TENNANT CO - Annual Report: 2007 (Form 10-K)

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Commission File Number 001-16191

TENNANT COMPANY
(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code 763-540-1200

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

The aggregate market value of the voting and non-voting common equity held by non-affiliates as of June 30, 2007, was approximately $678,347,147.

The number of shares outstanding of registrant’s only class of common stock on February 27, 2008 was 18,472,448.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s Proxy Statement for its 2008 annual meeting of shareholders (the “2008 Proxy Statement”) are incorporated by reference in Part III.

Tennant Company
Form 10–K
Table of Contents

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TENNANT COMPANY
2007
ANNUAL REPORT
Form 10–K

(Pursuant to Securities Exchange Act of 1934)

PART I

ITEM 1 – Business

General Development of Business

          Tennant Company, a Minnesota corporation incorporated in 1909, is a world leader in designing, manufacturing and marketing solutions that help create a cleaner, safer world. The Company’s floor maintenance and outdoor cleaning equipment, specialty surface coatings and related products are used to clean and coat floors in factories, office buildings, parking lots and streets, airports, hospitals, schools, warehouses, shopping centers and more. Customers include building service contract cleaners to whom organizations outsource facilities maintenance, as well as end-user businesses, healthcare facilities, schools and local, state and federal governments who handle facilities maintenance themselves. We reach these customers through the industry’s largest direct sales and service organization and through a strong and well-supported network of authorized distributors worldwide.

Industry Segments, Foreign and Domestic Operations and Export Sales

          The Company, as described under “General Development of Business,” has one reportable business segment. The Company sells its products domestically and internationally. Financial information on the Company’s geographic areas is provided on page 34 of this Annual Report on Form 10–K. Nearly all of the Company’s foreign investments in assets reside within The Netherlands, Australia, the United Kingdom, France, Germany, Canada, Austria, Japan, Spain, Brazil and China.

Principal Products, Markets and Distribution

          Products consisting mainly of motorized cleaning equipment and related products, including specialty surface coatings and preservation products, are sold through direct and distribution channels in various regions around the world. In North America, products are sold through a direct sales organization and independent distributors; in Australia, Japan and 15 countries principally in Western Europe, products are sold primarily through direct sales organizations; and in more than 80 other countries Tennant relies on a broad network of independent distributors.

Raw Materials and Purchased Components

          The Company has not experienced any significant or unusual problems in the availability of raw materials or other product components. The Company has sole-source vendors for certain components. A disruption in supply from such vendors may disrupt the Company’s operations. However, the Company believes that it can find alternate sources in the event there is a disruption in supply from such vendors.

Patents and Trademarks

          The Company applies for and is granted United States and foreign patents and trademarks in the ordinary course of business, no one of which is of material importance in relation to the business as a whole.

Seasonality

          Although the Company’s business is not seasonal in the traditional sense, historically revenues and earnings have been more concentrated in the fourth quarter of each year reflecting the tendency of customers to increase capital spending during such quarter and the Company’s efforts to close orders and reduce order backlogs. In addition, we offer annual distributor rebates and sales commissions which tend to drive sales in the fourth quarter.

Working Capital

          We fund our operations through a combination of cash and cash equivalents and cash flows from operations. Wherever possible, cash management is centralized and intercompany financing is used to provide working capital to subsidiaries as needed. In addition, our credit facilities are available for additional working capital needs or investment opportunities.

Major Customers

          The Company sells its products to a wide variety of customers, no one of which is of material importance in relation to the business as a whole. Our customer base includes several governmental entities; however, these customers generally have terms similar to our other customers.

Backlog

          The Company processes orders within two weeks on average. Therefore, no significant backlogs existed at December 31, 2007 or 2006.

Competition

          While there is no industry association or industry data, the Company believes, through its own market research, that it is a world-leading manufacturer of floor maintenance equipment. Significant competitors exist in all key geographic regions. However, the key competitors vary by region. The Company believes its market share exceeds that of several competitors in certain areas. The Company competes primarily on the basis of offering a broad line of high-quality, innovative products supported by an extensive sales and service network in major markets.

Product Research and Development

          The Company strives to be the industry leader in innovation and is committed to investing in research and development. The Company believes that it regularly commits an above-average amount of resources to product research and development. In 2007, 2006 and 2005, respectively, the Company spent $23.9 million, $21.9 million and $19.4 million on research and development activities relating to the development of new products and technologies and improvements of existing product design or manufacturing processes.

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Environmental Protection

          Compliance with federal, state and local provisions regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, has not had, and the Company does not expect it to have, a material effect upon the Company’s capital expenditures, earnings or competitive position.

Employment

          The Company employed 2,774 people in worldwide operations as of December 31, 2007.

Access to Information on the Company’s Website

          The Company makes available free of charge, through the Company’s website at www.tennantco.com, its Annual Reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or Section 15(d) of the Exchange Act as soon as reasonably practicable after such reports are filed electronically with, or furnished to, the Securities and Exchange Commission (“SEC”).

ITEM 1A – Risk Factors

          The following are significant factors known to us that could materially adversely affect our business, financial condition, or operating results. The risks described below are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

          If the United States economy or global economies slow down, the demand for our products could decrease and our revenue may be adversely affected.

          The demand for our products and services is dependent upon the overall success and general economic well-being of the U.S. and the foreign economies in which we conduct business. We are primarily susceptible to economic downturns in North America, Europe, the Middle East, Asia, Japan, Australia and Latin America. The global economy affects overall capital spending by businesses and consumers. An economic slowdown in the U.S. or abroad could result in a decrease in actual and projected spending on capital equipment. If, as a result of general economic uncertainty or otherwise, companies reduce their spending levels, such a decrease in spending could substantially reduce demand for our products and services and negatively impact our operating results.

          We may encounter difficulties obtaining raw materials or component parts needed to manufacture our products and the prices of these materials are subject to fluctuation.

          Raw materials and commodity-based components. As a manufacturer, our sales and profitability are dependent upon availability and cost of raw materials, which are subject to price fluctuations, and the ability to control or pass on an increase in costs of raw materials to our customers. We purchase raw materials, such as steel, rubber, lead and petroleum-based resins and components containing these commodities for use in our manufacturing operations. The availability of these raw materials is subject to market forces beyond our control. Under normal circumstances, these materials are generally available on the open market from a variety of sources. From time to time, however, the prices and availability of these raw materials and components fluctuate due to global market demands, which could impair our ability to procure necessary materials, or increase the cost of such materials. Inflationary and other increases in the costs of these raw materials and components have occurred in the past and may recur from time to time, and our performance depends in part on our ability to incorporate changes in costs into the selling prices for our products.

          Given the worldwide lead market conditions, we have experienced cost increases in our lead-based component parts. 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. We do not use derivative commodity instruments to manage our exposure to changes in commodity prices such as steel, oil, gas and lead. Any fluctuations in the supply or prices for any of these commodities could have a material adverse affect on our profit margins and financial condition.

          Single-source supply. We depend on many suppliers for the necessary parts to manufacture our products. However, there are some components that are purchased from a single supplier due to price, quality, technology or other business constraints. These components cannot be quickly or inexpensively re-sourced to another supplier. If we are unable to purchase on acceptable terms or experience significant delays or quality issues in the delivery of these necessary parts or components from a particular vendor and we needed to locate a new supplier for these parts and components, shipments for products impacted could be delayed which could have a material adverse affect on our business, financial condition and results of operations.

          We may consider acquisition of suitable candidates to accomplish our growth objectives. We may not be able to successfully integrate the businesses we acquire.

          We may consider, as part of our growth strategy, supplementing our organic growth through acquisitions of complementary businesses or products. We have engaged in acquisitions in the past and believe future acquisitions may provide meaningful opportunities to grow our business and improve profitability. Acquisitions allow us to enhance the breadth of our product offerings and expand the market and geographic participation of our products and services. However, our success in growing by acquisition is dependent upon identifying businesses to acquire and integrating the newly acquired businesses with our existing businesses. We may incur difficulties in the realignment and integration of business activities when assimilating the operations and products of an acquired business or in realizing projected efficiencies, cost savings, revenue synergies, and profit margins. Acquired businesses may not achieve the levels of revenue, profit or productivity or otherwise perform as expected. We are also subject to incurring unanticipated liabilities and contingencies associated with the acquired entity that are not identified or fully understood in the due diligence process. Current or future acquisitions may not be successful or accretive to earnings if the acquired businesses do not achieve expected financial results. In addition, we may record significant goodwill or other intangible assets in connection with an acquisition. We are required to perform impairment tests at least annually and whenever events indicate that the carrying value may not be recoverable from future cash flows. If we determine that any intangible asset values need to be written down to their fair values, this could result in a charge that may be material to our operating results and financial condition.

          Our strategic plans include international expansion. Our failure to meet the challenges associated with international expansion could adversely impact our ability to grow our business and our financial condition.

          We plan to continue international expansion of our sales and manufacturing operations, which will require significant management attention and financial resources. There are certain risks inherent in doing business in international markets. We must ensure compliance with the laws and regulations of foreign governmental and regulatory authorities of each country in which we conduct business. Our international operations could be adversely affected by changes in political and economic conditions, trade protection measures, restrictions on repatriation of earnings, or changes in regulatory requirements that restrict the sales of our products or increase our costs. We may encounter difficulties in collecting receivables, enforcing intellectual property rights, staffing and managing new foreign operations, achieving cost-reduction strategies because of, among other things, competitive conditions overseas, product acceptance in

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already established domestic markets, or certain cultural barriers. We may experience increased infrastructure costs including costs for legal, tax, accounting and information technology services. Failure of our products to succeed in the global marketplace could reduce our revenues and margins, thereby adversely impacting our financial condition, results of operations, and timing of our planned business expansion.

          Our inability to achieve certain planned operational efficiencies may adversely affect our strategic objectives, profit margins, and our earnings growth.

          As a manufacturing and service company operating with facilities, inventories, and workforce, our operations have been, and may continue to be, adversely affected by our ability to control costs and achieve planned operational efficiencies. We continuously endeavor to lower our cost structure through various savings measures, including lower-cost sourcing alternatives and consolidation of higher-cost manufacturing facilities. In support of this effort, we launched several corporate priorities in 2006 that focus on leveraging our global cost structure through consolidating our global manufacturing footprint, expansion in China, global sourcing, creating a lean enterprise and continuous process improvement. In connection with the manufacturing footprint consolidation, we completed our Minnesota plant consolidation and sold our Maple Grove, Minnesota facility in 2007. Through these initiatives, we expect to reduce product costs and improve operating efficiencies over the next three to five years. Our operating results may be adversely affected if we are unable to find lower-cost sources for our materials, shift production from higher-cost facilities, or cost-effectively manage our existing manufacturing facilities.

          We plan to continue our efforts to improve our performance through the adoption of lean manufacturing principles and focus on continous process improvement. It is our goal to become more efficient, better employ automation and thereby lower our operating costs. These initiatives will take some time to fully implement. Additionally, we may be unable to effectively complete the implementation of these initiatives or the impact of the initiatives may be less than expected, which could result in lower-than-expected financial results.

          We are subject to risks associated with developing innovative products and technologies, which could delay the timing and success of new product releases.

          Our products are sold in competitive markets throughout the world. Competition is based on product features and design, brand recognition, reliability, durability, technology, breadth of product offerings, price, customer relationships, and after-sale service. Although we believe that the performance and price characteristics of our products will provide competitive solutions for our customers’ needs, there can be no assurance that our customers will continue to choose our products over products offered by our competitors.

          The market for our products is characterized by changing technological and industry standards. Our product lines may be threatened by these new technologies or market demands for competitors’ products may reduce the value of our current product lines. Our success is based in part on our ability to develop innovative new products and services and bring them to market more quickly than our competitors. Our ability to compete successfully will depend on our ability to enhance and improve our existing products, to continue to bring innovative products to market in a timely fashion, to adapt our products to the needs and standards of our customers and potential customers, and to continue to improve operating efficiencies and lower manufacturing costs. Product development requires substantial investment by us. If our products, markets and services are not competitive, we may experience a decline in sales, pricing, and market share, which adversely impacts revenues, margin, and the success of our operations.

          We may not be able to adequately acquire, retain and protect our proprietary intellectual property rights which could put us at a competitive disadvantage.

          We rely on trade secret, copyright, trademark and patent laws and contractual protections to protect our proprietary technology and other proprietary rights. Our competitors may attempt to copy our products or gain access to our trade secrets. Notwithstanding the precautions we take to protect our intellectual property rights, it is possible that third parties may illegally copy or otherwise obtain and use our proprietary technology without our consent. Any litigation concerning infringement could result in substantial cost to us and diversions of our resources, either of which could adversely affect our business. In some cases, there may be no effective legal recourse against duplication of products or services by competitors. Intellectual property rights in foreign jurisdictions may be limited or unavailable. Patents of third parties also have an important bearing on our ability to offer some of our products and services. Our competitors may obtain patents related to the types of products and services we offer or plan to offer. Any infringement by us on intellectual property rights of others could result in litigation and adversely affect our ability to continue to provide, or could increase the cost of providing, our products and services.

          Our ability to effectively operate our Company could be adversely affected if we are unable to attract and retain key personnel and other highly skilled employees. 

          Our continued success will depend on, among other things, the skills and services of our executive officers and other key personnel. Our ability to attract and retain other highly qualified managerial, technical, manufacturing, research, sales and marketing personnel also impacts our ability to effectively operate our Company. Our senior management are employed at will and we cannot assure you that we will be able to attract and hire suitable replacements for any of our key employees. We believe the loss of a key executive officer or other key employee could have an adverse affect on our business, results of operations and financial condition.

          We are subject to risks associated with changes in foreign currency exchange rates.

          We are exposed to market risks from changes in foreign currency exchange rates. As a result of our increasing international presence, we have experienced an increase in transactions and balances denominated in currencies other than the U.S. dollar. There is a direct financial impact of foreign currency exchange when translating profits from local currencies to U.S. dollars. Our primary exposure is to transactions denominated in the Euro, Australian and Canadian dollar, British pound, Japanese yen and Chinese yuan. Any significant change in the value of the currencies of the countries in which we do business against the U.S. dollar could affect our ability to sell products competitively and control our cost structure. Because a substantial portion of our products are manufactured in the United States, a stronger U.S. dollar generally has a negative impact on results from operations outside the United States while a weaker dollar generally has a positive effect. Unfavorable changes in exchange rates between the U.S. dollar and these currencies impact the cost of our products sold internationally and could significantly reduce our reported sales and earnings. We periodically enter into 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. However, all foreign currency exposures cannot be fully hedged, and there can be no assurances that our future results of operations will not be adversely affected by currency fluctuation.

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          We are subject to product liability claims and product quality issues that could adversely affect our operating results or financial condition.

          Our business exposes us to potential product liability risks that are inherent in the design, manufacturing and distribution of our products. If product liability claims are brought against us for damages that are in excess of our insurance coverage or for uninsured liabilities and it is determined we are liable, our business could be adversely impacted. If products are used incorrectly by our customers, injury may result leading to product liability claims against us. Any losses we suffer from any liability claims, and the effect that any product liability litigation may have upon the reputation and marketability of our products, may have a negative impact on our business and operating results. Some of our products or product improvements may have defects or risks that we have not yet identified that may give rise to product quality issues, liability and warranty claims. We could experience a material design or manufacturing failure in our products, a quality system failure, other safety issues, or heightened regulatory scrutiny that could warrant a recall of some of our products. Any unforeseen product quality problems could result in loss of market share, reduced sales, and higher warranty expense.

          Environmental compliance costs and liabilities could increase our expenses and adversely affect our financial condition.

          Our manufacturing operations and our past and present ownership and operations of real property are subject to extensive and changing federal, state, and local environmental laws and regulations, as well as those of other countries pertaining to the handling or discharge of hazardous materials into the environment. We must conform our operations and properties to these laws and adapt to regulatory requirements in the countries in which we operate as these requirements change. We expect to continue to incur costs to comply with environmental laws and regulations. We may also be identified as a responsible party and be subject to liability relating to any investigation and clean-up of current or former properties that have been used for industrial purposes or the generation of hazardous substances in our operations. These laws and regulations can also result in the imposition of substantial fines and sanctions for violations, and could require the installation of costly pollution control equipment or operational changes to limit pollution emissions or decrease the likelihood of accidental hazardous substance releases. Imposition of new environmental laws and regulations, stricter enforcement of existing laws and regulations, or discovery of previously unknown contamination could require us to incur costs, or become the basis for new or increased liabilities, that could have a material adverse affect on our business, financial condition, or results of operations.

ITEM 1B – Unresolved Staff Comments

          None.

ITEM 2 – Properties

          The Company’s corporate offices are owned by the Company and are located in the Minneapolis, Minnesota, metropolitan area. Manufacturing facilities are located in Minnesota, Michigan, Uden, Northampton, United Kingdom and Shanghai, China. Sales offices, warehouse and storage facilities are leased in various locations in North America, Europe, Japan, Asia, Australia and Latin America. The Company’s facilities are in good operating condition, suitable for their respective uses and adequate for current needs. Further information regarding the Company’s property and lease commitments is included on pages 13 and 30 of this Annual Report on Form 10-K.

ITEM 3 – Legal Proceedings

          There are no material pending legal proceedings other than ordinary routine litigation incidental to the Company’s business.

ITEM 4 – Submission of Matters to a Vote of Security Holders

          No matters were submitted to a vote of security holders during the fourth quarter of 2007.

PART II

ITEM 5 – Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

          STOCK MARKET INFORMATION – Tennant common stock is traded on the New York Stock Exchange, under the ticker symbol TNC. As of January 31, 2008, there were approximately 600 shareholders of record and 7,700 beneficial shareholders. The common stock price was $32.99 per share on January 31, 2008.

          STOCK SPLIT – On April 26, 2006, the Board of Directors declared a two-for-one common stock split effective July 26, 2006. As a result of the stock split, shareholders of record received one additional common share for every share held at the close of business on July 12, 2006. All share and per share data has been retroactively adjusted to reflect the stock split, except for the Consolidated Statements of Shareholders’ Equity and Comprehensive Income in Item 8 of this Annual Report on Form 10-K.

          QUARTERLY PRICE RANGE – The accompanying chart shows the split-adjusted quarterly price range of the Company’s shares over the past two years:

          DIVIDEND INFORMATION – Cash dividends on Tennant’s common stock have been paid for 63 consecutive years. Tennant’s cash dividend payout increased for the 36^th consecutive year to $0.48 per share in 2007, an increase of $0.02 per share over 2006. Dividends generally are declared each quarter. The Company announced a cash dividend of $0.13 per share payable March 17, 2008, to shareholders of record on February 29, 2008. Following are the anticipated remaining record dates for 2008: May 30, 2008, August 29, 2008 and November 28, 2008.

          DIVIDEND REINVESTMENT OR DIRECT DEPOSIT OPTIONS – Shareholders have the option of reinvesting quarterly dividends in additional shares of Company stock or having dividends deposited directly to a bank account. The Transfer Agent should be contacted for additional information.

          TRANSFER AGENT AND REGISTRAR – Shareholders with a change of address or questions about their account may contact:

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          SHARE REPURCHASES – In November 2004, Tennant Company’s Board of Directors authorized the repurchase of 400,000 shares of our common stock under the share repurchase program approved by the Board of Directors in May 2001. In August 2006, the Board of Directors approved the adjustment of the number of shares then available for repurchase to reflect the impact of the two-for-one stock split. On May 3, 2007, the Board of Directors authorized the repurchase of 1,000,000 additional 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.

⁽¹⁾ Includes 1,630 shares delivered or attested to in satisfaction of the exercise price and/or tax withholding obligations by employees who exercised stock options or restricted stock under employee stock compensation plans.

          COMPARATIVE STOCK PERFORMANCE – The following graph compares the cumulative total shareholder return on the Common Stock of the Company for the last five fiscal years with the cumulative total return over the same period on the Overall Stock Market Performance Index (Hemscott Composite Index) and the Industry Index (Hemscott Group Index 62 – Industrial Goods, Manufacturing).

          This assumes an investment of $100 in the Company’s Common Stock, the Hemscott Composite Index and the Hemscott Group Index on December 31, 2002, with reinvestment of all dividends.

COMPARE 5-YEAR CUMULATIVE TOTAL RETURN
AMONG TENNANT COMPANY
HEMSCOTT COMPOSITE INDEX AND HEMSCOTT GROUP INDEX

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(1) 2007 includes restructuring charge and associated expenses of $2.5 million pretax ($1.7 million aftertax or $0.09 per diluted share), a one-time tax benefit relating to a reduction in valuation reserves, net of the impact of tax rate changes in foreign jurisdictions on deferred taxes of $3.6 million aftertax or $0.19 per diluted share and gain on sale of the Maple Grove, Minnesota facility of $6.0 million pretax ($3.7 million aftertax or $0.19 per diluted share). (2) 2004 includes workforce reduction expenses of $2,301 pretax ($1,458 aftertax or $0.08 per diluted share). (3) 2003 includes sales of $6,430, gross profit of $2,917 and aftertax earnings of $1,796 ($0.10 per diluted share) related to the recognition of previously deferred revenue resulting from the amendment of a contract and pretax charges of $1,960 ($1,215 net of taxes or $0.07 per diluted share) related to the dissolution of a joint venture.

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ITEM 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

          Tennant Company is a world leader in designing, manufacturing and marketing solutions that help create a cleaner, safer 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 primarily located in North America, Europe, Asia, Japan, Australia 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 solutions.

          Net earnings for 2007 were up 33.7% to $39.9 million, or $2.08 per diluted share. Record 2007 revenues of $664.2 million, up 10.9% over 2006, and efficiency gains drove operating profit improvement of 22.3% to $48.9 million, excluding the gain on the sale of our Maple Grove facility of $6.0 million pretax ($3.7 million after tax or $0.19 per diluted share). 2007 results also benefited from a lower effective tax rate resulting from net one-time tax benefits. These benefits were partially offset by the charge associated with the third quarter restructuring action.

          As previously disclosed, we completed the anticipated sale of our Maple Grove, Minnesota facility during the fourth quarter of 2007. All operations previously residing in this facility were integrated into our other North American facilities to enable greater efficiencies in conjunction with our manufacturing footprint consolidation initiative.

          A net tax benefit of $3.6 million, or $0.19 per diluted share was recognized in the third quarter of 2007. The benefit related to the reversal of a valuation allowance on foreign net operating loss carryforwards. This benefit was partially offset by the impact of tax rate changes in foreign jurisdictions on deferred taxes.

          Management approved a restructuring action during September 2007 in an effort to better match skill sets and talent in evolving functional areas that are critical to successful execution of strategic priorities as discussed in Note 2 to the Consolidated Financial Statements. These actions impacted approximately 60 positions within a workforce of 2,700, or about two percent of the employee base. The restructuring action resulted in the recognition of a pretax charge of $2.5 million or $0.09 per diluted share in 2007. These costs consist primarily of severance, outplacement benefits and recruiting expenses and are included within selling and administrative expenses in the Consolidated Statements of Earnings. These actions were substantially complete as of December 31, 2007.

          During 2006, we launched initiatives aimed at consolidating our global footprint, expanding our presence in China and establishing global sourcing capabilities. Through these initiatives, we expect to broaden our global sourcing capabilities, reduce product costs and improve operating efficiencies over the next three to five years.

          During 2007, in support of these strategic initiatives, we incurred approximately $4.2 million of costs. As we exit 2007, our North American manufacturing footprint consolidation initiative is complete. Our China facility is manufacturing two products for local and worldwide distribution, with another product platform ready for production in early 2008. Our global sourcing initiative contributed over $4.0 million in savings during 2007, allowing us to maintain our gross margin in 2007 despite rising material costs and investment in these initiatives. We also successfully doubled the percentage of materials and components sourced from low-cost regions from approximately 7-8% in 2006 to 14% in 2007.

          Tennant continues to invest in innovative product development, with 3.6% of net sales spent on research and development in 2007. We launched five new products which targeted all of our markets during 2007. Sales of new products introduced in the past three years generated approximately 35% our equipment sales during 2007, exceeding our target of 30%.

          In October 2007, we introduced a breakthrough new cleaning technology, ech₂o^TM that cleans using electrically activated tap water. We will begin global shipments of machines equipped with the ech₂o technology, which will initially be available on six walk-behind scrubbers, during the second quarter of 2008. In addition, we expect to launch 6 to 7 new products in 2008 that will take us into new market space and further enhance our product portfolio.

          We ended 2007 with a debt-to-capital ratio of 1.8% and $33.1 million in cash and cash equivalents. We generated operating cash flows of $39.6 million during 2007. Shareholders’ equity increased by 9.9% to $252.4 million, as compared to 2006. During 2007, we repurchased $29.0 million in Tennant stock under our share repurchase program.

          Current challenges facing Tennant include cost increases for raw materials and other purchased components due to rising commodity costs which are mitigated by selling price increases and cost reduction activities. We expect to continue to see volatility in commodity prices driving increases in our cost of commodity-based components in 2008.

          The relative strength or weakness of the global economies in 2008 may also impact demand for our products and services in the markets we serve. Tennant achieved solid performance during 2007 despite a softening in North American macro-economic indicators during the year. However, as both global and regional economies are unpredictable and somewhat volatile, we continue to monitor macro-economic indicators closely.

          Lastly, our results continue to be impacted by changes in value of the U.S. dollar primarily against the Euro, the Australian and Canadian dollars, the British pound, the Japanese yen and the Chinese yuan. To the extent the applicable exchange rates weaken relative to the U.S. dollar, the related direct foreign currency exchange effect would have an unfavorable impact on our 2008 results. If the applicable exchange rates strengthen relative to the U.S. dollar, our results would be favorably impacted.

Historical Results

          The following table compares the historical results of operations for the years ended December 31, 2007, 2006 and 2005 in dollars and as a percentage of net sales (in thousands, except per share amounts):

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Consolidated Financial Results

          In 2007, net earnings increased 33.7% to $39.9 million or $2.08 per diluted share. Net earnings were impacted by:

          In 2006, net earnings increased 30.0% to $29.8 million, or $1.57 per diluted share. Net earnings were impacted by:

          We use Economic Profit as a key indicator of financial performance and the primary metric for performance-based incentives. Economic Profit is based on our net operating profit after taxes less a charge for the net assets used in the business. The key drivers of net operating profit we focus on include net sales, gross margin and operating expenses. The key drivers we focus on to measure how effectively we utilize net assets in the business include “Accounts Receivable Days Sales Outstanding” (DSO), “Days Inventory on Hand” (DIOH) and capital expenditures. These key drivers are discussed in greater depth throughout Management’s Discussion and Analysis.

Net Sales

          In 2007, consolidated net sales of $664.2 million increased 10.9% from 2006. Consolidated net sales were $599.0 million in 2006, an increase of 8.3% from 2005. In 2007, growth was driven by increases in all geographic regions and all product categories. Growth in equipment sales was attributable to volume growth as well as price increases in all geographies. Organic volume growth in service, parts and consumables also contributed to the overall increase. Acquisitions contributed approximately $8.9 million, or approximately 1.5%, to net sales in 2007. Acquisitions contributed approximately $3.6 million, or approximately 0.6%, to net sales in 2006. Positive direct foreign currency exchange fluctuations increased net sales by approximately 3% and 1% in 2007 and 2006, respectively.

          The following table sets forth for the years indicated net sales by geography and the related percent change from the prior year (in thousands):

          North America – In 2007, North American net sales increased 6.8% to $417.8 million compared with $391.3 million in 2006. The primary drivers of the increase in net sales were price increases in all product categories and an increase in equipment volume within all sales channels. Shipment of several large non-recurring orders, primarily to national account customers, and continued success with new products were significant contributors to the growth in equipment volume in North America in 2007. Organic volume growth in service, parts and consumables sales also contributed to the increase.

          In 2006, North American net sales increased 5.7% to $391.3 million compared with $370.1 million in 2005. Growth in net sales was driven by volume increases in all product categories and price increases. Organic growth accounted for the volume increases in service, parts and consumables sales, while the volume growth in equipment sales was primarily driven by the continued success of new products. Growth in specialty surface coatings also contributed to the increase in North America net sales as compared to 2005.

          Europe – European net sales in 2007 increased 17.0% to $172.7 million compared to 2006 net sales of $147.7 million. Positive direct foreign currency exchange effects increased European net sales by approximately 10% in 2007. Our Hofmans and Floorep acquisitions contributed $7.4 million, or approximately 5% to Europe’s 2007 net sales. Europe’s organic base was essentially flat in 2007 when compared to 2006. Shipment of a large non-recurring order in 2006 for which a similar shipment did not occur in 2007 and lower sales of equipment in the United Kingdom offset volume growth from our Hofmans line of outdoor products during the second half of 2007 and benefits from price increases.

          European net sales in 2006 increased 16.3% to $147.7 million compared to 2005 net sales of $126.9 million. Growth in net sales was driven by increased demand in certain regions and new product sales as well as price increases. The acquisition of Hofmans in July 2006 contributed $3.6 million to Europe’s 2006 sales growth. Organic volume growth in service, parts and consumables also contributed to the overall increase in net sales. Positive direct foreign currency exchange effects increased European net sales by approximately 2% in 2006.

          Other International – Other International net sales in 2007 increased 22.9% to $73.8 million over 2006 net sales of $60.0 million. Growth in net sales was primarily driven by organic growth, resulting in part from expanded market coverage in Brazil and China as well as volume growth in Australia, Mexico and the Middle East. Price increases also contributed to the 2007 growth in net sales. Positive direct foreign currency exchange effects increased net sales in other international markets by approximately 4% in 2007.

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          Other International net sales in 2006 increased 7.5% to $60.0 million over 2005 net sales of $55.9 million. Growth in net sales was primarily driven by price increases, new product sales and expanded market coverage in China. Negative direct foreign currency exchange effects decreased net sales in other international markets by approximately 1% in 2006.

Gross Profit

          Gross profit margin was 42.0% in 2007, the same as in 2006. Price increases and cost reduction actions in 2007 nearly offset higher costs for raw materials and purchased components such as the high battery costs experienced during the year driven by increases in the cost of lead.

          We implemented a selling price surcharge during the fourth quarter on certain products including batteries and battery-operated equipment in North America. Price increases on similar products in Europe were implemented during the third quarter. The benefits from our global sourcing initiative along with these pricing actions allowed us to nearly fully mitigate the impact of rising material costs during 2007.

          Gross margins in 2007 were also impacted by positive direct foreign currency exchange effects and a favorable mix of products sold, which offset costs associated with our manufacturing footprint consolidation, China expansion and the integration of the Hofmans acquisition.

          Gross profit margin declined 0.5 percentage points to 42.0% in 2006 compared to 2005. Price increases taken earlier in the year and manufacturing cost reduction actions were not enough to offset higher material costs and expenses associated with the startup of our China facility and our manufacturing footprint consolidation.

          Future gross profit margins could continue to be impacted by fluctuations in the cost of raw materials and other product components, competitive market conditions, the mix of products both within and among product lines and geographies, and foreign currency exchange effects.

Operating Expenses

          Research and Development Expenses – Research and development expenses increased $1.9 million, or 8.8% in 2007 compared to 2006, and decreased 0.1 percentage points to 3.6% as a percentage of net sales in 2007. Research and development expenses increased $2.6 million, or 13.4%, in 2006 compared to 2005, and increased 0.2 percentage points to 3.7% as a percentage of net sales in 2006.

          We strive to be the industry leader in innovation and are committed to investing in research and development. We expect to maintain our spending on research and development at 3% to 4% of net sales annually in support of this commitment.

          Selling and Administrative Expenses – S&A expenses increased by $16.6 million, or 8.7%, in 2007 compared to 2006. S&A expenses included a $2.5 million charge for a restructuring action approved by management during the third quarter as discussed in Note 2 to the Consolidated Financial Statements. The charge consisted primarily of severance and outplacement benefits. The impact of foreign currency translation on S&A expenses was approximately $6.0 million in 2007. The remaining approximate 4% increase in S&A expenses was due in part to investments associated with expanding our international market coverage, the inclusion of expenses of acquired operations and recruiting expenses associated with filling restructured positions and other openings. Increased bad debt expense, benefit costs and depreciation expense also contributed to the increase in S&A expenses in comparison to 2006. Partially offsetting these increases was a decrease in performance-based compensation expenses and a reduction in warranty costs.

          As a percentage of net sales, S&A expenses declined 0.6 percentage points to 31.1%, as growth in net sales outpaced increases in S&A expenses, despite the inclusion of the restructuring charge, investments to grow the business and other cost increases.

          S&A expenses increased by $9.0 million, or 5.0%, in 2006 compared to 2005. S&A expenses increased in part due to general inflationary cost increases including salaries & wages, medical, travel and fuel costs. Increases in sales incentives and warranty expenses driven primarily by growth in net sales and higher levels of marketing expenses for new product launches also contributed to the increase in S&A expenses over the prior year. Additional costs due to the inclusion of expenses related to the acquired operations of Hofmans, costs to support expansion in China and international growth initiatives further increased our S&A expenses in comparison to 2005. Lastly, 2006 S&A expenses include the impact of recognizing stock option expense associated with the adoption of SFAS No. 123(R). As a percentage of net sales, S&A expenses declined 1.0 percentage point to 31.7%, as growth in net sales outpaced these cost increases.

          Gain on Sale of Facility – As discussed above, we completed the anticipated sale of our Maple Grove, Minnesota facility during the fourth quarter of 2007 for a net pretax gain of $6.0 million.

Interest Income, Net

          Interest income, net was $1.0 million in 2007, a decrease of $1.0 million from 2006. The decrease was a result of lower interest rates and lower average levels of cash, cash equivalents and short-term investments during 2007 compared to 2006.

          Interest income, net was $2.0 million in 2006, an increase of $0.8 million from 2005. The 2006 increase was primarily a result of higher interest rates and higher average levels of cash and cash equivalents invested.

Other Income (Expense), Net

          Total other income increased $0.5 million between 2007 and 2006.

          Net foreign currency exchange gains decreased $0.5 million between 2007 and 2006 due to fluctuations in foreign currency exchange rates.

          ESOP income increased $1.4 million between 2007 and 2006 due to a higher average stock price. The Company benefits from ESOP income when the shares held by the Company’s ESOP plan are utilized as the basis of those shares is lower than the current average stock price. This benefit will end when we issue the last of the shares held by the ESOP which is anticipated to occur on December 31, 2009.

          The change in other expense, net of $0.4 million between 2007 and 2006 was primarily due to an increase in discretionary contributions to Tennant’s charitable foundation.

          The $2.3 million change in other income (expense), net between 2006 and 2005 was primarily due to contributions made to the Tennant Foundation during 2005 that were not repeated in 2006, increased ESOP income due to a higher average stock price in 2006 than 2005 and fluctuations in foreign currency exchange rates.

Income Taxes

          Our effective income tax rate was 30.9%, 31.2% and 34.5% for the years 2007, 2006 and 2005, respectively. The decrease in the 2007 effective tax rate was substantially related to a favorable one-time tax benefit associated with the reversal of a valuation allowance, net of the impact of tax rate changes in foreign jurisdictions on deferred taxes. These items were partially offset by an increase in taxes due to the repeal of the extraterritorial income exclusion. In 2006 the decrease in the effective tax rate was substantially related to a refund from a state tax protective claim and the release of tax reserves accrued in prior years.

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          The third quarter of 2007 included a favorable one-time discrete item of $3.6 million related to the reversal of a German valuation allowance, net of the impact of tax rate changes in foreign jurisdictions on deferred taxes. During the third quarter of 2007 it was determined that it was now more likely than not that a tax loss carryforward in Germany will be utilized in the future and accordingly the valuation allowance on the related deferred tax asset was reduced to zero.

          During 2006 and 2005, we had a favorable impact from the Extraterritorial Income Exclusion Act (ETI Act), a U.S. tax law, of approximately 2% on our effective tax rate. On October 22, 2004, the American Jobs Creation Act of 2004 was signed into law, which phased out the ETI Act tax benefit during 2005 and 2006. In addition, the new law established a manufacturing deduction for profits on U.S. manufactured product to be phased in through 2010. For 2007, these changes resulted in an increase in our effective tax rate of slightly more than one percentage point. For 2008, we expect the change in the U.S. tax law will have a similar impact.

          We expect our effective tax rate in 2008 to be between 36.5% and 38.5%. This rate may vary based on changes in mix of taxable earnings by country and our ability to utilize the available foreign net operating loss carryforwards.

Liquidity and Capital Resources

          During 2007, our financial condition remained strong. Our debt-to-capital ratio was 1.8% as of December 31, 2007, compared with 1.6% as of December 31, 2006. Our capital structure was comprised of $2.1 million of current debt, $2.5 million of long-term debt and $252.4 million of shareholders’ equity as of December 31, 2007.

          As of December 31, 2007, we had an available committed line of credit totaling $125.0 million. We also had stand alone letters of credit of approximately $3.0 million outstanding as of December 31, 2007. There were no outstanding borrowings under these facilities and we were in compliance with all debt covenants as of December 31, 2007.

          On June 19, 2007, we entered into a credit agreement (the “Credit Agreement”) with JPMorgan Chase Bank, National Association, as administrative agent, Bank of America, N.A., as syndication agent, BMO Capital Markets Financing, Inc. and U.S. Bank National Association, as Co-Documentation Agents and the Lenders from time to time party thereto. The Credit Agreement provides us and certain of our foreign subsidiaries access to a $125.0 million senior unsecured revolving credit facility until June 19, 2012. Borrowings may be denominated in U.S. Dollars or certain other currencies. The Credit Agreement contained a $75.0 million sublimit on foreign currency borrowings and a $50.0 million sublimit on borrowings by the foreign subsidiaries. The agreement also contains an option which allows the Company to increase the commitment, in increments of $20.0 million, to a total of $225.0 million. Approval from the Board of Directors is required if the aggregate amount of the commitment exceeds $150.0 million. The facility is available for general corporate purposes, working capital needs, share repurchases and acquisitions.

          The fee for committed funds under the Credit Agreement ranges from an annual rate of 0.08% to 0.225%, depending on our leverage ratio. Borrowings under the Credit Agreement generally bear interest at an annual rate of, at our option, either (i) between LIBOR plus 0.32% to LIBOR plus 1.025%, depending on our leverage ratio, or (ii) the higher of (A) the prime rate or (B) the federal funds rate plus 0.50%.

          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. Further, the Credit Agreement contains a covenant requiring us to maintain an indebtedness to EBITDA ratio as of the end of each quarter of not greater than 3.5 to 1, and to maintain an EBITDA to interest expense ratio of no less than 3.5 to 1. The Credit Agreement also restricts us from paying dividends or repurchasing stock in an amount that exceeds $50.0 million during any fiscal year if, after giving effect to such payments, our leverage ratio would exceed 2.5 to 1. The company was in compliance with all such covenants at December 31, 2007.

          In February 2008, we completed the acquisition of one foreign-based company and announced that we had signed a purchase agreement to acquire a second foreign-based company. We used a combination of available cash and the Credit Agreement to fund the acquisition that closed and intend to use a combination of available cash and the Credit Agreement to fund the other acquisition which has not yet closed.

          On February 21, 2008, we amended the Credit Agreement to increase the sublimit on foreign currency borrowings from $75.0 million to the aggregate amount of the commitment and to increase the sublimit on borrowings by the foreign subsidiaries from $50.0 million to $100.0 million.

          On August 23, 2007, we entered into an unsecured revolving credit facility (the “Credit Facility”) with Bank of America, National Association which expires in August 2008. This Credit Facility is denominated in Renminbi (“RMB”) in the amount of 14.6 million RMB, or approximately $1.9 million U.S. Dollars, and is available for general corporate purposes, including working capital needs of our China location. The interest rate on borrowed funds is equal to the People’s Bank of China’s base rate. This facility also allows for the issuance of standby letters of credit, performance bonds and other similar instruments over the term of the facility for a fee of 0.95% of the amount issued. The balance outstanding on this facility was $0.2 million U.S. Dollars at December 31, 2007 at a rate of 6.21%.

          Cash and cash equivalents totaled $33.1 million at December 31, 2007, down 26.9% from $45.3 million of cash, cash equivalents and short-term investments as of December 31, 2006. We did not have any short-term investments as of December 31, 2007. Cash and cash equivalents held by our foreign subsidiaries totaled $3.8 million as of December 31, 2007 as compared to $6.7 million of cash and cash equivalents held by our foreign subsidiaries as of December 31, 2006. Wherever possible, cash management is centralized and intercompany financing is used to provide working capital to subsidiaries as needed. Our current ratio was 2.5 as of December 31, 2007 and 2006, based on working capital of $144.1 million and $140.6 million, respectively.

          If the global economy deteriorates, it could have an unfavorable impact on the demand for our products and, as a result, our operating cash flow. We believe that the combination of internally generated funds, present capital resources and available financing sources are more than sufficient to meet our cash requirements for 2008.

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          Our contractual cash obligations and commitments as of December 31, 2007, are summarized by period due in the following table (in thousands):