Overview

Tennant Company is a world leader in designing, manufacturing and marketing solutions that help create a cleaner, safer world. We provide equipment, parts and consumables and specialty surface coatings to contract cleaners, end-user businesses, healthcare facilities, schools and local, state and federal governments. We sell our products through our direct sales and service organization and a network of authorized distributors worldwide. Geographically, our customers are primarily located in North America, Europe, 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.

Net Earnings for 2008 were down 73.4% to $10.6 million, or $0.57 per diluted share, compared to 2007. Net Sales totaled $701.4 million, up 5.6% over 2007 driven primarily by sales from strategic acquisitions during the year, a net favorable impact from foreign currency exchange and benefits from pricing actions taken earlier in the year, partially offset by unit volume declines within our equipment business year over year. Gross Margins declined 120 basis points to 40.8% principally due to our inability to leverage our fixed manufacturing costs as a result of the significant unit volume decline experienced in the fourth quarter of 2008. Selling and Administrative Expense ("S&A Expense") increased 360 basis points as a percentage of Net Sales to 34.7% compared to 2007 due to the inclusion of a workforce reduction and other charges recognized in the fourth quarter of 2008 as well as S&A Expense incurred earlier in the year to expand international market coverage and support new product launches.

During the fourth quarter of 2008, Tennant announced a workforce reduction program to resize its worldwide employee base by approximately 8%, or about 240 people. A pretax workforce reduction charge totaling $14.6 million ($0.65 per diluted share) 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. When completed, this measure is estimated to achieve annualized savings of at least $15 million in 2009 and approximately $20 million in 2010. Additionally, early retirements, elimination of contracted positions and attrition will account for some of the eliminated positions and contribute to these annualized savings. The pretax charge consisted primarily of severance and outplacement service expenses and was included within S&A Expense in the Consolidated Statements of Earnings.

S&A Expense was also impacted by a significant increase in bad debt expense of $3.4 million ($0.16 per diluted share) resulting from increased Accounts Receivable reserves due to the global credit crisis and a write-off of $1.8 million ($0.07 per diluted share) related to technology investments that will be replaced by new solutions.

Net Earnings were impacted by a $0.15 per diluted share loss from our 2008 acquisitions. This amount includes the effect of purchase accounting items such as amortization expense on acquired intangible assets, the flow-through of the fair market value inventory step-up, the 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 our Sociedade Alfa Ltda ("Alfa") acquisition, as well as the increase in interest expense related to borrowing against our revolving credit facility during the year to fund our first quarter acquisitions.

In addition, Net Earnings were also impacted by the following items:

††† The inclusion of a $2.7 million ($0.09 per diluted share) net foreign currency gain in the third quarter of 2008 from settlement of forward contracts related to a British pound denominated loan.

††† A net benefit from discrete tax items, primarily related to U.S. federal tax settlements, added $0.07 per diluted share.

††† Legal settlement expenses of $0.06 per diluted share primarily related to the settlement of a claim filed in the second quarter by a terminated distributor in Brazil.

††† Expenses of $0.02 per diluted share related to curtailed acquisition initiatives.

††† A net gain of $0.2 million ($0.01 per diluted share) associated with the divestiture of assets related to the Centurion street sweeper product.

The total net effect of these items in 2008 was a reduction in earnings of $0.79 per diluted share.

Back in 2006, we launched initiatives aimed at consolidating our global footprint, expanding our presence in China and establishing global sourcing capabilities. Through these initiatives, we continue to broaden our global sourcing capabilities, reduce product costs and improve operating efficiencies. Our global sourcing initiative contributed approximately $6 million in savings during 2008, allowing us to essentially offset the impact of inflation in 2008 despite experiencing rising material costs throughout the majority of the year. We also successfully increased the percentage of materials and components sourced from low-cost regions from approximately 14% in 2007 to approximately 20% in 2008. Our footprint consolidation and lean initiatives contributed approximately $4 million in savings in 2008, in part from benefits of closing our Maple Grove, MN facility toward the end of 2007.

Tennant continues to invest in innovative product development, with 3.5% of Net Sales spent on Research and Development in 2008. We launched six new products in 2008 in addition to the global introduction of our electrically converted water technology ("ec-water") on six of our walk-behind scrubbers. Sales of new products introduced in the past three years generated approximately 44% of our equipment sales during 2008, exceeding our target of 30%. Our new product launches in 2009 will focus on expanding the roll-out of ec-water. This game-changing technology will be introduced on five rider scrubbers in 2009 in addition to the six walk-behind scrubbers introduced during 2008.

We ended 2008 with a debt-to-capital ratio of 31.2%, $29.3 million in Cash and Cash Equivalents and Shareholders' Equity of $209.9 million. During 2008 we generated operating cash flows of $37.5 million. During 2008, we repurchased $14.3 million in Tennant stock under our share repurchase program.

The relative strength or weakness of the global economies in 2009 is expected to impact demand for our products and services in the markets we serve. As both global and regional economies are currently difficult to predict, we continue to monitor macro-economic indicators closely and conservatively manage the business.

Our results are also impacted by changes in value of the U.S. dollar primarily against the Euro, British pound, Australian and Canadian dollars, Japanese yen, Chinese yuan and Brazilian real. To the extent the applicable exchange rates weaken relative to the U.S. dollar, the related direct foreign currency exchange effect would generally have an unfavorable impact on our 2009 results. If the applicable exchange rates strengthen relative to the U.S. dollar, our results would generally be favorably impacted.

Historical Results

The following table compares the historical results of operations for the years
ended December 31, 2008, 2007 and 2006 in dollars and as a percentage of Net
Sales (in thousands, except per share amounts):

                                     2008           %          2007           %          2006           %
Net Sales                          $ 701,405       100.0     $ 664,218       100.0     $ 598,981       100.0
Cost of Sales                        415,155        59.2       385,234        58.0       347,402        58.0
Gross Profit                         286,250        40.8       278,984        42.0       251,579        42.0
Operating Expense:
Research and Development Expense      24,296         3.5        23,869         3.6        21,939         3.7
Selling and Administrative
Expense                              243,614        34.7       206,242        31.1       189,676        31.7
Gain on Sale of Facility                   -           -        (5,972 )      (0.9 )           -           -
Gain on Divestiture of Assets           (229 )         -             -           -             -           -
Total Operating Expenses             267,681        38.2       224,139        33.7       211,615        35.3
Profit from Operations                18,569         2.6        54,845         8.3        39,964         6.7
Other Income (Expense):
Interest Income                        1,042         0.1         1,854         0.3         2,698         0.5
Interest Expense                      (3,944 )      (0.6 )        (898 )      (0.1 )        (737 )      (0.1 )
Net Foreign Currency
Transaction Gain (Loss)                1,368         0.2            39           -           516        0.10
 ESOP Income                           2,219         0.3         2,568         0.4         1,205         0.2
Other Income (Expense), Net           (1,679 )      (0.2 )        (696 )      (0.1 )        (344 )      (0.1 )
Total Other Income (Expense),
Net                                     (994 )      (0.1 )       2,867         0.4         3,338         0.6
Profit Before Income Taxes            17,575         2.5        57,712         8.7        43,302         7.2
Income Tax Expense                     6,951         1.0        17,845         2.7        13,493         2.3
Net Earnings                       $  10,624         1.5     $  39,867         6.0     $  29,809         5.0
Earnings per Diluted Share         $    0.57                 $    2.08                 $    1.57

Consolidated Financial Results

In 2008, Net Earnings declined 73.4% to $10.6 million or $0.57 per diluted share as compared to 2007. Net Earnings were impacted by:

††† Growth in Net Sales of 5.6% to $701.4 million, driven by 2008 acquisitions and increases in Other International.

††† A 120 basis point decline in Gross Margins to 40.8% as fixed manufacturing costs within our plants were not fully leveraged due to a significant equipment unit volume decline of $22.9 million experienced in the fourth quarter of 2008.

††† An increase in S&A Expense as a percentage of Net Sales of 360 basis points due to the inclusion of $19.8 million of expenses associated with the fourth quarter workforce reduction charge and other charges as well as expenses incurred earlier in the year to expand international market coverage and support new product launches.

††† The inclusion of a $2.7 million net foreign currency gain from settlement of forward contracts related to a British pound denominated loan.

††† A net benefit from discrete tax items, primarily related to U.S. federal tax settlements added $0.07 per diluted share.

††† A dilutive impact to Net Earnings related to our 2008 acquistions of $2.8 million.

In 2007, Net Earnings increased 33.7% to $39.9 million or $2.08 per diluted share as compared to 2006. Net Earnings were impacted by:

††† Growth in Net Sales of 10.9% to $664.2 million, driven by increases in all geographic regions (North America; Europe, Middle East, Africa ('EMEA") and Other International) and all product categories (equipment; service, parts and consumables; and specialty surface coatings).

††† Holding margins flat with 2006 at 42.0%, despite higher material costs and investments in our footprint consolidation and China expansion initiatives.

††† A decrease in S&A Expense as a percentage of Net Sales of 0.6 percentage points as growth in Net Sales outpaced increases in S&A Expense, despite the inclusion of a $2.5 million restructuring charge and higher costs in support of strategic initiatives and other cost increases.

††† A gain of $6.0 million associated with the sale of our Maple Grove, Minnesota facility.

††† A decrease in Interest Income, Net of $1.0 million primarily reflecting a lower average interest rate and a lower level of Cash and Cash Equivalents and Short-term Investments. In addition, Tennant contributed $0.5 million to the Tennant Foundation increasing Other Expense, Net. Partially offsetting these decreases is an increase of $1.4 million in ESOP Income due to a higher average stock price.

For 2008, we used Economic Profit as a key indicator of financial performance and the primary metric for performance-based incentives. Economic Profit is based on our Net Operating Profit After Taxes less a charge for the net assets used in the business. The key drivers of Net Operating Profit we focus on include Net Sales, Gross Margin and Operating Expense. The key drivers we focus on to measure how effectively we utilize net assets in the business include "Accounts Receivable Days Sales Outstanding" (DSO), "Days Inventory on Hand" (DIOH) and capital expenditures. These key drivers are discussed in greater depth throughout Management's Discussion and Analysis.

Net Sales

In 2008, consolidated Net Sales were $701.4 million, increasing 5.6% over 2007.
Consolidated Net Sales were $664.2 million in 2007, an increase of 10.9% from
2006.

The components of the consolidated Net Sales change for 2008 as compared to 2007
and 2007 compared to 2006 were as follows:

                            % Change    % Change
                            from 2007   from 2006
Organic Growth (Decline):
     Volume                   (5%)         3%
     Price                     4%          3%
                              (1%)         6%
Foreign Currency               2%          3%
Acquisitions                   5%          2%
     Total                     6%          11%

The 5.6% increase in consolidated Net Sales for 2008 from 2007 was primarily driven by:

††† An organic decline of 1%, which includes a decline in base business volume, primarily within North America, partially offset by the net benefit from pricing actions taken during the year.

††† A favorable direct foreign currency exchange impact of 2%.

††† An increase of 5% in sales volume due to our March 28, 2008 acquisition of Alfa , our February 29, 2008 acquisition of Applied Sweepers, Ltd. ("Applied Sweepers") and our February 1, 2007 acquisition of Floorep Limited ("Floorep").

The 10.9% increase in consolidated Net Sales for 2007 from 2006 was primarily driven by:

††† Organic growth in all geographic regions and all product categories.

††† A favorable direct foreign currency exchange impact of 3%.

††† An increase of 2% in sales volume due to our February 1, 2007 acquisition of Floorep.

                                     2008          %          2007          %          2006          %
North America                      $ 402,174       (3.7 )   $ 417,757        6.8     $ 391,309        5.7
Europe, Middle East and Africa       217,594       18.8       183,188       17.6       155,710       16.9
Other International                   81,637       29.0        63,273       21.8        51,962        4.9
Total                              $ 701,405        5.6     $ 664,218       10.9     $ 598,981        8.3

North America - In 2008, North American Net Sales declined 3.7% to $402.2 million compared with $417.8 million in 2007. The primary driver of the decrease in Net Sales is attributable to a decline in equipment unit volume, with the most significant declines occurring in the fourth quarter as a result of the credit crisis and its impact on an already sluggish U.S. economy. Partially offsetting these declines were benefits from pricing actions taken during the year and a net favorable impact from foreign currency translation. Our acquisition of Applied Sweepers contributed approximately 1% to North America's 2008 Net Sales.

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

Europe, Middle East and Africa - EMEA Net Sales in 2008 increased 18.8% to $217.6 million compared to 2007 Net Sales of $183.2 million. Positive direct foreign currency exchange effects increased EMEA Net Sales by approximately 6% in 2008. Our Applied Sweepers acquisition contributed approximately 14% to EMEA's 2008 Net Sales. EMEA's organic base was essentially flat in 2008 when compared to 2007. Pricing increases and volume growth in emerging markets were offset by lower sales of equipment in the mature markets within Europe. The majority of the equipment unit volume decline occurred in the fourth quarter following the global credit crisis and a significant slowdown in these economies.

EMEA Net Sales in 2007 increased 17.6% to $183.2 million compared to 2006 Net Sales of $155.7 million. Positive direct foreign currency exchange effects increased EMEA Net Sales by approximately 9% in 2007. Our Hofmans and Floorep acquisitions contributed approximately 5% to EMEA's 2007 Net Sales. EMEA's organic base grew slightly in 2007 when compared to 2006. Volume growth from our Hofmans line of outdoor products during the second half of 2007, volume growth within our emerging markets of this region, such as the Middle East, along with benefits from price increases were partially offset by lower sales of equipment in the United Kingdom, one of our largest markets within the region.

Other International - Other International Net Sales in 2008 increased 29.0% to $81.6 million over 2007 Net Sales of $63.3 million. Growth in Net Sales was driven in part by organic growth, resulting from expanded market coverage in Brazil and China as well as a net benefit from pricing actions taken during the year. Our acquisitions contributed approximately 12% to Other International's 2008 Net Sales. Price increases also contributed to the 2008 growth in Net Sales. Positive direct foreign currency exchange effects increased Net Sales in Other International markets by approximately 3% in 2008.

Other International Net Sales in 2007 increased 21.8% to $63.3 million over 2006 Net Sales of $52.0 million. Growth in Net Sales was primarily driven by organic growth, resulting in part from expanded market coverage in Brazil and China as well as volume growth in Australia and Mexico. Price increases also contributed to the 2007 growth in Net Sales. Positive direct foreign currency exchange effects increased Net Sales in Other International markets by approximately 5% in 2007.

Gross Profit

Gross Margin was 40.8% in 2008, down 120 basis points as compared to 2007. Although benefits from pricing actions and cost reduction initiatives were able to essentially offset higher raw material and purchased component costs during 2008, the inability to leverage the fixed manufacturing costs in our plants, due to the significant decline in unit volume experience in the fourth quarter, drove a decline in margins year over year. Gross Margin was also impacted by an unfavorable sales mix and by the inclusion of $1.2 million in expense from the flow-through of fair market value inventory step-up from our acquisitions of Applied Sweepers and Alfa.

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

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

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

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

Operating Expenses

Research and Development Expense - Research and Development Expense ("R&D Expense") increased $0.4 million, or 1.8%, in 2008 compared to 2007 and decreased 10 basis points to 3.5% as a percentage of Net Sales, which is in line with our target of investing 3% to 4% of Net Sales annually on research and development. R&D Expense increased $1.9 million, or 8.8%, in 2007 compared to 2006, and decreased 10 basis points to 3.6% of Net Sales.

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

Selling and Administrative Expense - S&A Expense increased by $37.4 million, or 18.1%, in 2008 compared to 2007. The inclusion of expense from our 2008 acquisitions of Applied Sweepers, Alfa and Shanghai ShenTan added $10.7 million to S&A Expense during 2008. S&A Expense included a $14.6 million workforce reduction charge as discussed in Note 3 to the Consolidated Financial Statements. S&A Expense was also impacted by a significant increase in bad debt expense of $3.4 million resulting from increased Accounts Receivable reserves due to the global credit crisis and a write-off of $1.8 million related to technology investments that will be replaced by new solutions. Unfavorable foreign currency exchange was approximately $4.5 million in 2008.

The remaining approximate 1% increase in S&A Expense was due to infrastructure investments implemented in the first quarter to expand market coverage within our international geographies, higher marketing expenses for new product launches, and higher base compensation and benefit costs as a result of wage rate and cost increases. Partially offsetting these increases was a decrease in performance-based compensation expenses as compared to 2007.

S&A Expense increased by $16.6 million, or 8.7%, in 2007 compared to 2006. S&A Expense included a $2.5 million charge for a restructuring action approved by management during the third quarter as discussed in Note 3 to the Consolidated Financial Statements. The charge consisted primarily of severance and outplacement benefits. The impact of unfavorable foreign currency translation on S&A Expense was approximately $6.0 million in 2007. The remaining approximate 4% increase in S&A Expense was due in part to investments associated with expanding our international market coverage, the inclusion of expenses of acquired operations and recruiting expenses associated with filling restructured positions and other openings. Increased bad debt expense, benefit costs and depreciation expense also contributed to the increase in S&A Expense in comparison to 2006. Partially offsetting these increases was a decrease in performance-based compensation expenses and a reduction in warranty costs.

Gain on Divestiture of Assets - We sold assets related to our Centurion line of sweepers during the second quarter of 2008 for a pretax gain of $0.2 million.

Gain on Sale of Facility - We completed the sale of our Maple Grove, Minnesota facility during the fourth quarter of 2007 for a net pretax gain of $6.0 million.

Total Other Income (Expense), Net

Interest Income - Interest Income was $1.0 million in 2008, a decrease of $0.8 million from 2007. The decrease between 2008 and 2007 reflects the impact of a decline in interest rates between periods on lower average cash levels.

Interest Income was $1.9 million in 2007, a decrease of $0.8 million from 2006. The decrease was a result of lower interest rates and lower average levels of Cash and Cash Equivalents and Short-Term Investments during 2007 compared to 2006.

Interest Expense - Interest Expense was $3.9 million in 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 that closed during the first quarter of 2008.

Interest Expense was $0.9 million in 2007, an increase of $0.2 million as compared to 2006. Interest Expense for both years was 0.1% of Net Sales.

Net Foreign Currency Transaction Gains (Losses) - Net Foreign Currency Transaction Gains increased $1.3 million between 2008 and 2007. A $2.7 million net foreign currency gain from the settlement of forward contracts related to a British pound denominated loan was the most significant contributor to the change between years. 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 that fixed the cash outlay in U.S. dollars for the Alfa acquisition in the first quarter of 2008. The remaining change was due to a net favorable impact from other foreign currency fluctuations between years.

Net Foreign Currency Transaction Gains decreased $0.5 million between 2007 and 2006 due to fluctuations in foreign currency exchange rates.

ESOP Income - ESOP Income decreased $0.3 million between 2008 and 2007 due to a lower average stock price. 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 year ended 2008 compared to 2007, we experienced a lower average stock price and issued additional shares during the fourth quarter of 2008.

ESOP Income increased $1.4 million between 2007 and 2006 due to a higher average stock price. We benefit from ESOP Income when the shares held by the Company's ESOP plan are utilized as the basis of those shares is lower than the current average stock price.

Other Income (Expense), Net - Other Expense, Net increased $1.0 million between 2008 and 2007. The increase in Other Expense, Net was primarily due to an increase in discretionary contributions to Tennant's charitable foundation.

The change in Other Expense, Net of $0.4 million between 2007 and 2006 was primarily due to an increase in discretionary contributions to Tennant's charitable foundation.

Income Taxes

Our effective income tax rate was 39.6%, 30.9% and 31.2% for the years 2008, 2007 and 2006, respectively. The increase in the 2008 effective tax rate was . . .