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TENNANT CO - Quarter Report: 2010 September (Form 10-Q)

form_10q.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 
FORM 10-Q

[ü]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2010
 OR
 
[   ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ___________ to __________
  
 
Commission File Number 1-16191

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

Minnesota
41-0572550
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)

701 North Lilac Drive
P.O. Box 1452
Minneapolis, Minnesota  55440
(Address of principal executive offices)
(Zip Code)
 
(763) 540-1200
(Registrant’s telephone number, including area code)
 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes
ü
No
 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
Yes
 
No
 
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer 
   
Accelerated filer
ü
Non-accelerated filer 
 
 (Do not check if a smaller reporting company)
Smaller reporting company
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes
 
No
ü
 
As of October 28, 2010, there were 18,990,233 shares of Common Stock outstanding.



 
 
 
 

TABLE OF CONTENTS

 PART I - FINANCIAL INFORMATION
Page
 
Item 1
Financial Statements (Unaudited)
3
     
Condensed Consolidated Statements of Operations
3
     
Condensed Consolidated Balance Sheets
4
     
Condensed Consolidated Statements of Cash Flows
5
     
Notes to the Condensed Consolidated Financial Statements
6
     
1
 
Basis of Presentation
6
     
2
 
Newly Adopted Accounting Pronouncements
6
     
3
 
Management Actions
6
     
4
 
Acquisitions
7
     
5
 
Inventories
7
     
6
 
Goodwill and Intangible Assets
7
     
7
 
Debt
8
     
8
 
Warranty
10
     
9
 
Fair Value Measurements
10
     
10
 
Retirement Benefit Plans
11
     
11
 
Comprehensive Income (Loss)
12
     
12
 
Commitments and Contingencies
12
     
13
 
Income Taxes
12
     
14
 
Stock-Based Compensation
13
     
15
 
Earnings (Loss) Per Share
13
     
16
 
Segment Reporting
13
     
17
 
Related Party Transactions
14
     
18
 
Subsequent Event
14
 
Item 2
Management's Discussion and Analysis of Financial Condition and Results of Operations
15
 
Item 3
Quantitative and Qualitative Disclosures About Market Risk
22
 
Item 4
Controls and Procedures
22
             
PART II - OTHER INFORMATION
 
 
Item 1
Legal Proceedings
23
 
Item 1A
Risk Factors
23
 
Item 2
Unregistered Sales of Equity Securities and Use of Proceeds
23
 
Item 6
Exhibits
   
24
 
Signatures
       
25



 
2

 

PART I – FINANCIAL INFORMATION

Item 1.  Financial Statements

TENNANT COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(In thousands, except shares and per share data)
 
   
Three Months Ended
   
Nine Months Ended
 
   
September 30
   
September 30
 
   
2010
   
2009
   
2010
   
2009
 
Net Sales
  $ 168,637     $ 154,427     $ 484,879     $ 431,651  
Cost of Sales
    96,775       89,539       277,715       253,939  
Gross Profit
    71,862       64,888       207,164       177,712  
Operating Expense:
                               
Research and Development Expense
    7,114       5,466       19,058       16,837  
Selling and Administrative Expense
    54,227       51,800       160,463       146,271  
Goodwill Impairment Charge
    -       -       -       43,363  
Total Operating Expense
    61,341       57,266       179,521       206,471  
Profit (Loss) from Operations
    10,521       7,622       27,643       (28,759 )
Other Income (Expense):
                               
Interest Income
    52       96       129       301  
Interest Expense
    (390 )     (726 )     (1,219 )     (2,290 )
Net Foreign Currency Transaction Gains (Losses)
    130       353       (432 )     145  
ESOP Income
    -       252       -       740  
Other Income (Expense), Net
    57       21       115       (27 )
Total Other Expense, Net
    (151 )     (4 )     (1,407 )     (1,131 )
                                 
Profit (Loss) Before Income Taxes
    10,370       7,618       26,236       (29,890 )
Income Tax Expense
    2,844       1,835       8,445       3,066  
Net Earnings (Loss)
  $ 7,526     $ 5,783     $ 17,791     $ (32,956 )
                                 
Earnings (Loss) per Share:
                         
Basic
  $ 0.40     $ 0.31     $ 0.95     $ (1.78 )
Diluted
  $ 0.39     $ 0.31     $ 0.92     $ (1.78 )
                                 
Weighted Average Shares Outstanding:
                 
Basic
    18,873,249       18,591,713       18,782,404       18,466,989  
Diluted
    19,402,902       18,954,008       19,299,783       18,466,989  
                                 
Cash Dividend Declared per Common Share
  $ 0.14     $ 0.13     $ 0.42     $ 0.39  
 
See accompanying Notes to the Condensed Consolidated Financial Statements.

 
3

 

TENNANT COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(In thousands, except shares and per share data)

    September 30,    
December 31,
 
   
2010
   
2009
 
ASSETS
           
Current Assets:
           
Cash and Cash Equivalents
  $ 33,730     $ 18,062  
Accounts Receivable, less Allowances of $5,568 and $5,077, respectively
    114,603       121,203  
Inventories
    68,541       56,646  
Prepaid Expenses
    8,433       10,295  
Deferred Income Taxes, Current Portion
    9,988       9,362  
Other Current Assets
    33       344  
Total Current Assets
    235,328       215,912  
Property, Plant and Equipment
    286,355       287,915  
Accumulated Depreciation
    (198,768 )     (190,698 )
Property, Plant and Equipment, Net
    87,587       97,217  
Deferred Income Taxes, Long-Term Portion
    6,511       7,911  
Goodwill
    20,221       20,181  
Intangible Assets, Net
    26,231       29,243  
Other Assets
    7,569       7,262  
Total Assets
  $ 383,447     $ 377,726  
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
Current Liabilities:
               
Current Portion of Long-Term Debt
  $ 4,066     $ 4,012  
Short-Term Borrowings
    -       7  
Accounts Payable
    44,494       42,658  
Employee Compensation and Benefits
    28,434       28,092  
Income Taxes Payable
    969       3,982  
Other Current Liabilities
    35,498       37,401  
Total Current Liabilities
    113,461       116,152  
Long-Term Liabilities:
               
Long-Term Debt
    27,685       30,192  
Employee-Related Benefits
    30,991       31,848  
Deferred Income Taxes, Long-Term Portion
    4,665       7,417  
Other Liabilities
    7,156       7,838  
Total Long-Term Liabilities
    70,497       77,295  
Total Liabilities
    183,958       193,447  
Commitments and Contingencies (Note 12)
               
                 
Shareholders' Equity:
               
Preferred Stock, $0.02 par value; 1,000,000 shares authorized; no shares issued or outstanding
    -       -  
Common Stock, $0.375 par value; 60,000,000 shares authorized; 18,945,500 and 18,750,828 shares issued and outstanding, respectively
    7,105       7,032  
Additional Paid-In Capital
    9,878       7,772  
Retained Earnings
    204,647       192,584  
Accumulated Other Comprehensive Loss
    (22,141 )     (23,109 )
Total Shareholders’ Equity
    199,489       184,279  
Total Liabilities and Shareholders’ Equity
  $ 383,447     $ 377,726  
 
See accompanying Notes to the Condensed Consolidated Financial Statements.

 
4

 

TENNANT COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In thousands)

   
Nine Months Ended
 
   
September 30
 
   
2010
   
2009
 
OPERATING ACTIVITIES
           
Net Earnings (Loss)
  $ 17,791     $ (32,956 )
Adjustments to Net Earnings (Loss) to Arrive at Operating Cash Flow:
               
Depreciation
    13,668       14,765  
Amortization
    2,356       2,409  
Deferred Tax (Benefit) Expense
    (2,119 )     1,384  
Goodwill Impairment Charge
    -       43,363  
Stock-Based Compensation Expense
    2,064       1,416  
ESOP Expense
    -       219  
Tax Benefit on ESOP
    -       6  
Allowance for Doubtful Accounts and Returns
    1,206       965  
Other, Net
    (3 )     130  
Changes in Operating Assets and Liabilities, Excluding the Impact of Acquisitions:
               
Accounts Receivable
    4,486       8,454  
Inventories
    (12,561 )     6,433  
Accounts Payable
    2,620       11,679  
Employee Compensation and Benefits
    96       1,717  
Other Current Liabilities
    1,167       (5,808 )
Income Taxes Payable/Prepaid
    (339 )     6,738  
Other Assets and Liabilities
    (248 )     (2,494 )
Net Cash Provided by Operating Activities
    30,184       58,420  
INVESTING ACTIVITIES
               
Purchases of Property, Plant and Equipment
    (6,651 )     (8,830 )
Proceeds from Disposals of Property, Plant and Equipment
    566       287  
Acquisition of Businesses, Net of Cash Acquired
    (26 )     (2,162 )
Net Cash Used for Investing Activities
    (6,111 )     (10,705 )
FINANCING ACTIVITIES
               
Change in Short-Term Borrowings, Net
    (7 )     353  
Payment of Long-Term Debt
    (3,194 )     (56,522 )
Purchases of Common Stock
    (3,153 )     -  
Proceeds from Issuance of Common Stock
    4,707       333  
Tax Benefit on Stock Plans
    1,281       11  
Dividends Paid
    (7,950 )     (7,238 )
Net Cash Used for Financing Activities
    (8,316 )     (63,063 )
                 
Effect of Exchange Rate Changes on Cash and Cash Equivalents
    (89 )     1  
Net Increase (Decrease) in Cash and Cash Equivalents
    15,668       (15,347 )
Cash and Cash Equivalents at Beginning of Period
    18,062       29,285  
Cash and Cash Equivalents at End of Period
  $ 33,730     $ 13,938  
SUPPLEMENTAL CASH FLOW INFORMATION
               
Cash Paid (Received) During the Period for:
               
Income Taxes
  $ 9,872     $ (5,355 )
Interest
  $ 1,143     $ 2,092  
Supplemental Non-cash Investing and Financing Activities:
               
Capital Expenditures Funded Through Capital Leases
  $ 2,599     $ 2,703  
Collateralized Borrowings Incurred for Operating Lease Equipment
  $ 582     $ 1,564  

See accompanying Notes to the Condensed Consolidated Financial Statements.

 
5

 
TENNANT COMPANY
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(In thousands, except shares and per share data)

1.     
Basis of Presentation

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.

2.     
Newly Adopted Accounting Pronouncements

Fair Value Measurements and Disclosures

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.

3.     
Management Actions

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:
 
   
Severance, Early Retirement and Related Costs
 
2008 workforce reduction action
  $ 14,261  
Cash payments
    (355 )
Foreign currency adjustments
    5  
Balance as of December 31, 2008
    13,911  
Cash payments
    (11,206 )
Foreign currency adjustments
    (56 )
Adjustment of accrual
    (2,003 )
Balance as of December 31, 2009
    646  
Cash payments
    (29 )
Foreign currency adjustments
    (45 )
Adjustment of accrual
    (73 )
Balance as of September 30, 2010
  $ 499  
 
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.
 
 
6

 
TENNANT COMPANY
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(In thousands, except shares and per share data)

4.     
Acquisitions

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:
 
Current Assets
  $ 339  
Identified Intangible Assets
    203  
Total Assets Acquired
    542  
Current Liabilities
    158  
Total Liabilities Assumed
    158  
Net Assets Acquired
  $ 384  
 
5.     
Inventories

Inventories are valued at the lower of cost or market. Inventories at September 30, 2010 and December 31, 2009 consisted of the following:
 
   
September 30,
   
December 31,
 
   
2010
   
2009
 
Inventories carried at LIFO:
           
Finished goods
  $ 42,636     $ 36,528  
Raw materials, production parts and work-in-process
    17,433       16,210  
LIFO reserve
    (28,873 )     (28,873 )
Total LIFO inventories
    31,196       23,865  
                 
Inventories carried at FIFO:
               
Finished goods
    17,984       17,063  
Raw materials, production parts and work-in-process
    19,361       15,718  
Total FIFO inventories
    37,345       32,781  
Total inventories
  $ 68,541     $ 56,646  

The LIFO reserve approximates the difference between LIFO carrying cost and FIFO.

6.     
Goodwill and Intangible Assets

The changes in the carrying value of Goodwill for the nine months ended September 30, 2010 are as follows:
 
         
Accumulated
       
         
Impairment
       
   
Goodwill
   
Losses
   
Total
 
Balance as of December 31, 2009
  $ 68,706     $ (48,525 )   $ 20,181  
Adjustments
    (177 )     -       (177 )
Foreign currency fluctuations
    (1,297 )     1,514       217  
Balance as of September 30, 2010
  $ 67,232     $ (47,011 )   $ 20,221  

 
7

 
TENNANT COMPANY
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(In thousands, except shares and per share data)

The balances of acquired Intangible Assets, excluding Goodwill, are as follows:
 
     Customer Lists                  
   
and
   
Trade
             
   
Service Contracts
   
Name
   
Technology
   
Total
 
Balance as of September 30, 2010:
                       
Original cost
  $ 26,654     $ 4,790     $ 3,509     $ 34,953  
Accumulated amortization
    (6,725 )     (830 )     (1,167 )     (8,722 )
Carrying value
  $ 19,929     $ 3,960     $ 2,342     $ 26,231  
Weighted-average original life (in years)
    14       14       11          
                                 
Balance as of December 31, 2009:
                               
Original cost
  $ 27,018     $ 4,999     $ 3,684     $ 35,701  
Accumulated amortization
    (4,911 )     (594 )     (953 )     (6,458 )
Carrying value
  $ 22,107     $ 4,405     $ 2,731     $ 29,243  
Weighted-average original life (in years)
    14       14       11          

The net adjustment to Goodwill during the first nine months of 2010 was a result of recording a portion of the Shanghai ShenTan Mechanical and Electrical Equipment Co. Ltd. earn-out, offset by the finalization of the valuation of the customer list acquired with the Applied Cleansing acquisition. The Applied Cleansing customer list has a useful life of 8 years.

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:
 
Remaining 2010
  $ 773  
2011
    3,090  
2012
    2,573  
2013
    2,452  
2014
    2,307  
Thereafter
    15,036  
Total
  $ 26,231  
 
7.     
Debt

Debt outstanding is summarized as follows:
 
   
September 30,
   
December 31,
 
   
2010
   
2009
 
Short-Term Borrowings:
           
Bank borrowings
  $ -     $ 7  
Long-Term Debt:
               
Bank borrowings
  $ 138     $ 174  
Credit facility borrowings
    25,000       25,000  
Collateralized borrowings
    582       1,342  
Capital lease obligations
    6,031       7,688  
Total Long-Term Debt
    31,751       34,204  
Less: current portion
    4,066       4,012  
Long-Term Portion
  $ 27,685     $ 30,192  
 
 
8

 
TENNANT COMPANY
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(In thousands, except shares and per share data)

As of September 30, 2010, we had committed lines of credit totaling $132,022 and uncommitted lines of credit totaling $80,000. There was $25,000 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 $1,937 outstanding and bank guarantees in the amount of $962. Commitment fees on unused lines of credit for the nine months ended September 30, 2010 were $284.
 
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.

Credit Facilities

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.
 

 
9

 
TENNANT COMPANY
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(In thousands, except shares and per share data)

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.

8.     
Warranty

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:
 
   
Nine Months Ended
 
   
September 30
 
   
2010
   
2009
 
Beginning balance
  $ 5,985     $ 6,018  
Additions charged to expense
    7,668       5,677  
Acquired liabilities
    -       17  
Foreign currency fluctuations
    (162 )     101  
Claims paid
    (6,653 )     (6,055 )
Ending balance
  $ 6,838     $ 5,758  
 
9.     
Fair Value Measurements
 
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:
 
§  
Level 1: Observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities.
 
§  
Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.
 
§  
Level 3: Unobservable inputs that reflect the reporting entity’s own assumptions.

Our population of assets and liabilities subject to fair value measurements at September 30, 2010 are as follows:
 
   
Fair
                   
Valuation
   
Value
   
Level 1
   
Level 2
   
Level 3
 
Technique
Assets:
                         
Applied Cleansing customer list
  $ 203     $ -     $ -     $ 203  
(a)
Foreign currency forward exchange contracts
    33       -       33       -  
(b)
Total Assets
  $ 236     $ -     $ 33     $ 203    
Liabilities:
                                 
Foreign currency forward exchange contracts
  $ 207     $ -     $ 207     $ -  
(b)
Total Liabilities
  $ 207     $ -     $ 207     $ -    
 
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:
 
(a)  
We used an internally developed discounted cash flow valuation model to value the Applied Cleansing customer list due to the relatively small value of this acquired intangible asset. Inputs for this valuation model were based on internally developed forecasts and assumptions.
 
10

 
TENNANT COMPANY
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(In thousands, except shares and per share data)

(b)  
Our foreign currency forward exchange contracts are valued based on quoted forward foreign exchange prices at the reporting date.
 
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 amounts 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.

10.  
Retirement Benefit Plans

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:
 
   
Three Months Ended
 
   
September 30
 
   
Pension Benefits
   
Postretirement
 
   
U.S. Plans
   
Non-U.S. Plans
   
Medical Benefits
 
   
2010
   
2009
   
2010
   
2009
   
2010
   
2009
 
Service cost
  $ 165     $ 162     $ 13     $ 10     $ 30     $ 35  
Interest cost
    508       529       52       45       171       214  
Expected return on plan assets
    (586 )     (692 )     (36 )     (26 )     -       -  
Amortization of net actuarial loss (gain)
    5       (38 )     -       -       -       -  
Amortization of transition asset
    -       (5 )     -       -       -       -  
Amortization of prior service cost
    138       139       -       -       (145 )     (145 )
Foreign currency
    -       -       95       23       -       -  
Net periodic cost
  $ 230     $ 95     $ 124     $ 52     $ 56     $ 104  
 
   
Nine Months Ended
 
   
September 30
 
   
Pension Benefits
   
Postretirement
 
   
U.S. Plans
   
Non-U.S. Plans
   
Medical Benefits
 
    2010     2009     2010     2009     2010     2009  
Service cost
  $ 493     $ 486     $ 40     $ 30     $ 91     $ 106  
Interest cost
    1,524       1,587       157       140       511       640  
Expected return on plan assets
    (1,755 )     (2,074 )     (109 )     (81 )     -       -  
Amortization of net actuarial loss (gain)
    16       (114 )     -       -       -       -  
Amortization of transition asset
    -       (15 )     -       -       -       -  
Amortization of prior service cost
    415       416       -       -       (435 )     (435 )
Foreign currency
    -       -       (42 )     42       -       -  
Net periodic cost
  $ 693     $ 286     $ 46     $ 131     $ 167     $ 311  


 
11

 
TENNANT COMPANY
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(In thousands, except shares and per share data)

11.  
Comprehensive Income (Loss)

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:
 
   
Three Months Ended
   
Nine Months Ended
 
   
September 30
   
September 30
 
   
2010
   
2009
   
2010
   
2009
 
Net Earnings (Loss)
  $ 7,526     $ 5,783     $ 17,791     $ (32,956 )
Foreign currency translation adjustments
    4,797       1,725       (1,173 )     5,324  
Pension adjustments
    (1 )     (49 )     2,141       168  
Comprehensive Income (Loss)
  $ 12,322     $ 7,459     $ 18,759     $ (27,464 )
 
12.  
Commitments and Contingencies

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.

13.  
Income Taxes

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.


 
12

 
TENNANT COMPANY
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(In thousands, except shares and per share data)
 
14.  
Stock-Based Compensation

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

   
Nine Months Ended
 
   
September 30
 
   
2010
   
2009
 
Stock options and stock appreciation rights
  $ 1,329     $ 643  
Restricted share awards
    634       629  
Share-based liabilities
    101       144  
Total Stock-Based Compensation Expense
  $ 2,064     $ 1,416  

During the first nine months of 2010 we granted 39,515 restricted shares. The weighted average grant date fair value of each share awarded was $28.85. Restricted share awards typically have a two or three year vesting period from the effective date of grant. The total fair value of shares vested during the nine months ended September 30, 2010 and 2009 was $131 and $545, respectively.

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.

15.  
Earnings (Loss) Per Share

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

   
Three Months Ended
   
Nine Months Ended
 
   
September 30
   
September 30
 
   
2010
   
2009
   
2010
   
2009
 
Numerator:
                       
Net Earnings (Loss)
  $ 7,526     $ 5,783     $ 17,791     $ (32,956 )
Denominator:
                               
Basic - Weighted Average Shares Outstanding
    18,873,249       18,591,713       18,782,404       18,466,989  
Effect of dilutive securities:
                               
Employee stock options
    529,653       362,295       517,379       -  
Diluted - Weighted Average Shares Outstanding
    19,402,902       18,954,008       19,299,783       18,466,989  
Basic Earnings (Loss) per Share
  $ 0.40     $ 0.31     $ 0.95     $ (1.78 )
Diluted Earnings (Loss) per Share
  $ 0.39     $ 0.31     $ 0.92     $ (1.78 )

Excluded from the dilutive securities shown above were options to purchase 299,799 and 161,057 shares of Common Stock during the three months ended September 30, 2010 and 2009, respectively. Excluded from the dilutive securities shown above were options to purchase 247,759 and 528,526 shares of Common Stock during the nine months ended September 30, 2010 and 2009, respectively. These exclusions are made if the exercise prices of these options are greater than the average market price of our Common Stock for the period, if the number of shares we can repurchase exceeds the weighted shares outstanding in the options, or if we have a net loss, as the effects are anti-dilutive.

16.  
Segment Reporting

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.
 
 
13

 
TENNANT COMPANY
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(In thousands, except shares and per share data)
 
The following table sets forth Net Sales by geographic area (net of intercompany sales):
 
   
Three Months Ended
   
Nine Months Ended
 
   
September 30
   
September 30
 
   
2010
   
2009
   
2010
   
2009
 
Americas
  $ 111,756     $ 95,957     $ 312,023     $ 264,887  
Europe, Middle East, Africa
    38,746       45,192       123,330       131,823  
Asia Pacific
    18,135       13,278       49,526       34,941  
Total
  $ 168,637     $ 154,427     $ 484,879     $ 431,651  
 
17.  
Related Party Transactions

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.

18.  
Subsequent Event

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.

 
14

 

Item 2.  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, 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 (“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):
 
   
Three Months Ended
   
Nine Months Ended
 
   
September 30
   
September 30
 
   
2010
   
%
   
2009
   
%
   
2010
   
%
   
2009
   
%
 
Net Sales
  $ 168,637       100.0     $ 154,427       100.0     $ 484,879       100.0     $ 431,651       100.0  
Cost of Sales
    96,775       57.4       89,539       58.0       277,715       57.3       253,939       58.8  
Gross Profit
    71,862       42.6       64,888       42.0       207,164       42.7       177,712       41.2  
Operating Expense:
                                                               
Research and Development Expense
    7,114       4.2       5,466       3.5       19,058       3.9       16,837       3.9  
Selling and Administrative Expense
    54,227       32.2       51,800       33.5       160,463       33.1       146,271       33.9  
Goodwill Impairment Charge
    -       -       -       -       -       -       43,363       10.0  
Total Operating Expense
    61,341       36.4       57,266       37.1       179,521       37.0       206,471       47.8  
Profit (Loss) from Operations
    10,521       6.2       7,622       4.9       27,643       5.7       (28,759 )     (6.7 )
Other Income (Expense):
                                                               
Interest Income
    52       -       96       0.1       129       -       301       0.1  
Interest Expense
    (390 )     (0.2 )     (726 )     (0.5 )     (1,219 )     (0.3 )     (2,290 )     (0.5 )
Net Foreign Currency Transaction Gains (Losses)
    130       0.1       353       0.2       (432 )     (0.1 )     145       -  
ESOP Income
    -       -       252       0.2       -       -       740       0.2  
Other Income (Expense), Net
    57       -       21       -       115       -       (27 )     -  
Total Other Expense, Net
    (151 )     (0.1 )     (4 )     -       (1,407 )     (0.3 )     (1,131 )     (0.3 )
                                                                 
Profit (Loss) Before Income Taxes
    10,370       6.1       7,618       4.9       26,236       5.4       (29,890 )     (6.9 )
Income Tax Expense
    2,844       1.7       1,835       1.2       8,445       1.7       3,066       0.7  
Net Earnings (Loss)
  $ 7,526       4.5     $ 5,783       3.7     $ 17,791       3.7     $ (32,956 )     (7.6 )
Earnings (Loss) per Diluted Share
  $ 0.39             $ 0.31             $ 0.92             $ (1.78 )        

 
15

 
 
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:

   
% Change as Compared to 2009
   
Three Months Ended
 
Nine Months Ended
Growth Elements
September 30, 2010
 
September 30, 2010
Organic Growth:
     
 
Volume
10.7%
 
11.3%
 
Price
-
 
-
Organic Growth
10.7%
 
11.3%
Foreign Currency
(1.5%)
 
1.0%
 
Total
9.2%
 
12.3%

The 9.2% increase in consolidated Net Sales in the third quarter of 2010 as compared to 2009 was primarily driven by:
 
 
·    an organic sales increase of approximately 10.7%, excluding the effects of acquisitions and foreign currency exchange, due to volume growth in equipment sales; partially offset
 
·    an unfavorable direct foreign currency exchange impact of approximately 1.5%.

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

 
·    an organic sales increase of approximately 11.3% due to an increase in equipment unit volume; and
 
·    a favorable direct foreign currency exchange impact of approximately 1.0%.

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):
 
   
Three Months Ended
   
Nine Months Ended
 
   
September 30
   
September 30
 
   
2010
   
2009
   
%
   
2010
   
2009
   
%
 
Americas
  $ 111,756     $ 95,957       16.5     $ 312,023     $ 264,887       17.8  
Europe, Middle East and Africa
    38,746       45,192       (14.3 )     123,330       131,823       (6.4 )
Asia Pacific
    18,135       13,278       36.6       49,526       34,941       41.7  
Total
  $ 168,637     $ 154,427       9.2     $ 484,879     $ 431,651       12.3  
 
Americas

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.

Europe, Middle East and Africa

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
 
 
16

 
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%.

Asia Pacific

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 & Development 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 & Administrative Expense

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.

Goodwill Impairment Charge

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.


 
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Other Income (Expense), Net
 
Interest Income
 
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
 
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 (Losses)
 
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.
 
ESOP Income
 
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.
 
Other Income (Expense), Net
 
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 tax 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.
 
Liquidity and Capital Resources

Liquidity

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.

 
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Cash Flow Summary

Cash provided by (used for) our operating, investing and financing activities is summarized as follows (dollars in thousands):
 
   
Nine Months Ended
 
   
September 30
 
   
2010
   
2009
 
Operating Activities
  $ 30,184     $ 58,420  
Investing Activities:
               
Purchases of Property, Plant and Equipment, Net of Disposals
    (6,085 )     (8,543 )
Acquisitions of Businesses, Net of Cash Acquired
    (26 )     (2,162 )
Financing Activities
    (8,316 )     (63,063 )
Effect of Exchange Rate Changes on Cash and Cash Equivalents
    (89 )     1  
Net Increase (Decrease) in Cash and Cash Equivalents
  $ 15,668     $ (15,347 )
 
Operating Activities

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):
 
   
September 30, 2010
 
December 31, 2009
 
September 30, 2009
DSO
 
62
 
67
 
66
DIOH
 
91
 
87
 
94
 
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

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
 
 
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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.

Financing Activities

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.

Indebtedness

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
 
 
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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.
 
Contractual Obligations

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

Multiple-Deliverable Revenue Arrangements

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.

Fair Value Measurements and Disclosures

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 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.

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.
 
 
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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.
 
Item 3.  Quantitative and Qualitative Disclosures About Market Risk

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.

Item 4.  Controls and Procedures

Disclosure Controls and Procedures
 
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.
 
Changes in Internal Controls

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


 
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PART II – OTHER INFORMATION

Item 1.  Legal Proceedings

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

Item 1A.  Risk Factors

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

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

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.
 
             
Total Number of
   
               Shares Purchased  
     Total Number      as Part of Publicly  
Maximum Number of
For the Quarter Ended
 
of Shares
 
Average Price
 
Announced Plans
 
Shares that May Yet
September 30, 2010
 
Purchased (1)
 
Paid Per Share
 
or Programs
 
Be Purchased
July 1 - 31, 2010
 
                 9
   
 $                33.82
 
                     -
   
                      288,874
August 1 - 31, 2010
 
       30,644
   
                   32.38
 
            30,005
   
                      258,869
September 1 - 30, 2010
 
       70,061
   
                   31.19
 
            69,995
   
                      188,874
Total
 
     100,714
   
 $                31.55
 
          100,000
   
                      188,874

(1) Includes 714 shares delivered or attested to in satisfaction of the exercise price and/or withholding obligations by employees who exercised stock options or had restricted stock vest under employee compensation plans.







 
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Item 6.  Exhibits

Exhibits

Item #
 
Description
 
Method of Filing
3i
 
Restated Articles of Incorporation
 
Incorporated by reference to Exhibit 3i to the Company’s report on Form 10-Q for the quarterly period ended September 30, 2006.
3ii
 
Certificate of Designation
 
Incorporated by reference to Exhibit 3.1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.
3iii
 
Amended and Restated By-Laws
 
Incorporated by reference to Exhibit 4(c) to the Company’s Registration Statement on Form S-3, Registration No. 333-160887 filed on July 30, 2009.
31.1
 
Rule 13a-14(a)/15d-14(a) Certification of CEO
 
Filed herewith electronically.
31.2
 
Rule 13a-14(a)/15d-14(a) Certification of CFO
 
Filed herewith electronically.
32.1
 
Section 1350 Certification of CEO
 
Filed herewith electronically.
32.2
 
Section 1350 Certification of CFO
 
Filed herewith electronically.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 
       
TENNANT COMPANY
         
Date:
 
November 2 , 2010
 
/s/   H. Chris Killingstad
       
H. Chris Killingstad
President and Chief Executive Officer
         
Date:
 
November 2, 2010
 
/s/   Thomas Paulson
       
Thomas Paulson
Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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