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Tennant Co. (NYSE:TNC)

Q1 2008 Earnings Call

April 24, 2008 11:00 am ET

Executives

Tom Paulson - Vice President and CFO

Chris Killingstad - President and CEO

Pat O'Neill - Treasurer

Karen Durant - Corporate Controller

Analysts

Ted Kundtz - Needham & Co.

Seaver Wang - Utendahl Capital Partners

Rick D'Auteuil - Columbia Management Advisors

Bob Nicholson - Pine Cobble Capital

Beth Lilly - Gabelli

Klaus Almer - Carnegie

Operator

Good morning everyone. My name is Jacob, and I will be your conference operator today. At this time I would like to welcome everyone to the Tennant Company's first-quarter Earnings Call. All lines have been placed on mute to prevent any background noise. After speakers remark, there will be a question and answer period. (OPERATOR INSTRUCTIONS).

Thank you. At this time, I would now like to turn the call over to Mr. Tom Paulson, Vice President and Chief Financial Officer. Please go ahead, sir.

Tom Paulson

Thanks, Jacob. Good morning, everyone, and welcome to Tennant Company's first quarter 2008 earnings conference call. I'm Tom Paulson, Vice President and Chief Financial Officer of Tennant Company. With me on the call today are Chris Killingstad, Tennant's President and Chief Executive Officer, Pat O'Neill, our Treasurer, and Karen Durant, our Corporate Controller.

Our agenda this morning is to review Tennant's performance during the quarter and discuss our outlook for 2008. First, Chris will update you on our operations, and then I will review the financials and our outlook. After that we will open up the call for your questions.

Before we begin, please be advised that our remarks this morning and our answers to questions may contain forward-looking statements regarding the Company's expectations of future performance. Such statements are subject to risks and uncertainties, and our actual results may differ materially from those contained in the statements. These risks and uncertainties are described in today's news release and the documents we file with the Securities and Exchange Commission. We encourage you to review those documents, particularly our Safe Harbor statement for description of the risks and uncertainties that may affect our results.

Our earnings release was issued this morning via BusinessWire and is also posted on the Investors section of our website at tennantco.com. At this time I will turn the call over to Chris.

Chris Killingstad

Thanks, Tom, and thank you all for joining us this morning. Clearly our first-quarter sales growth of 9%, or 2% excluding favorable foreign exchange and acquisitions was lower than we expected. Our performance was good in January and February, and it was not until mid-March that we began experiencing some sales softness, primarily in North America. This combined with our first-quarter investments and expanded market coverage and new product launches, resulted in lower-than-expected operating profit for the quarter. We continued to carefully monitor the uncertain US economy, and while we see inconclusive trends in our business at this point, we are implementing our contingency plans to reduce spending levels.

With that said, we still believe we can meet our full year EPS guidance of $2.25 to $2.40. Our outlook assumes a modest US economic recovery in the second half of this year. This is consistent with current economic forecast of positive GDP growth in the third and fourth quarters due to economic stimulus actions and a diminished drag from residential investment and business inventories. There are a number of bright spots in Tennant's first-quarter results that I would like to review with you, before I discuss where we are making adjustments to our spending levels.

Our focus on the first quarter remained on growing the business through innovative new products, expanding our international markets and acquiring complimentary businesses, as well as leveraging our operational efficiency. We made substantial progress in all of these areas during the quarter, which led to double-digit sales gains in our international markets, two completed acquisitions that will offer Tennant further opportunities for international market expansion, 38% of total equipment sales stemming from new products that we have introduced in the past three years, and improved gross margins, despite continued inflationary cost pressures.

We are pleased with these accomplishments, and we remain committed to pursuing our strategic priorities and investing to build our business for the long-term. We also recognize the need to make some spending adjustments in the short-term to match current sales levels.

At this point, I will briefly review results from our three business regions. Then, I will discuss our cost control actions and progress in leveraging operational efficiencies. After that, I will outline our efforts to continue growing the business.

It was a tough quarter for our North American business, which was up just 2% over the first quarter of 2007. This was mostly due to the benefits from our pricing actions. North America equipment sales started off the quarter strong in January and February, but fell offer in mid-March and ended the quarter with unit volumes down year-over-year. Most of the shortfall can be attributed to lower sales in our industrial and outdoor equipment. We are seeing a lengthening of our sales cycle, with customers potentially delaying their purchases due to broader economic factors.

Our pipeline of sales activity has remained good and the value and number of open projects has increased. So, we do not believe we're losing these sales to competition. To stimulate demand and close active deals, we have begun offering targeted incentives in order to re-energize sales. We did have a nice increase in our North America sales to building service contractors in the first quarter compared to the same period last year. Building service contractors provide cleaning services to customers who choose to outsource their facility cleaning. This segment has been a targeted opportunity for tennant as we have been historically underrepresented in this sector.

In our EMEA market, which encompasses Europe, the Middle East and Africa, we achieved limited organic growth compared to the very strong first quarter of 2007, which was in line with our expectations. We had a tough comparison in our Middle East and Africa region, which was down in the first quarter. A large shipment of Hofmans machines to the Middle East in the 2007 first quarter and the timing of distributor shipments to Africa were the main factors contributing to the lower sales in that region.

Europe posted modest sales gains in the quarter, due in part to increased sales in the UK. As we began to see the benefits of structural changes initiated there in the second half of 2007, and higher sales in Central and Eastern Europe due to market expansion initiatives.

For the remainder of 2008, we are expecting organic sales growth in our EMEA region of about 10%, which would result in annual growth for this region that is in line with our overall stated organic growth objective of 5% to 9%.

Results from our other international markets, which include China, Japan and other Asian countries, Australia, Latin and South America, were very positive. We had solid organic growth in these markets, especially where we have expanded our market coverage. In fact, sales more than doubled in Brazil in the quarter. China was also a solid contributor to growth in the quarter. We expect continued market penetration and expansion in these geographies throughout 2008 and beyond.

As I mentioned earlier, due to the uncertain economic environment, we have already taken actions to reduce our spending levels. We have either cut or delayed discretionary spending and have postponed non-revenue generating new hires. Consistent with our lean principles, we have reduced work hours to match demand in our Minneapolis factory where the majority of our industrial equipment is produced. This lowers are variable costs and prevents building unnecessary inventory.

Further, we remain committed to continuing to leverage our operational efficiency. You may recall that last year Tennant achieved $4 million in gross savings specifically related to our global sourcing initiative. In 2008, we expect to exceed those savings, and we made excellent progress in the first quarter with gross savings of approximately $2.8 million from our global sourcing, and lean manufacturing initiatives combined. Again, for comparison, in 2007 we doubled the percentage of materials and components sourced from low-cost regions from 7 to 14%.

In 2008 we anticipate increasing the percentage of materials and components sourced from low-cost countries such as China to approximately 20%. We are pleased with the progress we are making to leverage our cost structure, and we expect these efforts will enhance our bottom line in 2008.

Now turning to our growth priorities, I will update on our progress in building Tennant's sales through market expansion, including acquisitions and through new products. As you have seen, we took important steps to expand our market reach through two acquisitions that we completed in the first quarter. These acquisitions both fit with our strategy to add complementary products and expand our global sales and service coverage. We're excited about the potential for these two acquisitions to help us build our business globally.

On February 29th, we closed the acquisition of Applied Sweepers, which is based in the UK. Applied Sweepers offers synergies from both a product offering and market coverage standpoint. The Company is the leading manufacturer of subcompact outdoor sweeping machines in the United Kingdom and operates subsidiaries in the United States, France and Germany. Its products are sold under the brand name Green Machines. Through a broad distribution network around the world, it's city cleaning products complement Tennant Company's current outdoor offerings and will enhance our ability to offer a broader set of solutions to customers worldwide.

On March 28, we completed our acquisition of Sociedade Alfa in Brazil, which is an attractive emerging market for our products. This acquisition again fits with our strategy to expand Tennant's sales and service capabilities with complementary product lines.

Alfa is the Brazilian market leader in the cleaning equipment industry. Alfa's strong name recognition in the commercial equipment market, combined with our industrial equipment products and coatings, creates a tremendous foothold and foundation for growth in Brazil and throughout Latin America. And, as I mentioned earlier, volume growth in Brazil was a significant contributor to sales increases within our Latin America region. The integration of both these acquisitions is on track, and we will keep you updated on their contributions going forward.

New products are another important growth area for Tennant. On this front, we continued our commitment to invest 3% to 4% of annual sales and product development. New products continue to fuel a significant portion of our growth. We introduce two major new products during the quarter. Our Tennant branded M30 Scrubber-Sweeper is the second in our family of integrated single system Scrubber-Sweepers. It offers high-capacity cleaning for large-scale industrial applications. We also introduced the new Tennant S30, which is a mid-sized Rider-Sweeper. The S30 provides quiet, large area sweeping, and a patent pending three stage dust control system for indoor and outdoor spaces. The S30 also improves operator comfort and safety. We expect both the M30 and the S30 will offer customers considerable advantages.

Tennant also continued the global promotion of ech2o, our major new cleaning technology, which cleans with electrically activated water. We have received enthusiastic response to this breakthrough technology, which represents an entirely new and environmentally friendly method of cleaning for this industry. It reinforces our technology leadership in the cleaning industry and continues our evolution and growth as a provider of environmental cleaning solutions.

In the second half of March, we began global shipments of machines equipped with our electrically activated water technology. Initially, the system will be available on six Walk-behind scrubbers, including the Tennant T5, T3, 5680 and 5700, as well as the Nobles Speed Scrub Walk-Behind Scrubbers. We plan to extend it to other Tennant and Nobles brand scrubbers as well.

Our electrically activated water technology is a particularly good fit for general-purpose cleaning, which encompasses about 70% of our scrubber cleaning applications. We believe the technology will give us a competitive advantage, especially in targeted vertical markets such as hospitality, schools and hospitals. We have recently received certification for this technology to be used in food processing environments, which expands its market potential. We are very excited about the applications for the technology and expect sales to build throughout the year.

Looking ahead, our new product pipeline remains robust, and we anticipate offering and expanding number of environmentally-friendly products and solutions in the future. In 2008, we have already introduced two new products, as well as our new ech2o technology, as I mentioned. We expect to introduce an additional four to five new products yet this year that will further enhance our product portfolio and growth opportunities.

We continue to carefully monitor the uncertain US economy. Based on our current forecasts, we are cautiously optimistic in our outlook for 2008, and we are maintaining our annual guidance. We recognize that macroeconomic conditions add some risk to our anticipated performance in the short-term, but we remain confident in the long-term strength of our business.

Now I will turn the call over to Tom for a detailed review of our first-quarter financial results and 2008 outlook. Tom?

Tom Paulson

Thanks, Chris. In have my comments today, all referenced just to earnings per share are on a fully diluted basis. For the first quarter ended March 31, 2008, we reported net sales of $168.6 million, a 9% increase over last year's record first quarter sales. We sustained revenue growth across all of our geographies with the strongest results coming from outside the United States.

Our consolidated organic growth was led by pricing actions taken worldwide to mitigate higher material costs and also volume increases in key international areas such as China and Brazil. Foreign currency exchange added approximately 5% to consolidated net sales for the quarter, and acquisitions added approximately 2%. We posted first-quarter net earnings of $0.28 per diluted share. This included a $0.05 per share dilutive impact from the two acquisitions that we closed during the quarter, primarily due to a flow through of a portion of the fair market value step-up of inventory related to Applied Sweepers and the foreign exchange loss related to the Alfa purchase transaction.

Excluding the dilutive impact of the two acquisitions, the Company's earnings per share would have increased in the 2008 first quarter versus the comparable 2007 quarter. Earnings per share of $0.31 were reported in the 2007 first quarter.

In North America, 2008 first-quarter net sales totaled $98.3 million, up 1.8% versus the prior year quarter, mostly due to the benefit of pricing actions. Foreign currency exchange effects added 1% to sales in North America. As Chris discussed, sales in the market remained on track until late in the quarter. At that point, we began to experience a softening of industrial equipment sales in North America, which constrained our growth.

Currently we're still seeing strong customer interest in activity levels, which are very encouraging, but the sales cycle is taking somewhat longer.

In our EMEA markets, first-quarter net sales grew to $52.7 million, up 20.3% compared to the strong first quarter of 2007. Foreign currency exchange effects contributed approximately 14% to net sales for the quarter, and acquisitions added approximately 6%.

Tennant's other international markets posted another strong quarter. First-quarter net sales were up 19.7% to $17.6 million versus the prior year period. Organic growth was the primary contributor of these results, driven by expanded market coverage in Brazil and China.

We succeeded in further leveraging the Company's cost structure during the quarter. Tennant's gross margin rose to 41.3% for the 2008 first quarter, which include a $400,000 expense or 20 basis points from the flow through of a portion of the fair market value step up of inventory related to the Applied Sweepers acquisition. The gross profit margin in the 2007 first quarter was 41.1%. The rise in gross profit margin was primarily due to the benefits from pricing actions and cost reduction initiatives, which more than offset higher raw material and purchase component cost. As Chris noted, our two major cost reductions initiatives include global sourcing from low-cost regions, and the continued implementation of lean manufacturing processes.

During the 2008 first quarter, we achieved gross savings of approximately $2.8 million from our global sourcing and lean manufacturing initiatives combined with roughly half attributed to sourcing activities and the rest from lean initiatives and benefits from footprint consolidation. Gross margins also benefited from a positive impact from foreign currency exchange in the quarter.

Research and development expenses in the quarter totaled $6 million compared to $5.7 million in the 2007 first quarter. R&D expenses as a percent of net sales were 3.6% for the first quarter of 2008 compared to 3.7% in the comparable quarter of last year. We remain within our target of annual investing 3% to 4% of net sales in R&D.

Selling and administrative expenses in the 2008 first quarter totaled $55.1 million or 32.7% of net sales versus $48.9 million or 31.5% of net sales in the prior year quarter. We made key investments in the quarter to continue to expand our international market coverage and to support new product launch activity. We anticipate that these investments will begin contributing to sales during the second half of 2008. By comparison, our product launch activities in 2007 were focused more heavily in the second half of the year.

Foreign currency exchange effects added approximately $2.4 million to the increase in S&A expense for the first quarter of 2008. As Chris discussed, we're actively reducing our spending to be more in line with current sales levels.

Our first-quarter operating profit was $8.5 million versus $9.2 million in the 2007 first quarter, primarily due to the investments for growth and the initial dilution from the two recent acquisitions. The first-quarter operating margin was 5% versus 5.9% in the prior year quarter. We expect to see an operating margin benefit from our cost reduction actions beginning in the second quarter.

Other expense for the first quarter includes the charge of approximately $0.03 per share to settle foreign exchange contract involving our Brazilian acquisition. This contract was initiated to protect the cash outlay for the acquisition in US dollars and the charters realized due to the US dollar strengthening versus the Brazilian Real during the transaction period.

Tennant Company's 36.9% effective tax rate in the first quarter of 2008 was higher compared to the 36% in the first quarter of 2007, primarily due to the expiration of the US R&D tax credit at the end of 2007. The 36.9% is within the previously provided 2008 tax rate range of 36.5% to 38.5%, which primarily depends on the mix of taxable earnings by country. We continue to work on tax planning strategies to lower our overall tax rate.

Now turning to the balance sheet, net receivables at quarter end totaled $132.7 million compared with $117.5 million a year earlier, an increase of $15.2 million. Of this, $10.3 million is due to foreign currency translation and growth in net sales over the 2007 first quarter, and $4.9 million of the receivables is related to our 2008 first-quarter acquisition activity. Accounts Receivable days outstanding was 67 at quarter end. This is five days higher than in the comparable period last year, primarily stemming from a higher mix of sales in Europe, and those receivables do carry longer payment terms than in North America.

Our inventories at quarter-end totaled $77.3 million, up from $61.8 million at the end of the 2007 first quarter. The increase of $15.5 million included $10.1 million due to foreign currency translation, increased demo inventory and higher inventory levels in our Louisville distribution facility and China and $5.4 million of inventory from our 2008 first-quarter acquisition activity.

FIFO, Days Inventory On Hand was 95 days at the end of the quarter versus 93 days in the comparable period last year. Capital expenditures totaled $7.4 million in the first quarter of 2008, $500,000 lower than the $7.9 million in the 2007 first quarter. We expect full-year capital spending in 2008 to be approximately $26 million to $30 million inclusive of capital spending related to our recent acquisitions. This is similar to our levels of last year. This includes our upgrade of SAP and related infrastructure enhancements, which we accelerated by one year to improve the ability of our systems infrastructure to expand globally. In addition, we plan to invest in our corporate facilities in Minnesota, creating a global R&D center of excellence.

During the first quarter, the Company repurchased approximately 98,000 shares of common stock under the Board authorized $1.4 million share buyback program. Total cost of the shares repurchased was $3.6 million. At quarter end, approximately 641,000 shares remained under Tennant's share repurchase program.

We had a debt-to-capital ratio of 27.6% compared to the 1.8% at the end of the 2007 first quarter. The increased debt-to-capital ratio reflects the drawdown of $92.5 million from our credit facility during the quarter to fund our two acquisitions. Tennant's cash and cash equivalents totaled $25.3 million versus $33.1 million at the end of 2007.

Turning now to our outlook for 2008, and as a reminder, we provide annual guidance, but not quarterly guidance. Based on our current forecast, we are maintaining our 2008 guidance as Chris noted. Our forecast assumes a moderate recovery in the US economy in the second half of 2008. The current level of economic uncertainty does add some risk to our anticipated performance.

For the 2008 full year, Tennant continues to anticipate organic growth and net sales of 5 to 9%, fueled by strong new product pipeline and continued market expansion. The Company remains on track to realize savings of between $9 million and $12 million in 2008 from global low-cost sourcing and lean manufacturing initiatives. We also continue to target an operating profit margin of 9.5% in the fourth quarter of this year.

As a result, we continue to expect full-year 2008 earnings per diluted share to be in the range of $2.25 to $2.40. The guidance range now includes the two acquisitions completed in the first quarter, as they are expected to be neutral to modestly dilutive for the full-year 2008. This compares to 2007 earnings per diluted share of $2.08 or $1.79, including the onetime net tax benefit of $0.19, the gain from the sale of Maple Grove facility of $0.19 and the restructuring charge of $0.09.

With that, we would like to open up the call to questions. I will turn it over to Jacob.

Questions-and-Answers

Operator

1

(Operator Instructions). Our first question comes from Ted Kundtz, Needham & Co.

Ted Kundtz - Needham & Co.

Hello Chris and Tom.

Tom Paulson

Hey Ted.

Ted Kundtz - Needham & Co.

Couple of questions for you. Could you talk a little bit -- going back to your sales, you didn't really give an exact sales forecast, except organic growth being up 5% to 9%. And, I would think there will be a little bit of a stretch given what you have to make up after the first quarter. So looking at just the US, you mentioned that.

How about Europe? What are you seeing over in Europe? It sounds like -- it seems like things are starting to slow over in Europe as well. So, I just wanted to see you what your views and what your assumptions are for Europe in your outlook?

Chris Killingstad

Well, for us basically Europe met our planned expectations in the first quarter. Remember, if you look back to the first quarter of 2007, we had a very, very strong quarter in Europe, up in excess of 20%. So, being flat is what we planned.

Now for Europe, as we look for the balance of the year, we expect the European market or our European business to grow at approximately 10% organically.

Ted Kundtz - Needham & Co.

Okay.

Chris Killingstad

Right, which gets us to the 5% to 9% that we have set as a target for ourselves. So, and then the question is, are we seeing the same sort of economic slowdown in Europe as we did in March in North America? I would say right now the answer is no

Ted Kundtz - Needham & Co.

Okay. Okay, because we're just hearing more about that happening, but so far, so good. Okay.

Chris Killingstad

And, the other thing I would say about North America is that January and February were very strong. I mean, we had equipment sales up in excess of 10% in both of those months. So, it really was in the second half of March that the decline started, and it was pretty precipitous. The good news is that our order rates in April are back on track.

Ted Kundtz - Needham & Co.

Okay, okay great. Do you think any of the -- was there any hesitation do you think as you are introducing the new product line, people waiting for that, the ech2o started rolling out shipments, and would you think there was any impact from that at all?

Chris Killingstad

I don't think the impact has been material to our results. Sure, there are pockets where somebody may have waited for the new technology, sure but, we do not think it is material to the results in the first quarter.

Ted Kundtz - Needham & Co.

Okay. How about looking forward in terms of the cost pressures you might be seeing from inflationary issues? And, any plans for future price increases?

Tom Paulson

I will comment on that Ted. I mean, we are evaluating whether we need to take some pricing on our distribution, and it's under evaluation at the current time given the pressure we are seeing in that regard. So, that is the one area that we're taking a hard look at. Right now, though in our forecasts based on what we saw in the first quarter and our expectations, we believe that the pricing actions we have taken, the stick rates that we're seeing so far, are going to allow us to offset the cost pressures that we're seeing in the balance of the year.

So, our forecast is that we will be able to continue to maintain our gross margin level through being able to completely offset our cost increases.

Ted Kundtz - Needham & Co.

Okay. Do you think -- I mean, looking at your estimate on EPS, it seems to me that you will have to increase the gross margins nicely to get to those numbers?

Tom Paulson

We are anticipating some modest level of gross margin increase, and I do not want to commit to a specific number since, as you know, we're actively managing the cost of goods sold side of things, as well as the operating expense side of things. But, we do expect to see some improvement in gross margins.

Ted Kundtz - Needham & Co.

Okay. And, then you're going to be able to take some more out of the cost side to get to that operating margin level that you targeted?

Tom Paulson

Yeah. And, as you can see, I mean, we really felt good about what we did from a cost reduction standpoint in the first quarter. The $2.8 million that we saved lines up awfully well with the 9 to 12 million that we have built in our numbers, and we're seeing balance between the lean benefits and sourcing. But, we are comfortable with where we're heading in that regard.

Ted Kundtz - Needham & Co.

Okay, terrific. Let me jump back in queue, and thank you.

Tom Paulson

Thank you.

Chris Killingstad

Thanks Ted.

Operator

Thank you sir. Our next question comes from Seaver Wang, Utendahl Capital Partners.

Seaver Wang - Utendahl Capital Partners

I just want to touch on, Chris, you had mentioned that April order rates were kind of back on track. Was there any event that kind of was a catalyst for that, too or I mean, is it basically, you are just basically -- you basically think that people will kind of took a pause and said, maybe we should reevaluate our buying behavior in March?

Chris Killingstad

You know, I don't think there was a catalyst. I think people took pause. I mean, we saw lengthening of the sales cycle, and now we seem to be back on track. So, this was a three-week phenomenon for us, which is why we're saying the trends are inconclusive.

You have strong January and February, a tough second half of March, and then you see order levels rebound down in April. Then you look at, we still have four to five new products for launch in the remainder of the year. The ech2o technology has just now been launched and the pipeline is being filled. Our judgment is that we are cautiously optimistic that we can achieve our plan still.

Seaver Wang - Utendahl Capital Partners

You guys have mentioned that your customer base, they tend to adopt new technology kind of slowly. Is the response still very positive for the ech2o product and all the other new offerings?

Chris Killingstad

Well, let's say, when we sell the larger equipment, we sell it direct, and there we get very quick traction for new technology. With ech2o, what we have told you and remains true is that the response has been very, very enthusiastic, and we had the highest pre-launch order build that we have ever had for a product.

But, in terms of how we're doing in the marketplace, I mean, we really only started shipping in the second half of the year, and there's still many markets where we are still rolling out. So, we have got to take a wait and see position. Our hope is that the next quarter conference call we will be able to give you some more definitive information on progress on ech2o.

Seaver Wang - Utendahl Capital Partners

Okay. And, just to go back to raw materials again, you're sourcing -- do you think -- are you forecasting that the cost savings from sourcing overseas will offset all the raw materials costs, or will that be in addition to -- are you going to add-on to --?

Tom Paulson

Yeah, we will clearly need, if we're going to expand our gross margins, we need to be able to take some of those sourcing benefits to the bottom line, or some portion of those. So, we are comfortable that our pricing actions can offset the general inflation that we're seeing and commodity increases, and then some portion of the sourcing benefits we believe we can take that to the bottom line.

Seaver Wang - Utendahl Capital Partners

Okay.

Tom Paulson

And, we have not seen a -- the commodity market I would say, there are some up-and-downs, but it stayed relatively the same. We certainly have not seen an acceleration in concerns around the cost increases that we saw during probably each and every quarter last year. It's still on top, but we have not seen any kind of acceleration broadly.

Seaver Wang - Utendahl Capital Partners

Did you say it is steel components, and then resins and then maybe some copper --

Tom Paulson

Yeah, the two big areas -- I mean, we are still feeling pressure on plastics and other oil-related areas. Steel certainly is the one area that we believe we have some contracts in place, and we're taking some mitigating action as we're in sourcing some of our fabrication that we think for the near-term we can offset some of those increases that are coming out, but steel is the biggest area of concern right now.

The offset to that is we think that lead, it still hurt us in the first-quarter levels to prior year, but as we look at it the rest of the year that we believe is going to be -- we're going to get downward pressure there and actually will be some savings year-on-year.

Seaver Wang - Utendahl Capital Partners

Okay. Thank you.

Tom Paulson

You're welcome Seaver.

Operator

Thank you. Our next question comes from Rick D'Auteuil with Columbia Management Advisors.

Rick D'Auteuil - Columbia Management Advisors

Just a couple of things, just to understand, do you think any of the issues around financing availability, I don't know if leasing programs or anything like that might be affecting some of your particularly the North American sales?

Tom Paulson

You know, Rick, I don't have any data that would suggest that. I mean, I cannot definitively say that it's not. Today we -- out of the leases that we originate through our two leasing partners, it's only about somewhere slightly north of 15% of our equipment sales are on lease. We also know that our customers go to other partners. But we're not hearing anything about the inability of people to get leases. So, we don't think so.

Rick D'Auteuil - Columbia Management Advisors

Okay. And, how about, you know, any kind of feedback from the sales personnel on maybe some capital budget pullbacks out there, or are you not hearing that at this point as the source of some of the issues?

Chris Killingstad

We're not hearing that anybody has -- that anybody significant has canceled an order. So, our impression is they fully intend to buy. They put it on hold for a brief period of time in March it appears. And, I think, as I said, the good news is that our order levels have returned to normal here in April. So, I think it was a pause. And, as we also said, the activity pipeline in North America is actually building.

Rick D'Auteuil - Columbia Management Advisors

Okay. Unrelated question, the buyback you did 98,000 shares, just remind me about your philosophy. The stock is obviously getting hit pretty good here today, and what are your thoughts on the buyback? I know you've spent some money on a couple of acquisitions, so your capital structure is a little different than when it was in place. But, give me an updated idea of where you are thinking there.

Tom Paulson

Yeah, I could not give you, Rick, a targeted number. I can tell you philosophically that we will be opportunistic in going and buying some shares as we see the value being diminished. We believe it's as appropriate levels that it makes sense to buy back.

We do have at the current time most of the shares, for example, that we bought back last quarter. I mean it was a small amount. We have an arrangement with our 401K provider that as shares become available, we will purchase those. And, most of what we bought back last quarter was related to that.

We still firmly believe that there is going to be a more acquisition activity. So, from a capital structure standpoint, we're going to be measured in how many -- the level of share buybacks we do. So, we will wait and see at what level of the acquisition activity plays out over the next remainder of this year and into next year before we would get much more aggressive than we have currently been around share repurchases. But, we will continue to buy some back opportunistically.

Rick D'Auteuil - Columbia Management Advisors

Okay. Thank you, that’s all I have.

Tom Paulson

Great.

Chris Killingstad

Thank you.

Operator

Thank you sir. Our next question comes from Bob Nicholson with Pine Cobble Capital.

Bob Nicholson - Pine Cobble Capital

A quick question for you. Chris or Tom could you give us a quick perspective on as you talk about some of the cost actions on the G&A side that you have begun to implement, could you give us a flavor for what sort of spending you are either deferring or curtailing as you go into the second half?

Tom Paulson

Sure. I will give you a flavor for that. I will give you a flavor for that Bob. I mean, we have given some pretty specific directions. If you first look at any headcount, we have really categorized headcount around jobs that are indefinitely put on hold. That they are ultimately we won't hire, job that we're continuing to recruit for because they are revenue generating, and we believe the right thing to continue to drive the business, we will continue to recruit for those. And, we have other jobs that we've put on hold until July 1 till we really get a better flavor of what we see happening in the economy. We have done that globally, and we have put all of our headcounts into three buckets. Additional jobs that would open up will need -- everything needs approval at quite a high-level to move forward on.

From an expense spending standpoint, anything that's discretionary is being either eliminated or deferred. We have put a deferral program in place in Q2 as we are monitoring the economy slowly. We're not saying we're going to cut the spin, but we are deferring as much spending as we can out of the second quarter to taking more of a measured approach than we took in Q1.

We have made a decision that the total level that relative to our plan, we've told everybody to anticipate they will cut 5% of their operating expenses for the year, and we're putting in plans to go higher than that.

So, what we really are doing is executing against a plan that we put in place and if the year did not get off to the start, we expected. In all honesty, we got added a little. We would have liked to have gone a little earlier, but we did not see the softness in the business. So, when we saw it, we're being more measured than we were in Q1.

Bob Nicholson - Pine Cobble Capital

Okay, great. Thank you.

Tom Paulson

You're welcome.

Chris Killingstad

Welcome.

Operator

Thank you sir. Our next question comes from Ted Kundtz with Needham & Co.

Ted Kundtz - Needham & Co.

Got a little bit more about the acquisitions. You said the integration was going very well. The dilution effect, I guess is over in the first quarter, and I guess it will be slightly neutral or accretive going forward. Is that correct? And, maybe you could talk about the growth rates for that -- of those businesses. I think, if my memory is right, those two acquisitions represent about almost $50 million of revenues in '07. I am just wondering what kind of growth rates you are seeing out of those businesses?

Tom Paulson

Yeah, I will comment on that a little bit Ted. First, you are right. We do believe that the dilution is behind us, and we expect as we look across the next three quarters that those deals will be accretive to us. We had hoped that we can get back to being breakeven for the full year, meaning we would gain back in nickel across the next three quarters. We could be modestly dilutive.

Things are going well. We're quite excited about both the transactions. We're embedded in them deeply right away. From a growth rate standpoint, we are really not ready to commit to that. But, what I can say is you are right. They are about $49 to $50 million of the revenue, and if you are trying to get some flavor around what we were thinking, it would be reasonable to assume three quarters of a year of that revenue with some reasonable growth rate on top of that. We certainly expect to grow outside of our targeted 5% to 9% organic range, but I would not say anything more than that. That will give you a flavor for kind of how much upside there might be to our base revenue.

Ted Kundtz - Needham & Co.

Okay. Yeah, because I was looking at your organic growth projections and then just trying to incrementally add on what the acquisitions would do. Could you talk -- just a quick question on that? What is the interest rate on the -- what is it, a term loan you have got out there?

Tom Paulson

Little bit above -- it is about 3.3 or 3.4% of --

Chris Killingstad

The average would be, for everything we have drawn, about 3.2%.

Ted Kundtz - Needham & Co.

Okay. Is that fixed or is that float?

Chris Killingstad

It's float.

Ted Kundtz - Needham & Co.

Is it float?

Chris Killingstad

It's a LIBOR contract that we have got through -- it's a six month LIBOR contract.

Chris Killingstad

Okay, okay. Okay, terrific. Thank you.

Chris Killingstad

Thank you.

Operator

(Operator Instructions). Our next comes from Klaus Almer with Carnegie.

Klaus Almer - Carnegie

Hi.

Chris Killingstad

Hi.

Klaus Almer - Carnegie

Just a question about, you were saying that March was a difficult month. In the past, have you seen that now and then that one month is just dropping out of the bed, or is it of normal what you're seeing in 2008?

Chris Killingstad

Do we normally have maybe a slower month in the first quarter, and it's usually the month after the price increase? Right, because people buy in prior to the price increase, so the next month tends to be a little slower. But, that's a natural phenomenon that we experience every year. But, to see the type of drop-off that we did within a relatively short period of time, because it was not even all of March, it was really the second half, is very unusual.

Tom Paulson

Got to be a little more specific about that cost, we did, we moved our price increase in North America up by 30 days, and we really do not know conclusively exactly how that affected things. But, we do know that there had to be some level of impact on March as we took pricing around February 1 versus March 1. And, it would be normal that you would see after the price increase is fully implemented that you see some slowdown in your business, but certainly nowhere near what we did see. The good news as we commented is April back to normalized levels in North America.

Klaus Almer - Carnegie

Okay. Also, I was unable to hear the first 20 minutes of the call, so sorry if you have already commented or told this. But, are there any particular segments or products which really, really were badly hurt in Q1 in the US?

Chris Killingstad

It was -- the majority of it came from larger indoor equipment and outdoor equipment. It was sold to manufacturing distribution warehousing and customers of that nature. And, as we said, what we saw was not the cancellation of any orders. It was the lengthening of the sales cycle that people were cautious given the economic news that was coming out around that time. But, we are cautiously optimistic going forward based on what we are seeing with April order rates.

Klaus Almer - Carnegie

Do you see this just as a normal market reaction, or have you loss some market share to various reasons?

Chris Killingstad

No, we have not lost any sale due to this. There has been no cancellation of orders. We have not lost a deal that we knew we were going to win to competition. As a matter-of-fact, this year our expectation is we take market share in North America.

Klaus Almer - Carnegie

Thanks.

Chris Killingstad

You're welcome.

Operator

(Operator Instructions). Our next question comes from Ted Kundtz with Needham & Co.

Ted Kundtz - Needham & Co.

Could you comment a little bit on the competition? Are they -- what are they doing on pricing, on the pricing front as far as you know?

Tom Paulson

You know, I would prefer not to comment there Ted. I mean, what we can say is that on our side is, we have been felt good about our price stick. It has been at the higher end of our normal. We have always talked about pricing in the 2% to 3% range. What we're seeing now is that our stick rate is at the higher end of that. And, I could not give you any conclusions on what we're seeing from a competitive pricing standpoint.

Chris Killingstad

But generally, we are the price leaders in North America, and competition tends to follow. And, it has always been a very rational market. We do not expect that to change.

Ted Kundtz - Needham & Co.

Okay. The same would be in Europe? I mean, you're not as strong in Europe as you are here, but --?

Chris Killingstad

Yes, but I would say, yes, I would, can't characterize Europe as a rational market as well.

Ted Kundtz - Needham & Co.

As well? Okay. Okay, great. Do you anticipate any other further price increases, or this is it for the year?

Tom Paulson

I would say it would be unlikely that we would take any pure additional pricing unless something really changed. We are offering some modest incentives in given places to try to drive some revenue, we don’t want to comment on that, and we are looking at whether we should implement some pricing around some of our transportation or distribution costs. But no firm conclusions there yet.

Ted Kundtz - Needham & Co.

Okay, thanks.

Tom Paulson

Welcome.

Operator

Thank you sir. Our next comes from Rick D'Auteuil with Columbia Management Advisors.

Rick D'Auteuil - Columbia Management Advisors

Follow up. I don't know since it's in the rearview mirror, you might provide this. You have provided annual guidance. You're not providing quarterly guidance. It looks to me like you fell short on North America due to the month of March. Europe, even though it was flat, was in line with what your thoughts were.

In the rearview mirror, can you tell us where you were? Because the revenues were more or less in line with the street, and yet the bottom line was quite a bit off. So, was this street mis-guessing on how to allocate the quarters, or were you off your numbers, too?

Tom Paulson

I will give you some flavor for that. We did miss our number in the quarter both from -- at all three levels -- revenue, operating profit and EPS. But, the external numbers I would say were a fair amount higher than our own internal numbers, and I wont comment much more specifically than that.

We do not give quarterly guidance, but I did try to, on the last call, if you went back and looked at it to say that we expected the quarter to be seasonally comparable to other quarters, meaning EPS as a percent for the quarter of the total would be similar. And, then also knowing that we were in an investment mode to try to drive revenue, we would have expected EPS to be maybe a little lower than what the outside people looking in would think.

So, we were a little off kilter with our own internal numbers relative to the external world.

Rick D'Auteuil - Columbia Management Advisors

Okay. But, the street was too aggressive all along, even based on your internal forecast?

Tom Paulson

I should not comment further than that. But, I mean it's always a little difficult when you make the decision to only give annual guidance. You are going to have some inconsistency along within quarters, and this was an example of that.

Rick D'Auteuil - Columbia Management Advisors

Here is an opportunity. Is there any comments you want to make more on a big picture on seasonally how the year should play out as a percentage of your annual guidance?

Tom Paulson

Yeah, I won't get real specific, but I mean, I think it's pretty self-evident that the quarter that we would certainly hope is going to be the biggest success would be our fourth quarter. I mean, it's always the most important quarter of the year. I mean, we are -- you know we're being more measured right now, but we are continuing to be -- we are continuing to spend to try to drive the topline.

We are -- we have been in some level of investment mode, and if those investments pay off and we see the full benefit of our new product pipeline coming in, our fourth quarter should be our best quarter relative to the year. And, that should be a natural evolution of the way we're managing the business. So, that's about all I can really say.

Rick D'Auteuil - Columbia Management Advisors

Okay, that is very helpful. I appreciate it. Thanks.

Operator

(Operator Instructions). Next question comes from Beth Lilly with Gabelli.

Beth Lilly - Gabelli

I wanted to just talk a little bit more about you sticking to your goal to get operating margins to 9.5% by the fourth quarter. And, just can you give us a little more insight into how you think that is achievable given what happened this quarter?

Tom Paulson

Yeah, I would say it's, continues to be really three dimensions to that. One is, we do anticipate growing from a revenue standpoint at higher levels the rest of the year than we saw in Q1. So, that's certainly in our forecast that we expect to grow at higher levels.

We are going to manage our operating expenses. I mean, as you saw our operating expenses were -- they were too high for our revenue levels in Q1. That's just the reality of the situation. So, we anticipate for the full year that if you looked our operating expenses as a percent of revenue, we will see some level of benefit level to prior year. I mean, that is just something that we have continually attempted to do. We expect to do that again, and we are bullish on what we're seeing from our cost reduction efforts, particularly on the sourcing side.

So, we don't -- we are particularly feel very good about our efforts in that regard. So -- and our pricing actions. I mean, certainly one of the questions that we will ask is, as we have been somewhat aggressive on our pricing relative to history, and we believe that the pricing is sticking in the marketplace, and we are anticipating that as we go through the rest of the year too. So, we still -- we are still going after the 9.5%, and we're not moving off of that.

Chris Killingstad

And, the other thing we said is, in the first quarter, 38% of our equipment sales came from new products launched in the last three years. We have four to five new products coming up, and we've said that we won't launch a new product unless it has a higher gross margin than the product that it replaces. So, we're coming to market with products with higher gross margins than the products they are replacing, and the new products are representing a bigger, bigger piece of our equipment sales, and that impacts our ability to get the 9.5% as well.

Beth Lilly - Gabelli

Okay. Great, thanks.

Operator

(Operator Instructions). At this time, sir, there are no further questions in queue.

Chris Killingstad

Alright. Well then I will close and say thank you for your time today and for your questions. And coming off a record year in 2007, we feel that we remain confident in the long-term strength of our business. We believe a continued focus on our strategies of international market expansion, new products, operating efficiency gains, and coupling that with taking the necessary short-term actions to align our spending with our current sales levels positions us for continued success this year, and we look forward to keeping you posted on our progress. Thank you all.

Operator

Thank you, sir. That does conclude today's conference call. Everyone, you may now disconnect.

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