 million in 2009 from our restructuring actions and we anticipate incremental savings of another 5 million from these actions in 2010for a total of 20 million savings in 2010. Please note that by leveraging our existing workforce, we have held our employee count to 2,800, which is flat with when we completed the restructuring. That is down 11% from Tennant's pre-recession peak.

Tennant generated 24.4 million in cash from operations in the 2010 first half, of which 10.3 million was generated in the second quarter. Total cash and cash equivalents at the end of the 2010 second quarter was 34.5 million compared with 16.1 million a year ago. The company's total debt of 32.4 million is 23.8 million lower, compared to 56.2 million a year ago. The debt reduction was the result of our continued focus on cash optimization, lower capital spending and improved working capital management. Our debt to capital ratio fell to 14.5% at the end of the 2010 second quarter versus 24.5% at the end of the 2009 second quarter.

Moving now to our outlook. We saw continued improvement in the company's performance in the 2010 second quarter, but we will continue to manage the business conservatively with a focus on operational excellence and rigorous cost controls. For the second half of 2010, we anticipate steady recovery in North America, strong growth in emerging markets and sluggish conditions in Europe.

Additionally, our financial outlook includes the following expectations for 2010 as of today. Unfavorable foreign currency impact on sales in the 2010 second half in the range of 3% to 5%, after a favorable effect of approximately 2% in the 2010 first half; a gross margin in the range of 42% to 43%, up from previous range of 41% to 42%; research and development expense of approximately 4% of sales and capital expenditures in the range of 12 million to 14 million.

Also, as you might recall, we had ESOP income in 2009 of about $1 million. However, on December 31, 2009, our ESOP program ended, so we'll no longer have ESOP income this year. We continue to anticipate a base tax rate in 2010 in the range of 34% to 36%, depending primarily upon the mix of full-year taxable earnings by country.

Based on our financial results in the 2010 first half, we now estimate net sales for the full year in the range of 645 million to 665 million, which is higher than our previous guidance of 630 million to 660 million. We now estimate earnings for the full-year 2010 in the range of $1.00 to $1.30 per diluted share, which is also higher than our previous guidance of $0.90 to $1.20 per diluted share.

Our revised full-year guidance includes Tennant's strong first half results and assumes performance consistent with our original plan for the remainder of the year. We look forward to increased sales and profitability in 2010, along with continued investment in key initiatives to help secure our long term future.

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

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from Ted Kundtz from Needham & Company.

Ted Kundtz – Needham & Company

Hey, thank you good morning everyone.

Tom Paulson

Hi, Ted.

Ted Kundtz – Needham & Company

Very, very nice quarter. Congratulations on that. Could you talk a little bit about – what are you seeing in Europe in terms of the acceptance of the eco-H2O products? Are they accepting it – probably not as rapidly as here, but could you sort of give us a little more color on that?

Tom Paulson

Well, actually, they're accepting it more rapidly in Europe than they are here. So the adoption rate, the penetration rate of ec-H2O and scrubber sales is higher in Europe than it is in North America.

Ted Kundtz – Needham & Company

Why aren't you seeing the growth? Why wouldn't you be seeing more growth over there, then?

Tom Paulson

Well, were operating in a much lower growth environment, right? So when people are opening their pocketbooks and actually buying, we're winning; but they're just not doing that. So but if you look at within our sales portfolio, the dynamics of Europe sales being driven mostly by ec-H2O on scrubbers and strategic accounts, it's consistent with what we're seeing in North America but just in a much, much lower growth environment. The other impact we have in Europe that we don't have so much in North America is that a bigger part of our – a larger percentage of our sales go to municipal markets or city cleaning products or outdoor products to municipal markets, which are down across the board to a much greater extent than we're experiencing here. So, that and if you look…

Ted Kundtz – Needham & Company

Right.

Tom Paulson

If we were to split our sales up between our indoor portfolio, which includes ec-H2O on scrubbers and our outdoor portfolio, you'd see that we are struggling much more on the outdoor side and actually performing quite well on the indoor side but when you look at it in total, it looks a little distorted. So I understand your concern.

Ted Kundtz – Needham & Company

Got it. Okay. That makes some sense. That really did help clarify. I wasn't quite aware of that, Chris. Thank you. Is the – how's the pricing environment that you guys are seeing out there?

Tom Paulson

It's a tough pricing environment right now, Ted. We are – as you know, historically, we've priced more in the range at 2% to 3%, maybe even as higher as four times. This year, we're seeing very modest pricing ability and our pricing benefits we've seen in the first half is not even a percentage point. So it's effectively flat, as you look at what we're seeing this year. And we're conscious of that, competitively, that we aren't seeing the – while we're seeing commodity costs begin to uptick, they're not upticking significantly. And you combine that with a tough economical environment, we're more willing in this environment to just ensure we don't see price declines. We expect pricing to return to normal levels as we move forward and the economy recovers.

Ted Kundtz – Needham & Company

Okay. So that was the answer to the question, the net-net impact of the inflationary side versus the weakness price. You're saying they're kind of offsetting each other and that both of them are not really putting any pressure or helping margins either way?

Tom Paulson

The thing that's really helping us there is that while we're seeing some uptick from an inflationary standpoint, it's not significant. We're not getting – we're getting very limited pricing benefit, but we are continuing to generate sourcing savings from low cost sourcing and our factories continue to run extremely efficiently. And part of that is we're just doing a good job of running them and revenue always helps.

Ted Kundtz – Needham & Company

Okay. Do you have a longer term goal, I don’t know if you want to share, it a longer term goal on gross margins?

Tom Paulson

We're hesitant to give a target there. I mean, we're – obviously have gained some confidence over the last quarter that our sustainable margins are more in the 42% to 43% range, as we were historically around the 41% to 42% range. We're – I'm reluctant to commit to anything higher than that at the current time, but as I hope everybody knows at this point we are committed at the operating margin level to getting back to 9.5% earlier than we would have historically. And we are setting a new target of 12%. And we hope, in the not too distant future, to provide some more specifics around that and the timing associated with getting to that target.

Ted Kundtz – Needham & Company

Okay. Great. And then one last question from me would be – Chris, you talked – you mentioned the Ecolab partnership and could you – but I didn't know how that was ramping. You will be selling equipment to them; is that correct? And they resell it? I didn't know how that was ramping yet. You talked about the large number of, obviously, the potential locations out there and all the different restaurants that they deal with. Could you give us a little more color as to what revenue you're seeing out of that, maybe not specific numbers, obviously, but maybe just…?

Tom Paulson

We are starting to ramp. What I would say is we're starting to ramp. We haven't divulged any numbers yet. We think the opportunity is very substantial. And as you said, what we do is we make the equipment and we sell it to Ecolab; Ecolab sells it through their sales and distribution system to quick serve restaurants. Now, this is – there's a process involved here, first, you've got to go out and you've got to convince the big fast food chains that this is something they want to consider and so there's a bunch of testing that goes on. Then they have to decide whether or not they're going to officially approve it within their – both their company owned structure and their franchisee structure. And as we've talked about, we have a lot of the big chains that have done that now. Then the next step is, is the major multiple franchise store owners, they bring in a unit or two to test. Right? So we've gone through that phase now and based on the results of that, we are very optimistic, because we're beginning to see that the people who have been testing the product at the franchisee level, begin to order more. And we hope that will ramp up. So I would say that we're just beginning to ramp up the sales; they're not material to our results at this point, but we remain as optimistic as we were the day we launched this.

Ted Kundtz – Needham & Company

Okay. And do you think that could really start being significant in this – by the fourth quarter of this year or is this something we should maybe look into 2011?

Tom Paulson

Maybe life cycle forward basis, it will not be incrementally material for this year, but we do believe that as we move into 2011, it will be something we'll be talking about. We think it will be driving meaningful incremental revenue to Tennant.

Tom Paulson

But I would also ask, because a lot of – the fast food chains, they do annual planning, too. Right? And so we're already into this year, so I think what they're doing now is saying, okay, where does Scrub-N-Go fit within our portfolio and how much money are we willing to invest behind it, as we move into 2011 and build that into their plans? And that's why we think 2011 is the year it's really going to ramp up.

Ted Kundtz – Needham & Company

Okay, terrific. And maybe just one last question. With the building service contractors, how are you guys doing with them? And how is their business or the health of their business looking at the moment, because they – obviously, a lot of commercial business there.

Tom Paulson

I'd say, Ted that we still have a relatively low share in that market segment, but we are growing rapidly with them and they have, through the recession and continued to be, maybe the most robust part of the market.

Ted Kundtz – Needham & Company

Okay. Great. Thanks very much.

Tom Paulson

And we have in our solution, especially with ec-H2O is spot on in terms of what they're looking for.

Ted Kundtz – Needham & Company

Yeah. I would think so. I think that would be a great appeal to them as they make new decisions. Thank you both. Great quarter.

Operator

(Operator instructions) Your next question comes from the line Joe Maxa with Dougherty & Company.

Joe Maxa – Dougherty & Company

Thanks and congrats on a nice quarter.

Chris Killingstad

Thanks, Joe.

Tom Paulson

Thanks Joe.

Joe Maxa – Dougherty & Company

I wanted to ask a little more about strategic accounts. You mentioned ec-H2O strength plus strength of your strategic accounts. Could you give us a little color on what they're buying, I'm assuming its larger accounts that have held off on spending and maybe they're coming back, but I just wanted to get a little more color.

Tom Paulson

No, I mean, strategic accounts, there's two parts. I mean, there are some strategic accounts that we had prior to the recession that they're beginning to order again. But we've talked a lot about the number of new strategic accounts that we've won, especially last year and we were able to name some – SUPERVALU, Kroger, what was the Danish, I mean, IKEA the big building service contractor; ISS and a number of others like that, Tesco in the UK and others that we can't mention. But so I think that may be the more significant piece; that we've negotiated those agreements in 2009 and they have now started to order on those contracts on a fairly regular basis. And as we've said, it can take 18 to 36 months before they turn over their entire equipment portfolio with new Tennant ec-H2O products.

Joe Maxa – Dougherty & Company

Got it. And then the large outdoor equipment, I think you said you were up about 40% year-over-year in the first half or you looking for that to continue? What are you seeing in that market today?

Tom Paulson

Yeah. A big deal to be a more specific there, I probably wasn't as clear as I could have been there. That's actually just on the sweeper side of our large equipment business was up 40% in the first half. And we were still, I can't emphasize enough that that portion of our business is still substantially below pre-downturn levels. But we are seeing some momentum and particularly in North America and in some of our other markets like Australia, et cetera. And we expect to see modest recovery as we go through this year. And we're not – we don't know when we can call when we're going to really see the uptick. And we will at some point, because we know there's a fair amount of pent-up demand; we just don't know when that significant uptick will happen. We're not counting on it during this year, but it could happen later this year though, but we can't call the timing yet.

Tom Paulson

Joe, also to clarify, I mean and this is also a little bit confusing we divide sweepers into two, we have city cleaning, really which is our city cleaning products which are sweepers, but we don't include them in the sweeper category included in the city cleaning category, mostly sold to municipal markets. And as we said my comments earlier about Europe, where we sell most of them with the municipal business being weighed down, we're struggling there still, but our other sweeper products that are sold more for parking garages and for parking lots and for indoor environments where they don't need so much to clean and scrub, but they need to sweep that business has picked up and as Tom said, was up 40%, which is encouraging. So that's kind of more our traditional industrial business. And what we would say is that we're seeing month-to-month improvement in that, but we're still 20% below where we were pre-recession.

Joe Maxa – Dougherty & Company

Okay. I wanted to ask how July has been compared to Q2 and what your typical linearity is in Q3.

Tom Paulson

You know, we would normally see Q3 be a bit lower than Q2. We don't give quarterly guidance, as you know, but we could see our Q2 be a bit below from a revenue standpoint or it could be a bit higher, but it's traditionally, if you look at history, it's a little bit below; but in a recovery period, it's harder to call it. If you looked at July, though, on a seasonally adjusted basis, it's right on expectations. So we're – the trends that we're seeing at the front end of Q3 are meeting our expectations and we remain encouraged about our outlook for the rest of the year.

Joe Maxa – Dougherty & Company

No – I'm sorry the linearity I wanted to ask was regarding Q3 specifically in July versus the back half, the last two months of the quarter.

Tom Paulson

We would typically see more strength in August and particularly in September. But we don't see gigantic differences in the month; but typically, as we enter new quarters, the first month in new quarters tend to be a little bit lighter. And we see momentum as the quarter builds; but not gigantically differences between the weeks.

Joe Maxa – Dougherty & Company

All right. Thanks a lot.

Tom Paulson

Yeah.

Operator

And at this time, there are no further questions. I'll turn the call back over to you.

Tom Paulson

All right. Thank you, Amanda. So, let me just say that I'm very pleased with our financial performance in the second quarter and the first half of 2010. We made further progress across our operations that resulted in significant top and bottom-line gains. We also made continued investments in new products that we believe will fuel Tennant's future revenue growth. We remain excited and committed to achieving our long-term strategic vision to become a global leader in chemical free cleaning. We believe that our strategic direction, coupled with our strong cost controls, improved operating efficiencies and new products will further enhance Tennant's long-term value creation potential. So thank you for your time today and your questions. And we look forward to updating you next quarter. Take care.

Operator

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

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Source: Tennant Co. Q2 2010 Earnings Call Transcript
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