Tennant Company - 10-Q quarterly report FY

The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with the Securities and Exchange Commission (“SEC”) requirements for interim reporting, which allows certain footnotes and other financial information normally required by accounting principles generally accepted in the United States of America to be condensed or omitted. In our opinion, the Condensed Consolidated Financial Statements contain all adjustments (consisting of only normal recurring adjustments) necessary for the fair presentation of our financial position and results of operations.

These statements should be read in conjunction with the Consolidated Financial Statements and Notes included in our Annual Report on Form 10-K for the year ended December 31, 2009. The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year.

In January 2010, the Financial Accounting Standards Board (“FASB”) updated the disclosure requirements for fair value measurements. The updated guidance requires companies to disclose separately the investments that transfer in and out of Levels 1 and 2 and the reasons for those transfers. Additionally, in the reconciliation for fair value measurements using significant unobservable inputs (Level 3), companies should present separately information about purchases, sales, issuances and settlements. We adopted the updated guidance on January 1, 2010, except for the disclosures about purchases, sales, issuances and settlements in the Level 3 reconciliation, which are effective for fiscal years beginning after December 15, 2010. We will adopt the remaining guidance on January 1, 2011. The adoption of the required guidance did not have an impact on our financial position or results of operations. We do not expect that the adoption of the remaining guidance will have an impact on our financial position or results of operations.

2008 Actions – During the fourth quarter of 2008, we announced a workforce reduction program to reduce our worldwide employee base by approximately 8%, or about 240 people. A pretax charge of $14,551, including other associated costs of $290, was recognized in the fourth quarter of 2008 as a result of this program. The workforce reduction was accomplished primarily through the elimination of salaried positions across the organization. The pretax charge consisted primarily of severance and outplacement services and was included within Selling and Administrative Expense in the 2008 Consolidated Statement of Earnings.

 

A reconciliation of the beginning and ending liability balances is as follows:

 

The 2009 adjustment of accrual was primarily the result of an adjustment during the first quarter of 2009 due to lower than anticipated severance costs in Europe both on an employee settlement basis and also the opportunity to eliminate open positions due to employee turnover thereby avoiding some severance payments.

 

On February 27, 2009, we acquired certain assets of Applied Cleansing Solutions Pty Ltd ("Applied Cleansing"), a long-term importer and distributor for Green Machines™ products in Australia and New Zealand, in a business combination for an initial purchase price of $379 in cash. This acquisition provides us with the opportunity to accelerate our growth in the city cleaning business within the Asia Pacific region. The purchase agreement also provided for additional contingent consideration to be paid for each of the four quarters following the acquisition date if certain future revenue targets were met. We have paid all four quarterly payments following the acquisition date and there was no material difference between our original estimate recorded for contingent consideration of approximately $208 and the amounts paid.

The components of the purchase price of the business combination described above have been allocated as follows:

 

Inventories are valued at the lower of cost or market. Inventories at September 30, 2010 and December 31, 2009 consisted of the following:

 

The changes in the carrying value of Goodwill for the nine months ended September 30, 2010 are as follows:

 

The balances of acquired Intangible Assets, excluding Goodwill, are as follows:

 

Amortization expense on Intangible Assets for the three and nine months ended September 30, 2010 was $793 and $2,356, respectively. Amortization expense on Intangible Assets for the three and nine months ended September 30, 2009 was $825 and $2,283, respectively.

Estimated aggregate amortization expense based on the current carrying value of amortizable Intangible Assets for each of the five succeeding years is as follows:

 

Debt outstanding is summarized as follows:

 

 

Our most restrictive covenants are part of our Credit Agreement (as defined below) with JPMorgan, which are the same covenants in the Shelf Agreement (as defined below) with Prudential (as defined below), and require us to maintain an indebtedness to EBITDA ratio of not greater than 3.50 to 1 and to maintain an EBITDA to interest expense ratio of no less than 3.50 to 1 as of the end of each quarter. As of September 30, 2010, our indebtedness to EBITDA ratio was 0.64 to 1 and our EBITDA to interest expense ratio was 31.08 to 1.

JPMorgan Chase Bank, National Association

 

Our June 19, 2007 Credit Agreement (the “Credit Agreement”), as amended from time to time, with our bank group led by JPMorgan Chase Bank, National Association (“JPMorgan”), provides us and certain of our foreign subsidiaries access to a $125,000 revolving credit facility until June 19, 2012. Borrowings may be denominated in U.S. dollars or certain other currencies. The facility is available for general corporate purposes, working capital needs, share repurchases and acquisitions. If we obtain additional indebtedness as permitted under the agreement, to the extent that any revolving loans under the Credit Agreement are then outstanding, we are required to prepay the revolving loans in an amount equal to 100% of the proceeds from the additional indebtedness. Additionally, proceeds over $25,000 and under $35,000 will reduce the revolver commitment on a 50% dollar for dollar basis and proceeds over $35,000 will reduce the revolver commitment on a 100% dollar for dollar basis. The Credit Agreement limits the payment of dividends and repurchases of stock in fiscal years after 2009 to an amount ranging from $12,000 to $40,000 based on our leverage ratio after giving effect to such payments. The Credit Agreement contains customary representations, warranties and covenants, including but not limited to covenants restricting our ability to incur indebtedness and liens and to merge or consolidate with another entity.

 

We were in compliance with all covenants under the Credit Agreement as of September 30, 2010. There was $25,000 in outstanding borrowings under this facility as of September 30, 2010, with a weighted average interest rate of 2.46%.

 

Prudential Investment Management, Inc.

 

On July 29, 2009, we entered into a Private Shelf Agreement (the “Shelf Agreement”) with Prudential Investment Management, Inc. (“Prudential”) and Prudential affiliates from time to time party thereto. The Shelf Agreement provides us and our subsidiaries access to an uncommitted, senior secured, maximum aggregate principal amount of $80,000 of debt capital. The Shelf Agreement contains representations, warranties and covenants, including but not limited to covenants restricting our ability to incur indebtedness and liens and merge or consolidate with another entity. The Shelf Agreement limits the payment of dividends or repurchases of stock in fiscal years after 2009 to an amount ranging from $12,000 to $40,000 based on our leverage ratio after giving effect to such payments. 

 

As of September 30, 2010, there was no balance outstanding on this facility and therefore no requirement to be in compliance with the financial covenants under this facility. However, the financial covenants under this facility are the same as the financial covenants in the Credit Agreement, all of which we were in compliance with as of September 30, 2010. Should notes be issued under the Shelf Agreement, such notes will be pari passu with outstanding debt under the Credit Agreement.

 

ABN AMRO Bank N.V.

 

We have a credit facility with ABN AMRO Bank N.V. (“ABN AMRO”) of 5,000 Euros, or approximately $6,817, for general working capital purposes. Borrowings under this facility incur interest generally at a rate of 1.25% over the ABN AMRO base rate as calculated daily on the cleared account balance. This facility may also be used for short-term loans up to 3,000 Euros, or $4,090. The terms and conditions of these loans would be incorporated in a separate short-term loan agreement at the time of the transaction. As of September 30, 2010, bank guarantees of $962 reduced the amount available on this credit facility to $5,855. On October 1, 2010, we cancelled our credit facility with ABN AMRO.

 

Bank of America, National Association

 

On August 28, 2010, our revolving credit facility with Bank of America, National Association, Shanghai Branch expired and we elected not to renew it.

 

Royal Bank of Scotland N.V.

 

On October 1, 2010, we entered into a credit facility with Royal Bank of Scotland N.V. (“RBS”) in the amount of 4,000 Euros, or approximately $5,454, for general working capital purposes.

We record a liability for warranty claims at the time of sale. The amount of the liability is based on the trend in the historical ratio of claims to sales, the historical length of time between the sale and resulting warranty claim, new product introductions and other factors. Warranty periods on machines generally range from one to four years.

The changes in the warranty liability balance for the nine months ended September 30, 2010 and 2009 were as follows:

 

 

Estimates of fair value for financial assets and liabilities are based on the framework established in the accounting guidance for fair value measurements. The framework defines fair value, provides guidance for measuring fair value and requires certain disclosures. The framework discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow), and the cost approach (cost to replace the service capacity of an asset or replacement cost). The framework utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels:

 

 

 

Our population of assets and liabilities subject to fair value measurements at September 30, 2010 are as follows:

 

Assets and liabilities measured at fair value are based on one or more valuation techniques. The valuation techniques are identified in the table above and are as follows:

 

 

We use derivative instruments to manage exposures to foreign currency only in an attempt to limit underlying exposures from currency fluctuations and not for trading purposes. As of September 30, 2010 the fair values of such contracts outstanding were gains of $33 and losses of $207. As of September 30, 2009 the fair values of such contracts outstanding had no gains and losses of $244. Gains or losses on forward foreign exchange contracts to economically hedge foreign currency-denominated net assets and liabilities are recognized in Other Current Assets and Other Current Liabilities within the Condensed Consolidated Balance Sheets and are recognized in Other Income (Expense), Net under Net Foreign Currency Transaction Gains (Losses) within the Condensed Consolidated Statements of Operations. At September 30, 2010 and 2009, the notional am ounts of foreign currency forward exchange contracts outstanding were $47,318 and $51,518, respectively.

 

The carrying amounts reported in the Condensed Consolidated Balance Sheets for Cash and Cash Equivalents, Accounts Receivable, Other Current Assets, Accounts Payable and Other Current Liabilities approximate fair value.

 

The fair market value of our Long-Term Debt approximates cost, based on the borrowing rates currently available to us for bank loans with similar terms and remaining maturities.

As of September 30, 2010, we had four defined benefit pension plans and a postretirement medical plan, which are described in Note 11 of the 2009 Annual Report on Form 10-K. We have contributed $58 and $18 during the third quarter of 2010 and $174 and $635 during the first nine months of 2010 to our pension plans and our postretirement medical plan, respectively.

 

The components of the net periodic benefit cost for the three and nine months ended September 30, 2010 and 2009 were as follows:

 

We report Accumulated Other Comprehensive Loss as a separate item in the Shareholders’ Equity section of the Condensed Consolidated Balance Sheets. Comprehensive Income (Loss) is comprised of Net Earnings (Loss) and Other Comprehensive Income (Loss). For the three and nine months ended September 30, 2010 and 2009, Other Comprehensive Income (Loss) consisted of foreign currency translation adjustments and amortization and remeasurement of pension items.

The reconciliations of Net Earnings (Loss) to Comprehensive Income (Loss) are as follows:

 

Certain operating leases for vehicles contain residual value guarantee provisions, which would become due at the expiration of the operating lease agreement if the fair value of the leased vehicles is less than the guaranteed residual value. As of September 30, 2010, of those leases that contain residual value guarantees, the aggregate residual value at lease expiration was $7,742, of which we have guaranteed $6,167. As of September 30, 2010, we have recorded a liability for the estimated end of term loss related to this residual value guarantee of $1,169 for certain vehicles within our fleet. Our fleet also contains vehicles we estimate will settle at a gain. Gains on these vehicles will be recognized at the end of the lease term.

We and our subsidiaries are subject to U.S. federal income tax as well as income tax of numerous state and foreign jurisdictions. We are generally no longer subject to U.S. federal tax examinations for taxable years before 2007 and with limited exceptions, state and foreign income tax examinations for taxable years before 2005.

We recognize potential accrued interest and penalties related to unrecognized tax benefits in Income Tax Expense. Included in the net liability of $7,148 for unrecognized tax benefits as of September 30, 2010 was approximately $556 for accrued interest and penalties. The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate as of September 30, 2010 was $4,215. To the extent interest and penalties are not assessed with respect to uncertain tax positions, amounts accrued will be revised and reflected as an adjustment of the Income Tax Expense.

Unrecognized tax benefits were reduced by $509 in the third quarter and $774 for the first nine months of 2010 for expiration of the statute of limitations in various jurisdictions and completion of state tax audits.

We are currently undergoing income tax examinations in various state and foreign jurisdictions covering 2005 to 2008 for which settlement is expected prior to year end. Although the final outcome of these examinations cannot be currently determined, we believe that we have adequate reserves with respect to these examinations.

During the third quarter of 2010 it was determined that it was now more likely than not that all of the deferred tax assets in China would be utilized in the future and accordingly the valuation allowance on the deferred tax assets was reduced to zero. The one time tax benefit related to the reversal of the China valuation allowance was approximately $224.

The following table presents the components of Stock-Based Compensation Expense for the nine months ended September 30, 2010 and 2009:

On April 28, 2010, the shareholders approved the 2010 Stock Incentive Plan (“2010 Plan”), which provides for stock option grants to our executives, key employees and non-employee Directors. A total of 1,000,000 shares were authorized for future awards under the 2010 Plan.

The computations of Basic and Diluted Earnings (Loss) per Share are as follows:

We are organized into four operating segments: North America; Latin America; Europe, Middle East, Africa; and Asia Pacific. We combine our North America and Latin America operating segments into the “Americas” for reporting Net Sales by geographic area. In accordance with the objective and basic principles of the applicable accounting guidance, we aggregate our operating segments into one reportable segment that consists of the design, manufacture and sale of products used primarily in the maintenance of nonresidential surfaces.

 

The following table sets forth Net Sales by geographic area (net of intercompany sales):

 

On September 15, 2010, we entered into an agreement with a current employee for the right to manufacture and sell a product developed by the employee prior to becoming employed by Tennant.  Product fee payments made under this agreement are not material to our financial position or results of operations.

We have provided an exclusive technology license agreement to Activeion Cleaning Solutions, LLC (“Activeion”), a company in which a current employee of Tennant owns a minority interest. Royalties under this license agreement are not material to our financial position or results of operations.

During the first quarter of 2008, we acquired Applied Sweepers, Ltd. (“Applied Sweepers”) and Sociedade Alfa Ltda. (“Alfa”) and entered into lease agreements for certain properties owned by or partially owned by the former owners of these entities. Some of these individuals are current employees of Tennant. Lease payments made under these lease agreements are not material to our financial position or results of operations.

On October 1, 2010 we cancelled our revolving credit facility with ABN AMRO and entered into a credit facility with RBS as further discussed in Note 7.

Overview

Tennant Company is a world leader in designing, manufacturing and marketing solutions that help create a cleaner, healthier world. We provide equipment, 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, Latin America, Europe, the Middle East, Africa and Asia Pacific. 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 ( 8220;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, 2009.

Net Earnings for the third quarter of 2010 were $7.5 million, or $0.39 per diluted share, as compared to Net Earnings of $5.8 million, or $0.31 per diluted share, in the third quarter of 2009. Net Earnings during the 2010 third quarter were favorably impacted by increased Net Sales, chiefly driven by sales of equipment with our ec-H2O™ technology. Net Earnings were also favorably impacted by higher production levels and our ongoing emphasis on leveraging our cost structure which improved gross margins and operating profit margins.

Net Earnings for the first nine months of 2010 were $17.8 million, or $0.92 per diluted share, as compared to a Net Loss of $33.0 million, or a $1.78 loss per diluted share, for the first nine months of 2009. Net Earnings during the first nine months of 2010 were favorably impacted by increased Net Sales, driven primarily by increased equipment volume, continued tight spending controls and flexible production management. The Net Loss in the first nine months of 2009 was primarily due to the non-cash pretax goodwill impairment charge of $43.4 million, or a $2.29 loss per diluted share, taken during the first quarter of 2009 as well as a significant decline in Net Sales due to unfavorable global economic conditions during 2009.

Historical Results

The following compares the historical results of operations for the three and nine month periods ended September 30, 2010 and 2009 and as a percentage of Net Sales (dollars in thousands, except per share data):

 

 

Net Sales

Consolidated Net Sales for the third quarter of 2010 totaled $168.6 million, a 9.2% increase as compared to consolidated Net Sales of $154.4 million in the third quarter of 2009. Consolidated Net Sales for the first nine months of 2010 totaled $484.9 million, a 12.3% increase as compared to consolidated Net Sales of $431.7 million in the same period of 2009.

The components of the change in consolidated Net Sales in the third quarter and first nine months of 2010 as compared to the same periods in 2009 were as follows:

 

The 12.3% increase in consolidated Net Sales in the first nine months of 2010 as compared to 2009 was primarily driven by:

The following table sets forth the Net Sales by geographic area for the three and nine month periods ended September 30, 2010 and 2009 and the percentage change from the prior year (dollars in thousands):

 

Net Sales in the Americas were $111.8 million for the third quarter of 2010, an increase of 16.5% from the third quarter of 2009. Net Sales benefited by approximately 16.0% from sales volume increases, primarily from industrial equipment and scrubbers equipped with our ec-H2O technology. The direct impact of foreign currency translation exchange effects within the Americas favorably impacted Net Sales by approximately 0.5% during the third quarter of 2010.

Net Sales increased 17.8% to $312.0 million in the Americas for the nine months ended September 30, 2010 as compared to the same period in 2009. Net Sales benefited by approximately 16.8% from sales volume increases, primarily scrubbers equipped with our ec-H2O technology and industrial equipment. The direct impact of foreign currency translation exchange effects within the Americas favorably impacted Net Sales by approximately 1.0% during the first nine months of 2010.

In our markets within Europe, the Middle East and Africa (“EMEA”), Net Sales decreased 14.3% to $38.7 million for the third quarter of 2010 as compared to the third quarter of 2009. We experienced an organic sales decline of approximately 5.8% in the third quarter of 2010 when compared to the same period last year. Unit volume increases of equipment with our ec-H2O

 

technology were not sufficient to offset volume declines in other types of equipment, primarily large outdoor machines in our city cleaning business purchased by municipal governments, due to ongoing weakness in the European economy. Unfavorable direct foreign currency exchange fluctuations decreased Net Sales by approximately 8.5% in the third quarter of 2010.

EMEA Net Sales decreased 6.4% to $123.3 million for the nine months ended September 30, 2010. We experienced an organic sales decline of approximately 3.4% for the first nine months of 2010 as compared to the same period in 2009 primarily due to an overall decrease in equipment volume. Unfavorable direct foreign currency exchange fluctuations decreased Net Sales for the nine months ended September 30, 2010 by approximately 3.0%.

Net Sales in the Asia Pacific market for the third quarter of 2010 totaled $18.1 million, an increase of 36.6% as compared to the third quarter of 2009. Organic growth of approximately 29.1% in Net Sales was primarily driven by growth in equipment unit volume in both the China market as well as Australia. Favorable direct foreign currency translation exchange effects increased Net Sales by approximately 7.5% in the 2010 third quarter.

Net Sales for the first nine months of 2010 in the Asia Pacific market increased 41.7% to $49.5 million as compared to the same period last year. Organic sales growth increased by approximately 29.7% primarily due to equipment unit volume increases in both China and Australia. Favorable direct foreign currency translation exchange effects increased Net Sales by approximately 12.0% for the nine months ended September 30, 2010.

Gross Profit

Gross Profit margin was 42.6% and 42.7% for the third quarter and first nine months of 2010, respectively, as compared with 42.0% and 41.2% in the third quarter and first nine months of 2009, respectively. Gross margin increased by 60 and 150 basis points, respectively, primarily due to higher sales volume, continued tight spending controls and flexible production management.

Operating Expense

Research and Development (“R&D”) Expense in the third quarter of 2010 was up 30.2% to $7.1 million as compared with $5.5 million in the third quarter of 2009. R&D Expense as a percentage of Net Sales was 4.2% for the third quarter of 2010, an increase as compared to 3.5% of Net Sales for R&D Expense in the third quarter of 2009, primarily due to our investments in chemical-free cleaning.

R&D Expense for the nine months ended September 30, 2010 was $19.1 million, up 13.2% from $16.8 million in the same period in 2009. R&D Expense as a percentage of Net Sales was 3.9% for the first nine months of 2010, which is consistent with 3.9% of Net Sales in the same period last year.

Selling and Administrative (“S&A”) Expense in the third quarter of 2010 was $54.2 million as compared to $51.8 million in the third quarter of 2009. The increase in S&A Expense was primarily attributable to higher variable costs stemming from increased sales. S&A Expense as a percentage of Net Sales was 32.2% for the third quarter of 2010, down from 33.5% in the comparable 2009 quarter and was down sequentially from 34.5% and 32.8% in the 2010 first and second quarters, respectively, due primarily to tight spending controls and leveraging our existing resources as we have kept our employee headcount consistent with 2009 year end levels.

For the nine months ended September 30, 2010, S&A Expense increased 9.7% to $160.5 million from $146.3 million in the comparable period last year due to higher variable costs related to increased sales, product launch expenses and investments in chemical-free cleaning. S&A Expense as a percentage of Net Sales was 33.1% for the first nine months of 2010 as compared to 33.9% in the comparable period last year due to tight spending controls and leveraging our existing resources.

During the first quarter of 2009, we recorded a non-cash pretax Goodwill Impairment Charge of $43.4 million related to our EMEA reporting unit. Only $3.8 million of this charge was tax deductible.

Other Income (Expense), Net

 

 

Interest Income decreased nominally in the third quarter and first nine months of 2010, respectively, as compared to the same periods in 2009. The decrease between 2010 and 2009 mainly reflects the impact of no ESOP interest income in 2010 as the ESOP loan matured on December 31, 2009.

 

 

Interest Expense was $0.4 million and $1.2 million in the third quarter and first nine months of 2010, respectively, a decrease of $0.3 million and $1.1 million, respectively, as compared to the same periods in 2009. The decline in Interest Expense between periods was primarily due to a lower level of borrowings against our revolving credit facility in 2010 as compared to 2009.

 

 

Net Foreign Currency Transaction Gains in the third quarter of 2010 were $0.1 million, a decrease of $0.2 million as compared to the same period in the prior year.  Net Foreign Currency Transaction Losses were $0.4 million for the first nine months of 2010, as compared to Net Foreign Currency Transaction Gains of $0.1 million in the same period in the prior year. The net unfavorable change from the prior year of foreign currency transactions in the third quarter and first nine months of 2010 was due to fluctuations in foreign currency rates in the normal course of business.

 

 

There was no ESOP Income during the third quarter or first nine months of 2010 as compared to $0.3 million and $0.7 million in the same periods of 2009. On December 31, 2009, the term of the ESOP program expired.

 

 

There was no significant change in Other Income (Expense), Net in the third quarter and first nine months of 2010 as compared to the same periods in 2009.

 

Income Taxes

 

In the 2010 third quarter, the overall effective tax rate was 27.4% and our base tax rate, which excludes discrete tax items, was 37.9%. We had discrete net favorable tax items of approximately $1.1 million, including a one time benefit of $0.2 million related to the reversal of the China valuation allowance. During the third quarter of 2010 it was determined that it was more likely than not that all of the China deferred tax assets would be utilized in the future and accordingly the valuation allowance on the deferred tax assets was reduced to zero. Our base tax rate does not yet include any benefit for federal R&D tax credits, as we are not allowed to consider these credits in our tax rate until they are formally reenacted. The overall effective tax rate in the third quarter of 2009 was 24.1%. The increase in the overall effective t ax rate as compared to the third quarter of 2009 was primarily related to the mix in expected full year taxable earnings by country.

 

The overall effective tax rate for the first nine months of 2010 was 32.2% and our base tax rate, which excludes discrete tax items, was 37.0%. The overall effective tax rate during the first nine months of 2009 was a negative 10.3%, which included a $1.1 million tax benefit associated with the $43.4 million impairment of goodwill, materially impacting the overall effective tax rate. Excluding the tax benefit associated with the goodwill impairment, the overall effective tax rate for the first nine months of 2009 would have been 30.7%. The increase in the overall effective rate as compared to the prior year, excluding goodwill impairment, was primarily related to the mix in expected full year taxable earnings by country and the expiration of the R&D tax credit in 2010.

 

Cash and Cash Equivalents totaled $33.7 million at September 30, 2010, as compared to $18.1 million at December 31, 2009. We believe that the combination of internally generated funds and present capital resources are more than sufficient to meet our cash requirements for the next twelve months. Our debt-to-capital ratio was 13.7% and 15.7% at September 30, 2010 and December 31, 2009, respectively.

Cash provided by (used for) our operating, investing and financing activities is summarized as follows (dollars in thousands):

 

Operating activities provided $30.2 million of cash for the nine months ended September 30, 2010. Cash provided by operating activities was driven primarily by $17.8 million of Net Earnings as well as increased levels of Accounts Payable and reductions in Accounts Receivable, partially off-set by increased Inventories. The increase in Accounts Payable is primarily due to unit volume increase in sales as well as timing of payments. Reductions in Accounts Receivable are primarily due to our continued focus on proactively managing our trade receivable accounts and collecting past due balances. Increased Inventories are due to higher production levels in our manufacturing facilities.

Operating activities provided $58.4 million of cash for the nine months ended September 30, 2009. Cash provided by operating activities was driven primarily by reductions in working capital during the first nine months of 2009, partially offset by lower Employee Compensation and Benefit liabilities due to payments of severance associated with the workforce reduction announced in the fourth quarter of 2008.

Management evaluates how effectively we utilize two of our key operating assets, Accounts Receivable and Inventories, using Accounts Receivable “Days Sales Outstanding” (DSO) and “Days Inventory on Hand” (DIOH), on a FIFO basis. The metrics are calculated on a rolling three month basis in order to more readily reflect changing trends in the business. These metrics for the quarters ended were as follows (in days):

 

As of September 30, 2010, DSO decreased 4 days as compared to September 30, 2009 due to increased Net Sales as well as our continued focus on proactively managing Accounts Receivable by enforcing tighter credit limits and collecting past due balances. As of September 30, 2010, DSO decreased 5 days as compared to December 31, 2009 due to our continued focus on proactively managing Accounts Receivable as well as a slight increase in Net Sales as compared to the fourth quarter of 2009.

As of September 30, 2010, DIOH decreased 3 days as compared to September 30, 2009 primarily due to increased sales volume in the third quarter of 2010 as compared to the third quarter of 2009 and continued progress from inventory management initiatives. As of September 30, 2010, DIOH increased 4 days as compared to December 31, 2009, primarily due to a higher inventory balance, somewhat offset by a slightly higher level of Net Sales in the third quarter of 2010 as compared to the fourth quarter of 2009.

Investing activities during the nine months ended September 30, 2010 used $6.1 million in cash, almost entirely due to net capital expenditures. Investments in capital expenditures included technology upgrades, tooling related to new product development and manufacturing equipment.

Investing activities during the nine months ended September 30, 2009 used $10.7 million in cash. Investing activities included net capital expenditures of $8.5 million and $2.2 million related to acquisition of businesses. Investments in capital expenditures

 

included technology upgrades, tooling related to new product development and investments in our Minnesota facilities to complete the new global R&D center of excellence to support new product innovation efforts. The $2.2 million related to acquisitions was primarily comprised of the 2009 first quarter earn-out payment for our March 28, 2008 acquisition of Sociedade Alfa Ltda. and the 2009 third quarter earn-out payment for our August 15, 2008 acquisition of Shanghai ShenTan Mechanical and Electrical Equipment Co. Ltd.

Net cash used by financing activities was $8.3 million during the first nine months of 2010, primarily from $8.0 million in dividend payments, a $3.2 million repayment of Long-Term Debt and $3.2 million in repurchases of Common Stock related to our share repurchase program, partially offset by $4.7 million from the issuance of common stock related to equity awards and a $1.3 million tax benefit on stock plans.

Net cash used by financing activities was $63.1 million during the first nine months of 2009, primarily from net repayments of Long-Term Debt of $56.5 million, and $7.2 million in dividend payments.

As of September 30, 2010, we had committed lines of credit totaling $132.0 million and uncommitted lines of credit totaling $80.0 million. There was $25.0 million in outstanding borrowings under our JPMorgan (as defined below) facility and no borrowings under any of our other facilities as of September 30, 2010. In addition, we had stand alone letters of credit of $1.9 million outstanding and bank guarantees in the amount of $1.0 million. Commitment fees on unused lines of credit for the nine months ended September 30, 2010 were $0.3 million.

 

Our most restrictive covenants are part of our Credit Agreement (as defined below) with JPMorgan, which are the same covenants in the Shelf Agreement (as defined below) with Prudential (as defined below), and require us to maintain an indebtedness to EBITDA ratio of not greater than 3.50 to 1 and to maintain an EBITDA to interest expense ratio of no less than 3.50 to 1 as of the end of each quarter. As of September 30, 2010, our indebtedness to EBITDA ratio was 0.64 to 1 and our EBITDA to interest expense ratio was 31.08 to 1.

 

JPMorgan Chase Bank, National Association

 

Our June 19, 2007 Credit Agreement (the “Credit Agreement”), as amended from time to time, with our bank group led by JPMorgan Chase Bank, National Association (“JPMorgan”), provides us and certain of our foreign subsidiaries access to a $125.0 million revolving credit facility until June 19, 2012. Borrowings may be denominated in U.S. dollars or certain other currencies. The facility is available for general corporate purposes, working capital needs, share repurchases and acquisitions. If we obtain additional indebtedness as permitted under the agreement, to the extent that any revolving loans under the Credit Agreement are then outstanding we are required to prepay the revolving loans in an amount equal to 100% of the proceeds from the additional indebtedness. Additionally, proceeds over $25.0 million and under $ 35.0 million will reduce the revolver commitment on a 50% dollar for dollar basis and proceeds over $35.0 million will reduce the revolver commitment on a 100% dollar for dollar basis. The Credit Agreement limits the payment of dividends and repurchases of stock in fiscal years after 2009 to an amount ranging from $12.0 million to $40.0 million based on our leverage ratio after giving effect to such payments. The Credit Agreement contains customary representations, warranties and covenants, including but not limited to covenants restricting our ability to incur indebtedness and liens and to merge or consolidate with another entity.

As of September 30, 2010 we were in compliance with all covenants under the Credit Agreement. There was $25.0 million in outstanding borrowings under this facility at September 30, 2010, with a weighted average interest rate of 2.46%.

Prudential Investment Management, Inc.

 

On July 29, 2009, we entered into a Private Shelf Agreement (the “Shelf Agreement”) with Prudential Investment Management, Inc. (“Prudential”) and Prudential affiliates from time to time party thereto. The Shelf Agreement provides us and our subsidiaries access to an uncommitted, senior secured, maximum aggregate principal amount of $80.0 million of debt capital. The Shelf Agreement contains representations, warranties and covenants, including but not limited to covenants restricting our ability to incur indebtedness and liens and merge or consolidate with another entity. The Shelf Agreement limits the payment of dividends or repurchases of stock in fiscal years after 2009 to an amount ranging from $12.0 million to $40.0 million based on our leverage ratio after giving effect to such payments. 

 

As of September 30, 2010, there was no balance outstanding on this facility and therefore no requirement to be in compliance with the financial covenants under this facility. However, the financial covenants under this facility are the same as the financial

 

covenants in the Credit Agreement, all of which we were in compliance with as of September 30, 2010. Should notes be issued under the Shelf Agreement, such notes will be pari passu with outstanding debt under the Credit Agreement.

 

ABN AMRO Bank N.V.

 

We have a credit facility with ABN AMRO Bank N.V. (“ABN AMRO”) of 5.0 million Euros, or approximately $6.8 million, for general working capital purposes. Borrowings under this facility incur interest generally at a rate of 1.25% over the ABN AMRO base rate as calculated daily on the cleared account balance. This facility may also be used for short-term loans up to 3.0 million Euros, or $4.1 million. The terms and conditions of these loans would be incorporated in a separate short-term loan agreement at the time of the transaction. As of September 30, 2010, bank guarantees of $1.0 million reduced the amount available on this credit facility to $5.8 million. On October 1, 2010, we cancelled our credit facility with ABN AMRO.

 

Bank of America, National Association

 

On August 28, 2010, our revolving credit facility with Bank of America, National Association, Shanghai Branch expired and we elected not to renew it.

 

Royal Bank of Scotland N.V.

 

On October 1, 2010, we entered into a credit facility with Royal Bank of Scotland N.V. (“RBS”) in the amount of 4.0 million Euros, or approximately $5.5 million, for general working capital purposes.

 

There have been no material changes with respect to contractual obligations as disclosed in our 2009 Annual Report on Form 10-K.

Newly Issued Accounting Guidance

In October 2009, the Financial Accounting Standards Board (“FASB”) issued new guidance that sets forth the requirements that must be met for an entity to recognize revenue for the sale of a delivered item that is part of a multiple-element arrangement when other elements have not yet been delivered. The new guidance is effective for fiscal years beginning on or after June 15, 2010 and therefore we will adopt this guidance on January 1, 2011. We are currently evaluating the impact the adoption of the new guidance will have on our Consolidated Financial Statements.

In January 2010, the FASB updated the disclosure requirements for fair value measurements. The updated guidance requires companies to disclose separately the investments that transfer in and out of Levels 1 and 2 and the reasons for those transfers. Additionally, in the reconciliation for fair value measurements using significant unobservable inputs (Level 3), companies should present separately information about purchases, sales, issuances and settlements. We adopted the updated guidance on January 1, 2010, except for the disclosures about purchases, sales, issuances and settlements in the Level 3 reconciliation, which are effective for fiscal years beginning after December 15, 2010. We will adopt the remaining guidance on January 1, 2011. The adoption of the required guidance did not have an impact on our financial position or results o f operations. We do not expect that the adoption of the remaining guidance will have an impact on our financial position or results of operations.

Cautionary Statement Relevant to Forward-Looking Information

 

This Quarterly Report on Form 10-Q, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 2, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements generally can be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “estimate,” “anticipate,” “believe,” “project,” or “continue” or similar words or the negative thereof. These statements do not relate to strictly historical or current facts and provide current expectations of forecasts of future events. Any such expectations or forecasts of future events are subject to a variety of factors. Particular risks and uncertainties presently facing us include: our ability to effectively manage organizational changes; our ability to optimize the allocation of resources to our strategic objectives; the competition in our business; geopolitical and economic uncertainty throughout the world; our ability to acquire, retain and protect proprietary intellectual property rights; our ability to maintain and manage our computer systems and data; the occurrence of a significant business interruption; unforeseen product liability claims or product quality issues; fluctuations in the cost or availability of raw materials and purchased components; our ability to comply with laws and regulations; and the relative strength of the U.S. dollar, which affects the cost of our materials and products purchased and sold internationally.

 

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. Information about factors that could materially affect our results can be found in Part I, Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2009. 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.

 

We undertake no obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. Investors are advised to consult any further disclosures by us in our filings with the Securities and Exchange Commission and in other written statements on related subjects. 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.

 

There have been no material changes in our market risk since December 31, 2009. For additional information, refer to Item 7A of our 2009 Annual Report on Form 10-K.

 

Our management, with the participation of our Chief Executive Officer and our Principal Financial and Accounting Officer, have evaluated the effectiveness of our disclosure controls and procedures for the period ended September 30, 2010 (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)). Based on that evaluation, our Chief Executive Officer and our Principal Financial and Accounting Officer have concluded that our disclosure controls and procedures 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, and that such information is accumulated and communicated to our management, including our principal executive and our principal financial officers, as appropriate to allow timely decisions regarding required disclosure.

 

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.

PART II – OTHER INFORMATION

There have been no material changes in our legal proceedings from those disclosed in our 2009 Annual Report on Form 10-K.

There have been no material changes in our risk factors from those disclosed in our 2009 Annual Report on Form 10-K.

On May 3, 2007, the Board of Directors authorized the repurchase of 1,000,000 shares of our common stock. 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. Our March 4, 2009 amendment to our Credit Agreement limits the payment of dividends and repurchases of stock in fiscal years 2010 to 2012 to an amount ranging from $12.0 million to $40.0 million based on our leverage ratio after giving effect to such payments.

 

Exhibits