Tennant Co (TNC) 2006 Q3 法說會逐字稿

Thank you for participating in Tennant's third quarter teleconference. All lines have been placed on listen-only until the question-and-answer session. Following the question-and-answer session, please remain online for closing remarks from Tennant. Beginning today's conference is Mr. Tom Paulson, Vice President and Chief Financial Officer. Mr. Tom Paulson, you may begin.

Thanks, Mary. Good morning, everyone, and welcome to Tennant Company's third-quarter 2006 earnings conference call. I am Tom Paulson, Vice President and Chief Financial Officer of Tennant Company.

With me on the call today, as usual, is Chris Killingstad, Tennant's President and CEO, and Pat O'Neill, our Treasurer.

Our agenda for this morning is to review Tennant's performance during the quarter and our outlook for the remainder of this year. After that, we will open up the call for your questions.

Before we begin, please be advised that 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 these documents, particularly our Safe Harbor statements, for a description of the risks and uncertainties that may affect our results.

Our news release was issued this morning via Business Wire, and is also posted in the investor section of our website at tennantco.com. At this time, I will turn the call over to Chris.

Thanks, Tom. Good morning, everyone, and welcome to our third-quarter earnings conference call. Let me start by saying that we are pleased with the Company's continued growth in the third quarter. Our performance builds on our success over the past two years.

During the quarter, Tennant's solid revenue growth generated double-digit earnings gains. Combined with last quarter's record earnings, Tennant has produced some very strong result in the first nine months of the year, consistent with the goals that we set for ourselves and that we have communicated to our investors.

Given our year-to-date performance and our prospects for the remainder of 2006, we are raising our full-year guidance for the second time this year. In just a moment, Tom will review our financials and our revised outlook with you.

After that, I will review the highlights of the quarter, including progress on our five corporate priorities and the rounding out of our management.

At this point, I will let Tom present the financials. Tom?

Thanks, Chris. In my comments today, all references to earnings per share are on a fully diluted basis. For the 2006 third quarter ended September 30, we reported net earnings of $0.42 per diluted share, an increase of 20% compared with $0.35 per diluted share in the 2005 third quarter. The 2006 earnings include $0.01 per diluted share for the non-cash expense of stock options in accordance with our adoption of FAS 123.

With last quarter's stock split and the exercise of options, Tennant now has nearly 19 million fully diluted shares outstanding versus about 18 million last year on a split-adjusted basis. Our earnings per share for the third quarter of 2006 is $0.02 per share higher than it would have been had the number of shares -- lower, I'm sorry -- lower than what it would have been had the number of shares outstanding not changed from the prior-year period.

Year-to-date net earnings per diluted share totaled $1.14, up 25% from $0.91 per share in 2005. The 2006 year-to-date earnings include $0.03 per share for the non-cash expense of stock options in accordance with FAS 123.

Consolidated net sales for the quarter totaled $145.7 million, up 5.7% from 2005's strong $137.8 million. The Company increased sales for the quarter in all three of our geographic regions. Favorable foreign currency exchange effects added approximately 1% to consolidated net sales.

Year-to-date, consolidated net sales grew 7.8% to $432.1 million. The net impact of foreign currency exchange was negligible on 2006 consolidated net sales for the nine-month period.

In North America, third-quarter net sales rose 1.1% to $94.9 million. This surpassed last year's high third-quarter sales, which were at 12.2%. For the first nine months, net sales in North America increased 6.3% to $286 million.

Foreign currency exchange effects added less than 1% to net sales for both the third quarter and nine months of 2006. We remain confident about growth opportunities moving forward.

In Europe, third-quarter sales totaled $35.8 million, up 21.8% compared to prior-year quarter, an outstanding performance. Contributing to the growth was our Hofmans acquisition, which generated approximately 6% of the increase in our $1.7 million of the quarter's sales in Europe; sales of new products, including shipment of a large order to a new customer also contributed to Europe's sales growth in the third quarter. Favorable foreign currency exchange effects added approximately 5% to sales in Europe for the quarter.

Year-to-date, net sales in Europe increased 13.5% to $103.2 million compared to the same period last year. Unfavorable foreign currency exchange effects lowered net sales in Europe by approximately 2% year-to-date.

In other international markets, net sales for the third quarter rose 3.4% to $15 million compared rest of the prior-year quarter. Unfavorable currency exchange effects lowered net sales by approximately 1%.

Year-to-date net sales in other international markets totaled $42.9 million, a 4.9% increase versus the first nine months of 2005. Unfavorable foreign currency exchange effects lowered net sales and other and international markets by roughly 2% year-to-date.

The Company's gross profit margin for the 2006 third quarter was 41.6% versus 42.9% in the same quarter last year. This price increase was taken earlier in 2006 as well as ongoing cost reductions were not enough to offset higher material costs. Startup manufacturing costs in China in integrating the Hofmans opposition acquisition as well as a product mix of smaller equipment sales also reduced margins in the third quarter.

Year-to-date, the gross profit margin was 42.4% compared to 42.8% in the first nine months of last year.

Selling and administrative expenses for the third quarter totaled $45.2 million, down nearly 1% from $45.6 million in the 2005 third quarter. Selling and administrative expenses improved to 31% of sales versus 33% of sales in the year-ago quarter.

Our R&D spending in the quarter totaled $5.5 million, up from $4.9 million in the 2005 third quarter. R&D spending of 320% of net sales remains within the Company's targeted range.

Our operating profit for the third quarter this year totaled $9.9 million, up 15.1% compared to the 2005 third quarter. Operating profit benefited from sales growth across all products, categories, and geographies, as well as operating expense efficiencies.

Year-to-date, we have spent approximately $1.7 million pretax, or $0.07 per diluted share, on our China strategy and manufacturing footprint consolidation. For the first nine months of 2006, our operating profit rose 14.5% to $29.2 million.

Operating margin for the third quarter of 2006 was 6.8% versus 6.2% in the third quarter last year. As we've said, our objective over the next three to five years is to achieve an operating margin of 9.5%. We continue to make progress towards this goal, and we will comment more on that shortly.

Tennant's tax rate in the quarter was 28.6% compared to 29.7% in the prior-year period.

Turning to the balance sheet, we continue to maintain a strong financial position. Net receivables at quarter end totaled $101.2 million, up from the $93.6 million at the end of the 2005 third quarter, due to increased sales volumes at the end of the quarter and the Hofmans acquisition. Account receivables days outstanding were 64 at the end of the quarter versus 62 the prior-year period

Inventories totaled $61.4 million in the third quarter, up slightly over the prior-year quarter, as we supported new products launched as well as anticipated fourth-quarter shipments. FIFO days inventory on hand were 91 at the end of the 2006 third quarter versus 93 at quarter end last year.

Capital spend was $13.2 million for the nine-month period. And we now anticipate full-year spending in the range of $18 to $23 million, which is a decrease from our previous guidance of $23 to $28 million. The Company's cash, cash equivalents and short-term investments increased to $45.1 million compared to $28.5 million at the end of the 2005 nine-month period.

With that, I would like to hand the call back to Chris for an update on our strategy and progress.

Thanks, Tom. As I mentioned earlier, our third-quarter results continue to build on the growth momentum and efficiencies that we have been generating. And I am especially pleased with our improved performance year-to-date which comes on top of last year's record gains. Our efforts to achieve success through new products, market expansion, and by leveraging our cost structure are beginning to pay off. We believe we can achieve even greater growth and efficiencies as we move forward.

A driving factor in our improved top- and bottom-line performance is our continued focus on five corporate priorities. During the third quarter, we made further progress in these areas, and I will review some of the highlights for you now.

First, our China initiative. As you know, we have established a manufacturing base in Shanghai, and we are rapidly expanding our market coverage. Our team has done an an outstanding job of building and getting our China facility up and running within one year.

During the third quarter, our first products manufactured in China rolled off to production line, on schedule. Initially, our China facility is producing walk behind floor scrubbers and sweepers for sale into the Chinese and other Asian markets. We also plan to begin manufacturing some products in China for sale in North America.

During the quarter, we continued to build our organization in China with the addition of several distributors. We see China as an important part of our market expansion efforts; and I am very pleased with our progress there.

China is also a key element in our second corporate priorities, which is to build Tennant's low-cost global sourcing capability. This strategy will help drive long-term gains on the Company's profitability, and help us reach our stated goal of 9.5% operating margins.

To fully leverage our increasingly global operations and supply chain opportunities, we recently announced that Don Westman has joined Tennant as Vice President of Global Operations. Don brings extensive global operations and lean experience to Tennant. Most recently, as Vice President of Operations, Pump Division. He led (indiscernible) manufacturing and distribution operations in the U.S., China, Mexico, and Canada.

At Tennant, he will be responsible for the global manufacturing, sourcing, and logistics and driving our operational excellence agenda.

We are absolutely thrilled that Don has joined the team.

Establishing a lean enterprise is another key strategic initiative. We remain in the early stages -- let me emphasize again -- early stages of building operating efficiencies and improving profitability through the implementation of lean manufacturing principles, which includes our manufacturing footprint consolidation project. And let me just remind you what that entails.

By the end of 2007, our plan is to close our Maple Grove facility where we do mostly machining and fabrication. We plan to integrate those operations into our Golden Valley plant, which is our largest plant. We also plan to take the brush operations out of Maple Grove, and moved down to Louisville, which is our distribution center, because 90% of all of our brushes are shipped out of Louisville.

Also, some manufacturing lines in our biggest plant in Golden Valley will be moved to Holland, Michigan. And we expect all of this to happen by the end of 2007.

Also, to help enable our footprint consolidation, we are in the process of designing new products that share common platforms and assembly lines, use fewer parts, and enhance workflow and productivity. As we have discussed in prior quarters, we anticipate that we will gain increasing benefit from our lean initiatives over the next year or two.

In addition to leveraging efficiencies and lowering costs, we remain focused on generating revenue growth across all of our businesses. Our growth momentum through the first nine months of this year has been fueled through product innovation, services, and market expansion. We are confident that will continue.

On the new product front, our pipeline for 2006 and beyond was robust. We introduced the new M20 in the second quarter in North America which is our largest market. The M20 is the cleaning industry's first integrated single-system Scrubber-Sweeper. We were very optimistic about this product, and so far, sales are exceeding our expectations.

Sharing the same design platform as the M20, we recently introduced the T20 Rider Scrubber, which is engineered to reduce the total cost of ownership by improving the customer's daily process of cleaning without sacrificing performance or safety. Initial response has been very positive like with the M20.

At the end of the third quarter, we launched several additional new products. For commercial applications, we extended our ReadySpace carpet cleaning line with two new Rider machines. These are the Tennant R14 and the Nobles Strive machine -- both of which are dual technology carpet cleaners that offer two distinct cleaning functions. One is the ReadySpace function, and the other is Deep Extraction. And they do that in a single machine.

Also during the third quarter, we extended our successful FaST -- Foam activated Scrubbing Technology -- with the introduction of two new walk behind scrubbers for both the Company's core brands -- the Tennant T5 and the Nobles SS 5, appeal to a wide range of applications and environments such as retail, hospitality, and light industrial markets.

With these new products and others on the way, Tennant Company continues to meet our customers' demands for innovative cleaning solutions.

In addition, we believe that we are taking great strides to meet that demand of premium solutions that help our customers create cleaner, healthier and safer facilities. For the last few years, Tennant has been committed to delivering solutions that reduce water usage -- in some cases, by as much as 70% -- and help prevent slip and fall accidents. Our patented FaST Packs allow customers to reduce their consumption of cleaning chemicals, and dramatically increase their cleaning productivity, all within a small, recyclable package.

We are thrilled that two of our FaST detergents have now achieved Green Seal certification, recognizing FaST as an environmentally responsible cleaning agent.

In terms of market expansion, our acquisition last quarter of Hofmans Machinefabriek had a significant positive impact on our sales in Europe during the third quarter, as Tom has mentioned. The Hofmans line of outdoor street cleaning products complements our current suite of products in the European market. We believe these small compact units also have global potential that fit with our growth objectives. We are very pleased with the initial integration of Hofmans into our business.

In other international markets, we opened a new South American office in Sao Paolo, Brazil, during the third quarter. Brazil is one of the emerging markets that we have highlighted in our 2005 annual report because we believe it has growth potential for our products.

We will keep you updated on our progress in this market and others as we strive to further expand our international market presence.

To lead our international expansion efforts, we announced today that we have hired Karel Huijser, as Vice President of International. Karel comes to us from General Electric, where he was most recently the President and CEO of Asia-Pacific for GE's infrastructure group which includes their water business, their security and sensing business, and their factory, automation and controls business as primary ones in the portfolio.

Karel Huijser will be based in our European headquarters in Antwerp, Belgium.

Filling this position completes our new leadership team. I am very pleased with the talent that we have attracted to Tennant and look forward to working together to achieve our performance goals.

I am also pleased to note that David [Matheson] will join our Board of Directors on November 1. David, a Scotsman, is a seasoned international executive who currently serves as the Chief Financial Officer for Brady Corporation in Milwaukee. We look forward to benefiting from his insights. With his addition, Tennant will have nine board members.

We are on track to meet or exceed our objectives this year. Looking ahead to 2007, we anticipate building on the success of the past two years, and expect consolidated sales growth of between 5 and 9%, which is consistent with previously communicated targets. We also anticipate another year of solid, double-digit earnings gains, despite higher expenses versus fiscal 2006, related to manufacturing footprint consolidation.

There remain significant efficiencies to be gained in our operation. And we will continue to innovate through new products, services, and solutions. All of this makes us confident in our ability to maintain our growth momentum, and to further leveraged operating efficiencies going forward.

We now anticipate attaining our goal of 9.5% operating margins by the end of 2008.

Now, I will turn it over to Tom to review our raised guidance for 2006. Tom?

Thanks, Chris. Based on the Company's strong performance in the first nine months of 2006, we are raising our full-year earnings outlook for the second time this year. You should keep in mind that the fourth quarter of 2005 was a very strong quarter, so we will be up against a tough comparison. We also continue to expect inflation-driven material cost increases and spending on our China and footprint rationalization initiatives to continue for the remainder of this year.

For 2006, the Company now anticipates earnings per diluted share to range from $1.42 to $1.50, up from our previous and estimate of $1.30 to $1.42 and up from $1.26 per diluted share for 2005. The Company's 2006 estimate includes $0.03 to $0.05 per diluted share for stock option expense as a result of the adoption of FAS 123, and approximately $0.03 per diluted share for the integration costs related to the July acquisition of Hofman's.

This outlook also includes approximately $3.1 million in pretax for $0.12 per diluted share of expense related to the Company's China expansion and manufacturing footprint consolidation initiative. Excluding the impact of the adoption of FAS 123, the dilutive impact of the Hofman's acquisition, and our China and footprint initiatives, we anticipate 2006 diluted earnings per share to range from $1.60 to $1.70, or an increase of 27% to 35% over 2005.

We now anticipate $3.5 to $4 million of pretax expenses in fiscal 2007 related to our China expansion and manufacturing footprint consolidation initiatives. These expenses are higher than originally forecasted, but are changes that give us further confidence we can now achieve 9.5% operating margins by the end of 2008.

In connection with the manufacturing footprint consolidation, Tennant anticipates selling its Maple Grove, Minnesota facility. While the Company cannot estimate the impact of this sale and its results -- because of the uncertainty of the transaction price and timing -- the Company does anticipate a substantial gain on the sale. The forecasted gain on this sale was not factored into 2007 expectations that Chris mentioned earlier in the call.

At this point, we'd like to open up the call to any questions. Mary?

(OPERATOR INSTRUCTIONS) David Taylor, David P. Taylor & Co.

Nice-looking quarter, overall. I thought the North American sales looked a little tepid. They were up, but not a great deal, and obviously, currency [isn't] a factor. Could you comment?

Yes. This is Chris. And as we said, we are lapping a very strong third-quarter 2005, where we were up 12.2%. And we have also said that our business is increasingly volatile from a quarter-to-quarter standpoint, because more and more of our business is coming from national accounts and big deals.

So it makes a big difference to us when those big deals hit. So we had a big hit on a big deal last year. We didn't duplicate that in the third quarter of this year, but the underlying business remains extremely strong. And as we have said, we remain committed to the 5 to 9% topline growth by going forward.

So we are not coming off any of our objectives in the North American business nor in any other part of the Company, either.

Okay, is there a similar reason for the rest of the world -- which is primarily Asia, I presume?

Well, you see strong performance in Europe. We spent a lot of time over there the last couple of years, building a good team there. And so we have made some progress. The rest of the world, quite frankly, we are not satisfied with that growth. But we have put that part of the business on hold. And it is not just Asia. It is South America. It is Africa, it is the Middle East, and it is Asia, including China.

And that's why we are bringing Karel Huijser on board. We have determined that we are under represented in international markets. We have not had a clear strategy -- a clear aggressive growth strategy. We have brought Karel Huijser on board to put that together and lead that effort in the future.

So I hope -- not necessarily in the next six months, but over the next 12 to 18 months, you are going to see significant progress being made in those markets, as well.

Andrea Sharkey, Sidoti & Co.

A couple of questions for you. I was wondering first if you could talk about the China expenses. I guess looking at it, it looks like -- well, China and Maple Grove combined -- you still expect $1.1 million in the fourth quarter. Maybe if you could just first talk about why things seem to be heavier in this fourth quarter coming up than they have been in the past three quarters?

Andrea, the primary driver of that is we are really going to start making some moves on our footprint initiative. So whereas to date, more of our expenses have been related to China and in the fourth quarter, we really are going to start kicking in and moving on the footprint initiative. And as Chris commented earlier, we anticipate having that move completely completed by the end of next fiscal year. So this was the point in time where activities start.

Okay, and then can you talk about the $3 to $4 million pretax that you expect in '07 -- is that combined China and Maple Grove as well?

Yes it is.

And then is Maple Grove still -- I think the initial expectation had been $1 million in expenses for Maple Grove in each year, '06 and '07. Is that the same, or has that number increased at all?

That number has increased for next year and we have not given a precise split between -- and actually, the number we gave for next year was $3.5 to $4 million of pretax expense for both of those areas. And we have not given a precise split. And our anticipation is -- and in our next call we will be able to give a better refinement of that spending, and also talk more precisely about the benefits we are going to see as we go into the '08 time frame.

And we have commented that it gives us a lot more confidence now, and we are very convicted to hitting to the 9.5% by the end of '08. And this is an important part of that but we will shed even further light on that in our upcoming call. That will be next quarter.

Okay, so -- I guess you cannot comment on why those expenses are higher?

There is really about three different -- or two different key pieces to it. One is, and we commented on this earlier, that we were going to be favorable to our initial spending from a China standpoint in the year, and part of that was, we just [haven't] been able to spend less, but an important part of that is that we defer some expenses into next year. Not intentionally -- it's just the way the spending fell. So some of that increased spending next year is just a deferment in China.

The other element of that is is we are making some refinements to our footprint rationalization that is going to cause us to spend more money. But it is going to increase the benefits on a go-forward basis. And if you went back in time, I think the only number we publicly talked about was -- I believe it was $1.5 million of benefit from footprint in '08, and we will give you an update on that. But suffice it to say our expectations are higher than that now.

Okay, great. And I guess staying on the margin side of the equation, looking at the 9.5% by the end of '08, I think that is great. Could you maybe clarify how much or just give us a general sense where is that going to come over the next two years? Is it going to be 60/40, we will see that jump '07, '08, or the other way around? Or some clarification on how that will play out over the next few years?

You know, I am really not prepared to do that, Andrea, right now. But we will really -- there is really, as you know, three key pieces to it. And one of it is revenue growth. But the two most important elements of that are continuing improvement in our gross margins due to the operating initiatives that are in place; and very importantly, continuing to leverage our operating expenses.

So all three of those are -- I would not say of equal importance, but they are all three contributing to getting to the 9.5% at the front end of our original expectations.

Okay, great. A couple of more clean-up items. Tax rate was lower this quarter again -- 29% or so. And I had thought that the assumption was going to be more in the 37, 38% range. I guess can you give us an update on why it was lower, what you think it will be for the full year, and maybe out into '07 as well?

Sure. I will make a couple of different comment on that. One is, I will first point to the fact that it is really a third-quarter tax rate was very much in line with last year, in roughly the 28, 29% range. And a big driver of the tax rate being lower than what we would consider our ongoing rate is really a function of where we are making our money.

We started to become more probable outside of North America, and that is driving us to pay lower taxes in other geographical areas, just given the tax rate structure and the way we are structured outside of North America. So that was an important driver of the lower tax rate in the quarter versus what people might assume our ongoing rate would be.

If I look forward, our tax rate in the fourth quarter would be more similar to what our full year tax rate was last year, which is in that 37% range. And on an ongoing basis, our base tax rate is -- it's hard to predict given our earnings splits. But it is somewhere in the 36% vicinity would be our ongoing base tax rate.

But we will be closer to 37% in the fourth quarter, and call 36% on an ongoing basis. And it will move quarter to quarter, though.

Okay, great. And last question for you guys is on CapEx. It seems a little bit lower this quarter than I had anticipated. What is your expectations for CapEx for this year, and then also for '07?

We did lower our expectations. We had previously been at $23 to $28 million for the year, and we have now revised that to $18 to $23 million for this fiscal. In all honesty, we are not prepared to give a target number for next year. But it will not be dramatically different than our original expectations for this year. It will be somewhere in that vicinity, I would say. But it is early to speculate now on that.

Jim Norris of [Kirk and Bieler].

I had a question about inventories. I guess, coming into the quarter and really for the last couple of quarters I have been expecting to see inventories move up a little bit because normally, when you have a strong new product pipeline, you have to have inventories to support the ramp in new products as well as I was expecting some extra inventory to support the start up in China as well as perhaps some justification inventory related to your footprint rationalization program.

But I was pleasantly surprised to see that the inventories were essentially flat. I did not see the increase that I was looking for, and I was curious if you could comment on what was going on there. Were my assumptions incorrect to begin with? Once these things are over, should we see the inventories step down? What is a sustainable level of inventory turns for you guys?

I'll take that first and then let Chris comment, if he wants to comment further. I just would take some credit for some pretty solid management from an inventory management standpoint. We're an EVA-driven company. We are focused on both the P&L and the balance sheet; and there's a lot of people in this organization that are incented to pay really close attention to what's going on from a working capital standpoint.

Some of the work we're doing is kicking in, and it's benefiting us. So I'd say a big part of it is it's in line with what we would expect, and we continue to think we're going to get better at managing inventory, over the next several years. I'm not prepared to give you a target at this point, but we think we will continue to see our inventory turns get better as an organization, as we move forward.

But you are right with the new products we did ramp up inventory; but we were able to offset it with some of actions that we have taken. Your question, should we see a falloff once the new products are launched? Well, I don't think we're going to see a lot of falloff because, if you look at our new product pipeline, it's pretty robust. Our intention is to keep launching new products on a pretty regular basis going forward.

Obviously, with your superior balance sheet management, your cash flow continues to look pretty good and your balance sheet has always been underlevered. The balance sheet just keeps getting stronger. So I had a question about what are your plans there. Obviously, you are a net debt-free company, and it's pretty hard to make the case that that's an optimal capital structure.

So I'm just curious what the thoughts are, what perhaps might be the priorities for the use of cash going forward and where do you see the balance sheet going?

We have taken the project on to take a look at what our optimal capital structure is. Again, you can't make those changes overnight. It's not anything that we can share any details on today, but we have brought on an adviser to help us and take a look at, given we do anticipate to continue to generate cash on a go-forward basis, and we're evaluating all of our options where we would like to deploy that cash. We will have more to come in this space, but we are taking out. We're going to take a more strategical look at where we're going to move our capital structure over time.

Seaver Wang of Utendahl Capital Partners.

I was wondering if you had a number for a percentage of sales from new products, and your definition of new products -- two years, three years. And what you might expect for next year, considering the large roll out of new products.

We have a stated goal of having 30% of our consolidated equipment sales in any one year coming from new products introduced in the prior three years. We have publicly said that we've achieved the goal in 2005 and we fully expect to achieve it again in 2006. Again, many of our new products will launch in the third quarter, so we need to see what the fourth quarter brings. But that is our goal, and so far we have been able to achieve it.

Then just a little bit more detail on Brazil. What type of market is that in terms of have you quantified the size? And kind of current market share there? Is it going to be equipment more from China, more lower end, or are you going to be a combination of the lower end plus the higher end?

Well, I personally went down for the grand opening of our office there, an eye toward Brazil and an eye toward Chile. I was actually presently surprised by the opportunity down there. I think initially the opportunity is more on the big equipment side. The number of manufacturing facilities in both countries, the number of mining operations, agricultural operations, oil exploration that's starting to take place, the automobile manufacturing that continues to get bigger and bigger in Brazil.

These are all significant opportunities for us. But we have dealt with these markets on an arm's length basis historically, flying in once a year, having dinner with our one distributor in Brazil and our one distributor in Chile. There's no way that we could effectively cover the markets. So now have established an office in Sao Paulo, which will be the office for South America. Initially, we will focus most of our attention on Brazil. We will have sales, service and marketing people on the ground there; and their goal is to build a robust distributor network in the key countries. I would say the key countries to start off with are going to be Brazil, Chile and Argentine.

Have we quantified what we think the possibilities are? Yes, but I don't think we're prepared to state publicly what we think they are. But we would not have established an office there unless we felt that they were significant.

David Taylor of David P. Taylor Company.

You are talking about an expansion of margins of 270 basis points from where they are at the current quarter, both the third quarter and nine months, to nine quarters from now. Is most of it going to come in to gross margin or most of it going to come from selling, general and administrative expenses?

More of it will come from below the gross margin line on a percentage basis. If you see it -- we're going to get leverage that we will achieve as we continue to grow the top line at our targeted rate of 5% to 9% and holding our operating expense growth to, at the maximum, half of that will create more leverage below the gross margin line. But it's important to note, we remain very committed to growing the gross margins. It's just -- it's a more difficult task for us to grow that. We feel we can grow both.

It's also important that we will see a bigger jump in our margin structure in 2008 versus 2007. We remain comfortable we can expand operating margins in 2007, certainly. But our initiatives really start to kick in in a bigger way as we get toward the tail end of 2007 and move into 2008. So 2008 will be where we will see a higher proportion of an improvement.

So the earnings gain in 2008, if we are doing 20% this year and maybe something similar next, we're looking for, what, 30%, 40% in 2008?

We're not prepared to comment on that at the current time. We're just, at the current time, providing our double-digit earnings growth. We're not prepared to comment on 2008 EPS growth.

(indiscernible) say that we're going to get to the 9% operating margin, which we have been saying three to five years, that this basically tells everybody we should achieve that closer to three years than five years. So we have accelerated our perspective on our ability to achieve some of these results.

We've tried to become more pointed in the information we're giving on the go-forward basis, which [we shared] a lot of people.

I appreciate that.

-- to do their own modeling work on that. But we're not prepared to precisely comment on it.

Is it fair to say when we approach the end of 2008 that some new goal of a higher operating margin will, assuming you're successful in getting to the 9.5%, will be forthcoming?

We would reiterate what we have said in the past in that regard, but we're going to be happy when we get the 9.5%, and we're not going to be satisfied with that. But we're not prepared to give a new target.

(OPERATOR INSTRUCTIONS). [Kevin Sonnett] of [Arcade Capital].

What is the (indiscernible) grow the facility on the books for today?

We are not prepared to give that. It's a low number, though.

You mentioned, hopefully, recognizing a substantial gain there. I just way to get a little more even qualitative info around that. Are we talking about substantial meaning -- $1 a share? We're talking $10 million, $20 million in gain from that or just substantial as a decent dollar number but doesn't really move the needle in terms of the cash balances?

Obviously, it's a listed property. So it's out there, and we would prefer not to comment publicly on that. but it's meaningful from a cash perspective is the way we commented. I would also like to reiterate that we have not factored that into our -- we can grow on a double-digit EPS bases without the gain on that. But it will be meaningful.

Just following upon the last gentleman's question about where the gain and operating margin could potentially come from, the SG&A line or the cost of goods line, there are a couple of things. I wonder if, Tom, you are really thinking about it when you said more of the gains from the SG&A line.

From the September quarter, which was the base he was using, gross margins were only 41.6%. Given the gross margin trend, I understand it will bounce around based on mix and geography and all from quarter to quarter. I was kind of thinking, given what you had been doing gross margin-wise, as we look out to 2008 and beyond and as we think about the things you're doing, the footprint consolidation in the U.S., more global sourcing, it seems like a lot of cost of goods type initiatives, and you are starting from a low base in the September quarter.

I guess it strikes me that, of the 250 through 300 basis points improvement from here, more of it would actually come from gross margins. So I just maybe wanted to ask that question again with that in mind.

I will let you do your own math on that one, Kevin. I think we've given you enough information to model off of that. We have talked about targeted 30 basis points improvement on our gross margins year on year and our operating expenses only growing at half of our revenue growth. So you can kind of model that and come to some conclusions.

I think the other important part is we're going to continue to see benefits quarter in and quarter out on the leverage that we're seeing in our operating expenses, whereas the gross margin side -- we're not going to see a lot of that benefit till later on into FY 2008 and later. I think the big benefits from our operating initiatives or our initiatives on the operational side is going to be into the future. So it's later on, and it will be an ongoing basis.

Which makes some sense, because we're saying that we're closing the Maple Grove facility at the end of 2007. So next year, there are a lot of moving pieces on the operational side. So the benefits from that really start accruing in 2008.

We have also said that the big benefit comes from platforming our products so that they will be built on to common platforms, mixed model assembly lines, greater amount of common parts and fewer parts. But, really, the first family of products comes off the line next year, and then the next family comes off in 2008. So, really, those benefits start to accruing toward the end of 2008 and into 2009.

The last one is global procurement. We hired a VP of global procurement earlier this year. I think we now have a sound strategy in place as to what we want to focus on but being able to execute against that and really have material benefits start to flow through, most of that is going to start coming in on 2008 as well. That's what I think we are more bullish on the SG&A side of things in the early going, and then I think we are more bullish on the gross margin side of things in the medium to longer-term.

That makes a lot of sense. It's actually quite encouraging because it's it sounds like you think you can get to that 9.5% level without a lot of the results of the initiatives in 2006, 2007 and even part of 2008. You can get to that 9.5% without all the benefits from consolidating the U.S. footprint and the benefits of the new platform products, et cetera. So beyond 2008 or even beyond that level, it sounds like there should be nice potential for the margins.

We keep reiterating that we're still in early stages of this.

Tom, you mentioned 30 basis points a year on the gross margin level on an annual basis. Do you still think you can get there this year? Can you still achieve that goal this year?

Not prepared to comment on that. That's really a goal that we have talked about publicly, if you went back and remind me, Pat, when we first commented on that. But we commented around 2004 that we would see 30 basis points improvement. We actually jumped out of the gate pretty solidly in that regard and improved faster, but -- in 2005, than we had originally anticipated. But we're not ready to give a specific target in the fourth quarter on gross margins.

Even 2006 in general, 2007 in general, 2008 in general? Is that a goal you're still focused on? Or, since you made a lot of progress upfront now, that goal -- we should not really think about that goal?

We're still focused on improving both sides of it, so we would certainly expect to see some level of gross margin percentage improvement in the next fiscal year. We're going to strive for that. We're hesitant to give targets on it, just given the cost environment we're in right now. If we were in a flatter cost increase environment, I think we could give better information there. But it's a tough balancing act to make sure we're getting enough price to offset it, so we're not prepared to give anything specific there.

The range of $1.42 to $1.50 for the year means there's an $0.08 variation in the fourth quarter, which is about a -- depending on the what the number is -- maybe as much as a 20% swing in the bottom line. I'm curious. What are maybe the largest one or two variables that would lead you to come in at the low end of that range versus the high end? It just doesn't seem like a very big range for the full year, but with one quarter left, maybe you're anticipating a little bit of variability there or it's a little tough to predict fourth quarter at this point?

I would just suffice it to say that we feel we're being conservative and giving a broad range, and we're certainly comfortable saying we anticipate being near the higher end of that range and the lower end of the. But it is the range, and the biggest thing that could affect us would be if something happened on the revenue side. But we don't anticipate that.

But the biggest variable that could affect us is if we didn't achieve revenue expectations.

Actually, sir, if you'd like to go ahead we don't have anyone else right now.

You mentioned the M20 was shipping above your expectations. I understand it shipped in Q3, but are you referring more to what you have already seen in Q3 and what's been recognized, or are you referring more to what you have seen so far in October?

I think it's both. I think it's both what we have sold so far has exceeded expectations, and I just, also, the interest, the interest pipeline is also stronger than anticipated.

Andrea Sharkey, Sidoti & Co.

I noticed there was $1 million, other income. I was just curious with that was from, if you could clarify that.

Yes, I will comment on that. If you'd look at the -- a couple different components of that. One is on a nine-month basis; we did have a donation to our foundation last year. So that was why we generated expense on year-to-date basis. But there was two components to the $1 million benefit. One was we have gains in our ESOP as our stock price has gone up, so that was one of the benefits. The other benefit is we so hedge from a balance sheet standpoint on currencies. We did generate some games. Again, we're not speculating; we're just hedging.

But there was offsets within the P&L, so where we saw gains on the other income line we see expense within our cost side of things. Basically just a flip-flop between -- within the P&L there.

Could you possibly break out how much was the ESOP and how much was the FX?

We have not historically provided that. We have talked about it in pieces.

Just back to China a little bit, you said products were rolling off the line in this quarter. Have you made any sales on that? I am sure it's just a portion of sales at this point, but could you give us a sense of what you actually are selling or expect to sell in the next couple quarters?

We have not divulged that for competitive reasons. But really, the big ramp up in China occurs next year, is really when it can become material to our results. We have not divulged that specifically.

(OPERATOR INSTRUCTIONS). I am showing no further questions at this time.

Okay, well, then, let me just say thank you all for your time today for your questions. We're excited about Tennant's third quarter and how strong it was and our year-to-date performance as well. And just to let you know that our other expectations remain high for the balance of this year and beyond. We look forward to keeping you posted on our progress. Thank you all.

This concludes today's conference. We thank you for your participation.