Tennant's (TNC) CEO Chris Killingstad on Q1 2016 Results - Earnings Call Transcript

| About: Tennant Company (TNC)

Tennant Company (NYSE:TNC)

Q1 2016 Earnings Conference Call

April 25, 2016 11:00 A.M. ET

Executives

H. Chris Killingstad - President and CEO

Thomas Paulson - SVP and CFO

Analysts

Rosemarie Morbelli - Gabelli & Company

Joseph Maxa - Dougherty & Company

Christopher Moore - CJS Securities

Bhupendra Bohra - Jefferies & Company

Operator

Good morning, my name is Sean, and I will be your conference operator today. At this time I would like to welcome everyone to Tennant Company's First Quarter 2016 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 the line for closing remarks from management. [Operator Instructions]. Thank you for participating in Tennant Company's first quarter 2016 earnings conference call. Beginning today's meeting is Mr. Tom Paulson, Senior Vice President and Chief Financial Officer for Tennant Company. Mr. Paulson, please go ahead.

Thomas Paulson

Thanks, Sean. Good morning, everyone and welcome to Tennant Company's first 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; Karen Durant, Vice President and Controller; and Tom Stueve, Treasurer.

Our agenda today is to review Tennant's performance during the 2016 first 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.

H. Chris Killingstad

Thank you, Tom and thanks to all of you for joining us this morning. As you saw in our earning release today we experienced a continued sluggish business environment in the 2016 first quarter, despite the adverse macroeconomic conditions and despite lapping record sales for our first quarter in the prior year period. Tennant's operations are performing well and we continue to build our business for sustained success. The company posted 2016 first quarter net sales of $179.9 million and diluted earnings per share of $0.25. Organic net sales were equal to the prior year period.

On a constant currency basis Tennant would have reported first quarter earnings per share of $0.29 which would have been up 7.4% versus the prior year period. A more favorable channel mix and product mix contributed to our performance. We have increased sales through distribution and direct sales particularly in the Americas region. And higher sales of industrial equipment compared to the prior year quarter when we saw a stronger sales for commercial equipment due to orders from two U.S. big box retailers.

Also benefiting our 2016 first quarter results, sales of scrubbers equipped with ec-H2O technology totaled approximately $32 million with solid growth in North America. Although sales in the 2016 first quarter got off to a slower start than we wanted, we were encouraged to see rising sales momentum towards the end of the quarter. As a result we are reaffirming our guidance for the full year. Tom will discuss our guidance in more detail in a moment.

Looking ahead, we are staying the course strategically. We are committed to reaching our goals of $1 billion 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, and the application of lean principles throughout our organization. We remain confident in our growth strategies and we are well positioned to leverage our operational efficiency as economic conditions improve.

Now I would like to update you on our progress driving top and bottom line results through innovative products and technologies and efficiencies. Even in an adverse economy we continue to invest approximately 4% of sales annually in research and development to ensure future growth. And we continue to execute against the strongest new product pipeline in Tennant's history. The introduction of new products and technologies is important to our revenue growth. In fact equipment sales coming from new products introduced within the last three years rose to 26% for the full year of 2015 and was 36% for the 2016 first quarter.

In 2016 we are on track to introduce at least 13 new products including several significant industrial machine launches. The M17 Battery-Powered Sweeper-Scrubber was the first industrial machine we unveiled this year. Released in late March, the M17 is our largest Battery-Powered Sweeper-Scrubber. It is the result of significant voice of the customer research which provide insights for the development of next generation products that meet our customer's needs.

The versatile and fume free M17 does the job of several smaller machines giving customers the option to choose between dry sweeping, scrubbing, or simultaneously doing both. It offers the largest available battery capacity in its class for maximum runtime and improved productivity. The M17 also is equipped with our industry leading Pro-Panel intuitive touch-screen interface for custom settings and ease of use. These are just some of the benefits and among the reasons we are excited about the potential for this new industrial product.

We continue to be pleased with the success of ec-H2O NanoClean which is our next generation of sustainable cleaning technology. It is now available on all of 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 original ec-H2O the next-generation ec-H2O 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 applications.

I also want to mention our Orbio os3 which is gaining sales momentum. We recently won a significant order from a large national health and fitness chain. The os3 delivers onsite generation of an effective multi-surface cleaner and an anti-microbial solution that disinfects and sanitizes. This amazing technology is cost effective, easy to use, and fits into most janitorial closets. Orbio continues to make progress, and customers who have adopted it love it.

Now I’d like to give you a preview of our advanced product development efforts that are focused on creating new growth avenues for Tennant. We have significantly enhanced our capabilities to use voice-of-the-customer research to view our customers’ cleaning needs more holistically. We are no longer just trying to improve cleaning performance but also looking to address a broader array of customer needs such as demands for managing labor costs, productivity, and machine maintenance information. We anticipate expanding our business through telemetry, battery technology, water recycling, and robotics.

In the area of telemetry which involves automated data collection and transmission, we introduced the IRIS Asset Manager in the 2015 fourth quarter. Already IRIS is generating strong interest and winning us new business and new customers. We have received a significant order from a big box retailer in Canada, in addition to a large retailer in Europe, both of which specified IRIS.

The IRIS Asset Manager is an intelligent command center that tracks machine productivity and maintenance needs, including machine and ec-H2O 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 and a fast emerging trend. The IRIS Asset Manager is available on many of our commercial and industrial cleaning machines.

Another product development area that we are working on involves battery technologies. Battery life and machine uptime are among our customers’ greatest pain points. We are actively looking at 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 solutions that offer measurable environmental impact improvements. Onboard water recycling using filtration technologies is one of the sustainable solutions that Tennant is currently working on. 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 the advancement in robotics technology and increasing customer pain points related to 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 to customers, 70% of their cleaning costs today are labor related; only 10% of their costs are related to machines. As this technology is more widely adopted in various industries and as costs decline, it is advancing to a point where it may be more practical for our customers’ applications. Excuse me. These examples give you a sense of how we are using voice-of-the-customer research and viewing our customer's cleaning needs more holistically in order to create exciting new growth avenues for Tennant.

Another important endeavor involves our investments in Tennant's digital transformation. 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 further improve Tennant's operating efficiency. One way we are achieving this is by focusing on marketing automation which allows us to continuously and in real time update and tailor our messages to specific customer needs. This will improve lead generation, facilitate the buying journey, and provide a better customer experience.

A few of our other digital e-business initiatives include e-commerce and CREP. E-commerce 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 anticipate launching a more robust e-commerce platform in the U.S. that offers expanded functionality to purchase products and parts, enhances lead generation, and enables cost effective sales.

E-commerce is a growing trend in other industries and we expect this evolution to occur in the cleaning industry as well. 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. We also continued the global roll out of our new 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 have 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 roll out -- the global roll out to Japan, China, and other regions in the second half of this year.

Looking ahead Tennant remains competitively advantaged and well positioned to leverage our growth through the application of lean principles in our plants and throughout the rest of our organization. We expect a return to a higher level of sales growth as macroeconomic conditions improve driven by new products and technologies and a growing customer base.

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 running a more efficient business to raise productivity.

Now I will ask Tom to take you through Tennant's first quarter financial results. Tom.

Thomas Paulson

Thanks Chris. In my comments today, all references to earnings per share are on a fully diluted basis. For the first quarter ended March 31, 2016, Tennant reported net sales of $179.9 million, compared to a record sales of $185.7 million in the 2015 first quarter, excluding an unfavorable foreign currency exchange impact of about 2% and the impact from the divestiture of the Green Machines outdoor city cleaning line that reduced net sales by 1.2%, organic sales were equal to the prior year quarter.

First quarter 2016 net earnings were $4.4 million or $0.25 per share. In the year-ago quarter, Tennant reported net earnings of $5 million or $0.27 per share. Foreign currency exchange headwinds unfavorably impacted our 2016 first 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 first 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 first quarter organic sales increased approximately 1.7%, excluding about 2% of unfavorable foreign currency impact despite lapping the very robust Americas organic sales growth of approximately 11.5% in the prior year quarter.

Organic sales in the 2016 first quarter were bolstered by sales through distribution and direct sales including sales of new products. Sales of scrubbers equipped with ec-H2O technology also grew in North America. Organic sales growth in Brazil was approximately 7.5% despite the continued economic headwinds. 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 first quarter decreased approximately 2.8%, excluding an unfavorable foreign currency impact of about 2% and excluding the impact of the Green Machines divestiture of 6.5%. Strong sales to strategic accounts throughout EMEA were more than offset by lower direct sales and sales through distribution. As you’ll recall, at the end of January 2016 we sold the Green Machines outdoor city cleaning lines to our master distributor for this EMEA region. This was the right decision for Tennant. The buyer will continue to invest and manufacture in Scotland and maintain jobs and employment conditions. Additionally Tennant has an 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 first quarter decreased 5.8% excluding an unfavorable foreign currency impact of about 3%. Organic sales growth was particularly strong in Australia and Japan and was also positive in China. However this was more than offset by lower organic sales in the other Asian countries.

Tennant’s gross margin for the 2016 first quarter was 43.1% compared to 42% in the prior year quarter. A 110 basis points improvement was due to a more favorable channel mix and product mix. As Chris mentioned, we had higher sales of industrial equipment in the 2016’s first quarter compared to the prior year quarter, when we had stronger sales of commercial equipment due primarily to orders from two U.S. big box retailers. Also these results include foreign currency headwinds that unfavorably impacted gross margins by approximately 40 basis points.

Research and development expense in the 2016 first quarter totaled $7.9 million or 4.4% of sales compared to $7.7 million or 4.2% of sales in the prior year quarters. We continue to invest in both our traditional core business and Orbio which is focused on advancing a suite of sustainable water-based cleaning technologies.

Selling and administrative expense in the 2016 first quarter totaled $62.4 million or 34.7% 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 first quarter of 2015 was $62.1 million or 33.4% of sales. Our first quarter operating profit totaled $7.1 million or 3.9% of sales compared to the year earlier operating profit of $8.3 million or 4.4% of sales.

We have routinely discussed the impact of foreign currency exchange on our sales. Both 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 have calculated and estimated constant currency income statement which assumes no change in exchange rates from the prior year. In so doing we are able then 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 first quarter financial results. Unfavorable impact of sales of approximately 2% or about $3.6 million, unfavorable impact to gross margin of 40 basis points, using a constant currency our growth margin would have been about 43.5% compared to 43.1% as reported.

Unfavorable impact to operating profit of approximately $1.1 million; using a constant currency our operating profit margin would’ve been about 4.5% compared to 3.9% as reported. And unfavorable impact to earnings per share of approximately $0.04 using a constant currency our earnings per share would’ve been about $0.29 compared to $0.25 as reported. The estimated unfavorable impact from foreign currency exchange during the 2016 first 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 increase in selling prices and the effect of local markets where possible, starting to produce and ship some products and more cases to 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 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 of the gross profit line, and standardizing and simplifying processes globally to continue to improve the scalability of our business model while minimizing any increases on operating expenses.

We continue to successfully execute our tax strategies. Tennant’s overall effective tax rate for the 2016 first quarter was 32% compared to 32.4% for the 2015 first quarter. The base tax rate for the 2016 first quarter was 30.3%, which excludes routine discrete tax items. The federal R&D tax credit was reenacted before the start of 2016, so the favorable impact of that is included in our 2016 tax rates.

Turning now to the balance sheet. Again, this continues to be very strong. Net receivables at the end of the 2016 first quarter were a $134.2 million versus a $134 million a year earlier. Quarterly average accounts receivable days outstanding were 63 days in the first quarter compared to 64 days in the prior year quarter. Tennant’s inventories at the end of the 2016 first quarter were $84.1 million versus $85.6 million a year earlier. Quarterly average FIFO days inventory on hand were 103 days for the 2016 first quarter compared to 97 days in the year ago quarter.

Capital expenditures of $6.8 million in the 2016 first quarter were $2.7 million, higher than the $4.1 million in a prior year, with planned investments in Information Technology projects, tooling related to new product developments and manufacturing equipment. Tennant’s cash from operations which is typically negative in the first quarter due to the seasonality of business totaled a negative $6.5 million in the 2016 first quarter compared to a negative $2.1 million in the prior year quarter. Cash and cash equivalents totaled $26.9 million and total debt was $22.7 million. Our debt-to-capital ratio was 8.3% at the end of the 2016 first quarter compared to 8.7% in the prior year quarter.

Regarding other aspects of our capital structure, Tennant is currently paying a quarterly dividend of $0.20 per share. We paid cash dividends of $3.5 million in the 2016 first quarter. 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’s stock for a total cash outlay of $46 million. During the 2016 first quarter we purchased a 137,000 shares of stock for a total cash outlay of $7.1 million. As of March 31, 2016, we had approximately 500,000 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 repurchase to create value based on overall market conditions. Assuming the stock market continues to be volatile we expect to be active in repurchasing Tennant shares.

Moving now to our outlook, we are reaffirming our guidance for the 2016 full-year. We continue to estimate 2016 full year net sales in the range of $795 million to $825 million, down 2.1% to up 1.6%, or approximately 0% to up 4% organically, excluding an unfavorable foreign currency impact and a sales decline from the divestiture. We continue to estimate 2016 full year earnings in the range of $2.25 to $2.55 per share.

Foreign currency exchange headwinds in 2016 are estimated to negatively impact operating profit in the range of $3 million to $6 million or a negative impact of approximately $0.10 to $0.20 per share. On a constant currency basis, 2016 full-year earnings are anticipated to be in the range of $2.35 to $2.75 per share. The estimated slightly higher effective tax rate in 2016 is also anticipated to negatively impact 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 $6 million negative effect on operating profit, decline in sales of approximately 1% from the sale of the Green Machines outdoor city cleaning line with an immaterial impact on earnings. Gross margin performance of approximately 43%, 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 and our objective is to continue to build our business for sustained success. We expect our 2016 financial results will be stronger in the second half of the year. And now, we'd like to open up the call to any questions. Thanks Sean.

Question-and-Answer Session

Operator

[Operator Instructions]. And your first question comes from Rosemarie Morbelli from Gabelli & Company. Your line is now open.

Rosemarie Morbelli

Thank you, good morning everyone.

H. Chris Killingstad

Good morning Rosemarie.

Thomas Paulson

Good morning.

Rosemarie Morbelli

In the press release you mentioned that you are working on an enhanced go-to-market strategy, I was wondering if you could give us little more detail on what are you doing differently from what you did for example last year, two years ago?

H. Chris Killingstad

Well, what -- we have been actually working on this probably for the last two years and we continue to make progress but what has changed is we finally have the information necessary to determine by geography, by vertical market, and by customer where we are well represented, underrepresented, and had no representation at all. We have not been able to do that in the past, so that is why we are able to target our investments in terms of building market coverage against the biggest opportunities. We have started this effort first and foremost in the U.S. where we have I think the most sophisticated infrastructure but we are rolling it out into Europe, into China, and Brazil and other markets as well. But it is really the ability to pinpoint where the opportunities are in terms of attracting new customers or vending business where we are underrepresented that is driving our enhanced go-to-market abilities and success.

Rosemarie Morbelli

Is this Chris how you ended up growing in Brazil in spite of the current economic environment?

H. Chris Killingstad

It may play a certain role but I think that what you are seeing is that we are I think winning more business from competition outside of our go-to-market strategy. I just think that we -- our reputation in Brazil is getting stronger and stronger, the quality of our products and especially the quality of our service offering which in down economic periods plays a more and more important role as businesses try to keep their machines longer and are going to pay more to maintain them. We really have the only national service organization I think that’s what's helping us outperform the market and perform well in a down economy.

Rosemarie Morbelli

And as people do a lot more maintenance is the margin on that particular side of the business similar higher than when they buy new machines?

Thomas Paulson

You know unfortunately our margin structure if you compare the gross margins that we make on the sale of a piece of equipment versus what we make in an aftermarket support which includes both the sales of labor and parts and consumable sale. But the gross margin structure is quite similar and so we can really -- it’s a great annuity stream for us as equipment sales slow a bit and we make up for an aftermarket support that the margin structure doesn’t suffer through that.

Rosemarie Morbelli

Thank you and if I may ask one last question, in the press release you mentioned that you have a seen a sales momentum towards the end of the quarter, are you continuing to see that momentum or was that kind of just a little surge which has…?

H. Chris Killingstad

It is actually good news. I mean we -- the growth momentum did come later then we would have liked in the quarter but it did build and the best part of about it is that we’re seeing a continuation of that as we move into Q2. And it is not just isolated in one area, it’s a pretty broad based and so it is encouraging that we have seen a continuation of that. It has got to keep building. I mean Q2 is a really big quarter for us but it is progressing as we would like.

Rosemarie Morbelli

Thank you.

H. Chris Killingstad

You’re welcome.

Operator

And your next question comes from Joe Maxa with Dougherty & Co. Your line is now open.

Joseph Maxa

Thank you, good morning.

H. Chris Killingstad

Good morning Joe.

Joseph Maxa

The sales momentum that’s building, Q2 obviously is a strong quarter typically, is that -- are you thinking you will be able to see some organic growth in the quarter or is it too early to tell?

H. Chris Killingstad

You know we certainly hope to see organic growth in the quarter. It's honestly too early to tell for sure. Just because this is a quarter where this momentum has to build across the quarter and June ends up being the biggest month of the quarter, so again too soon to know for sure but early indications based on the trends that we’d expect to see some level of organic growth.

Joseph Maxa

And with the introduction of more industrial products this year, is that more back half weighted first half, I am just trying to get a sense of how that may affect margins as we look through the year?

H. Chris Killingstad

It is one of the reasons why we are more confident in our ability in the back half of the year because we do build and we really aren't starting to ship in earnest until the quarter run rate now. But that momentum does build as we go through the back half and that’s kind of the normal thing that happens and it might even be a bit more pronounced in industrial equipment. So it should bode well for the back half of the year.

Thomas Paulson

And also I would just mention, at the M17 that we launched in the first quarter is probably our biggest launch of the year with the most potential. And that doesn’t just go from 0 to a 100 in a month. You are going to see the biggest impact in terms of sales in that product also happening in the back half of the year.

Joseph Maxa

Just any commentary or color from what you are hearing from customers regarding the environment, any spending plans, are they typical spending they are going to holding off, maybe wait a little bit longer any…?

Thomas Paulson

What we see is its mixed and so I think if you look at healthcare education retail in the U.S. for example it is pretty robust. Certain parts of the industrial marketplace anything associated with or anything associated with agriculture that we’re and to a certain extent government too that we sell into is a little bit weaker. So we’re redirecting our resources against the biggest opportunities in the vertical markets that seemed to be spending.

Joseph Maxa

Okay, great. That’s all I had, thank you.

H. Chris Killingstad

Thanks Joe.

Operator

And your next question comes from Chris Moore, CJS Securities. Your line is now open.

Christopher Moore

Good morning guys, thanks so much. Sure, with respect to Europe it looks like the strategic sales were kind of the bright spot there. Can you give any sense in terms of how from a percentage standpoint how important strategic sales are now and probably more importantly kind of moving forward where are you in that initiative?

Thomas Paulson

I would say in Europe we have duplicated the success that we had in the U.S. in terms of how we organized around strategic accounts. But we are number of years behind the U.S. So we’re just now starting to get traction but if you look at what happened in the U.S. over the last six to seven years it went from a nice piece of business for us to by far the most dominant part of our business and continues to grow aggressively. We see that happening in Europe overtime as well. So we feel we have the right people, we have the right structure in place, and we’re building relationships with the big players across Europe to really continue to grow that business.

The one difference in Europe versus the U.S. is that most of the strategic accounts exist within a given country, so you got to negotiate in every country to generate business. While in the U.S. if you negotiate with a strategic account you basically get access to all of their locations throughout the United States, the much more efficient sale and it builds much more quickly. But we are quite optimistic about our prospects for strategic accounts in Europe over the coming years.

Christopher Moore

Got you and it is probably a little early to answer this but in terms of the markets that you are selling into obviously, things there are still struggling but from a kind of market share perspective particularly in the U.S. any reason to think that you are number one share there has not been eroded or do you get a feel for that?

Thomas Paulson

The share information is hard to come by in our industry. We got to triangulate information with multiple sources. The only other company that does publish information publically is Nykredit Bank [ph] part of the NKG Group out of Denmark. And if you look at their performance and our performance over the last nine quarter we are beating them very heavily. So in that regard in the largest market against what is probably our most significant competitor we are definitely taking share.

Christopher Moore

Great, alright, thanks guys.

H. Chris Killingstad

Thank you.

Operator

And your next question comes from Bhupendra Bohra from Jeffries. Your line is now open.

Bhupendra Bohra

Hey, good morning Chris and Tom. Let's go back on the fourth quarter call, if you look at the gross margins I think you mentioned there were some headwind from the channel, let's say direct versus distribution and if you look at the gross margins right now your assumptions for the year were like about 43, you came in slightly above that, could you give us some color like what changed over like in February and March especially with respect to your direct and distribution channel and then we can talk about the industrial versus commercial here?

Thomas Paulson

Sure, one comment as always we hope we are being conservative as we talk about our gross margin. We were really pleased with our performance in Q1 and we had a great efficiency in our service organization, our supply chain ran very nicely, and importantly we did get a little bit of pricing benefit. And then it was meaningful that the prior year we had a significant business from two big box retailers in the United States and that’s a strategic account businesses lower margin. And I mean it is still great operating profit margin but its lower gross margins and we lap at with more strength in our peer direct business which is a higher margin piece of our business. And then there was a bit of a skew towards industrial versus commercial and directionally that tends to -- it can help us -- it doesn’t always help but in this case it was beneficial.

Bhupendra Bohra

Okay, so Chris I think you gave a number -- new products were about like 36% of the sales in this particular quarter. So, did we get a tailwind from some of the new products which were introduced over like 2015, end of quarter because M17 if I am looking at that was introduced like end of the quarter here so, it sounds like that did not contribute much to the numbers?

H. Chris Killingstad

The thing you have to remember is that when we launch a new product we often get peak annual sales in the second or third year after launch after their built. So, the first year is normally not the high sales mark. And so we continued to launch new products every year, quite a few. Last year was 36 so cumulatively speaking we’ve now got to a point where in the first quarter of this year for the first time in a while we’ve got above 30% which is the vitality index that we target. It’s a pretty high bar for industrial companies but as a innovation leader we think that’s appropriate and we have finally gotten above the 30% again, which says that our new product strategy is working and working very well.

Bhupendra Bohra

Okay, got it. Thank you.

H. Chris Killingstad

Thanks Bhupendra.

Operator

[Operator Instructions]. Your next question comes from Rosemarie Morbelli with Gabelli & Company. Your line is now open.

Rosemarie Morbelli

Thanks. If I look at your operating margin target of 12%, this compares to if we exclude FX 4.5% for this quarter and I know you have not given us any kind of a timing but what should we expect a 100 basis point a year improvement, can it jump to a 300 basis points, can you help us understand how long it will take to get to that?

Thomas Paulson

We are consciously not trying to be as precise as we have been in the past around the magnitude of the leverage that we are creating given the uncertainty of the economy. But our objective is now going forward as to consistently see margin expansion at the operating margin line each and every quarter versus the prior year. We are not going to always be successful but we are marching down a path where even in a really low growth environment we are working very hard to create some level of a leverage. If we begin to see a return to more normalized growth and we will -- and weakening of the U.S. dollar that will significantly expand margins quickly. So we are going as fast as we can to get to 12%. We’ve committed ourselves to it. We are just not prepared to say precisely what kind of benefit we are going to get each and every year. But we are internally moving towards trying to improve versus the prior year in each and every quarter as we manage the business.

Bhupendra Bohra

Thanks and your definition of a normalized environment is that top line growth of about 5% organic?

Thomas Paulson

5% or higher. I mean we target 5% and 9% and we unfortunately don’t -- we are not guiding to that yet this year and we hope we see a return to that and we just don’t know when. So we contain to manage the business cautiously but we are pleased with the momentum we are seeing right now.

Bhupendra Bohra

Thank you.

H. Chris Killingstad

You’re welcome.

Operator

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

H. Chris Killingstad

Alright, thanks Sean. 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 through our 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 $1 billion in organic sales and a 12% or above operating profit margin. And we are very excited about Tennant's future. We are hosting our Annual Shareholder Meeting this Wednesday in Golden Valley, Minnesota. Please join us if you can. Otherwise we look forward to updating you on our 2016 second quarter results in July. Thank you for your time today and for your questions. Take care everybody.

Operator

And this concludes today's conference. You may now disconnect.

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