Tennant Co (TNC) 2008 Q2 法說會逐字稿

Good morning. Thank you for participating in today's Tennant Co. second quarter earnings conference call. This call is being recorded. If you do not wish to participate, you may disconnect at this time. (Operator Instructions). Beginning today's meeting is Tom Paulson, Vice President and Chief Financial Officer for Tennant Company. You may begin your conference.

Good morning everyone, and welcome to Tennant Company's second quarter 2008 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, the Tennant's President and CEO, Pat O'Neill, our Treasurer, and Karen Durant, our Corporate Controller.

Our agenda this morning is to review Tennant's performance during the quarter and first six months and discuss our revised outlook for the remainder of 2008. First I'll review the financials and then Chris will update you on our operations. After that we will 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 in the documents we file with the Securities and Exchange Commission. We encourage you to review these documents, particularly our Safe Harbor statement, for a description of the risks and uncertainties that may affect our results.

Our earnings release was issued this morning via Business Wire and is also posted on the investors section of our website, TennantCO.com. Before I review the financials let me start by stating that we at Tennant are very disappointed with our second quarter earnings and the need to revise our full-year outlook for 2008. We stated in our first quarter conference call that our 2008 outlook was predicated on a modest US economic recovery in the second half of 2008.

At this point we are less confident that we will see any economic recovery in the US in the second half and we expect slower economic growth in Europe than in the first half of the year. We also anticipate commodity inflation pressure to intensify, which may increase our cost for oil derivative groups such as tires, plastic, chemicals and resins, as well as steel products.

We believe that these combined macroeconomic headwinds will result in Tennant's 2008 financial performance being below the earnings we originally forecasted for the year. And while we cannot control an economic recession or commodity price hikes, we are addressing the factors within our control as Chris will discuss in a moment. In my comments today, all references to earnings per share are on a fully diluted basis.

For the second quarter ended June 30, 2008, Tennant reported that net sales increased 17.2% to 193.6 million versus net sales of 165.2 million in the second quarter of 2007. Contributing to the rise in net sales or recent acquisitions, strong volume gains in emerging markets, sales of new products as well as selling price increases taken worldwide to mitigate higher material costs.

The Applied and Alfa acquisitions added approximately 8% to consolidated net sales for the quarter, and foreign currency exchange added approximately 5%. Organic net sales growth, which excludes acquisitions and foreign currency benefits, was approximately 4%. We've seen results from our long-term strategy to build our international business with revenue outside of North America rising to 44% of sales in the 2008 second quarter, up from 35% a year ago.

Net earnings were 8.3 million, or $0.44 per diluted share in the 2008 second quarter compared to net earnings in the prior year second quarter of 10.5 million, or $0.55 per diluted share. There were several unusual items that reduced 2008 second quarter earnings by $0.10 per share. These included legal settlement expenses of $0.06 per share, primarily related to the settlement of a claim filed in the second quarter by a terminated distributor in Brazil, expenses related to curtail the acquisition initiatives of $0.02 per share, a tax reserve of $0.03 per share for a discrete item related to prior period uncertain tax provisions.

These are partially offset by $0.01 per share gain from the divestiture of certain assets. In addition to these unusual items, we incurred dilution of $0.01 per share in the second quarter from the Applied and Alfa acquisitions, although the full-year impact is still expected to only be modestly dilutive. Let me provides in context around unusual legal settlement expenses in the quarter.

First, we terminated a distributor in Brazil which was necessary in order to have broader sales coverage in that country. The terminated distributor filed a legal claim in the second quarter and we made the decision to settle that claim outside of the Brazilian court system in order to swiftly transition business to our new Brazil distributor. Although the action was not directly related to the Alfa acquisition, the timing was important to move forward with a new distributor in order to capture the sales synergies for Alfa and Tennant.

We also accrued for a legal settlement for an unemployment claim filed in France that was indirectly related to the Applied acquisition. We moved quickly to reorganize and combined the Applied and Tennant French sales forces in order to improve sales efficiency. We also had two other legal settlements, one related to a former board member and one related to a severed employee.

In addition to the unusual items in the second quarter continued economic weakness in North America resulted in lower equipment sales than anticipated, and commodity inflation pressure became more intense. Our results in the quarter were also somewhat impacted by the softening economy in Europe.

For the six months ended June 30, 2008, Tennant net sales grew 13.1% to 362.2 million, with acquisitions and favorable foreign currency exchange effects each contributing approximately 5% to first-half net sales. Year-to-date net earnings totaled 13.5 million or $0.17 per diluted share.

The first-half results in 2008 include $0.10 per share for unusual items in the second quarter and $0.06 per share dilution from the two acquisitions. In the comparable 2007 period we reported net earnings of 16.3 million, or $0.85 per diluted share on net sales of 320.3 million.

In North America, 2008 second quarter net sales totaled 108.6 million, up 0.7% versus the prior year quarter, primarily due to the benefit from selling price actions taken to mitigate the impact of inflationary cost increases. We continue to see a longer sales cycle during the second quarter. We also had a large non-recurring shipment to a national account customer in the second quarter of 2007 that did not repeat in the 2008 second quarter.

For the first six months of 2008, net sales in North America rose 1.2% to 206.8 million versus the prior year period. Foreign currency exchange effects on North America sales added less than 1% for the second quarter and first-half of 2008. Continued soft sales of industrial equipment were somewhat offset by increased sale of service and parts and consumables.

In our EMEA markets which encompasses Europe, the Middle East and Africa, second quarter net sales grew to 63.7 million, up 50.2% compared to the 2007 second quarter. The Applied acquisition contributed approximately 24% to second quarter sales growth in this region. Favorable foreign currency exchange effects added approximately 16% to sales for the quarter.

For the year-to-date, net sales in the EMEA region increased 35% to 116.4 million. The Applied acquisition was responsible for approximately 15% of the first-half EMEA sales gain and favorable foreign currency exchange effects added approximately 15% to sales for the first-half of 2008.

In Tennant's other international markets, which is comprised of China and other Asian markets, Japan, Australia and Latin America, 2008 second quarter net sales rose 42% to 21.3 million versus the comparable 2007 quarter. The Alfa acquisition contributed approximately 13% to the sales increase while favorable foreign currency exchange effects benefited sales by approximately 11% in the 2008 second quarter. Volume gains in the Latin America and Asia Pacific regions reflect the investments we've made in these emerging markets.

Year-to-date, other international grew 31.3% to 39 million versus the first-half of 2007 with Alfa acquisition responsible for approximately 7% of the growth and favorable foreign currency exchange effects adding approximately 7% to sales and other international markets in the first-half of 2008.

Tennant's gross margin was 42.5% for the 2008 second quarter compared with 42.9% in the 2007 second quarter. Given the current environment we're pleased with this performance. Earlier selling price increases and continued cost reduction initiatives more than offset rising raw material and purchase component costs. A favorable impact from foreign currency fluctuations also benefited gross margins in the quarter.

The slight decrease in a gross margin was due to approximately 900,000 of expense or 40 basis points from the flow-through of a portion of the fair market value step up of inventory related to the Applied and Alfa acquisitions. Year-to-date, Tennant's gross margin was 41.9% compared with 42% in the comparable prior year period. The 1.3 million of expense from the flow-through of fair market value inventory step up reduced gross margin by 40 basis points, which was nearly offset by selling price increases and savings initiatives.

For a number of quarters we discussed our programs to reduce operational costs. We generated approximately 6.4 million of gross savings from global low-cost sourcing and lean manufacturing combined in the first-half of 2008. And we remain on track to generate savings in our stated range of between 9 million and 12 million in 2008 from these initiatives.

Research and development expenses in the second quarter were 5.7 million compared with 6 million in the 2007 second quarter. R&D expense as a percent of sales was 2.9% in the second quarter of 2008 compared with 3.6% in the comparable quarter last year. Year-to-date research and development expense was 11.7 million compared with 11.8 million in the first-half of 2007. R&D expense as a percent of sales was 3.2% in the first-half of 2008 compared to 3.7% in the comparable period last year. We plan to stay within our target of annually investing 3 to 4% of net sales in R&D.

For the quarter, selling and administrative expenses were 60.7 million, or 31.4% of sales versus 49.7 million or 30.1% of sales in the 2007 second quarter. Included in the 2008 expense was 3.4 million of selling and administrative expenses from the Applied and Alfa acquisitions, and approximately 3 million of unfavorable foreign currency exchange. Also included is 1.7 million or 90 basis points of unusual legal settlement expenses.

The increase in F&A expense in the second quarter outpaced sales growth due in part to investments in infrastructure made earlier in the year to expand market coverage as well as new product launch expenses. We began implementing our contingency plans in early April 2008 to better align expenses with sales.

These actions help control growth and expenses in the second quarter. However the benefits of those actions are skewed more towards the back half of the year. To further control expenses we have both tightened and extended our policies to prevent non-essential hiring and reduce discretionary spending on a global basis.

Year-to-date selling and administrative expenses was 115.8 million or 32% of sales compared to 98.6 million or 30.8% of sales in the prior year period. Our second quarter operating profit was up approximately 6% to 16 million compared to the 2007 second quarter.

On a percentage basis our operating profit margin was 8.3%, including the net unfavorable 120 basis point impact from the legal settlement expenses, the gain from the divestiture of assets and the flow-through of inventory step up from the recent acquisitions. Operating profit margin was 9.1% in the 2007 second quarter.

Year-to-date our operating margin was 6.8% including the net unfavorable 70 basis points impact from those same items I just mentioned. Operating profit margin totaled 7.6% in the first-half of 2007. Although operating margins have been constrained in the first-half of this year, we still expect to reach an operating margin of 9.5% in the fourth quarter of 2008.

The effective tax rate in the second quarter and first-half of 2008 was 43.7% and 41.2% respectively. In the 2008 second quarter, the base tax rate increased to 38.5% from 36% due to lower overall level and geographic mix of earnings in the current outlook. We also established an additional tax reserve of approximately 500,000 or $0.03 per share for a discrete item related to prior period uncertain tax positions.

The base tax rate for 2008 is still expected to be in the range of 36.5% to 38.5% and discrete tax items are anticipated to be insignificant for the full year. Our estimate of the full year tax rate does include the recent acquisitions.

We hired a new tax director and an international tax manager in the first quarter of 2008. One of our top priorities this year is to develop a more comprehensive long-term tax strategy to achieve a lower tax rate in the future. That process is well underway and we do already anticipate some favorable tax benefits will occur in the second half of this year.

Now turning to the balance sheet. Net receivables at quarter end totaled 149.9 million compared with 116.3 million a year earlier, a 33.6 million increase. Of this, 10.3 million is related to our 2008 first quarter acquisitions and the remaining 23.3 million is due to foreign currency translations and growth in net sales over the 2007 second quarter.

Accounts receivable days outstanding was 66 at quarter end versus 61 in the prior year period. The increase was primarily due to a higher mix of sales in Europe, which carry longer payment terms than in North America.

Our inventories at quarter end totaled 78.1 million, up from 61 million and end of the 2007 second quarter. The 17.1 million increase included 5.5 million of foreign currency translation and 5.4 million of inventory from our 2000 -- first quarter acquisitions with the remaining 6.2 million from increased demo inventory related to the transition to new products and a higher inventory level due to low-cost country sourcing and new product introductions. FICO days inventory on hand was 90 days at the end of the quarter versus 86 days in the comparable period last year.

Capital expenditures totaled 10.9 million of the first-half of 2008, 6.6 million lower than the 17.5 million in the first-half of 2007. We expect full year capital spending in 2008 to be approximately 26 million to 30 million, including spending related to our recent acquisitions. This also includes our SAP upgrade and related infrastructure enhancements, which we accelerated by one year to improve the ability of our systems infrastructure to expand globally.

In addition we're investing and our Minnesota facilities, creating a global R&D center of excellence. These investments were initiated last year and we need to follow through and complete them in order to complete our business processes and continue our new product innovation.

During the second quarter we repurchased approximately 129,300 shares of common stock under the board authorized one million share buyback programs. Total cost of the shares repurchased was 4.7 million.

At quarter end approximately 512,000 shares remained under Tennant's shares repurchase program. We're willing to use our current authorization to buyback the shares remaining and we will continue to consider the repurchase of shares whenever we feel our stock is undervalued. We will likely recommend another repurchase authorization through our Board of Directors in the near future.

Tennant's cash and cash equivalents totaled 18.5 million at the end of 2008 second quarter compared to 32.9 million in the prior year quarter. We had a debt to capital ratio of 28% at end of the second quarter compared to 1.8% at December 31st 2007. The increased debt to capital ratio primarily reflects the drawdown of 95.5 million from our credit facility during the first-half to fund our two acquisitions. At this time I'll turn the call over to Chris.

Thank you all for joining us this morning. Let me begin by saying that the lower second quarter earnings and the lower 2008 guidance obviously is not the news we wanted to share with you today. We are disappointed with this short-term setback, but not in Tennant's strategic direction or long-term future. Know that we are intensely focused on addressing the factors within our control.

Clearly the second quarter sales and profit margins did not meet our expectations, and the economic climate especially in North America and in Europe, is very challenging. We originally forecasted a modest economic recovery in North America in the back half of this year, and planned that Europe would not be impacted by economic weakness.

At present the most significant risks to our performance this year are rising commodity costs and continued economic uncertainty, both in North America and the potential for the downturn in the US economy to adversely impact other regions. We continue to execute against our contingency plans. Our approach during this period of uncertainty is one of making selective and highly disciplined investments in the business that are balanced against our current rate of growth, and protect our overall profitability.

There were, however, a number of bright spots in the second quarter. These included second quarter revenue growth despite a difficult macroeconomic environment. Tennant's ability to maintain gross margins through selling price increases and our lean and low-cost sourcing efforts in the face of inflationary commodity pressures and lower volume, on track execution with our integration plans for Applied and Alfa acquisitions. Volume gains in emerging markets and the successful introduction of several important new products.

I'll touch on these highlights in more detail as I review results from our three business regions. I'll also discuss our cost control actions and progress in leveraging operational efficiencies. After that I will outline our efforts to continue growing the business.

It was another tough quarter for our North American business, which grew less than 1% during the second quarter. A decline in unit volume was caused by lower sales of our industrial and outdoor equipment as we experienced late in the first quarter. As Tom mentioned, we continue to see a longer sales cycle with customers potentially delaying their purchases due to broader economic factors. We're focusing on the growing segments of the market such as building service contractors, as well as offering targeted incentives in order to stimulate demand and close active deals.

In our EMEA market, which encompasses Europe, the Middle East and Africa, we were pleased that net sales grew 50% compared to the prior year second quarter. The Applied acquisition contributed approximately 24% of the increase, but we also had approximately 10% organic sales growth in EMEA. This organic growth was in line with our expectations and came from new product volume and sales gains in Central and Eastern Europe due to our continued market expansion initiatives.

Results from our other international markets, which include China and other Asian countries, Japan, Australia, and Latin America, were again very positive with sales up 42% in the second quarter. As Tom noted, the Alfa acquisition added approximately 13% to the sales gains in this region. Our volume gains in Latin America and Asia Pacific reflect the investments we have made in these emerging markets. We're pleased with the solid revenue growth here and we expect continued market penetration and expansion in these geographies throughout 2008 throughout 2008 and beyond.

As I mentioned last quarter, due to the uncertain economic environment, we have already implemented strict policies to control expenses. Our contingency plans are in place and are anticipated to continue to reduce costs globally throughout the second half of 2008. We're developing a stronger cost control culture with the goal of significantly lowering our operating expenses as a percent of sales over the next few years.

Some of the cost cutting actions that we have already taken include delays in non-revenue generating new hires, reduced hours in the plants and a combination of deferrals and permanent cuts in discretionary spending. Additionally, we remain committed to leveraging our operational efficiency. Tennant's global sourcing and cost reduction initiatives contributed to the solid gross margins we were able to maintain in the first half of 2008, especially in this tough commodity market.

We're gaining further traction from the manufacturing footprint consolidation we completed last year. As Tom noted, we generated approximately $6.4 million in gross savings year-to-date from our global sourcing and lean manufacturing initiatives combined, and expect to meet our savings goal of between 9 million and 12 million this year from these initiatives.

Now turning to our growth priorities, I'll update you on our progress in building Tennant's sales through market expansion, including acquisitions and through new products. The integration of both our Applied and Alfa acquisitions are on plan and proceeding smoothly. We're very pleased with the significant sales generated by both Applied and Alfa. Of note, we completed the merger of Alfa with Tennant do Brasil on May 31st, which cements the overall tax and legal structures surrounding this acquisition. We will continue to update you on the contributions from these new acquisitions going forward.

We're also excited about this year's new products. New products are a key driver of our revenue growth. We target 30% of Tennant's annual sales to come from new products. In the first six months of 2008 we have exceeded this goal as 41% of our year-to-date equipment revenues came from new products launched over the past three years. We have been successful in introducing new products that carry the same or higher gross margins than the ones they replace.

Following its launch in the 2008 first quarter, we continued the global rollout of our electrically converted water technology, which represents an entirely new and environmentally friendly method of cleaning. We have rebranded this technology from Echo to ec-H20 in order to strengthen and protect the trademark globally. Despite the tough economy, ec-H20 continues to meet our expectations. We are very pleased with the customer adoption of this game changing technology that reinforces Tennant's leadership position in the cleaning industry.

In fact, we have recently been notified that ec-H20 is a 2008 R&D 100 award winner. ec-H20 was selected by R&D magazine as one of the 100 most technologically significant products introduced into the marketplace over the past year. We recently won our first major deal with a large retailer, who is mandating that ec-H20 be the exclusive cleaning method used in all of their stores. This is a big win for our North America business and hopefully the first of many national account conversions.

In the first quarter we also introduced two new products. Then in the 2008 second quarter, Tennant lot launched a family of three new products, a carpet cleaner, cylindrical floor scrubber, and carpet extractor. These compact, maneuverable, cord-electric floor care machines were specifically designed to quickly and effectively clean small congested spaces in the education, health care, retail, government and commercial office markets.

The products are marketed globally under the Tennant brand as the R3 carpet cleaner, the T1 cylindrical scrubber, and E5 carpet extractor. They're also marketed in North America under the Nobles brand as the Stride compact carpet cleaner, the Speed Scrub cylindrical scrubber, and the Speed EX carpet extractor. We're excited about the global appeal of this new product family, which will enable us to reach market segments where we have been traditionally under-represented. These three new products, which were built on a common platform, demonstrate our emphasis on lean manufacturing.

We plan to introduce a couple of additional new products in the second half to further enhance our product portfolio and growth opportunities. Because new products will continue to fuel a significant portion of our growth, we remain committed to investing 3 to 4% of annual sales in product development.

Going forward, we will continue to focus on leveraging our global cost structure, investing in international expansion, and developing and launching innovative new products. Despite the current macroeconomic conditions, we remain confident in the long-term strength and value creation potential of our business. Now I'll turn the call over to Tom for a review of our outlook for the remainder of 2008.

As we noted in the release, we're lowering our 2008 full-year outlook due to a combination of factors that impacted our second quarter results and our expectations for the last six months of the year. Tennant's current outlook assumes no second half economic recovery in North America, as well as slower growth in the European economy during the last six months of the year than in the first six months of 2008. As a result we now expect full-year 2008 organic net sales growth to be at the low end of or slightly below our targeted range of 5% to 9%.

Our revised 2008 expectations are based on achieving sales gains in the second half in North America and EMEA similar to what we experienced in the first half. In our other international markets we anticipate double-digit sales gains for all of 2008.

As we said the Company expects to realize savings of between 9 million and 12 million in 2008 from global low cost sourcing and lean manufacturing initiatives. We continue to target an operating profit margin of 9.5% in the fourth quarter 2008, also as noted earlier. This outlook assumes the Applied and Alfa acquisitions will be modestly dilutive for the year.

The base tax rate for 2008 is still expected to be in the range of 36.5% to 38.5% and discrete tax items are anticipated to be insignificant for the full-year. Given these assumptions, we now anticipate 2008 full-year dilutive earnings per share to be in the range of $1.85 to $2.10 versus the 2007 reported earnings per share of $2.08. This does represent an increase of 3% and 17% compared to 2007 adjusted earnings per diluted share of $1.79.

This includes the onetime tax benefit of $0.19 recorded in the third quarter 2007, the gain from the Maple Grove facility sale of $0.19 reported in the fourth quarter 2007, and the restructuring charge of $0.09, of which $0.06 and $0.03 were recorded in the third and fourth quarters of 2007 respectively. Previously the Company's 2008 forecast called for full-year diluted earnings per share of $2.25 to $2.40, and organic sales growth at the high-end of the targeted range of 5% to 9%.

As you are aware we do not provide quarterly guidance, however we would like to remind you of two additional items that affect the results in the second half of 2007. First we had a higher effective tax rate in the fourth quarter 2007 than in the third quarter 2007, even excluding the impact of the net onetime tax benefit recognized in the third quarter of 2007.

Second, our ESOP plan generated fairly significant income in the 2007 third quarter when Tennant's stock price was at record levels. This income is recorded below operating profit as other income. We expect these items will affect our comparisons in the third and fourth quarters of 2008 to some extent. With that we would like to open up the call to any questions.

(Operator Instructions). Ted Kundtz.

Could you talk a little bit about -- given this environment, a little weaker environment, could you talk about the competitive situations, and any kind of price pressure you're seeing from your competition, or from your customers as the case may be? They're putting pressure on you to lower prices.

I think we're probably seeing a little more price pressure than we would normally do. I don't think our competitors are acting any differently than they have historically. Most of us, we basically have list prices and offer our salespeople, opportunity to discount within a limited range. And they have probably taken that opportunity a little bit more then they normally do and we see that in the case of our competition as well.

But the price gap between us -- we're the price leader, especially in North America. The price gap between us and competition has not changed.

Nor do you think the market shares changed to -- in any significant way?

I can't tell you definitively. We know our market share has changed because of the two acquisitions we just made --

Right, ex-that.

But organically, we don't have good enough information in real time to be able to measure that. I think we once a year can step back and figure out what progress we've made from a market share standpoint. But what I will tell you it is that most of the deals we're involved in are being postponed. We're not losing deals. We said this in the first quarter, and that's the same thing we experienced in the second quarter.

Okay.

As a matter of fact, with our ec-H20 technology, we're probably winning more than our fair share of deals. As we did with the one major retailer which I can't name, but it's a significant one, and the fact that they mandated the exclusive use of ec-H20 to clean all of their stores is a huge win for us, something we can use to market ec-H20 with other national accounts, both in North America and around the world.

I'd add one thing. We did pricing that we took in the first quarter was an important part of holding onto margins. That was even more successful in Q2, and really based on all the data we have, we just -- we believe our pricing can hold up for the rest of the year. We aren't seeing we're losing deals due to price.

Are there any more price increases scheduled for the balance of the year to reflect the inflationary environment?

We will continue to evaluate that. The one thing we're doing is in selected areas within Europe, we are in the process of implementing a price increase due to some of the pricing pressures you have seen there. We will evaluate pricing in other geographies as we continue to go forward.

Going back to the ec-H20 outlook, do you expect to see -- maybe you could talk a little bit about the reception to that product line. You mentioned one large retailer coming on with -- kind of exclusively with this technology. Are you seeing other people thinking that way, or do you think this would be kind of a slower take-up given the environment, what is kind of your outlook for that?

Even though we're in a tough environment, it's meeting our expectations. We haven't divulged what the sales are yet for competitive reasons, but it is meeting our expectations. And we are in discussions with many national accounts around the world regarding ec-H20. And our hope is and our anticipation is that we will win some of that business. It is being received extremely favorably across the board. We have not gotten a negative reaction from any customer that we're talking to that's important to our business, important to our future.

Now it is currently on six machines, is that correct?

It's currently on six machines, yes (multiple speakers)

And you plan to expand that?

We'll expand that to some of our ride on equipment as we go into 2009 (multiple speakers) it's on walk behind scrubbers now.

Okay. And one final question and I'll get back in queue. The gross margin outlook going forward, given the environment, do you expect to be able to see any increase in gross margin from the current levels?

I think probably the safer way to characterize the back half of the year is we believe we will continue to see flat gross margin relative to the prior year.

Okay.

That's really all about -- we believe we can hold onto pricing. The offset to that is we're going to -- our forecast would say we're going to see higher inflationary costs from commodities, and we believe that we can offset that through our cost savings initiatives and our pricing. But I think it would be overly aggressive for us to assume we can expand margins of any significance in the back half. I would say flat margins would be a better way to think.

Which would be down from where you currently are. The gross margins in the second half of last year were 41.4 and 42.4. So you expect them to be down?

We would expect them to be.

I'm sorry, down from the current quarter.

Right. Down, but flat to modestly above prior year (multiple speakers) I would say flat relative to prior year is a better way to think about it.

Okay, thank you.

Seaver Wang.

I have a question on the product mix in different geographies, in terms of profitability. You had a pretty good -- you had some favorable currency for -- the international volumes seem to be pretty good too. What's the difference between the profit margins there? And also I had a question on your Chinese plant. Is that profitable at this point?

Let me take the China piece first. We would say that if you just looked at China as an entity by itself and it still going to be modestly unprofitable. We don't think we're that far away from turning the corner to profits, so in the grand scheme of things it's not material. When you consider the level of sourcing savings that that factory is helping generate as a base, it's clearly profitable overall. But as an entity basis, it is slightly unprofitable.

And I will comment partially on your other question. North America is a far more mature market than any of our other markets. It's got a significantly higher revenue base. We don't give out profitability numbers by geography, but it is somewhat more profitable than other areas. And clearly that's one of the things we're working against.

As we have done acquisitions and expanded internationally, we want to create further leverage. And we're working toward enhancing the profitability in all of our geographies. But it is one of those things that has had somewhat of a negative impact on us this year as we haven't grown North America as highly as we have. We haven't generated some of the profits this year to fund some of our other markets. So it is one of the things that is negatively affecting profitability right now.

Can you -- one last question. Can you quantify the amount of discretionary expenses, kind of ballpark do you think you can kind of cut for the year? (multiple speakers)

Here's how I would think about it. If you look at our operating expenses in the back half of the year, I would say that we should be able to be a percentage point to 1.5% lower than our operating expenses as a percent of revenue in the back half of the year. I think that's just -- for the back half of this year versus the back half of the prior year, I believe we can be about 1% to 1.5% lower.

Okay. And R&D will stay at least above 3% --

Yes. The full-year R&D numbers will be -- certainly be within the 3% to 4% range.

Has the obvious new product introductions, has that significantly increased the SG&A too?

It certainly did in the front part of the year. It was -- one of the couple of things that we have not done is any of our longer-term strategic initiatives and all of our new product launches, we have not compromised any of our spending against those.

As you guys know in the first quarter and in the second quarter, we didn't get the revenue growth we expected, therefore our expenses from -- as we added people in marketing and sales and as we supported some launches, our spending higher than we would like it to be with the revenue. We firmly believe we have corrected that in the back half of the year and it will be completely back in line with spending being at an appropriate level for the revenue expectation.

Okay, thank you.

Rob Damron.

I wanted to talk about the building service contractors here in the US. One assumption that has been discussed in the past was -- as the building service contractors grow in importance or as a percentage of your sales, that would help mitigate any slowing in the overall economy. So I guess would you say that is playing out kind of as expected? Is it helping to mitigate the softness in the economy? And maybe you could give us a percent of the sales and North America now that goes through building service contractors.

We predicted that the next recession hit that the fact that building service contractors represent -- it's our estimate, about 40% of all facilities cleaned in North America would help smooth out our sales. I think that has come to be true. We said in our statements the one growing part of our business and North America is building service contractors. And we're seeing the weakness is more direct sales of our bigger indoor and outdoor equipment.

So I think that as building service contractors continue to grow, we said they represent 40% in North America, they represent about 70% in Europe, that's a good thing for us. And we're beginning to win more than our fair share of business against them. And technologies like ec-H20 are spot on.

That's helpful. (multiple speakers)

I'm not going to tell you what the split is internally within Tennant but I did give you the split kind of externally within the market.

And then just another unrelated question, just in terms of the acquisitions, the two acquisitions made recently this year. Maybe you would just give us how the integration of those acquisitions are going, and as they get more fully integrated into the business, would you anticipate better margins out of those businesses?

I'll comment on that. As we said in our prepared remarks, things are going very much according to plan from an integration standpoint. They're both very big and important deals to us. They actually each of them have a very senior level person, that's 100% of their job is to lead the overall integration of the businesses into the world of Tennant, and we also recognize what things we shouldn't change too.

And we are at the upfront stage. The biggest benefit we're seeing is we're fully deployed our sourcing team against sourcing where we can save money in both those acquisitions, and that's going quite well, particularly on the Applied side. And we will see further integration as we go forward, and that will drive margin improvement from where we stand today.

I think we are on track to start producing the Applied machines out of [Skyland] in our Minneapolis facility early in 2009 for the North America market.

That helpful, that's all I have. Thanks.

Robert Schenosky.

I have a couple questions here. First, you mentioned the FX benefit to topline and gross margin. Do you know with the net benefit is, if there is any, to operating income?

We haven't commented on that historically. Call it -- it would be better to say we haven't commented on it historically. (multiple speakers) It's a tricky number, and that's -- Tennant historically had commented on that, and when you start to get into that it's a hard number to get at and show. So we've chosen to walk away from that.

But is it fair to say it wasn't meaningful?

I wouldn't say -- it's not a big benefit overall.

Given the new range that you have given for the full-year, what macro assumptions do you have in place in terms of the low-end of your range versus the high-end, and do you have any FX delta assumptions in there as well?

We have not assumed any significant change in FX, so that would be one piece overall. We're not even close to good enough to forecast what's going on in foreign currency. And it would be hard for me to comment on the other broader macroeconomic trends, given the significant number of moving parts with North America, Europe, other international markets, commodities.

So I think we would stick with what we've talked about is basically North America is kind of more of the same from a growth perspective in the back half. In Europe we expect to grow slightly lower in continuation of the trends in our other international markets. We really don't want to get any more specific than that at this time.

And related to that, can you give us any additional color or any numbers related to the increase of raw material costs in the second half? You talked about that as a concern, and is it a function of increasingly difficult to pass through in the second half versus the first half? Is it changes in supply contracts? Or is it a function of the acquisition of the two companies reworking contracts there? If you can give us a little bit more detail.

Nothing related to the acquisitions, in fact that's probably an opportunity for us in the back half. But the biggest thing we're seeing is one, there's just more pressure and it's constant and -- we would certainly hope it would start to lessen but it hasn't. The one area that's favorable for us is lead, but in all other fronts the pressure remains really tough.

We managed to really push out the increases in many instances from our suppliers, and so we haven't seen the full effect coming through in the front part of the year. And therefore we're going to see more of that come through in the back half as some of our contracts do run out and we see the full impact of those price increases. But like I said, we still do believe that we can hold our gross margins flat to last year in the back part, which would be similar to what our gross margins were for the first full six months.

We even have suppliers telling us yes, we know you have a valid contract, we don't care. We're going to take the price FX.

No, I understand a lot of companies are in the same boat.

So it's either -- contracts expiring or suppliers basically saying we don't care what the contract says, we have to take the prices up.

Thanks for your time.

Beth Lilly.

Good morning. I wanted just a better understand of these unusual items that you talked about, in terms of the Brazilian distributor, the legal settlements, there are legal issues, and then you said there were also some expenses related to a former board member and a terminated employee. Can you walk through those items again?

Sure. Would you like to ask specific questions, or would you like me to walk through them?

Why don't you walk through them? And then -- I just want to better understand them. Can you go into a little bit more description of each issue? (multiple speakers)

Yes, and I'll let my colleagues here jump in too as I miss anything. But the first one, the Brazilian piece, we had an existing distributor in Brazil prior to the acquisition. Frankly we felt that we could get better performance from a different distributor. We were in the process of looking at making that change.

And as we brought on the Alfa acquisition, it became even more apparent that we just couldn't have the conflict that was impending there, and we just decided to move quickly and settled it outside of the court system, and allowed ourselves to firmly move forward. And we feel -- we certainly don't like the expense we saw in the quarter, but we feel very strongly that was the right decision and will optimize what we're going to be able to do in that market, with moving onto a far bigger distributor who has a lot more reach than our previous distributor had.

[As long as] they know the distributor we managed to sign up, they're called [Somoff], and they're the biggest I think Caterpillar distributor in Brazil. So they have unbelievable reach in the markets that we're trying to penetrate.

So the problem was you had a contract with an existing distributor in terms of guaranteed amounts?

I mean -- the issue is -- listen, we're an American company operating in Brazil. We decided that if we were to take this to court, the chances that they would side with the local distributor and against us were very high. And the expense related to that and the time and effort we decided wasn't worth it, so we just bit the bullet and settled upfront.

One of the things the courts are pretty famous for in that part of the world is just the time that things would take. And we heard numbers in excess of 10 years that a case could take to get resolved. We just couldn't afford that, and we felt it was -- and still feel very strongly it was the right decision to move outside the legal system and settle and move forward.

So you paid them over $1 million, right?

Less than $1 million.

Less than $1 million.

It was more in the vicinity of -- all parts of the settlement were more in the vicinity of $700,000 or so, roughly.

Because I took the $0.06 a share times 18.8 million shares. That's how I got over $1 million.

There's other components to that -- the legal settlement. That's just one piece of it. So the other major piece of that was the settlement we talked about in France, and that was really related to, as we started down our path of integration of our existing organization in France and the Applied organization, we made some changes.

It's -- France is a tough market when it comes to what you need to pay in severance costs, and we again decided that it was the best thing for us was to settle that and move forward. It's not completely settled yet, so it's still -- we've made an accrual for the expense that we expect for that to cost us in the quarter.

Okay.

We expect to be able to move forward positively.

There were a couple other issues, one was the expenses related to curtail acquisition initiatives?

We had two different transactions, which was the price we're going to -- we hope it doesn't happen frequently, but we had some activities on two different transactions that we were very excited about. We went pretty deep into them. We got into due diligence and determined that the things that we found in due diligence were -- we needed to walk away from them. So we made -- as interested as we were, we found things that dictated that we should walk away and we had to eat that expense.

And then two other -- you said something about a former or board member and a terminated employee. Can you talk about that?

Terminated employee, I would say is immaterial. It's just honestly -- it's a normal part of doing business, it just happened to be slightly expensive. But I wouldn't say at the time we could share any more details on that.

On the case of the board member, we had -- determined that we hadn't done as good of a job as we could have in ensuring that -- related to some ensuring the people cashed some stock options. And we had -- we decided to settle that disagreement and settle that outside of -- going forward with any kind of legal action. And we recognized that in the quarter also and took care of that action

So wait, there was issues with their options?

There were issues with whether we had appropriately communicated when those options should have been cashed.

There were some mistakes made, and they were honest mistakes that had to be dealt with. It is now behind us, it is settled, and it settled to the satisfaction of both parties involved.

So -- okay. So as you go forward and you look out to let's say a more normal environment, with whatever that is, are you comfortable that this business can grow 5% to 9%?

Yes.

Absolutely. As I said, we remain very bullish about the long-term prospects for this business and for the value creation potential. If you step back and you look at our strategic direction, it remains spot on. And we're making very significant progress against all of our key strategies and all of our key initiatives. We're getting good traction. So we -- we anticipate that we will be in very strong shape as we come out of this economic environment. And so the 5% to 9% organically remains our commitment.

Great. Thanks for that.

Nothing has changed from that perspective.

Great.

There are no further questions at this time.

Thank you for your time today and for your questions. We continue to make solid progress in all of our key strategies and initiatives, and we remain firmly committed to the long-term strategic direction that we have established. We believe a continued focus on our strategies of international market expansion, new products and operating efficiency gains, coupled with strong cost controls positions us for long-term success. We look forward to keeping you posted on our progress. Thank you all.

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