Tennant Company - 10-Q quarterly report FY

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

As of April 30, 2008, 18,502,759 shares of Common Stock were outstanding.

Tennant Company is a world leader in designing, manufacturing and marketing solutions that help create a cleaner, safer world. We provide equipment, service, parts and consumables and specialty surface coatings to contract cleaners, end-user businesses, healthcare facilities, schools and local, state and federal governments. We sell our products through our direct sales and service organization and a network of authorized distributors worldwide. Geographically, our customers are located in North America, Europe, the Middle East, Africa, Asia, and Latin America. We strive to be an innovator in our industry through our commitment to understanding our customers’ needs and using our expertise to create innovative products and solutions.

The Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with the MD&A included in our Annual Report on Form 10-K for the year ended December 31, 2007.

Net earnings for the first quarter of 2008 were $5.2 million, or $0.28 per diluted share, down 10.5% compared to the same period in 2007.  The first quarter results for 2008 included a $0.05 per diluted share dilutive impact related to our recent acquisitions. Net earnings in the first three months of 2008 were favorably impacted by growth in net sales of 8.7% and a 20 basis point improvement in gross margin.  Offsetting these improvements were increases in selling and administrative expenses, a decline in interest income and an increase in interest expense.

The dilutive impact of the February 29, 2008 acquisition of Applied Sweepers totaled approximately $0.02 per diluted share in the quarter, due to purchase accounting adjustments including the flow-through of a portion of the step-up of inventory to fair market value as well as interest expense on the Credit Facility used to fund the transaction.

The dilutive impact of the March 28, 2008 acquisition of Sociedade Alfa was approximately $0.03 per diluted share in the first quarter due to the movement in the foreign currency exchange rates related to a deal contingent non-speculative forward contract that we entered into which fixed the cash outlay in U.S. dollars for this acquisition.

Tennant expects full year 2008 earnings per diluted share to be in the range of $2.25 to $2.40.  This guidance range includes the two acquisitions completed in the first quarter of 2008, as they are expected to be neutral to modestly dilutive for the full year 2008.

We continue to carefully monitor the uncertain U.S. economy, and while we saw inconclusive trends in our business at the end of our first quarter of 2008, we implemented our contingency plans and have already taken actions to reduce spending levels beginning in the second quarter of 2008.  Our outlook assumes a modest U.S. economic recovery in the second half of this year.  This is consistent with current economic forecasts of positive gross domestic product growth in the third and fourth quarters, due to economic stimulus actions and a diminished drag from residential investment and business inventories.

The following compares the historical results of operations for the three month periods ended March 31, 2008 and 2007 in dollars and as a percentage of net sales (dollars in thousands, except earnings per diluted share):

Consolidated net sales of $168.6 million for the first three months of 2008 increased 8.7% compared to the first three months of 2007. The components of the change in consolidated net sales in the first quarter of 2008 as compared to the first quarter of 2007 were:

North American net sales of $98.2 million for the first quarter of 2008 increased 1.7% from the first quarter of 2007. The favorable direct impact of foreign currency increased net sales within North America by approximately 1% during the first quarter of 2008.  Price increases taken to mitigate the impact of inflationary cost increases within all product lines as well as volume gains within our service, parts and consumables business contributed to the organic growth in net sales in the first quarter of 2008.  A decline in equipment volume partially offset these increases.  The volume decline within our equipment business was driven by lower sales of our industrial and outdoor equipment during the latter part of the quarter. We saw a lengthening of our sales cycle, with customers potentially delaying their purchases due to broader economic factors.

In our markets within Europe, the Middle East and Africa, net sales increased 20.3% to $52.7 million for the first quarter of 2008 as compared to the first quarter of 2007. Positive direct foreign currency exchange fluctuations increased net sales by approximately 14% in the first quarter of 2008.  Acquisitions added approximately 6% to this region’s net sales in the first quarter.  The organic base within this market was essentially flat in the first quarter of 2008 when compared to the same period in 2007.  The benefit from price increases taken to mitigate the impact of inflation was offset by volume declines in certain regions. Sales in European regions posted modest gains, which were offset by lower sales in the other regions due to a large shipment of Hofman’s machines to the Middle East in the first quarter of 2007 and the timing of distributor shipments to Africa.

Our Other International markets are comprised of the following key geographic regions: China and other Asian markets, Japan, Australia and Latin America.  Net sales in these markets for the first quarter of 2008 totaled $17.6 million, up 20.1% from the first quarter of 2007. Growth in net sales was primarily driven by organic volume growth, resulting in part from expanded market coverage in key geographies within these markets such as Brazil and China.  Price increases also contributed to the overall growth in net sales. Positive direct foreign currency translation exchange effects increased sales in Other International markets by approximately 3% in the 2008 first quarter.

Gross profit margin was 41.3% for the first quarter of 2008 compared with 41.1% reported in 2007. The increase in gross profit margin was due in part to selling price increases and cost-reduction initiatives more than offsetting higher raw materials and purchased component costs in the first quarter.  Favorable foreign currency fluctuations also favorably impacted gross margins in the quarter.

Partially offsetting net gains in gross margin in the quarter was $0.4 million of 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.

Research and development (“R&D”) expense in the first quarter of 2008 increased 5.1% to $6.0 million from $5.7 million in 2007. R&D expense as a percentage of net sales was 3.6% for the first quarter of 2008 compared to 3.7% in the comparable quarter last year, which is in line with our target of spending 3% to 4% of net sales on R&D annually.

Selling and administrative (“S&A”) expense in the first quarter of 2008 increased 12.7% to $55.1 million from $48.9 million in 2007. Direct foreign currency exchange added approximately $2.4 million to the increase in S&A expense for the first quarter of 2008.  The inclusion of expense related to the February 29, 2008 acquisition of Applied Sweepers added $0.7 million to S&A expense in the first quarter.  The remaining $3.1 million, or approximately 6%, increase in expenses in the first quarter of 2008 was primarily due to a continued focus on expanding market coverage within our international geographies and higher marketing expenses in the quarter to support new product launch activity.  In 2007, product launch activities were focused more heavily in the second half of the year. Partially offsetting these increases was a decrease in performance-based compensation in the first quarter of 2008 as compared to the same period last year.

S&A expense as a percentage of net sales was 32.7% for the first quarter of 2008, up from 31.5% in the comparable quarter last year. The increase in S&A expense as a percentage of net sales in the first quarter of 2008 is primarily attributable to investments in expanded market coverage and marketing in the quarter, which are anticipated to contribute to sales during the latter part of 2008.

Other income (expense), net was $0.2 million of expense in the first quarter of 2008 compared to a nominal amount in 2007.  Other income (expense), net was impacted by the following factors in the first quarter of 2008 compared to the first quarter of 2007:

The effective tax rate in the first quarter of 2008 was 36.9% compared to the effective tax rate in the first quarter of the prior year of 36.0%. The increase in the effective tax rate between quarters is primarily related to the expiration of the research and development tax credit on December 31, 2007 and the mix in expected full year taxable earnings by country. 

We expect our 2008 full year tax rate will be in the range of 36.5% to 38.5% before the impact of any one-time items.  Our estimate of the full year tax rate reflects recent acquisitions and is subject to change and may be impacted by changes in our forecasts of operating profit in total or by taxing jurisdiction, or to changes in the tax laws and regulations.

During the first quarter of 2008, we borrowed $87.5 million on our Credit Agreement with our bank group led by JPMorgan in connection with our acquisitions of Applied Sweepers and Sociedade Alfa. We also borrowed $5.0 million for general corporate purposes.  The interest rate on these borrowings will adjust six months from the borrowing dates. We have classified the $87.5 million as long-term debt as we have the intent and ability to extend or refinance such obligations on a long-term basis.  We have classified the $5.0 million as short-term debt as we have the intent and ability to repay this amount within the next year. Our debt to total capitalization ratio was 27.6% and 1.8% at March 31, 2008 and December 31, 2007, respectively.  Cash and cash equivalents totaled $25.3 million at March 31, 2008, compared to $33.1 million at December 31, 2007. We believe that the combination of cash and cash equivalents on hand, as well as internally generated funds and amounts available under the Credit Agreement and the Credit Facility, are more than sufficient to meet our cash requirements for the next year. The Credit Agreement contains customary representations, warranties and covenants. We were in compliance with all such covenants as of March 31, 2008.

OPERATING ACTIVITIES — Operating activities used $5.9 million of cash for the three months ended March 31, 2008. Primary uses of cash during the quarter included a decrease in Employee compensation and benefits and other accrued expenses of $9.9 million due to payments of 2007 annual performance awards, incentives, profit sharing and rebates as well as increased inventory levels due to higher demo inventories related to the introduction of new products and increased inventory at our Louisville distribution center and China manufacturing facility.  Partially offsetting these uses of cash was cash provided by net earnings of $5.2 million.

In the comparable 2007 period, operating activities used $9.0 million of cash, which primarily reflects Employee compensation and benefits and other accrued expenses of $16.5 million due to payments of 2006 annual performance awards, incentives, profit sharing and rebates as well as timing of accounts payable payments. Partially offsetting these uses of cash was net earnings of $5.9 million.

For the period ended March 31, 2008, DSO increased five days compared to the same period last year and six days compared to December 31, 2007, primarily due to a higher mix of international receivables which have longer payment terms.

During the first quarter of 2008, DIOH increased two days compared to the same period last year primarily due to higher demo inventories related to the introduction of new products.  As compared to December 31, 2007, DIOH increased twelve days, due to pipeline fill for new products and our normal seasonal buildup of inventory to replenish inventory to normal levels due to seasonality of sales volumes.

INVESTING ACTIVITIES — Investing activities during the three months ended March 31, 2008 used $88.8 million in cash. Investing activities included the acquisitions of Applied Sweepers and Sociedade Alfa for $81.4 million and capital expenditures of $7.4 million during the three months ended March 31, 2008.  Investments in capital expenditures included technology upgrades and new product development.

We currently anticipate full-year capital spending to be in the range of approximately $26 to $30 million, including capital spending related to our recent acquisitions.

During the three month period ended March 31, 2007, investing activities included the acquisition of Floorep Limited, a distributor of cleaning equipment based in Scotland. Floorep was purchased for $2.7 million, net of cash acquired. Capital expenditures during the first three months of 2007 of $7.9 million included investments in support of our footprint consolidation, global expansion initiatives and new product development.

FINANCING ACTIVITIES — Net cash provided by financing activities was $86.5 million during the first three months of 2008, primarily from borrowings totaling $92.5 million from our Credit Agreement with our bank group led by JP Morgan. Significant uses of cash included $3.6 million for repurchases of common stock under our share repurchase program and $2.4 million in dividend payments.

During the first three months of 2007, net cash used by financing activities was $1.9 million. Significant uses of cash included $2.8 million for repurchases of common stock under our share repurchase program and $2.3 million in dividend payments. Proceeds from issuance of common stock of $3.0 million driven by employee stock options exercises generated a significant source of cash in the first quarter of 2007.

We are subject to exposures resulting from potential cost increases related to our purchase of raw materials or other product components. We do not use derivative commodity instruments to manage our exposures to changes in commodity prices such as steel, oil, gas, lead and other commodities.

Various factors beyond our control affect the price of oil and gas, including but not limited to worldwide and domestic supplies of oil and gas, political instability or armed conflict in oil-producing regions, the price and level of foreign imports, the level of consumer demand, the price and availability of alternative fuels, domestic and foreign governmental regulation, weather-related factors and the overall economic environment. We purchase petroleum-related component parts for use in our manufacturing operations. In addition, our freight costs associated with shipping and receiving product and sales and service vehicle fuel costs are impacted by fluctuations in the cost of oil and gas. If the price of oil and gas continue to increase, our results could be unfavorably impacted in 2008.

Increases in worldwide demand and other factors affect the price for lead, steel and related products. We do not maintain an inventory of raw or fabricated steel or batteries in excess of near-term production requirements. As a result, increases in the price of lead or steel can significantly increase the cost of our lead- and steel-based raw materials and component parts.

During 2007 and through the period ended March 31, 2008, our raw materials and other purchased component costs, such as batteries, were unfavorably impacted by commodity prices. We will continue to focus on mitigating the risk of continued future raw material or other product component cost increases through product pricing, negotiations with our vendors and cost-reduction actions. The success of these efforts will depend upon our ability to increase our selling prices in a competitive market and our ability to achieve cost savings. If the commodity prices remain at their current levels or continue to increase, our results may be unfavorably impacted in 2008.

Due to the global nature of our operations, we are subject to exposures resulting from foreign currency exchange fluctuations in the normal course of business. Our primary exchange rate exposures are with the Euro, the Australian and Canadian dollars, the British pound, the Brazilian real, the Japanese yen and the Chinese yuan against the U.S. dollar. The direct financial impact of foreign currency exchange includes the effect of translating profits from local currencies to U.S. dollars, the impact of currency fluctuations on the transfer of goods between Tennant operations in the United States and abroad and transaction gains and losses. In addition to the direct financial impact, foreign currency exchange has an indirect financial impact on our results, including the effect on sales volumes within local economies and the impact of pricing actions taken as a result of foreign exchange rate fluctuations. We could experience favorable or unfavorable foreign exchange effects for the remainder of 2008, compared with prior year results.

Because our products are currently manufactured or sourced primarily from the United States, a stronger dollar generally has a negative impact on results from operations outside the United States, while a weaker dollar generally has a positive effect. Our objective in managing the exposure to foreign currency fluctuations is to minimize the earnings effects associated with foreign exchange rate changes on certain of our foreign currency-denominated assets and liabilities. We periodically enter into various contracts, principally forward exchange contracts, to protect the value of certain of our foreign currency-denominated assets and liabilities. The gains and losses on these contracts generally approximate changes in the value of the related assets and liabilities. The potential for material loss in fair value of foreign currency contracts outstanding and the related underlying exposures as of March 31, 2008, from a 10% adverse change is unlikely due to the short-term nature of our forward contracts. Our policy prohibits us from entering into transactions for speculative purposes.

Management regularly reviews our business operations, processes and overall organizational structure with the objective of improving financial performance and maximizing our return on investment. As a result of this ongoing process to improve financial performance, we may incur restructuring charges in the future which, if taken, could be material to our financial results.

Additional information on market risk is included in the Management’s Discussion and Analysis section of our 2007 Annual Report on Form 10-K.

Certain statements contained in this document as well as other written and oral statements made by us from time to time are considered “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act. These statements do not relate to strictly historical or current facts and provide current expectations or forecasts of future events. Any such expectations or forecasts of future events are subject to a variety of factors. These include factors that affect all businesses operating in a global market as well as matters specific to us and the markets we serve. Particular risks and uncertainties presently facing us include:

We caution that forward-looking statements must be considered carefully and that actual results may differ in material ways due to risks and uncertainties both known and unknown. Shareholders, potential investors and other readers are urged to consider these factors in evaluating forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements. For additional information about factors that could materially affect Tennant’s results, please see our other Securities and Exchange Commission filings, including the “Risk Factors” section of our 2007 Annual Report on Form 10-K.

We do not undertake to update any forward-looking statement, and investors are advised to consult any further disclosures by us on this matter in our filings with the Securities and Exchange Commission and in other written statements we make from time to time. It is not possible to anticipate or foresee all risk factors, and investors should not consider any list of such factors to be an exhaustive or complete list of all risks or uncertainties.

(a)    Evaluation of disclosure controls and procedures.   Based on their evaluation as of the end of the period covered by this report, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

(b)    Changes in internal controls.   There were no changes in our internal controls over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

There have been no material changes in our risk factors from those disclosed in our 2007 Annual Report on Form 10-K.

There have been no material changes in our legal proceedings from those disclosed in our 2007 Annual Report on Form 10-K.

On May 3, 2007, Tennant Company’s Board of Directors authorized the repurchase of 1,000,000 shares of our common stock under the share repurchase program approved by the Board of Directors in May 2001. Share repurchases are made from time to time in the open market or through privately negotiated transactions, primarily to offset the dilutive effect of shares issued through our stock-based compensation programs.

Exhibits