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Edited Transcript of TNC earnings conference call or presentation 24-Apr-17 3:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Tennant Co Earnings Call

MINNEAPOLIS May 3, 2017 (Thomson StreetEvents) -- Edited Transcript of Tennant Co earnings conference call or presentation Monday, April 24, 2017 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* H. Chris Killingstad

Tennant Company - CEO, President and Director

* Thomas Paulson

Tennant Company - CFO and SVP

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Conference Call Participants

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* Bhupender Singh Bohra

Jefferies LLC, Research Division - Equity Analyst

* Christopher Paul Moore

CJS Securities, Inc. - Research Analyst

* Joseph A. Maxa

Dougherty & Company LLC, Research Division - VP and Senior Research Analyst

* Marco Andres Rodriguez

Stonegate Capital Markets, Inc., Research Division - Director of Research and Senior Research Analyst

* Rosemarie Jeanne Morbelli

G. Research, LLC - Research Analyst

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Presentation

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Operator [1]

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Good morning. My name is Mike, and I will be your conference operator today. At this time, I would like to welcome everyone to Tennant Company's First Quarter 2017 Earnings Conference Call. This call is being recorded. (Operator Instructions) Thank you for participating in Tennant Company's First Quarter 2017 Earnings Conference Call. Beginning today's meeting is Mr. Tom Paulson, Senior Vice President and Chief Financial Officer for Tennant Company. Mr. Paulson, you may begin.

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Thomas Paulson, Tennant Company - CFO and SVP [2]

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Good morning -- thanks, Mike. Good morning, everyone, and welcome to Tennant Company's First Quarter 2017 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; Karen Durant, Vice President and Controller; Tom Stueve, Vice President and Treasurer; and also with us today is Jim Stoffel, Vice President of Global Planning and Analysis, who played an integral role in the IPC acquisition.

Our agenda today is to review Tennant's performance during the 2017 first quarter and our outlook for the 2017 full year. First, Chris will brief you on our operations, then I'll cover the financials. After that, we will open up the call for your questions. We're 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 3 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 file with the Securities and Exchange Commission. We encourage you to review those documents, particularly our safe harbor statement, for a description of the risks and uncertainties that may affect our results.

Additionally, on this conference call, we will discuss non-GAAP measures that include or exclude special or nonrecurring items. For each non-GAAP measure, we'll also provide the most directly comparable GAAP measure. There were special non-GAAP items in the first quarter of 2017. There were no special non-GAAP items in 2016. Our 2017 first quarter earnings release includes a reconciliation of these non-GAAP measures to our GAAP results for the 2017 first quarter. 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.

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H. Chris Killingstad, Tennant Company - CEO, President and Director [3]

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Thank you, Tom, and thanks to all of you for joining us this morning. As you saw in today's earnings release, Tennant executed well against our strategies in the 2017 first quarter, and we made further progress toward our goals. Building on our growth in the 2016 fourth quarter, we are pleased to report record first quarter sales in 2017. Our results were fueled by continued growth in our Americas and EMEA regions. For the 2017 first quarter, consolidated net sales grew 6.2%, or 5% organically, to $191.1 million. Adjusted net earnings increased 24% to $0.31 per diluted share. Contributing to our results were organic sales growth in the Americas of approximately 4.2% and organic sales growth in EMEA of approximately 14.3%. Tom will provide more detail on our performance by geography in a moment.

In the 2017 first quarter, we took bold steps to further ignite Tennant's growth and improve profitability. In keeping with our core strategies to maintain a strong new product and technology pipeline, expand Tennant's global market coverage, build our e-Business capabilities and leverage the company's cost structure to improve operating efficiency. To this end, in early April, we completed the largest acquisition in Tennant's history of IPC Group. We also undertook restructuring actions to better align our global resources and expense structure with a lower growth global economic environment. The savings from the restructuring are estimated to be approximately $7 million in 2017 and a total of $10 million in 2018. Together, we expect these actions to further enhance Tennant's revenue and earnings performance.

Looking at our acquisition of IPC Group. Just after first quarter end, on April 6, 2017, we announced the close of our acquisition of IPC Group in an all-cash transaction for $353 million or EUR 330 million. We anticipate that the acquisition will be accretive to Tennant's 2018 full year earnings per share. The IPC Group designs and manufactures innovative professional cleaning equipment, tools and other solutions. IPC is a growing and profitable business based in Italy with a strong management team. We are very pleased that IPC's key leaders are staying with the business and they are excited to be -- become a part, an important part of Tennant. IPC generated annual sales in 2016 of about $206 million or EUR 186 million. Its products are sold in over 100 countries.

Acquiring IPC is a strategic move that aligns with our aspirations to grow Tennant's revenue and profitability. We will gain the scale needed to accelerate both Tennant's and IPC's growth in EMEA and better leverage our cost structure in this important region. As I mentioned on our earnings call last quarter, IPC is an attractive addition, because our businesses are highly complementary and differentiated in terms of our geographies, products and go-to-market approach. IPC offers us significant growth opportunities as well as select synergies. Geographically, IPC makes us more competitive in the European market. It significantly expands our EMEA presence and market share and more than doubles our current EMEA business. Over 80% of IPC's sales are concentrated in Europe with the remainder split evenly between the Americas and Asia-Pacific regions. With this acquisition, we will strengthen our presence in the key markets of Germany, France and the U.K., and enhance our access to Italy and Scandinavia. In terms of products, IPC offers a strong mid-tier value proposition, coupled with Tennant's premium brand, IPC broadens the range of product offerings to customers.

As you know, Tennant chiefly produces midsize commercial to large industrial floor cleaning equipment. With IPC, we will gain small to midsize commercial cleaning equipment, cleaning machines and equipment, including floor sweepers and scrubbers, vacuum cleaners, high-pressure washers and related aftermarket parts and service. In addition, we will enter an adjacent cleaning tools and supplies segment with new products such as multipurpose cleaning trolleys, window washing systems, proprietary anti-microbial microfiber mops and cloths and a wide array of consumables. We anticipate very little brand overlap between Tennant and IPC Group due to our highly differentiated market positions. IPC Group's brands are known for their quality and performance and are sold under the brand names IPC, IPC Foma, IPC Eagle, IPC Gansow, ICA, Vaclensa, Portotecnica, Sirio and Soteco, Readysystem, Euromop and Pulex. We anticipate that both companies' brands will continue to successfully operate in their markets as they do today as part of our multibrand portfolio.

Our companies also share a commitment to product innovation and sustainability with a focus on reducing energy, water and detergent use.

Lastly, our sales channels are complementary. Tennant primarily has a direct sales model, while IPC predominantly sells through distributors. We believe our channels will provide cross-selling opportunities to reach new customers with both brands and will provide incremental sales for both companies going forward. In addition to sales growth benefits, we believe the combination of Tennant and IPC will provide us the opportunity to realize significant savings across our cost of sales and selling and administrative expenses. We have identified approximately $10 million in run rate synergies to be achieved by 2019 related to sourcing savings by driving greater volume to fewer vendors, improving our sales and service capabilities and leveraging our larger scale as a combined business to improve operating efficiencies. We are expecting to incur $10 million of costs that will be necessary to achieve these synergies, including approximately $6 million in capital expenditures for information technologies and facilities and approximately $4 million in redundancy costs. There are also potential tax synergies to be realized through tax planning and entity reorganization activities. We are very excited about our combined potential with IPC, along with our 2016 third quarter acquisitions of Florock and Dofesa. The addition of these businesses demonstrates our commitment to pursue growth through the addition of interesting products and global sales and service expansion.

Turning to another strategic priority. We are focused on improving Tennant's profitability. In the 2017 first quarter, we restructured our organization in order to support our key strategic growth initiatives, reduce costs and accelerate Tennant's ability to reach our 12% operating profit margin goal. This resulted in an approximate 3% net reduction of Tennant's global workforce, and the majority of the actions already occurred in March. As I stated earlier, the savings from the restructuring are estimated to be $7 million in 2017 and a total of $10 million in 2018.

Turning now to new products, which are important to Tennant's growth. We continue to execute against a robust new product pipeline. In 2017, Tennant plans to introduce 31 new products and product variants. Among our major products that launched in the 2017 first quarter were a new family of T500 Commercial Walk-Behind Scrubbers, which enable professional cleaners to improve cleaning performance and battery maintenance. The T500 line is comprised of 20 new products and product variants ranging from base models to premium models equipped with ec-H2O NanoClean technology. Also new is the enhanced IRIS Web Based Fleet Management System, which allows users to remotely monitor and manage their machines with full visibility of the user's fleet through broad reporting and monitoring capabilities. These products are being well received by customers and our product vitality index remains very strong.

In the first 3 months of 2017, 42% of our equipment sales came from products introduced within the last 3 years, which was well above our target of 30%. Our new products demonstrate our commitment to address a wider array of customer needs, such as managing labor costs, productivity and machine maintenance information. We remain focused on developing innovative new products and technologies that fuel our revenue growth. We also are exploring new growth avenues that go beyond improving cleaning performance. Our advanced product development efforts include technologies such as autonomous guided scrubbers, among others.

We continue to invest in our digital platform with the goal to build the company's e-Business capabilities in order to meet customers' changing needs, enhance our long-term sales growth and further improve Tennant's operating efficiency. This summer, we anticipate launching a more robust e-commerce platform in the U.S. that offers expanded functionality for our customers to purchase products and parts, while enhancing lead generation and enabling cost-effective sales. In a few years, we anticipate being able to report e-commerce as another significant revenue channel, along with our existing direct distribution and strategic account channels.

Looking ahead to the remainder of 2017, we are excited about our strategic plans, but we are cautious about the global macroeconomic environment for industrial companies. We are staying the course strategically. Tennant is competitively well positioned in our markets, with exciting technologies and opportunities to expand our product portfolio and geographic presence, particularly in EMEA with the IPC Group acquisition. Through this acquisition and our restructuring actions, we are positioning Tennant to accelerate revenue growth and improve profitability. Notably, our acquisition of IPC Group will put us over $1 billion -- put us over our $1 billion sales target on an annualized basis. Additionally, our combined acquisition and restructuring actions will move us closer to our 12% operating profit margin goal. Now, I'll ask Tom to take you through Tennant's first quarter financial results. Tom?

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Thomas Paulson, Tennant Company - CFO and SVP [4]

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Thanks, Chris. In my comments today, references to earnings per share on a fully diluted basis except for the first quarter 2017, which was calculated with the basic weighted average shares outstanding due to the as reported net loss. For the first quarter ended March 31, 2017, Tennant reported net sales of $191.1 million, increased 6% compared to sales of $179.9 million in the 2016 first quarter. The foreign currency exchange impact was essentially flat versus the prior year. Excluding the net impact of the August 2016 Florock acquisition and the January 2016 Green Machines divestiture that increased net sales by 1.2%, organic sales increased approximately 5%.

First quarter 2017 net loss was $4 million or a loss of $0.22 per share. Tennant reported adjusted net earnings of $5.4 million or $0.31 per share. The as adjusted results in the 2017 first quarter excluded 2 special items that totaled a charge of $9.4 million after-tax or a loss of $0.53 per share. The first special item was a restructuring charge of $8 million pretax or $0.32 per share to better align our global resources and expense structure with a lower growth global economic environment. As Chris mentioned, the savings from the restructuring are estimated to be approximately $7 million in 2017 and a total of $10 million in 2018. The second special item was $4 million pretax or $0.21 per share of onetime costs related to the acquisition of the IPC Group. In the year-ago quarter, Tennant reported net earnings of $4.4 million or $0.25 per share.

Turning now to a more detailed review of the 2017 first quarter. Our sales are categorized into 3 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, 2017 first quarter sales increased 6.9% or grew 4.2% organically, excluding about 1% of favorable foreign currency impact and the 1.7% impact of the Florock acquisition. Sales in the Americas reflected strong sales through strategic accounts and direct sales fueled by demand for new products in North America as well as increased sales in Latin America. Organic sales growth in Latin America was approximately 14% in the 2017 first quarter despite continued economic headwinds. In September of 2016, we acquired our long-time distributor in Mexico, however, the incremental revenue impact is not material. This is an important emerging market for us, and we remain confident about its long-term growth prospects.

In EMEA, our organic sales in the 2017 first quarter increased 14.3%, excluding an unfavorable foreign currency impact of about 5.5% and the impact of the Green Machines divestiture of 0.5%. Positive organic sales growth was achieved in all countries with particular strength in Central Eastern Europe, Middle East and Africa markets through our master distributor for that region, and also Iberia, France and the Netherlands. In the Asia-Pacific region, organic sales in the 2017 first quarter decreased approximately 4.1%, excluding a favorable foreign currency impact of about 0.5%. Robust sales growth in Japan and Korea were more than offset by lower sales in Australia and China.

Tennant's gross margin for the 2017 first quarter was 41.7% compared to 43.1% in the prior year quarter. The 140 basis point decrease was primarily due to temporary service inefficiencies related to organizational changes from the restructuring, a less favorable mix of sales by geography and customer and raw material cost inflation. Research and development expense in the 2017 first quarter totaled $8.4 million or 4.4% of sales versus $7.9 million or 4.4% of sales in the prior year quarter. We continue to invest in developing the robust pipeline of innovative new products and technologies that Chris noted. Selling and administrative expense in the 2017 first quarter was $73.9 million or 38.7% of sales and as adjusted was $63 million or 33% of sales. [Sales] in the first quarter of 2016 was $62.4 million or 34.7% of sales. The 2017 first quarter S&A expense as adjusted was 170 basis points lower compared to the prior quarter as we continue to balance disciplined spending control with investments in key growth initiatives.

Our 2017 first quarter operating loss was $2.6 million or a negative 1.4% of sales and the operating profit as adjusted to exclude the restructuring charge and the onetime acquisition cost and S&A expense related to the IPC acquisition was an operating profit of $8.3 million or 4.3% of sales. Operating profit in the prior year quarter was $7.1 million or 3.9% of sales. We do not typically discuss other expense net. However, in the 2017 first quarter, we did have $1.2 million of onetime financing costs in net foreign currency transaction losses related to the IPC acquisition. We entered into a derivative to hedge the EUR 330 million purchase price and the cost incurred was the premium less the mark to market adjustment.

We remain committed to our goal of 12% or higher operating profit margin by successfully executing our strategic priorities and assuming the global economy improves. In order to achieve this target, we need to drive organic revenue growth in the mid- to high-single digits, hold fixed costs essentially flat in our manufacturing areas as volume rises, strive for 0 net inflation at the gross profit line and standardize and simplify 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 full year was 29.9%. The overall effective tax rate for the 2017 first quarter was 27.7%, excluding the special items. The base tax rate for the 2017 first quarter was 31.3%, which excludes the special items and the routine discrete tax items.

Turning now to the balance sheet. Again, this continues to be very strong. Net receivables at the end of the 2017 first quarter were $137.4 million versus $134.2 million a year earlier. Quarterly average accounts receivable days outstanding were 61 days for the first quarter compared to 63 days in the prior year quarter. Tennant's inventories at the end of 2017 first quarter were $88.1 million versus $84.1 million a year earlier. Quarterly average FIFO days inventory on hand were 100 days for the 2017 first quarter compared to 103 days in the year-ago quarter.

Capital expenditures totaled $4.7 million in the 2017 first quarter. That is $2.1 million lower than $6.8 million in the prior year quarter, and reflects our continued planned investments in information technology products, tooling related to new product development and manufacturing equipment. Tennant's cash from operations, which is typically negative in the first quarter due to the seasonality of the business, totaled a negative $11.4 million in the 2017 first quarter compared to a negative $6.5 million in the prior year quarter. Cash and cash equivalents totaled $45 million at the end of the 2017 first quarter versus $26.9 million at the end of the prior year quarter.

Total debt was $45 million, up from $22.7 million at the end of the prior year quarter chiefly due to incurring long-term debt related to our fall 2016 acquisitions and the March 2017 refinancing activity in preparation for the IPC acquisition that occurred in April 2017. Our debt-to-capital ratio was 14% at the end of the 2017 first quarter compared to 8.3% a year ago.

Regarding other aspects of our capital structure, Tennant increased the quarterly dividend to $0.21 per share effective December 2016. We paid cash dividends of $14.3 million in the 2016 full year and $3.7 million in the 2017 first quarter. Reflecting our commitment to shareholder return, we're proud to say that Tennant has increased the annual cash dividend payout for 45 consecutive years.

Regarding our recent financing activities, on April 5, 2017, we filed an 8-K for a new $600 million senior secured credit facility with JP Morgan, which comprised of -- which was comprised of a $200 million revolving credit facility, a $100 million term loan A1 and $300 million term loan A2. On April 6, 2017, funds were drawn under the new $600 million senior secured credit facility for the IPC acquisition and to pay related fees and expenses. The $400 million draw was comprised of $100 million term loan A and $300 million term loan A2.

On April 7, 2017, we announced the offering of $300 million of senior unsecured notes due 2025. The senior notes offering was priced at 5.625% and the closing occurred on April 18. The net proceeds of the senior notes together with the borrowings under our senior secured credit facility were used to refinance the $300 million term loan A2. The overall weighted average cost of debt of $100 million term loan A1 and the $300 million of senior notes and a related cross-currency swap instrument is approximately 4.2%.

Moving to our outlook for full year 2017, which now includes the 2017 first quarter restructuring charge, onetime acquisition and financing costs related to the IPC Group acquisition and the April 2017 IPC Group acquisition, including the impact of earnings from preliminary estimates of purchase accounting valuations and also the interest expense from the related financing. We now estimate 2017 full year net sales in the range of $960 million to $990 million, up 18% to 22.4% or up approximately 1% to 3% organically, assuming an unfavorable foreign currency exchange impact on sales of approximately 1%, an additional 0.8% inorganic growth from the 2016 Florock acquisition and inorganic growth from the 2017 IPC acquisition in the range of 18.6% to 20.4%. Previously, we anticipated 2017 full year net sales in the range of $810 million to $830 million.

We now expect 2017 full year reported earnings in the range of $1.05 to $1.25 per share. We expect 2017 full year as adjusted earnings in the range of $2.40 to $2.60 per share, excluding the following non-recurring costs totaling $30.8 million pretax or $1.35 per share: one, $8 million restructuring charge recorded in the 2017 first quarter in S&A expense; $7.5 million IPC acquisition costs, $2.9 million recording in the 2017 first quarter in S&A expense; $8.1 million IPC related financing costs, $1.2 million recorded in the 2017 first quarter and other expense net; $7.2 million IPC acquisition inventory step-up to be recorded in cost of goods sold.

Foreign currency exchange in 2017 is estimated to negatively impact operating profit by approximately $2.5 million or a negative impact of approximately $0.10 per share. On an as adjusted and constant-currency basis assuming no change in foreign currency exchange rates from the prior year, 2017 full year earnings are estimated to be in the range of $2.50 to $2.70 per share. Previously, we anticipated 2017 full year earnings on an as adjusted and constant-currency basis to be in the range of $2.60 to $2.80 per share. The decrease in the range of $0.10 per share primarily reflects the anticipated as adjusted 2017 dilution from the IPC Group acquisition. For the 2016 full year earnings per share totaled $2.59 on net sales of $808.6 million.

Tennant's 2017 annual financial outlook includes the following additional assumptions: continued stable economy in North America, modest improvement in Europe and a challenging business environment in APAC; gross margin performance in the range of 42% to 43%; R&D expense of approximately 4% of sales; capital expenditures in the range of $25 million to $30 million; and an effective tax rate of approximately 28%. Our objective is to continue to build our business for sustained success both through organic sales growth and through acquisitions. And now we would like to open up the call to any questions. Mike?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question is from Joe Maxa from Dougherty & Company.

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Joseph A. Maxa, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst [2]

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I do have a lot of moving parts here. I'll ask a few questions and maybe jump in the queue. I want to talk about gross margins first. They're down in the core business, and you've laid out some of the issues. Are those continuing with the raw material inflation and the -- basically the product mix. And second, I was going to say -- and secondly, how does that look for Q2? You got a few more moving pieces with the acquisition, a little bit lower gross margin, the stepped up inventory cost, I am assuming will be down, under 40% and then maybe some other thoughts.

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Thomas Paulson, Tennant Company - CFO and SVP [3]

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Let me comment. That's a bunch bundled into 1 question, but let me take a shot at it. First, we really do anticipate that the issues were temporary in our service inefficiencies. And really that's all about more trucks being open than we would like to see. We will rectify that situation, those inefficiencies will back away as we go forward. We do anticipate continuing to see a bit of modest inflation. We think it's manageable at this point. And in fact, we did see some pricing benefit of 1% in the first quarter, roughly, and we anticipate being somewhere around that to slightly better for the balance of the year.

And as far as the mix of business, I think that's a bit unusual in that while our gross margins aren't that different by geography, 14% growth in Europe along with really strong growth out of our key distributor there did put some pressure on gross margins. But if I look at it, Joe, across total Tennant base, we still believe that our gross margins for the old Tennant business will be between 43% and 44%. So they'll remain in our targeted range. We obviously try to run and increase our gross margins year-on-year. Our gross margins were 43.5% in the prior year. We certainly hope to be modestly above that, but we are comfortable to be within our range.

Our total range now is 42% to 43% for the total entity now, and that's really a function of IPC having lower gross margins than Tennant, and that's not surprising. They are 80% distribution-based and the distributors have to make money. So our total gross margin will be a bit lower, but our base at Tennant remains the same and we are very comfortable with that for the full year.

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Joseph A. Maxa, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst [4]

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And is that -- that would be, of course, excluding the onetime step-up charges?

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Thomas Paulson, Tennant Company - CFO and SVP [5]

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It does exclude it. Yes, that will be -- obviously that's going to put a lot of pressure on gross margins. I mean, it's just one of those accounting things that I won't get into here. But we really do believe that we expect the stepped-up inventory to bleed itself out and be gone by the end of the year. So we can't say precisely when that will be, but that's our expectation. So we'll have a pure gross margin number next year, and we will report our gross margins excluding that step-up as we go across the next 3 quarters to make sure people understand how our base business is performing.

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Joseph A. Maxa, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst [6]

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Right. And then on the European business, you have been having some nice growth last couple of quarters. The outlook on Europe for both your core business as well as IPC, how they are performing?

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Thomas Paulson, Tennant Company - CFO and SVP [7]

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Yes, we are thrilled. I mean, to have back-to-back quarters like that in our base Tennant business is very encouraging. I can't say that we would anticipate to repeat a 14% organic growth. We certainly haven't built anything like that in our numbers, but we do anticipate seeing growth for the balance of the year in EMEA. And Q2 will be a tougher quarter, but our business is strong and it's pretty broad-based, so that's even -- very encouraging. And we can also say IPC had a really nice start to their year too in Q1. So we remain confident in our ability to more consistently grow in Europe and further total Tennant businesses.

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Joseph A. Maxa, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst [8]

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Okay. That's helpful. What about just the order patterns now into the first part of the quarter, what do you see? And maybe, by geography, is it similar to Q1 or...

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Thomas Paulson, Tennant Company - CFO and SVP [9]

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Yes, actually it's one of the reasons why we considered taking our guidance up from the 1% to 3% organic. We've held that firm. Our order patterns are -- they're not as strong as they were in the last quarter. Last quarter was a 5% organic growth quarter. We're certainly -- we're lapping a very good quarter last year and our order patterns are -- they're a little bit slower right now, but we expect those to recover. We anticipate being able to have modest growth in the quarter, we hope, but 1 quarter doesn't make a trend. So we remain cautious on what we saw in Q1.

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Joseph A. Maxa, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst [10]

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When you think of the sales synergies between the 2 companies, where do you see your biggest opportunity? And as part of that, I was just wondering if this cleaning tools and supplies is a big opportunity for you to bring to your current customers?

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Thomas Paulson, Tennant Company - CFO and SVP [11]

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Yes. We do. If you just think about it and look at facility managers as just one example, they're important customers for us around the world, the ARAMARKs, the IFS's, the ABM's of the world, they all buy cleaning tools and -- every day. And so -- do we anticipate being able to get some benefit from that due to our customer base? We sure hope so. And that's our expectation. But we really think the opportunities are broad based, Joe. I mean, we're focusing on Europe. We do think there's opportunities in the U.S. and in the Americas and APAC, but our primary focus is going to be on Europe.

And we think that product line -- our product line and their product lines can be sold through respective channels, so that's 1 area of opportunity. We think the cross-selling of products can accelerate with what IPC is having some success doing it. It's one of the premises of our -- of the acquisition that they can continue to improve their cross-selling capabilities, they just got it started on that effort. And we also believe we can learn something from how they run a distribution channel. And we think we can help with their strategic account efforts so the growth platform is multidimensional, and we are nothing but more confident as we -- in early days of owning the business.

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Joseph A. Maxa, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst [12]

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Okay. And last one would be on the debt. Can you tell us what your debt level is post the debt raising acquisition and what your blended rate is?

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Thomas Paulson, Tennant Company - CFO and SVP [13]

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Yes, it's $420 million right now and the blended debt rate is going to be, if you include the hedge, it'll be at about 4.2%. So the actual weighted average interest on the bond is 5.625%. We then have some money drawn on our credit facility, but the weighted average of all that is about 4.2 %.

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Operator [14]

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The next question is from Chris Moore from CJS Securities.

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Christopher Paul Moore, CJS Securities, Inc. - Research Analyst [15]

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Maybe just follow up on the debt, kind of from a leverage standpoint, where are you now? And where is your kind of comfort zone there?

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Thomas Paulson, Tennant Company - CFO and SVP [16]

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We're obviously comfortable at the leverage above 3 right now, but that's certainly not where we want to stay. And we will be extremely focused on using our excess cash to pay down debt. We're going to invest in the business, we're going to run the business the way we have been, but all of our excess cash will -- we continue to expect to pay a dividend, but the balance of it will be paying down debt. And we'll feel better when our leverage is at 2 or lower, so that's what our focus will be for a period of time here. And we -- I'll remind you that we do generate a lot of cash on both of these businesses and we will take advantage of that.

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Christopher Paul Moore, CJS Securities, Inc. - Research Analyst [17]

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Got you, all right. On the gross margins, the total range kind of 42%, 43% with IPC in there. Moving into '18 and '19, is it possible to get back into your -- kind of the core business range of 43% to 44%, or is that too aggressive for '18?

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Thomas Paulson, Tennant Company - CFO and SVP [18]

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I'd like to think we could eke our way back in there, but for now we're going to stick with the 42% to 43%. But we'd like to think that's a conservative number. We'd certainly strongly prefer to be at the high end of that. And we -- we're not going to be bashful about trying to get our gross margin back above 43%, but we're just not prepared to say when that might be.

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Christopher Paul Moore, CJS Securities, Inc. - Research Analyst [19]

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Got you, and Chris had mentioned just basically accretive in 2018. Assuming that this stepped-up inventory is gone by the end of '17, are there any more acquisition or any other kind of noncash charges that would still be out there in '18?

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Thomas Paulson, Tennant Company - CFO and SVP [20]

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No. Everything should really be behind us by that point, that's certainly what we hope to be. And we'll provide more details and more insight as we go forward, and certainly as we're able to give you information on each of the respective quarters this year, that will bring more clarity to what next year looks like. So we are certainly -- we better be quite comfortable that we're going to be accretive or we wouldn't be saying that, we're just not prepared to say how accretive at the current time.

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Operator [21]

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The next question is from Bhupender Bohra from Jefferies.

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Bhupender Singh Bohra, Jefferies LLC, Research Division - Equity Analyst [22]

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So I just wanted to get some color behind your North America core sales number here. Nice growth actually in the quarter. And you did actually say that mostly driven by the industrial business. Can you, from a revenue -- end market perspective, just give us some color within your commercial vertical and some of the retail stuff which we're looking at like the headline news and all those things. Just give us some color what actually drove that strong core sales in the Americas, especially in the U.S.?

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Thomas Paulson, Tennant Company - CFO and SVP [23]

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Sure. The 2 big pieces of it were that our new product success and -- it was really important and strategic accounts were very important. And part of the new product success is, as I remind you, we had important industrial launches last year. The timing of those industrial launches wasn't perfect, and that was a sluggish economy last year, and you're introducing high-priced items into a sluggish economy. We still had a great vitality index year, but we're starting to see some momentum on those new products now as they're fully global now. And that's been a very important part of the growth success in Q1, was the beginning of growth on those industrial products starting to accelerate. And we are seeing some better demand in the industrial side of the business, and that is one of the things that gives us some confidence that maybe we just are beginning to pull out of this. We just don't know for sure.

And we had a lot of questions from folks around the retail segment and I mean, I know most people view it as a headwind, and we're not going to say that it's an easy environment, but I'd remind people that we are not in small sites, in mall-driven areas. We have a premier set of retailers as our base business and we have share opportunities virtually everywhere in the world with marquee retailers. And we still believe that we can grow it in retail. And we would say we know it's a headwind, but we think, given the quality of our customers and the ability, I think we can grow. And we also are seeing some nice offsets on the distribution side of the business, meaning where we sell into logistic locations, people buying online. We do really well in those environments that those online orders are fulfilled out of, and we're taking advantage of spending more energy there.

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H. Chris Killingstad, Tennant Company - CEO, President and Director [24]

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And we did have very solid growth in the first quarter in retail. We don't report by vertical, but the growth in retail was above the total Americas and North America growth rates. So -- and we expect that to continue.

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Bhupender Singh Bohra, Jefferies LLC, Research Division - Equity Analyst [25]

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Okay. Nice to hear that. Now, you did say the order patterns as you exited first quarter have slowed down. Is that respective to any particular geographies like U.S. or are we talking about like overall?

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Thomas Paulson, Tennant Company - CFO and SVP [26]

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It's pretty consistent, but I mean, I would say that Europe is honestly holding up a bit better than the other geographies, but not notably different. And we remain comfortable based on the forecasts we're getting, on what we're seeing is that the order patterns will get stronger as we go through the rest of the quarter. But they're a little slower than we would like as the quarter starts out. I'd also remind you that April is the least important month by quite a bit as we go into Q2. So we're not -- we're just -- we're paying attention, but we still believe and we're very comfortable with our organic growth rates we've given for the full year.

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Bhupender Singh Bohra, Jefferies LLC, Research Division - Equity Analyst [27]

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Okay. I was just trying to get a sense of that 1% to 3%, which you kind of maintained coming into the quarter, like beating it. A nice 5% organic growth here, and then kind of maintaining the growth for the overall rest of 2017. It just tells me like you are being a little bit more conservative or you just want to go into like the June quarter to make -- and get a sense of what the organic growth is?

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Thomas Paulson, Tennant Company - CFO and SVP [28]

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We would like some more data points, Bhupender. One really solid quarter doesn't make a trend. We frankly -- the economy does feel like it's getting better, particularly in Europe, but we're also seeing some strength in North America. We're just not ready to take our numbers up for the full year. We sure hope we're being conservative. That's how we like to be and we're still managing the business very tightly.

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Bhupender Singh Bohra, Jefferies LLC, Research Division - Equity Analyst [29]

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Okay. And lastly, I just wanted -- on the IPC, now you guys have been -- you have a good track record in terms of new product introduction and the vitality index. Give some colors on like IPC, how they handle their new product growth and if they do track like a vitality index internally or how they have benefited over time. Kind of a refresh cycle they have, like how many months, just any color on that.

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H. Chris Killingstad, Tennant Company - CEO, President and Director [30]

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I'll answer that. We love their portfolio. As we mentioned, it's very complementary to ours because it's midsize commercial down to small commercial and some new product categories. But we quite frankly have not had the chance yet to get deeply into their R&D efforts to understand some of the details and be able to answer some of the questions that you're asking. But our initial review of their R&D efforts indicate that it's pretty robust and they have a nice process, and they do launch a lot of new products. And they have a pipeline going forward, in totality, in terms that what they've showed us, that looks pretty good. But I think that -- let us get it. We just had the kick-off meeting for the integration last week, on Wednesday and Thursday. And so we are just jumping into it. There is still a lot to learn and hopefully next quarter we'll be able to provide a little more color around some of these opportunities.

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Operator [31]

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The next question is from Marco Rodriguez from Stonegate Capital Markets.

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Marco Andres Rodriguez, Stonegate Capital Markets, Inc., Research Division - Director of Research and Senior Research Analyst [32]

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I was wondering if you could talk a little bit more here about the strength you guys saw in Europe. On the organic gross side, obviously pretty healthy rate there. Were there any sort of, I don't know, sales events? Or was this maybe like some pent-up demand that didn't get closed in the last -- the prior few quarters? Or any sort of color there would be helpful.

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H. Chris Killingstad, Tennant Company - CEO, President and Director [33]

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Well, first of all, I think the underlying European economy is improving, and within that our business is improving as well. But you got to remember, this wasn't an overnight sensation. We have been doing a lot of work in Europe over the last 3 or 4 years. We have pretty much a new management team, new leadership, strategic restructuring, go-to-market restructuring in all the key countries. And I think that all that hard work and effort is finally starting to pay dividends, and we're seeing it in the results in the last 2 quarters. And hopefully that continues. But as Tom said, 14.3% growth in the first quarter, don't expect that to continue into the second quarter. But we do look forward to a continuing sustainable growth environment in our European business, and IPC is just going to add to that going forward. So we're really excited.

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Thomas Paulson, Tennant Company - CFO and SVP [34]

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I'll add one thing to that, that EMEA did have a -- prior year is where they had a 2.8% decline organically in Q1, so we were lapping an easier quarter. And it just so happened that if you look across last year, Q2 is by far the best quarter that EMEA had. They actually grew 8% organically last year, so it's a much tougher lap. But we still think we can grow. And we're confident in both of the businesses, the old Tennant business and the IPC business. We really do feel that both of those business will respectively have organic growth in the quarter in EMEA.

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Marco Andres Rodriguez, Stonegate Capital Markets, Inc., Research Division - Director of Research and Senior Research Analyst [35]

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Okay. Perfect. It's helpful. And then to come back and circle back around on gross margins in the quarter, the 140 basis point year-over-year decline. I know you already called out the 3 major items there, but then also I was a little perplexed about the fact that about 42% of your revenue are from new products. So I would assume that those are pretty high margin. Can you maybe, I don't know, quantify in those particular buckets, I mean, what -- where were the pluses and the minuses?

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Thomas Paulson, Tennant Company - CFO and SVP [36]

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In the actual gross margins in Q1?

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Marco Andres Rodriguez, Stonegate Capital Markets, Inc., Research Division - Director of Research and Senior Research Analyst [37]

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Right, in comparison. The year-on-year 140...

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Thomas Paulson, Tennant Company - CFO and SVP [38]

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If you look at the gross margins from the prior year, the prior year gross margins were particularly strong at 43%. And what I would tell you is that, if you went back to 2015, gross margins in Q1 of 42% were more normalized. Last year was unusually high as we actually saw deflation in the quarter, and had a really solid mix, et cetera. Whereas, in Q1, I'll recomment on a couple of things I said. One is, new products is definitely not a negative. I mean, it's -- at worst case, it's neutral to positive if you look at the gross margin impact. It's one of the things we do best, we don't introduce new products that don't have better margins than the products that it's replacing.

So it is -- new products are generally worst-case neutral, but in most instances modestly additive to our margin structure. But we really do believe that the -- we were probably 50 basis points in the quarter below where we'd like to be in total. And that really was a function of the inefficiencies in the service organization that we believe are temporary. And also, when you see the level of growth we saw of our saw master distributor combined with the growth on the balance of Europe, that's going to apply a little bit of gross margin pressure. And we're honestly fine with those gross margins. We think our -- maybe 50 basis points below, we'll get that back, and we'll be within our range for the full year. So we really view it as onetime in nature and transitional.

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Marco Andres Rodriguez, Stonegate Capital Markets, Inc., Research Division - Director of Research and Senior Research Analyst [39]

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Got you, helpful. And maybe if you could talk a little bit more about the potential revenue synergies. Do you guys have a strategic plan that you are rolling out? Any sort of initiatives that will be discussed? Just any sort of color there to kind of help us understand that?

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Thomas Paulson, Tennant Company - CFO and SVP [40]

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Well, we -- if we looked at the base Tennant business, there is really no change whatsoever in strategic direction. I mean, we think we'll see growth from continued rollout of new products. Our pipeline is particularly strong this year, that will be a meaningful benefit. We continue to improve our market coverage and optimize our market coverage and we think the restructuring actions that we just took, while they reduce cost, I think it will actually improve our go-to-market positioning, particularly in the Americas. And strategic accounts continue to matter in the short-term and the long-term. And then the acquisition is going to drive some incremental revenue. I mean, we are not prepared to be precise about that at the current time, but we really do intend to begin to see some incremental revenue pickup through each of our respective channels. And we're really enthused about the opportunity to begin to see incremental revenue growth out of both of our respective businesses due to the 2 businesses being together.

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Marco Andres Rodriguez, Stonegate Capital Markets, Inc., Research Division - Director of Research and Senior Research Analyst [41]

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Got it. And last quick question, just kind of a housekeeping item, post-acquisition here is there a significant change to your cash balance?

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Thomas Paulson, Tennant Company - CFO and SVP [42]

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No, it's not -- there is not. I mean, we, in fact, right now, our cash position is actually up a little bit. But we don't see a major change. We'll continue to carry a cash balance, but it won't be significant. We'll generally only carry as much cash as we need to run the business day to day and any excess money will be going to pay down debt. And we don't have cash trapped anywhere. It's really been one of the smart things that we've done over time, that we've got a lot of flexibility. We have the ability to freely move money to pay down our debt and we will continue to do that very aggressively.

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Operator [43]

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The next question is from Rosemarie Morbelli from Gabelli & Company.

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Rosemarie Jeanne Morbelli, G. Research, LLC - Research Analyst [44]

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Just, Tom, following up on the last question, how much cash is needed to run the business?

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Thomas Paulson, Tennant Company - CFO and SVP [45]

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We would say $25 million to $50 million roughly is -- we'll err as close to being at the $25 million as we can, but we really -- it's somewhere in that range. And we don't have big seasonal moves in our business either. I mean, the one quarter that's generally a bit tougher is Q1 where we generally don't -- we don't generate cash. We tend to be modestly negative. But we always expect to generate a meaningful level of cash in the other quarters and we don't have big swings quarter-to-quarter.

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Rosemarie Jeanne Morbelli, G. Research, LLC - Research Analyst [46]

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And in terms of free cash flow, what is the average? What do you expect to generate now that you have IPC?

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Thomas Paulson, Tennant Company - CFO and SVP [47]

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We haven't specifically given free cash flows. But if you went back and looked at our free cash flow history, if you looked across the last 5 years, our free cash flow has varied between the low point of $21 million and the high point of $45 million. We would expect that free cash flow on the base Tennant business would improve in the year that we're in relative to the prior year. And IPC, if you look at their cash generation as a percent of their revenue, they are similar to what Tennant does. So if you wanted to make some estimates, that would be the best way to do it. But we expect to see an improving cash flow position in our business and that will be through earnings growth. But also we've had more inventory in our system than we'd like to see and we think we'll begin to work that inventory position down and that will allow us to generate further cash. So we think there is some leverage in our working capital there.

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Rosemarie Jeanne Morbelli, G. Research, LLC - Research Analyst [48]

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If -- can you talk about the growth rates that IPC has experienced over the last few years?

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Thomas Paulson, Tennant Company - CFO and SVP [49]

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Sure. If you -- I'll first comment about Q1. I mean, they certainly didn't grow at the same levels that Tennant grew, but they did see organic growth of 8% in Q1. That's -- we don't anticipate that continuing, but they got off to a really nice start. And then as you look back across the last couple of years, they have seen growth in the 2% to 4% range. And one of the beauties of their business is, they've been more consistent than we have been. It's one of the things that we loved in their business, and that's really a function of a solid business model being well managed by their management team. And we are thrilled that we've retained the key people and they've done a great job of managing the business and improving margins and getting growth, but very importantly, consistent predictable growth on a quarterly basis.

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Rosemarie Jeanne Morbelli, G. Research, LLC - Research Analyst [50]

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Is that consistent growth based -- due to the fact that they actually have smaller, less expensive machines, and therefore you don't -- a lot more customers are willing to spend that amount versus the amount necessary for your machines?

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Thomas Paulson, Tennant Company - CFO and SVP [51]

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It does help. They're not as dependent on strategic accounts as we -- that's not going to diminish us from trying to capitalize on that more, but that does help the business be more predictable. And there is a -- lower price items tend to be more consistent. You don't see the economical swings up and down. And also their tool business, that's a business where people are buying those products every day, it's very consumable, and that business is one of the things we love. It's a great business with nice margins, and we think there is upside, but it is a much more predictable, consistent piece of business also.

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Rosemarie Jeanne Morbelli, G. Research, LLC - Research Analyst [52]

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And looking at e-commerce, what do you see the potential size of that e-commerce, let's say, over the next 3 to 5 years, [ you can pick the pieces... ]

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Thomas Paulson, Tennant Company - CFO and SVP [53]

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I'll let Chris comment on this one.

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H. Chris Killingstad, Tennant Company - CEO, President and Director [54]

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Rosemarie, what we've said is -- we haven't given any numbers, but what we've said is that we expect, within a reasonable period of time, to begin reporting e-commerce as a separate sales channel to go along with direct distribution and strategic accounts. So that indication -- should indicate to you that we anticipate it will be quite material to our results.

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Rosemarie Jeanne Morbelli, G. Research, LLC - Research Analyst [55]

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And reasonably for years?

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H. Chris Killingstad, Tennant Company - CEO, President and Director [56]

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Within -- in that time frame, yes.

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Rosemarie Jeanne Morbelli, G. Research, LLC - Research Analyst [57]

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Okay. And then lastly, if I may. Regarding the strength of Europe, was there some short inventory buildup in some of the channels or pending demand that were suddenly being filled?

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Thomas Paulson, Tennant Company - CFO and SVP [58]

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No. We really don't -- we'd love our distributors to carry more inventory than they do. The reality of it is they don't carry a lot of inventory. I mean we -- we don't have this typical channel fill kind of situations where you get onetime benefit pickups and that's factual all over the world. So it was real demand.

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Operator [59]

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(Operator Instructions) The next question is from Joe Maxa from Dougherty & Company.

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Joseph A. Maxa, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst [60]

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I was just wondering if you could give us what you think the depreciation and the amortization will be in Q2 and the following quarters?

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Thomas Paulson, Tennant Company - CFO and SVP [61]

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We'll give you an answer real quickly there. I mean, there is no material change to the base Tennant business. You can see from the 8-K filing that the intangible is -- the amortization on that is -- I think it's about $8.5 million annual, yes. And then the incremental depreciation and amortization, Jim is going to give me a number here in a second, about $5 million.

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Joseph A. Maxa, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst [62]

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For the quarter or for the year?

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Thomas Paulson, Tennant Company - CFO and SVP [63]

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No, for the year.

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H. Chris Killingstad, Tennant Company - CEO, President and Director [64]

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Annually.

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Thomas Paulson, Tennant Company - CFO and SVP [65]

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Yes. So if you looked at our historical DNA, which has been in the $20 million to $22 million range, and then you add in $5 million and then also the intangible annual amortization, is a big number.

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Joseph A. Maxa, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst [66]

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Okay. And the $10 million cost, you need to generate that $10 million in annual savings, when do we -- when does that start kicking in?

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Thomas Paulson, Tennant Company - CFO and SVP [67]

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Yes. We would anticipate that we would have some modest level of savings this year. We haven't given that precisely, but we'd like to think that maybe there is a little bit of opportunity there. But we would anticipate getting somewhere close to half of the benefits next year. And then we would get the full annualized benefit by 2019. So we need to start making progress, but we're to go at a measured pace, as we said many times. And we'd certainly like to believe that that's a conservative number relative to comparable industrial deals. But we're in early days, but we will begin to execute. We've said we're going to take our time. We're taking 100 days to formulate our definitive plan through a very deep integration team, and we'll go after the $10 million of synergies. Were you talking about the $10 million on the restructure, Joe?

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Joseph A. Maxa, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst [68]

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Well, I thought you -- thought there was another -- no I wasn't on the restructuring.

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Thomas Paulson, Tennant Company - CFO and SVP [69]

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Okay. Okay. Sorry. That's the $10 million on the cost on the acquisition. As we've talked about the total synergy number that we built in, it was actually -- we've talked a EUR 12 million number. And the difference between those is the modest amount of -- that we have built in around some of the revenue synergies that exist.

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Joseph A. Maxa, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst [70]

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Okay. And then lastly, seasonality on IPC compared to Tennant's historical seasonality?

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Thomas Paulson, Tennant Company - CFO and SVP [71]

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Yes. It's best to say in their business that their quarters are much more consistent, so there isn't really a meaningful difference between each of the respective quarters. So you could be pretty safe by just assuming that it's equal across quarters and you're not going to be far off.

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Joseph A. Maxa, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst [72]

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Oh, really, even in Q3 where Europe is...

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Thomas Paulson, Tennant Company - CFO and SVP [73]

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Yes. I mean if you wanted to adjust a quarter downward, Q3 would be the one to do it. Also Q1, but the differentials are -- as you know, our business is -- it's not gigantically different, but it's real clear year in and year out, Q1 and Q3 are meaningfully lower. And our front half/back half in Tennant is pretty consistent, 51, 49 generally, but their business is pretty consistent quarter to quarter.

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Operator [74]

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

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H. Chris Killingstad, Tennant Company - CEO, President and Director [75]

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We continue to make progress against our growth aspirations. Our acquisition of IPC Group will put us over our $1 billion sales target on an annualized basis. Additionally, our combined acquisition and restructuring actions will move us closer to our 12% operating profit margin goal. Looking ahead, we believe that Tennant is competitively advantaged with attractive growth prospects in a stronger global economy. We are focused on creating value for Tennant shareholders and we are excited about the company's future. We look forward to updating you on our 2017 second quarter results in early August.

Thank you for your time today and for your questions. Take care, everybody.

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Operator [76]

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