Overview

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

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

Net earnings for the third quarter of 2008 were $14.0 million, or $0.76 per diluted share, up 27.5% compared to $11.0 million in the third quarter of 2007. Net earnings in the third quarter of 2008 were favorably impacted by growth in net sales of 15.3% and a 80 basis point improvement in gross margins. S&A expense as a percentage of sales was 130 basis points lower in the third quarter of 2008 compared to same quarter last year. The improvement as a percentage of sales in the third quarter of 2008 is primarily due to a 2007 third quarter restructuring charge as well as cost control actions put in place earlier in 2008.

The 2007 third quarter included the recognition of a pretax restructuring charge of $1.7 million ($1.2 million after-tax or $0.06 per diluted share). Management approved the 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 3 to the Consolidated Financial Statements. This action impacted approximately 60 positions within a workforce of 2,700, or about two percent of the employee base. The charge consisted primarily of severance, outplacement benefits and recruiting expenses and was included within Selling and Administrative Expense in the Consolidated Statements of Earnings.

The 2008 third quarter included a $2.7 million net foreign currency gain from the settlement of forward contracts related to a British Pound denominated loan, adding $0.09 per diluted share to earnings.

Benefits from discrete tax items primarily related to U.S. Federal tax settlements added $0.10 per diluted share to earnings in the third quarter of 2008. A net tax benefit of $0.19 per diluted share was also recognized in the third quarter of 2007. The benefit related to the reversal of a tax valuation allowance on foreign net operating loss carryforwards and was partially offset by the impact of tax rate changes in foreign jurisdictions on deferred taxes.

The total net effect of unusual items including the $0.09 per diluted share net foreign currency gain and the net tax benefit of $0.10 per diluted share was a positive $0.19 per diluted share in the third quarter of 2008. For the third quarter of 2007, the net effect of unusual items including the $0.06 per diluted share restructuring charge and net tax benefit of $0.19 per diluted share was a positive $0.13 per diluted share.

The third quarter of 2008 also included dilution of $0.01 per diluted share from the acquisitions of Applied and Alfa.

Net earnings for the nine months ended September 30, 2008 increased 0.9% to $27.5 million, or $1.48 per diluted share, compared to $27.3 million in the first nine months of 2007. Net earnings in the first nine months of 2008 were favorably impacted by growth in net sales of 13.8%. Gross margins were relatively flat in the first nine months of 2008 and 2007 at 42.0% and 41.8%, respectively. The growth in S&A expense in the first half of the year outpaced sales growth, due in part to investments in infrastructure made earlier in the year to expand market coverage as well as new product launch expenses. An increase in interest expense on our outstanding debt balance also contributed to lower earnings in the first nine months of 2008 when compared to the prior year.

Included in results for the first nine months of 2008 were net benefits from unusual items of $0.09 per diluted share. For the first nine months of 2007, the net effect of unusual items was a positive $0.13 per diluted share. The results for the first nine months of 2008 also included a $0.07 per diluted share dilutive impact related to our acquisitions.

Historical Results

The following compares the historical results of operations for the three and
nine month periods ended September 30, 2008 and 2007 in dollars and as a
percentage of net sales (dollars in thousands, except earnings per diluted
share):


                                  Three Months Ended                                     Nine Months Ended
                                     September 30                                          September 30
                     2008           %           2007           %           2008           %           2007           %
Net sales          $ 185,935        100.0     $ 161,329        100.0     $ 548,120        100.0     $ 481,610        100.0
Cost of sales        107,383         57.8        94,465         58.6       317,725         58.0       280,137         58.2
Gross profit          78,552         42.2        66,864         41.4       230,395         42.0       201,473         41.8

Research and
development
expense                6,033          3.2         5,999          3.7        17,773          3.2        17,788          3.7
Selling and
administrative
expense               56,074         30.2        50,821         31.5       171,904         31.4       149,417         31.0
Gain on
divestiture of
asset                      -            -             -            -          (246 )          -             -            -

Profit from
operations            16,445          8.8        10,044          6.2        40,964          7.4        34,268          7.1
Other income
(expense), net         1,627          0.9         1,201          0.7           127            -         2,522          0.5

Profit before
income taxes          18,072          9.7        11,245          6.9        41,091          7.4        36,790          7.6
Income tax
expense                4,087          2.2           278          0.2        13,578          2.5         9,517          2.0
Net earnings       $  13,985          7.5     $  10,967          6.7     $  27,513          4.9     $  27,273          5.7
Earnings per
diluted share      $    0.76                  $    0.57                  $    1.48                  $    1.42

Net Sales

Consolidated net sales for the third quarter of 2008 totaled $185.9 million, an
increase of $24.6 million or 15.3% compared to 2007. Consolidated net sales for
the first nine months of 2008 totaled $548.1 million, an increase of $66.5
million or 13.8% compared to 2007.

The components of the consolidated net sales change for the three and nine
months ended of 2008 as compared to 2007 were as follows:

                           % Change from 2007
                  Three Months Ended  Nine Months Ended
                    September 30        September 30
Organic Growth:
    Volume               0%                 (1%)
    Price                4%                  4%
                         4%                  3%
Foreign Currency         3%                  5%
Acquisitions             8%                  6%
    Total                15%                 14%

The 15.3% increase in consolidated net sales in the third quarter of 2008 from 2007 was primarily driven by:

· an increase of 8% in sales due to our March 28, 2008 acquisition of Alfa and our February 29, 2008 acquisition of Applied;

· a favorable direct foreign currency exchange impact of 3%; and

· organic growth of 4%, driven almost entirely by the net impact of pricing actions taken worldwide to mitigate the impact of inflationary cost increases as overall our base business volume was essentially flat compared to the third quarter last year.

· an increase of 6% in sales due to our March 28, 2008 acquisition of Alfa, our February 29, 2008 acquisition of Applied and our February 1, 2007 acquisition of Floorep;

· a favorable direct foreign currency exchange impact of 5%; and

· organic growth of 3%, driven almost entirely by the net impact of pricing actions taken worldwide to mitigate the impact of inflationary cost increases as overall our base business volume was down slightly compared to the first nine months of 2007.

The following table sets forth the net sales by geographic area for the three and nine month periods ended September 30, 2008 and 2007 and the percentage change from the prior year (dollars in thousands):

                                 Three Months Ended                         Nine Months Ended
                                    September 30                              September 30
                          2008          2007            %           2008          2007            %
North America           $ 107,193     $ 104,672           2.4     $ 314,008     $ 309,017           1.6
Europe, Middle East
and Africa                 55,300        42,106          31.3       171,698       128,359          33.8
Other International        23,442        14,551          61.1        62,414        44,234          41.1
Total                   $ 185,935     $ 161,329          15.3     $ 548,120     $ 481,610          13.8

North America

North American net sales were $107.2 million for the third quarter of 2008, an increase of 2.4% from the third quarter of 2007. Acquisitions also added approximately 0.5% to net sales within this market in the third quarter. Price increases taken to mitigate the impact of inflationary cost increases across all product lines contributed to growth in net sales in the third quarter of 2008. In addition to benefits from our annual pricing action taken in the first quarter of 2008, we also began to see benefits from transportation and service rate increases and surcharges. A decline in unit volume of our industrial and outdoor equipment offset the majority of these increases. We continued to see a longer sales cycle for our products during the third quarter, with customers delaying their purchases due to broader economic factors. The direct impact of favorable foreign currency on net sales within North America was approximately 0.5% during the third quarter of 2008.

Sales increased 1.6% to $314.0 million in North America for the nine months ended September 30, 2008 compared to the same period in 2007. The favorable direct impact of foreign currency increased net sales within North America by approximately 1% and acquisitions added approximately 0.5% during the first nine months of 2008. Organic growth within North America has been constrained during the first nine months of 2008 due to lower demand for our industrial and outdoor equipment resulting from a sluggish U.S. economy. However, benefits from pricing actions across all product lines along with organic growth within our service, parts and consumables business have helped offset the decline in equipment unit volume.

Europe, Middle East and Africa

In our markets within Europe, the Middle East and Africa ("EMEA"), net sales increased 31.3% to $55.3 million for the third quarter of 2008 as compared to the third quarter of 2007. Favorable direct foreign currency exchange fluctuations increased net sales by approximately 6% in the third quarter of 2008. Acquisitions added approximately 20% to net sales within this market in the third quarter. Organic growth accounted for the remainder of the increase in the third quarter of 2008 when compared to the same period last year as benefits from pricing actions more than offset a decline in equipment unit volume.

EMEA net sales increased 33.8% to $171.7 million for the nine months ended September 30, 2008. Favorable direct foreign currency exchange fluctuations added approximately 12% to EMEA net sales for the nine months ended September 30, 2008. Acquisitions added approximately 17% to net sales within this market for the first nine months of 2008. Organic growth accounted for the remainder of the year-to-date increase in net sales, with contributions from pricing actions accounting for the majority of the growth as equipment unit volumes were only slight up over the first nine months of last year.

Other International

Our Other International markets are comprised of the following key geographic regions: China and other Asia Pacific markets, Japan, Australia and Latin America. Net sales in these markets for the third quarter of 2008 totaled $23.4 million, up 61.1% from the third quarter of 2007. Favorable direct foreign currency translation exchange effects increased sales in Other International markets by approximately 5% in the 2008 third quarter. Acquisitions added approximately 29% to net sales within this market during the third quarter. Organic growth in net sales was driven by equipment unit volume increases, in part due to expanded market coverage within these markets including emerging markets such as China and Brazil. Higher selling prices in certain regions also contributed to the organic growth in net sales.

Gross Profit

Gross profit margin was 42.2% for the third quarter of 2008 compared with 41.4% reported in 2007. The increase in gross profit margin was primarily due to a positive impact from selling price increases and cost-reduction initiatives that more than offset higher raw material and purchased component costs in the quarter. Favorable impacts from foreign currency fluctuations and sales mix also improved gross margins in the quarter.

Gross profit margin was 42.0% for the first nine months of 2008 compared with 41.8% in 2007. Selling price increases and cost-reduction initiatives offset higher raw material and purchased component costs through the first nine months of 2008. A favorable impact from foreign currency fluctuations also improved gross margins during the first nine months of 2008. Somewhat offsetting this improvement was the $1.2 million of expense from the flow-through of fair market value inventory step-up from the company's acquisitions of Applied and Alfa that unfavorably impacted year-to-date gross margins by 30 basis points.

Operating Expense

Research & Development Expense

Research and development ("R&D") expense in the third quarter of 2008 was $6.0 million and also $6.0 million in 2007. R&D expense as a percentage of net sales was 3.2% for the third quarter of 2008 compared to 3.7% in the comparable quarter last year.

R&D expense for the nine months ended September 30, 2008 was $17.8 million and also $17.8 million in 2007. R&D expense as a percentage of net sales was 3.2% for the first nine months of 2008 compared to 3.7% in the same period last year, which is in line with our target of investing 3% to 4% of net sales annually on R&D.

Selling & Administrative Expense

Selling and administrative ("S&A") expense in the third quarter of 2008 increased $5.3 million, or 10.3% to $56.1 million from $50.8 million in 2007. The inclusion of expense from our 2008 acquisitions of Applied and Alfa added $3.7 million to S&A expense during the third quarter of 2008. Unfavorable direct foreign currency exchange added approximately $1.2 million to the increase in the third quarter of 2008 S&A expense.

The remaining $0.4 million, or approximately 1%, increase in expenses during the 2008 third quarter was due to infrastructure investments implemented in the first quarter to expand market coverage within our international geographies and higher compensation and benefits costs as a result of wage rate and cost increases. These increases were partially offset by a decrease in performance-based compensation in the third quarter of 2008 as compared to the same period last year, as well as benefits from actions taken to control costs and limit discretionary spending implemented during the second quarter.

The 2007 third quarter included the recognition of a pretax restructuring charge of $1.6 million and related expenses of $0.1 million. Management approved this 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. This action impacted approximately 60 positions within a workforce of 2,700, or about two percent of the employee base. The charge consisted primarily of severance, outplacement benefits and recruiting expenses.

For the nine months ended September 30, 2008, S&A expense increased $22.5 million, or 15.0% to $171.9 million from $149.4 million in the comparable period last year. The inclusion of expense from our 2008 acquisitions of Applied and Alfa added $7.5 million to S&A expense during the nine months ended September 30, 2008. Unfavorable direct foreign currency exchange added approximately $6.0 million to the increase in S&A expense for the nine months ended September 30, 2008. As discussed above, the first nine months of 2007 included a $1.6 million restructuring charge and related expenses of $0.1 million.

The remaining $9.0 million, or approximately 6%, increase in expenses during the first nine months of 2008 was due in part to infrastructure investments implemented in the first quarter to expand market coverage within our international geographies, an increase in marketing expenses, in part to support new product launches, and expenses associated with four separate legal settlements that were recognized in the second quarter. These increases were partially offset by a decrease in performance-based compensation in the first nine months of 2008 as compared to the same period last year, as well as benefits from actions taken to control costs and limit discretionary spending implemented during the second quarter.

S&A expense as a percentage of net sales for the nine months ended September 30, 2008 was 31.4%, up from the 31.0% in the comparable period last year. S&A expense as a percentage of sales in the first six months of 2008 increased over the prior year as growth in S&A expenses outpaced sales growth, due in part to investments in infrastructure made earlier in the year to expand market coverage and the inclusion of expenses in the second quarter of 2008 for four separate legal settlements.

Gain on Divestiture of Assets

During the second quarter of 2008, we realized a pre-tax gain of $0.2 million on the divestiture of assets related to our Centurion chassis-mounted street sweeper product.

Other Income (Expense), Net

The increase (decrease) in total other income (expense), net for the three and nine month periods ended September 30, 2008, as compared to the same periods in 2007 was an increase of $0.4 million and a decrease of $2.4 million, respectively. Other income (expense), net was impacted by the following factors during the third quarter and first nine months of 2008 compared to the same periods of 2007:

Interest income decreased by $0.2 and $0.5 million for the three and nine month periods ended September 30, 2008, respectively, compared to the same periods of 2007. The unfavorable comparison between 2008 and 2007 reflects the impact of a decline in interest rates between periods on lower average cash levels.

Interest expense increased by $0.9 million and $2.1 million for the three and nine month periods ended September 30, 2008 as we became a net debtor during the first quarter of 2008 borrowing against our revolving Credit Facility, primarily to fund the two acquisitions closed during the first quarter of 2008.

The net change from the prior year of foreign currency gains for the three and nine month periods ended September 30, 2008 was $2.5 million and $1.4 million, respectively. The 2008 third quarter included a $2.7 million net foreign currency gain from the settlement of forward contracts related to a British Pound denominated loan, which was the most significant contributor to the change in net foreign currency between quarters. For the first nine months, this gain was partially offset by the $0.9 million unfavorable movement in the foreign currency exchange rates related to a deal contingent non-speculative forward contract that we entered into which fixed the cash outlay in U.S. dollars for the Alfa acquisition in the first quarter of 2008.

ESOP income decreased $0.1 million and $0.2 million during the three and nine month periods ended September 30, 2008, respectively. We benefit from ESOP income when the shares held by Tennant's ESOP Plan are utilized and the basis of those shares is lower than the current average stock price. This benefit is offset in periods when the number of shares needed exceeds the number of shares available from the ESOP as the shortfall must be issued at the current market rate which is generally higher than the basis of the ESOP shares. During the three and nine months ended September 30, 2008 compared to the same period in 2007, we experienced a lower average stock price and our 2008 current estimate incorporates the expected need to issue additional shares in the fourth quarter of 2008.

The third quarter 2008 included a $1.0 million contribution to Tennant's charitable foundation. A similar contribution was not made during the third quarter of 2007. On a year-to-date basis, contributions to the Tennant's charitable foundation are up $0.6 million over the prior year.

For the first nine months of 2008, other income (expense) included $0.7 million in cost associated with potential acquisitions that we did not complete while the first nine months of 2007 included $0.3 million of costs associated with a potential acquisition that we did not complete.

The effective tax rate in the third quarter of 2008 was 22.6% compared to the effective rate in the third quarter of the prior year of 2.5%. The year-to-date effective rates were 33.0% for 2008 compared to 25.9% for 2007. The third quarter of 2007 included net favorable unusual discrete items primarily related to the reversal of a $4.1 million German valuation allowance, net of the impact of tax rate changes in foreign jurisdictions on deferred taxes.

The decrease in the 2008 effective tax rate, including discrete tax items, between quarters is primarily related to the settlement of the U.S. Federal examination covering 2005 and 2006, expiration of statute of limitations in various jurisdictions, resolution of other tax matters and the mix in expected full year taxable earnings by country. The effective tax rate was also negatively impacted by 1.3% due to a correction of an immaterial error related to reserves for uncertain tax positions covering tax years 2004 to 2006. See Note 10 for further discussion.

We expect our 2008 base tax rate, excluding year-to-date discrete tax items, will be approximately 36% and discrete tax items are anticipated to be insignificant for the fourth quarter. Our estimate of the full year tax rate reflects recent acquisitions and is subject to change and may be impacted by changes in our forecasts of operating profit in total or by taxing jurisdiction, or to changes in the tax laws and regulations.

Liquidity and Capital Resources

Liquidity

Cash and cash equivalents totaled $22.8 million at September 30, 2008, compared to $33.1 million at December 31, 2007. We believe that the combination of cash and cash equivalents on hand, as well as internally generated funds and amounts available under the Credit Agreement and other credit facilities are sufficient to meet our cash requirements for the next year. Our debt to total capitalization ratio was 29.0% and 1.8% at September 30, 2008 and December 31, 2007, respectively.

Cash Flow Summary

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

                                                                  Nine Months Ended
                                                                    September 30
                                                                 2008          2007
Operating activities                                           $  12,653     $  31,382
Investing activities - purchases of property, plant and
equipment, net of disposals                                      (15,554 )     (23,493 )
Investing activities - (acquisitions)/divestitures               (82,161 )      (2,588 )
Investing activities - change in short-term investments                -         6,325
Financing activities                                              74,855       (18,974 )
Effect of exchange rate changes on cash and cash equivalents        (111 )         256
Net change in cash and cash equivalents                        $ (10,318 )   $  (7,092 )

Operating Activities

Operating activities provided $12.7 million of cash for the nine months ended September 30, 2008. Primary uses of cash included payments of 2007 annual performance awards, incentives, profit sharing and rebates as well as lower accruals for these items in 2008 and higher receivables due to net sales growth over the 2007 third quarter, especially in the last month of the quarter. In addition, we have increased inventory levels due to higher demo and used inventories related to the introduction of new products and increased inventory at our Louisville distribution center and China locations. Partially offsetting these uses of cash was cash provided by net earnings of $27.5 million.

In the comparable 2007 period, operating activities provided $31.4 million of cash. Cash provided by operating activities was driven primarily by strong net earnings, and a decrease in cash income taxes paid, partially offset by a decrease in employee compensation and benefits and other accrued expenses and accounts payable. The decrease in employee compensation and benefits and other accrued expenses was primarily a result of payments of prior fiscal year performance awards, annual rebates, incentives and profit sharing. Timing of payments was the primary reason for the decrease in accounts payable.