Tennant Company (TNC) Q2 2016 Earnings Report, Transcript and Summary

Good morning. My name is Andrew and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Tennant Company’s Second Quarter Earnings Conference Call. This call is being recorded. There will be time for Q&A at the end of the call. [Operator Instructions] After the Q&A please stay on line for closing remarks from management. [Operator Instructions] Thank you for participating in Tennant Company's Second Quarter Earnings Conference Call. Beginning today's meeting is Mr. Tom Paulson, Senior Vice President and Chief Financial Officer for Tennant Company. Mr. Paulson, you may begin.

Thanks, Andrew. Good morning, everyone, and welcome to Tennant Company's second quarter 2016 earnings conference call. I'm Tom Paulson, Senior Vice President and Chief Financial Officer of Tennant Company. With me on the call today are Chris Killingstad, Tennant's President and CEO; and Karen Durant, Vice President and Controller. Our agenda today is to review Tennant's performance during the 2016 second quarter and our outlook for the 2016 full-year. First, Chris will brief you on our operations, and then I'll cover the financials. After that, we'll open up the call for your questions. We are using slides to accompany this conference call. We hope this makes it easier for you to review our results. A taped replay of this conference call along with these slides will be available on our Investor Relations website at investors.tennantco.com for approximately three months after this call. Now, before we begin, please be advised that our remarks this morning and our answers to questions may contain forward-looking statements regarding the company's expectations of future performance. Such statements are subject to risks and uncertainties and our actual results may differ materially from those contained in the statements. These risks and uncertainties are described in today's news release and the documents we filed with the Securities and Exchange Commission. We encourage you to review those documents, particularly our Safe Harbor statement, for a description of the risks and uncertainties that may affect our results. Our earnings release was issued this morning via Business Wire and is also posted on our Investor Relations website. At this point, I'll turn the call over to Chris.

Thank you, Tom. And thanks to all of you for joining us this morning. As you saw in our earnings release today, Tennant returned to modest organic growth of approximately 2.4% in the 2016 second quarter. This stemmed primarily from sales to strategic accounts in the Americas and in the Europe, Middle East, Africa, or EMEA regions. The company's second quarter net sales were $216.8 million, with diluted earnings per share of $0.85. On a constant currency basis, Tennant would have reported second quarter earnings per share of $0.89, which would have been up 12.7% versus a year ago. In the Americas region, we posted record second quarter sales and in EMEA we were pleased to see the strongest organic sales growth since the second half of 2014. The company's sales and earnings gains over the prior year quarter demonstrate our ongoing focus on executing our growth strategies and leveraging our operating efficiency. Tennant's operations are performing well and we continue to build our business for sustained success. As I mentioned last quarter, we were encouraged to see rising sales momentum toward the end of the first quarter and into the early second quarter. As we progressed through the second quarter, order patterns were lumpy, reflecting sluggish economic conditions. The third quarter was starting out as expected, although it is early. We anticipate the global economy will continue to be volatile. Based on Tennant's performance to-date and our expectations for the remainder of 2016, we are narrowing our full-year revenue guidance. We are also raising our earnings guidance to reflect a less adverse foreign currency exchange environment than we previously anticipated. Tom will discuss our guidance in more detail in just a moment. As I said before, we are staying the course strategically. We are committed to reaching our goals of a billion dollars in organic sales and a 12% operating profit margin through a strong new product and technology pipeline, sales gains in emerging markets, a return to growth in Europe, ongoing focus on strategic accounts, and enhanced go to market strategy designed to significantly expand Tennant's worldwide market coverage and customer base, building Tennant's e-Business capabilities and the application of lean principles throughout our organization. We remain confident in our growth strategies. They are yielding positive results in a slow growth environment and we are well-positioned to leverage our operating efficiency as economic conditions improve. Now I'd like to update you on our key initiatives to drive top and bottom line results through innovative products and technologies and efficiencies. I can't emphasize enough the importance of new products and technologies to Tennant's revenue growth. In the first half of 2016, our equipment sales from products introduced within the last three years was 35%, well above the 26% that we reported for the full year of 2015 and above our target of 30%. We invest approximately 4% of sales annually in research and development to ensure future growth. And we continue to execute against the strongest new product and technology pipeline in Tennant's history. In 2016, we remain on track to introduce at least 14 new products, including several significant industrial machine launches. In late June, we unveiled the next generation of three of our large high performance cleaning machines for the industrial market. These include the M20 and M30 Integrated Sweeper-Scrubbers and the T20 Heavy-Duty Industrial Rider Scrubber. With these new models, we are relaunching our most established industrial products with our latest digital innovations and technology, such as the new and easy to use pro-panel intuitive touchscreen interface. In late March, we announced our largest Battery-Powered Sweeper-Scrubber, the M17. This was our first industrial machine launch this year. The M17 is versatile and fume-free. It does the job of several smaller machines, giving customers the option to choose between dry sweeping, scrubbing or simultaneously doing both. It also offers the largest available battery capacity in its class for maximum run time and improved productivity. We are excited about this new industrial product, which is being well-received by customers. We also continue to be pleased with the growth of our sustainable cleaning technologies. Our ec-H2O NanoClean is available on all our applicable commercial scrubbers. The name NanoClean refers to the creation of nano scale bubbles that are an important part of the cleaning mechanism. Like the original ec-H20, the next generation ec-H20 NanoClean technology electrically converts water into an innovative solution that offers the same benefits as the original, but cleans better, cleans more soils and is effective in more application. Company-wide sales of scrubbers equipped with ec-H20 technology rose 2% to approximately $40.4 million in the 2016 second quarter with strong growth in EMEA and solid gains in North America. In addition, the Orbio os3 is also gaining sales momentum in organizations that value sustainable cleaning options. The os3 delivers on-site generation of an effective multi-surface cleaner and an antimicrobial solution that disinfects and sanitizes. This technology is cost effective, easy to use, and fits into most janitorial closets. Further, we are focused on creating entirely new growth avenues for Tennant through our advanced product development efforts. These initiatives go beyond trying to improve cleaning performance. We are looking at our customers' needs holistically to address a broad array of issues, such as managing labor costs, productivity, and machine maintenance information. We anticipate expanding our business through telemetry, battery technology, water recycling and robotics. Let me give you a few examples. In the area of telemetry, which involves automated remote data collection and transmission, we introduced the IRIS Asset Manager in late 2015 and it is generating strong interest from our customers. In fact, we have already won a number of deals due to our telemetry capabilities. The IRIS Asset Manager is an intelligent command center that tracks machine productivity and maintenance needs, including ec-H20 usage. It helps customers with large fleets of equipment make informed decisions and reduce their overall cost to clean, which is a very attractive proposition. Another advanced product development area that we are working on involves battery technologies. Battery life and machine up time are among our customers’ greatest pain points. We are actively evaluating lithium ion, hydrogen fuel cell and other emerging battery technologies. We are committed to offering our customers industry-leading battery options that enhance productivity. Regarding water recycling, we are developing solution that offer measurable environmental improvements. Onboard water recycling using advanced filtration technologies is an example. We see opportunities to help customers conserve water and improve operator productivity by significantly reducing the time-consuming activity of dumping and refilling. Our efforts in the area of robotics are a longer-term proposition. With advances in robotics technology and our customers' desire to lower labor costs and turnover, we are exploring autonomous navigation technology. This would enable a machine to operate unmanned or with reduced labor. Robotics technology is potentially highly attractive since 70% of our customers' cleaning costs today are labor related. Only 10% of customers' costs are related to machines. As this technology is more widely adopted in various industries and the cost declines, it may become more practical for our customers' applications. These examples give you a sense of how we are working to create exciting future growth pathways for Tennant. As I mentioned on this call last quarter, another important endeavor involves our investments in a digital platform. Our goal here is to build the company's e-Business capabilities in order to meet customers' changing needs, enhance our long-term sales growth and improve Tennant's operating efficiency. Among our digital e-Business initiatives are eCommerce and CRM. eCommerce continues to grow as an important sales platform and customer interface for Tennant. We estimate that more than 70% of our customers start their buying journey online and increasingly they purchase parts and consumables this way. By the end of 2016, we plan to launch a more robust eCommerce platform in the U.S. that offers expanded functionality to purchase products and parts, enhances lead generation, and enables cost effective sales. In a few years, we anticipate being able to report eCommerce as another significant revenue channel, along with our existing direct distribution and strategic account channels. We also continue the global rollout of our customer relationship management or CRM marketing and sales management tool. This system helps us identify new customers, grow our existing business, and improve the overall Tennant customer experience. We've implemented our new CRM solution in North America, EMEA and Australia and we are benefiting from its improved sales analytical capabilities. We expect to complete the rollout to Japan, China, and other regions in the second half of this year. We are pleased with the sales and earnings gains Tennant posted in the second quarter. Looking ahead, the company remains competitively advantaged and well-positioned in all vertical markets. We have been able to shift our focus to the faster growing verticals, notably education, health care, and most recently construction. We will continue to pursue our platform to accelerate organic sales. We have a diverse portfolio of initiatives and are creating value through new product and technology introductions, expanding our global sales and marketing initiatives to increase our global market share and building Tennant's e-business capabilities while concurrently applying lean principles and running a more efficient business to raise productivity. Now I'll ask Tom to take you through Tennant's second quarter financial results. Tom?

Thanks, Chris. In my comments today, all references to earnings per share are on a fully diluted basis. Also, please note as I go through the results, I'll generally not comment on the year-to-date financials as those were detailed in the earnings release. For the second quarter ending June 30, 2016, Tennant reported net sales of $216.8 million, compared to sales of $215.4 million in the 2015 second quarter. Excluding an unfavorable foreign currency exchange impact of about 1% and the impact from the divestiture of the Green Machines outdoor city cleaning line reduced net sales by 0.7%. Organic sales grew approximately 2.4%, as Chris noted. Second quarter 2016 net earnings were $15.3 million, or $0.85 per share. In the year ago quarter Tennant reported net earnings of $14.8 million or $0.79 per share. Foreign currency exchange head winds unfavorably impacted our 2016 second quarter financial results. I'll provide more information about this in just a few minutes. Turning now to a more detailed review of the 2016 second quarter, our sales are categorized into three geographic regions, which are the Americas, which encompasses all of North America and Latin America; EMEA, which covers Europe, the Middle East and Africa; and lastly Asia-Pacific, which includes China and other Asian markets, Japan, and Australia. In the Americas, 2016 second quarter organic sales increased approximately 2.5%, excluding about 1% of unfavorable foreign currency impact. This is despite lacking the strong Americas organic sales growth of approximately 7.5% in the prior year quarter. Organic sales in the 2016 second quarter benefited from sales to strategic accounts and sales of new products. Organic sales growth in Latin America was approximately 15%, despite the continued economic head winds. This is an important emerging market for us and we remain confident about the long-term growth prospects there. In EMEA, our organic sales in the 2016 second quarter increased approximately 6.3%, excluding the impact of the Green Machines divestiture of 4.4%, and minimal unfavorable foreign currency impact. EMEA achieved sales growth to strategic accounts in all countries and had strong sales of scrubbers equipped with ec-water technology. As you'll recall, at the end of January 2016, we sold the Green Machines outdoor city cleaning line to our master distributor for Central Eastern Europe, Middle East and Africa or CMEA region. Tennant retained the opportunity to generate revenue two ways, by continuing to sell Green Machines in certain regions as a distributor and by serving as the exclusive service provider for Green Machines. The impact of the sale is anticipated to reduce Tennant's annual revenues by approximately $10 million or about 1% with an immaterial impact on earnings. In the Asia-Pacific region, organic sales in the 2016 second quarter decreased 7.2%, excluding an unfavorable foreign currency impact of about 1%. Organic sales growth in Southeast Asia and Japan was more than offset by low organic sales in the other Asia-Pacific countries, primarily due to ongoing sluggish economic conditions in this region. Tennant's growth margin for the 2016 second quarter was 43.9%, compared to 44.1% in the prior year quarter. The 20 basis point decline was primarily due to the impact from foreign currency exchange. We anticipate the 2016 full year growth margin will be in our target range of 43% to 44%. Research and development expense in the 2016 second quarter total $8.4 million, or 3.9% of sales, which was equal to the prior year quarter. We continue to invest in developing a robust pipeline of innovative new products and technologies that Chris described for you. Selling and administrative expense in the 2016 second quarter totaled $64.3 million or 29.6% of sales. We continue to tightly control spending, while investing in projects such as e-business, which is anticipated to enhance our long-term sales growth. S&A in the second quarter of 2015 was $64 million or 29.7% of sales. Our 2016 second quarter operating profit totaled $22.6 million or 10.4% of sales, compared to the year ago quarter operating profit at $22.6 million or 10.5% of sales. We have routinely discussed the impact of foreign currency exchange on our sales, but with the significant change in foreign currency exchange rates during 2015 and also to a lesser extent in 2016, we believe it's helpful to provide additional information. As many of you know in a global company such as Tennant, isolating the impact of foreign currency exchange is complicated. We've calculated an estimated constant currency income statement, which assumes no change in exchange rates from the prior year. In so doing we're then able to compare that to our actual financial results to isolate the estimated impact of foreign currency exchange. Here's a recap of the estimated foreign currency exchange impact on our 2016 second quarter financial results. Unfavorable impact to sales of approximately 1% or about $2.1 million; unfavorable impact to gross margin of 20 basis points, using a constant currency our gross margin would have been about 44.1%, compared to 43.9% as reported. Unfavorable impact to operating profit of approximately $1.1 million, using a constant currency our operating profit margin would have been about 10.8%, compared to 10.4% as reported and unfavorable impact earnings per share of approximately $0.04. Using a constant currency, our earnings per share would have been about $0.89 or up 12.7% versus a year ago, compared to $0.85 as reported. The estimated unfavorable impact from foreign currency exchange during the 2016 second quarter was in line with our expectations based on the prevailing strength of the U.S. dollar. We continue to actively work on a number of opportunities to help mitigate the foreign currency exchange head winds that include increasing selling prices in the affected local markets where possible, starting to produce and ship some products from locations with a more favorable foreign currency exchange pairing and expanding the scope of our hedging strategies to include cash flow hedging in order to hedge forecasted foreign currency transactions with foreign exchange option contracts or forward contracts. Despite external circumstances beyond our control, we remain committed to our goal of a 12% or higher operating profit margin by successfully executing our strategic priorities and assuming the global economy improves. As we work towards this target, we are keenly focused on driving organic revenue growth in the mid-to-high single digits, holding fixed costs essentially flat in our manufacturing areas as volume rises, striving for zero net inflation at the gross profit line and standardizing and simplifying processes globally to continue to improve the scalability of our business model, while minimizing any increases in our operating expenses. We continue to successfully execute our tax strategies. Tennant's overall effective tax rate for the 2016 first half was 32.1%, the same as it was in the 2015 first half. The base tax rate for the 2016 first half was 34.1%, which excludes routine, discreet tax items. The federal R&D tax credit was reenacted before the start of 2016, so the benefit of that is included in our 2016 tax rate. Turning now to the balance sheet, again, this continues to be very strong. Net receivables at the end of the 2016 second quarter were $154.6 million versus $151.1 million a year earlier. Quarterly average accounts receivable days outstanding were 60 days for the second quarter, compared to 62 days in the prior year quarter. Tennant's inventories at the end of the 2016 second quarter were $82.5 million versus $86.5 million a year earlier. Quarterly average FIFO days inventory on hand were 86 days for the 2016 second quarter, compared to 89 days in the year ago quarter. Capital expenditures totaled $14.8 million in the 2016 first half. That is $7.2 million higher than $7.6 million in the prior year and reflects planned investments and information technology projects related to new product development and manufacturing equipment. Tennant's cash from operations total $12.4 million in the 2016 first half compared to $6.6 million in the prior year first half. Cash and cash equivalents totaled $27.9 million at the end of the 2016 second quarter versus $67.6 million at the end of the prior year quarter. The decrease in cash of $39.7 million was primarily due to the higher than typical level of share repurchases, particularly in the back half of 2015. Total debt was $21.2 million, down from $24.6 million at the end of the prior year quarter. Our debt to capital ratio was 7.5% at the end of the 2016 second quarter, compared to 8.1%, a year ago. Regarding other aspects of our capital structure, Tennant is currently paying a quarterly dividend of $0.20 per share. We paid cash dividends of $7.1 million in the 2016 first half. Reflecting our commitment to shareholder return, we're proud to say that Tennant has increased the annual cash dividend payout for 44 consecutive years. During the 2015 full year, we purchased 764,000 shares of Tennant stock for a total cash outlay of $46 million. During the 2016 first half, we purchased 246,000 shares of stock, for a total cash outlay of $12.8 million. As of June 30, 2016, we had approximately 395,000 shares remaining under our repurchase program, which aims to enhance shareholder value by providing the financial flexibility to offset any dilutive effect of stock-based compensation programs and to consider repurchases to create value based on overall market conditions. Assuming the stock market continues to be volatile, we expect to remain active in repurchasing Tennant shares. Moving now to our outlook, as Chris mentioned we're adjusting our guidance for the 2016 full year to narrow our revenue range and to raise our earnings range to reflect a less adverse foreign occurrence exchange environment than we previous anticipated. We now estimate 2016 full year net sales in the range of $800 million to $820 million, down 1.5% to up 1%, or approximately up 1% to 3% organically, excluding an unfavorable foreign currency impact and a sales decline from the divestiture. Previously, we had anticipated 2016 full year net sales in the range of $795 million to $825 million. We now estimate 2016 full year earnings in the range of $2.35 to $2.60 per share. Previously, we anticipated a range of $2.25 to $2.55 per share. Foreign currency exchange head winds in 2016 are estimated to negatively impact operating profit in the range of 3 million to 4 million or a negative impact of approximately $0.10 to $0.15 per share. On a constant currency basis, we expect 2016 full year earnings to be in the range of $2.50 to $2.70 per share. The estimated slightly higher effective tax rate in 2016 is also anticipated to reduce earnings per share by approximately $0.05. For the 2015 full year, adjusted earnings per share totaled $2.49 on net sales of $811.8 million. Our 2016 annual financial outlook includes the following expectations: Slower economic growth in North America, modest improvement in Europe and growth in emerging markets, continued negative foreign currency impact on sales for the full year in the range of an unfavorable 1% to 2% with a $3 million to $4 million negative effect on operating profit, decline in sales of approximately 1% from the Green Machines divestiture with an immaterial impact on earnings. Gross margin performance in the range of 43% to 44%. Research and development expense of approximately 4% of sales, capital expenditures in the range of $25 million to $30 million, and an effective tax rate of approximately 31%. Tennant's operations are performing well. We expect our 2016 financial results will be stronger in the second half of the year. However, the 2016 third quarter will be a more challenging quarter over quarter comparison because we had an organic sales growth of 7.6% in the 2015 third quarter. Our objective is to continue to build our business for sustained success. Now I'd like to open up the call to questions. Andrew, please.

[Operator Instructions] Your first question comes from the line of Joe Maxa with Daugherty & Company. Your line is open.

Thank you, good morning.

Good morning, Joe.

Good morning, Joe.

Congrats on a nice quarter.

Thank you.

Wanted to ask a little bit about the guidance, sounded like the Q3 tougher comp was that in a certain geography? And then to continue along those thoughts with your guidance, you talked about growth in emerging markets. Are you suggesting that Asia-Pacific region may see some growth in the back half of the year versus the weakness you saw in the first half?

We do anticipate right now, I mean, we had - we're obviously not pleased with our growth organically in Asia-Pacific in the front half and as we were going into second quarter after our decline in Q1, we commented that we were concerned we might not return a growth in Q2 and in fact we didn't, but we now anticipate based on some adjustments to the business we've made that we will see some level of organic growth in the back half of the year. Regarding your question about the Q3 comparison, there's an - and Asia-Pacific will be a tough one here. The Americas was really - grew 8% organically in the third quarter last year, EMEA was down a couple percent, but APAC had a great quarter, was up 21% so the Q3 comp in APAC is going to be tough. It gets easier as we go into Q4.

I see, okay. And then on Europe, nice organic growth, or I should say EMEA, are you expecting that to continue? What happened to drive that growth in this quarter? And …

Yeah, I mean, we …

…back half.

The two biggies in EMEA, I mean, we've been at this a long time and been making adjustments to the business. I would consider Q2 a bit of a break through. The particular strength was in strategic accounts in all of our key markets and also new products, which - there's some overlap there obviously we're highly successful.

Thanks a lot.

Joe, this is Chris. I mean, this has been a long-term effort. We've been working on restructuring our EMEA business for a number of years now and I think we're finally in a position where we have the best organization and the best strategy in place we've ever had, so a strong foundation upon which to grow. And an example is, you know, the restructuring we did in the French business, and that's beginning to pay off. I mean, if our business - if I recollect - and maybe, Tom, you have the number, but it was like up 27% in the second quarter.

Yeah. It was dramatic, dramatic growth. And to add on that, Joe, you did comment around the back half. I mean, we do anticipate growth organically in the back half for Europe and for the full year. Not at the rates that we saw in Q2. We would acknowledge that Q2 was certainly better than our typical run rate. We'll take it, but we'd expect to see organic growth but at a lower rate in the back half of the year.

All right. Thank you.

I think the right example where we started, a lot of the restructuring in France first bodes well for the work we've done in the other markets as well over time, which is why we're, you know - even though one quarter is not a trend make, we are somewhat confident now in the future.

The France growth rate was factual, I don't have the actual number in front of me, so it was 27%, which is stellar performance, obviously.

I know it's early, but have you seen or expect to see any impact from the Brexit situation?

You know, it's hard to say. We’d say a couple things. One, we no longer have manufacturing in that country and our revenue exposure is less than 5%. So it's not material. But it's anybody's guess what kind of impact we'll see over the long haul, but it's certainly seemed to stabilize and we're not seeing any impact today.

Thank you.

Thanks, Joe.

The next question comes from the line of Bhupender Bohra with Jeffries. Your line is open.

The question on second quarter, Tom, can you talk about, like, you know, what trends you saw, like, as we, you know, passed through April, May, and June on a monthly basis, you know, did it get stronger? Because as we heard from some of the industrial customers out there, you know, they took some extended shutdowns and, you know, things were not up to the mark in terms of, you know, performance-wise, so could you just give us some flavor, some color on the monthly progression of orders here for the second quarter?

Sure, yeah. It is inconsistent and, I mean, as you remember when we commented and gave guidance for back towards the end of April for the full year, at that point we had seen a strong finish to Q1, particularly the last several weeks of March, and that momentum continued into April and for basically the full month of April, it was pretty darn good. And then it was choppy the rest of the quarter. I mean, it was up and down and it did not honestly finish with momentum. That's one of the reasons why we're being a bit conservative we hope as we look to the rest of the year, but, you know, we didn't finish with as much momentum. We still had a decent open order exposition and our quarter now in Q3 is starting out like it needs to, choppy, but we're seeing the order - we're seeing the level of orders that we need. We'd like to see it be more consistent, but the reality of it is Q3 is made in the back part of August and September. I mean, July, you know, matters, but it really - the last six to seven weeks are where you make the quarter, so we're - we're being a bit tempered in our thoughts.

Right. And the other thing we've seen and we talked about this is that, you know, the business in manufacturing and warehousing is somewhat soft and that's not surprising. You see, you know, business investment, industrial production has been down so that has impacted us. So, I think what you saw is that we have been pretty good at adjusting our efforts against the vertical markets that are more robust right now, where there's more activity, and that's education, health care, and construction.

Right, yeah. That was my next question because I just wanted, you know - good that you gave color on that, commercial versus industrial, I believe most of that North America 2% growth came from the commercial side of the business, right.

Yeah. I mean, but, we have the construction business where we do sell our bigger industrial equipment into construction. So that is actually pretty robust. It's the traditional manufacturing and warehousing part of our business where we have traditionally been strong that's a little bit weaker, but it's weaker across the board for most companies, I think right now, especially in North America.

Okay. That's good. Just one more question. You know, you guys talked about, like, you know, you focused on some new growth avenues here over the long-term medium to long-term telemetry and some robotics and all those things. Just give us some color, like have we -- you talked about, like, IRIS has gained traction. What kind of revenue opportunities IRIS will have over the next few years and, you know, I'm sure like we're in the early stages of robotics here, still haven't seen that yet.

Yeah, I'll comment on that. I mean, we're not in a position to give any specifics around what the telemetry or IRIS will drive in our business. We're really pleased with the traction we're gaining though. We commercialized it in Q4 after several years of hard work and it is mattering and we're actually seeing telemetry being specked into bids and that's advantageous for you see because we think we're a bit ahead of our competitors. They are doing the same things. We think we're advanced. But it is, we're having success, early days and we think it really will matter over the long haul, but we're not prepared to give any specifics, but it will matter. In the case of robotics, you know, there's nothing meaningful in the market today. I mean, but it will happen. It's just a matter of when. And we think before it's going to begin to be material we're probably three years out. Chris commented on that last call. But we're investing. We have a partner and we're really pleased with the progress we're making around being able to get a product commercially into the market here in the not too distant future.

But the most exciting thing, I think, medium long-term is that we are moving away from competing just on cleaning performance, which is a lot harder to do. You could say a Tennant machine is better than a competitive machine, but it's harder to prove. We are starting to look at our customers' needs much more holistically and address a broader array of higher order issues. As we said, managing labor costs, right, at 70% of their costs for the first time we're putting in place solutions such as IRIS and eventually robotics, but even things, like, you know, battery technology and water recycling that address those. And I think those solutions, if we are advantaged, are much stickier, right, because if they adopt them it - the changing costs are much higher and as Tom said we think, we don't know definitively, but when we hear in the market that we are advanced in some of these technologies. And I think first move or advantage could be very meaningful. And that's what we're going for.

Okay. And lastly on the new products share, you guys talked about M17, the battery powered and the new launches, M20 and 30 on the industrial side, you know, when you look at the second half guidance, is anything baked in there from, you know, getting traction in those new products for the year? Or …

One of the positive pieces - it is one of the positive pieces in the back half Bhupender and we're not assuming any great big wins.

Okay.

You know, that typically isn't the way that particularly industrial equipment happens. You gain momentum. We will have more momentum in the back half than we have in the front half and we'll have more momentum next year. So, you know, the back half ability to grow a bit higher is, that is clearly one of the components of that. And I think very importantly the - it really bodes well for next year, where we get a full complete year of those industrial products and remember those are - there's a smaller number in new products, but the ring value of those is much higher and we hope to see momentum for at least two to three years as we go forward.

Well history tells us that on the industrial equipment we see peak annual sales either in the second or third year, but usually in the third year. So this should continue to accelerate for, you know, for another 18 months or so.

Right. Just wanted to make sure there's nothing highly baked in from those products in the second half, especially the fourth quarter here.

No.

These are mostly 2017, 2018 kind of …

Certainly part of the growth, but there's nothing big baked in.

Okay, okay. Got it. Thanks a lot, guys.

You're welcome, Bhupender. A - Chris Killingstad You’re welcome.

Your next question comes from the line of Chris Moore with CJS Securities. Your line is open.

Maybe just focus on the margins for a second. Operating margins were 10.4% this quarter, do you see that as being sustainable for the rest of fiscal 2016?

You know, it would be, certainly not in Q3 and we would expect, you know, we're certainly going to be striving to have our margins be above the prior year, and as you know, Chris, we don't really think about our margins on a sequential basis.

Right.

We really look at our margins and trying to drive improvement versus the prior year and that will be our objective in both Q3 and in Q4. But we're happy with the performance in Q2, but, you know, we want to keep seeing improvement versus the prior year in each and every quarter that we possibly can and that's one of our number 1 objectives every quarter as we're going in.

Got you. From a gross margin kind of trend perspective, the 14 new products that you're introducing, any of them meaningfully higher gross margins, you know, that might impact you next fiscal year? I know Chris talked about the industrial equipment being, you know, strong into the construction arena. Are the gross margins there a little bit better than normal? Or – in that same 44%, 43% range?

They actually are a bit higher.

Okay.

Particularly as we're selling in through some of the rental categories, you know, going to construction. So we do have a little bit better margins there, but our key objective with new products is we always want to have equal to or better margins on the product that it's replacing and so in general over time new product activity does help our margins structure modestly.

Got you, got you. And last question, in terms of – I know that overall target 12% range on the operating margin side, how much of that is coming from, you know, kind of on the lean initiative side versus, you know, growth that you'll need to get there?

The two primary drivers are growth and then very importantly creating leverage in our operating expenses by not adding people in our overhead positions. That's the key, is we need growth and the critical component is we want to add position that drive revenue, meaning through enhanced sales and service coverage and in our functions that are support functions we need to hold the line and really just see inflationary type increases. And so most of it will come through operating expense leverage that will be a result of the growth, and we hope we have upside in our gross margins and that we're not counting on that. We're just counting on our lean efforts through the gross margin line to mitigate inflation.

Got you, okay.

Yeah, but we're actually pretty happy with the way we're operating right now. We're operating pretty efficiently. I mean there's more to come, but if you look at it, I mean, you know – the 43.9% gross margin at the top end of our range and if you look at our S&A expenses they were pretty much flat versus last year, which I think is strong performance in this environment. So if we can continue to remain the discipline that we've established in those two areas and we get a little bit of tailwind on the sales side, we should be able to leverage very nicely.

And we don't talk about it specifically, Chris, but we tend to focus on the lean efforts that are going through our supply chain, you know, operationally. We also add initiatives that are going on around lean in our other support functions that are positively impacting operating expenses. We just tend to not focus as much there, but a lot of the same principles are happening throughout the organization.

Got you. All right, thanks.

Thanks.

You're welcome.

[Operator Instructions] Your next question comes from the line of Marco Rodriguez with Stonegate Capital Markets. Your line is open.

Good morning, guys. Thank you for taking my questions.

Sure, Marco.

Most of my questions have actually been asked and answered, but just a couple of quick follow-ups. Just wanted to dive a little deep into the increased sales you guys saw in the Americas and also EMEA on the strategic accounts, were there any sort of additional marketing activities, promotional activities that help drive those types of sales? If you can just kind of talk a little bit about that and then what your kind of expectations for strategic accounts are for the remainder of the year?

Well, strategic accounts has been our biggest source of growth over the last five years and we continue to count on benefits out of strategic accounts as we go into the future in basically all geographies. And I can't really point to saying there's one marketing campaign that drove incremental strategic account revenue. We tend to be targeting big strategic accounts, not only to penetrate existing customers deeper, but we're constantly going after accounts where we haven't made in-roads yet, and so it's really a combination of deeper penetration with existing strategic accounts and having some wins with new strategic accounts. And in that case, the marketing effort matters, but also the quality of our sales organization, it's very targeted against them and organized around strategic accounts and in conjunction with new products, all those things work together to create the success we're having.

And I would add that some of the strategic account business that we've won we have mentioned that we've won two major deals because of our IRIS technology, one in Europe and one in North America. So IRIS, we feel – we're getting in the door of customers that have not bought from us in the past because of that technology. And I think that bodes really well for the future and, as I said, because we're solving a higher order need for them, it's not just about the cleaning performance anymore. And it's still very, very early phase on IRIS. The other thing I would say is that we are very advantaged in terms of how we're organized around strategic accounts in North America and have been for a number of years. You know, we've duplicated that structure now in Europe, and so going forward we hope to see similar types of benefits.

Got you. Very helpful. Thanks. And last quick question, in terms of the guidance change on EPS due to the FX change, is there one currency in particular that drove you to make the change or is it across the board?

It's really across the board. And no one – no one currency, and we hope we're being conservative. I mean, we’ve adjusted our currency impact down. I mean, we've been relatively in line in the first half, although slightly favorable in total and certainly our expectations are we're going to be a fair amount favorable in the back half, original to our original operating plan. We hope our assumptions are being conservative, but with things like Brexit happening and the volatility I think it's advantageous to just be cautious how we're thinking about it.

Got you. Thanks a lot, guys. I appreciate it.

Thank you, appreciate it.

You're welcome.

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

All right, thanks, Andrew. We were pleased with both our return to organic growth in the second quarter and stronger earnings. We are continuing to pursue our growth agenda. While we anticipate that the global macroeconomic environment will remain challenging, we believe that Tennant is competitively advantaged, your innovative products and technologies and our go-to-market strategy and we are well positioned to leverage our operating efficiency. We remain committed to reaching our goals of a billion dollars in organic sales and a 12% or above operating profit margin and we are very excited about Tennant's future. We look forward to updating you on our 2016 third quarter results in October. Thank you for your time today and for your questions. Take care.

Excuse me presenters.

Yes.

We did have one final question come in. Your next question comes from the line of Joseph Garner with Emerald Advisers. Your line is open.

Hey, guys, sorry about that. Chris, I just thought while we have you maybe get your thoughts on how you see the competitive environment and how you think you're doing in terms of market share?

Well, as you know, the only company that reports public information is Nilfisk-Advance, that is part of the NKT Group out of Denmark, so we kind of use them as a proxy in some ways and I can't remember exactly what the statistic is and in terms of how many – you know, how many quarters in a row we actually outperformed them from --

Its nine to ten quarters globally we've outperformed Nilfisk from an organic growth point of view.

Organic growth standpoint nine to ten quarters in a row. That tells you that we're getting market share from them. They along with us, we're the two biggest players in the market. We're seeing Kärcher out of Germany being very active, so we have increased our focus on them and view them maybe as a more significant competitor going forward. But historically, it's always been Nilfisk, but we used the proxy of Nilfisk to say that we are well positioned and we probably have been taking a share over the last 18 months or so.

And in the markets where you've taken some price to offset the FX impact, what have you found have been the responses in those markets? Have the competitors followed or, you know – or are you, you know, kind of taking those and kind of being the only one raising prices? Just kind of curious what responses you're seeing, if any, out there.

Yes, I mean, we've – I can't say that we've had great success taking price increases in those markets. We've taken it where we can. In all honesty in the markets where we would need to take price to offset in places like Australia and Canada are two examples, we have strong market positions. We want to protect our market position so the pricing benefits that we've gotten are not meaningful and so, I mean – and as we look at it overall, Joe, I mean, our pricing benefit through the first half of the year is virtually zero, it's slightly positive.

Right.

And, you know, for the full year, we anticipate very minimal pricing benefit in total. It's about a half a percent through the first half so that's trailing below where we've been in the last few years, so it's pretty tough to get price.

Okay.

And it should be in a non-inflationary environment, it’s common, we see inflation. There's lots of forecasts. We anticipate that we'll be in a position where we'd certainly, based on the trends and what we're hearing is that it could very well be an environment where people are able to take price in our industry in the first quarter of next year.

Very good. Sorry, again, to extend the call. Just I thought the sales results were particularly solid and just wanted to get your thoughts on how those were stacking up versus what you were seeing elsewhere out there in the industry. So thanks a lot. Appreciate it.

No, our pleasure.

Our pleasure, Joe. Thank you.

And there are no further questions at this time.

All right.

Thank you.

Thanks again, everybody. Take care.

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