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FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Quarterly Report Under Section 13 or 15 (d)
of the Securities Exchange Act of 1934

For Quarter Ended March 31, 2005
Commission File No. 1-16191

TENNANT COMPANY

701 North Lilac Drive
P.O. Box 1452
Minneapolis, Minnesota 55440

Telephone No. 763-540-1200

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    [X]   No    [  ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).   Yes    [X]   No    [  ]

The number of shares outstanding of Registrant’s common stock, par value $.375 on April 29, 2005, was 9,005,892

TENNANT COMPANY
Quarterly Report - Form 10-Q

ITEM 1 – Financial Statements

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS (Unaudited)
(In thousands, except per share data)

See accompanying Notes to Condensed Consolidated Financial Statements.

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TENNANT COMPANY
Quarterly Report - Form 10-Q

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(In thousands)

See accompanying Notes to Condensed Consolidated Financial Statements.

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TENNANT COMPANY
Quarterly Report - Form 10-Q

See accompanying Notes to Condensed Consolidated Financial Statements.

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TENNANT COMPANY
Quarterly Report - Form 10-Q

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(In thousands, except per share data)

Tennant Company is referred to as “Tennant,” “us,” “we,” or “our” in these notes to the condensed consolidated financial statements.

In our opinion, the accompanying unaudited, condensed consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments, except as noted elsewhere in the notes to the condensed consolidated financial statements) necessary to present fairly our financial position as of March 31, 2005, the results of our operations and cash flows for the three months ended March 31, 2005 and 2004. These statements are condensed and, therefore, do not include all of the information and note disclosures required by accounting principles generally accepted in the United States of America for complete financial statements. The 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, 2004. The results of operations for the three months ended March 31, 2005 are not necessarily indicative of the results to be expected for the full year.

During January 2004, we acquired Walter-Broadley Machines Limited, a cleaning equipment company based in the United Kingdom, with annual sales of $13,000. We paid $6,491 in the form of cash and debt for all the stock of Walter-Broadley and assumed $2,576 in outstanding debt, of which $2,516 was immediately retired. The acquisition was not material to our operations or financial position. The operations of Walter-Broadley have been included in our results of operations since the date of acquisition.

Management approved actions during the third quarter of 2004 to reduce costs as part of a continuing effort to improve profitability. These actions included the elimination of a net 64 management and administrative positions company-wide and were substantially completed by the end of the first quarter of 2005. The workforce reductions resulted in the recognition of a pretax charge of $2,301 ($1,458 after-tax, or $0.16 per diluted share) in our 2004 results. The charge consisted primarily of severance and outplacement benefits and was included within Selling and Administrative (S&A) Expenses in the Consolidated Statement of Earnings. The severance and outplacement benefits were accounted for under the Financial Accounting Standards Board Statement (SFAS) No. 112, “Employers’ Accounting for Postemployment Benefits.”

The cash and non-cash applications against this charge during the three months ended March 31, 2005 were as follows:

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TENNANT COMPANY
Quarterly Report - Form 10-Q

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(In thousands, except per share data)

Inventories are valued at the lower of cost (principally on a last-in, first-out basis) or market. Inventories at March 31, 2005 and December 31, 2004 consisted of the following:

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

As of March 31, 2005 and December 31, 2004, FIFO-based inventories in Europe totaled $25,334 and $25,456, respectively.

Income taxes paid (refunded) during the three months ended March 31, 2005 and 2004 were $515 and $(1,134), respectively. Interest costs paid during the three months ended March 31, 2005 and 2004 were $213 and $244, respectively.

We report accumulated other comprehensive income as a separate item in the shareholders’ equity section of the balance sheet. Comprehensive income is comprised of the net earnings and other comprehensive income (loss). Other comprehensive income (loss) consists solely of foreign currency translation adjustments. The reconciliations of net earnings to comprehensive income are as follows:

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TENNANT COMPANY
Quarterly Report - Form 10-Q

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(In thousands, except per share data)

We operate in one reportable segment that consists of the design, manufacture and sale of products used primarily in the maintenance of nonresidential surfaces. Our products are sold in North America, Europe, and other international markets including the Middle East, Asia, Japan, Latin America and Australia. The following table sets forth net sales by geographic area (net of intercompany sales):

The components of goodwill and other intangible assets are as follows:

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TENNANT COMPANY
Quarterly Report - Form 10-Q

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(In thousands, except per share data)

We account for stock-based compensation for employees under Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees.” APB No. 25 requires compensation cost to be recorded on the date of the grant only if the current market price of the underlying stock exceeds the exercise price. Accordingly, no compensation cost has been recognized for stock option plans. As of March 31, 2005, we had six stock-based employee compensation plans, which are described in Note 13 of the 2004 Annual Report on Form 10-K.

We have adopted the disclosure-only provisions of SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” (“SFAS No. 148”). SFAS No. 148 amends the disclosure requirements of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”). In accordance with SFAS No. 123, the fair value of options at the date of grant in 2004 was estimated using the Black-Scholes option pricing model with the following assumptions:

No options were granted during the three months ended March 31, 2005.

Had stock-based compensation cost been determined using the fair value-based method of accounting under SFAS No. 123, net earnings would have been reduced to the pro forma amounts indicated below:

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TENNANT COMPANY
Quarterly Report - Form 10-Q

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(In thousands, except per share data)

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 range from one to four years. The changes in warranty reserve balances for the three months ended March 31, 2005 and 2004 were as follows:

Certain operating leases for vehicles contain residual value guarantee provisions, which would become due at the expiration of the operating lease agreement if the fair value of the leased vehicles is less than the guaranteed residual value. Of those leases that contain residual value guarantees, the aggregate residual value at lease expiration is $8.1 million, of which we have guaranteed $6.1 million. As of March 31, 2005, we have not recorded a liability related to this residual value guarantee as we estimate our future settlements to be a net gain.

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TENNANT COMPANY
Quarterly Report - Form 10-Q

As of March 31, 2005, we had four defined benefit retirement plans and a postretirement medical plan, which are described in Note 9 of the 2004 Annual Report on Form 10-K.

We have contributed $61 and $197 during the first quarter of 2005 to our pension benefit plans and to our postretirement medical benefit plan, respectively. We expect to contribute approximately $200 and $900 to our pension benefit plans and to our postretirement medical benefit plan in 2005, respectively.

We amended our postretirement medical plan during 2004, which reduced our net periodic cost associated with this plan by $195 in the first quarter of 2005 and will reduce our full year expense by approximately $600 in 2005.

The components of the net periodic cost (benefit) for the three months ended March 31, 2005 and 2004 were as follows:

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TENNANT COMPANY
Quarterly Report - Form 10-Q

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 products that help create a cleaner, safer world. We provide equipment, parts and consumables and floor 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 and other international markets including the Middle East, Asia, Japan, Latin America and Australia. We strive to be an innovator in our industry through our commitment to understanding our customers’ needs and using our expertise to create innovative solutions.

Net earnings for the first quarter of 2005 were up 38.6% to $3.5 million and earnings per diluted share were up 39.3% to $0.39 driven by sales growth of 5.8% and a 2.6 percentage point increase in gross profit margins, partially offset by higher selling and administrative expenses.

During the first quarter of 2005, our results continued to be favorably impacted by weakness of the U.S. dollar against the Euro, the Australian and Canadian dollars, the British pound and the Japanese yen. We can estimate the direct financial impact of foreign currency exchange on net sales and earnings; however, it is difficult to estimate the indirect financial impact. The indirect financial impact would include such factors as the effect on sales volumes within local economies and the impact of pricing actions taken as a result of foreign exchange rate fluctuations. We expect that our sales and earnings will continue to be impacted by the effects of foreign currency exchange rate fluctuations in the future. If the applicable exchange rates continue to remain strong relative to the 2004 value of the U.S. dollar, the related effect on our results would continue to be favorable during 2005.

Historical Results

The following compares the historical results of operations for the three-month periods ended March 31, 2005 and 2004 in dollars and as a percentage of net sales (dollars in thousands, except earnings per diluted share):

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TENNANT COMPANY
Quarterly Report - Form 10-Q

Net Sales

Consolidated net sales of $126.0 million for the first quarter of 2005 increased 5.8% compared to first quarter 2004 sales of $119.1 million. The growth in net sales for the quarter was primarily driven by price increases in certain markets and volume growth, in part from new product introductions. Positive direct foreign currency exchange fluctuations, resulting from a weakened U.S. dollar compared to the Euro, Japanese yen, British pound sterling and Canadian and Australian dollars, increased net sales by approximately 1% in the 2005 first quarter.

The following table sets forth the net sales by geographic area for the three-month periods ended March 31, 2005 and 2004 and the percentage change from the prior year (dollars in thousands):

North America

North American sales for the first quarter of 2005 increased 4.9% to $82.7 million compared with $78.9 million in 2004. The growth in net sales was driven by increases in all product categories. Growth in equipment net sales was primarily attributable to price increases, volume increases resulting from new product introductions in the latter half of 2004 and a strengthening economy. In addition, growth in service, parts and consumables resulting from organic growth and price increases contributed to the overall increase.

Europe

In Europe, net sales for the first quarter of 2005 increased 7.8% to $30.8 million versus the comparable 2004 period. The increase in net sales was primarily driven by new product introductions in the latter half of 2004, organic growth in service, parts and consumables as well as price increases. The growth in net sales was achieved despite continued economic weakness in Europe and the shipment of a large order to a new customer during the first quarter of 2004. Positive direct foreign currency translation effects increased European net sales by approximately 3% in the 2005 first quarter.

Other International

In Other International markets, net sales for the first quarter of 2005 totaled $12.5 million, up 6.5% from the first quarter of 2004. Overall growth in net sales was primarily driven by increases in Latin America and the Middle East resulting in part from new product introductions in these markets. Positive direct foreign currency translation exchange effects increased sales in Other International markets by approximately 1% in the 2005 first quarter.

Gross Profit

Gross profit margin was 42.9% for the first quarter of 2005 compared with 40.3% reported in 2004. Gross profit margins in the first quarter of 2005 were favorably impacted by the mix of products sold that included a larger-than-usual percentage of direct sales that have higher gross margins, operational efficiencies including cost reduction actions taken in 2004, and a favorable foreign currency exchange impact compared to the same period in 2004.

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TENNANT COMPANY
Quarterly Report - Form 10-Q

Operating Expenses

Research & Development Expenses

Research and development (R&D) expenses in the first quarter of 2005 increased 10.1% to $4.5 million from $4.1 million in 2004. R&D expenses as a percentage of net sales was 3.5% for the first quarter of 2005 compared to 3.4% in the comparable quarter last year, which is in line with our target of investing 3–4% of net sales annually on R&D.

Selling & Administrative Expenses

Selling and administrative (S&A) expenses in the first quarter of 2005 increased 9.5% to $43.4 million from $39.7 million in 2004. The increase in S&A expenses is due in part to an increase in performance-based incentive compensation expense, including additional expense resulting from modifications to our management compensation program which replaced stock options with performance-based shares which are expensed over the performance period. Previously issued but unvested stock options will be expensed beginning in 2006 as discussed under “New Accounting Pronouncements.” Our expanded sales and service market coverage also added to the increase in S&A expenses during the first quarter of 2005. In addition, Sarbanes-Oxley compliance costs and direct foreign currency exchange effects contributed to the increase in S&A expenses compared to the prior year. We also began to see benefits from the cost reduction actions taken in 2004, which partially offset the increase in S&A expenses.

S&A expenses as a percentage of net sales was 34.5% for the first quarter of 2005, up from 33.3% in the comparable quarter last year. The increase as a percentage of net sales is primarily due to Sarbanes-Oxley compliance costs and additional expense for performance-based shares.

Other Income (Expense), Net

Other income (expense), net was $(0.4) million in the first quarter of 2005, due to a $0.4 million contribution made to Tennant’s charitable foundation.

Income Taxes

The effective tax rates for the first quarter were 39.0% for 2005 and 42.0% for 2004. The decrease in the effective tax rate between quarters is primarily related to the mix in expected full-year taxable earnings by country.

On October 22, 2004, the American Jobs Creation Act of 2004 was signed into law. The new law included a provision to phase out the ETI Act tax benefit over the next two years. In addition, the new law established a manufacturing deduction for profits on U.S. manufactured product to be phased in over six years. For 2005, we expect the phase-out of the ETI Act tax benefit to be substantially offset by the phase-in of the U.S. manufacturing deduction. For 2006 to 2009, we expect that the change in the U.S. tax law will have a negative impact on our effective tax rate since the ETI Act is phased out more quickly than the phase-in of the U.S. manufacturing deduction.

Our effective tax rate for the full year is subject to change and may be impacted by changes to our forecasts of operating profit in total or by taxing jurisdiction, or to changes in the tax laws and regulations.

Liquidity and Capital Resources

The debt-to-total-capitalization ratio was 2.3% at March 31, 2005 versus 4.8% at December 31, 2004. Cash, cash equivalents and short-term investments totaled $11.3 million at March 31, 2005, compared to $22.9 million at December 31, 2004. We believe that the combination of cash, internally generated funds and available financing sources are more than sufficient to meet our cash requirements for the next year.

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TENNANT COMPANY
Quarterly Report - Form 10-Q

OPERATING ACTIVITIES — Operating activities used $1.2 million of cash during the three months ended March 31, 2005. Cash used in operating activities for the three months ended March 31, 2005 was driven by decreases in accounts payable, accrued expenses and deferred revenue, increases in inventory levels and decreases in other current/noncurrent assets and liabilities. The decrease in accounts payable, accrued expenses and deferred revenue was a result of payments of annual rebates, incentives and profit-sharing and accrued severance as well as timing of accounts payable payments. Inventory level increases were due to a build-up of inventory to replenish certain inventories to normal levels due to the seasonality of sales volumes and to support new products launched during the latter part of 2004. The decrease in other current/noncurrent assets and liabilities is primarily a result of a payment of deferred compensation. Partially offsetting these uses of cash was a decrease in receivables due to seasonality of sales volumes.

In the comparable 2004 period, operating activities provided cash of $8.6 million. Cash provided by operating activities for the three months ended March 31, 2004 was primarily generated by a decrease in receivables due to seasonality of sales volumes as well as a decrease in inventories primarily attributable to inventory reduction initiatives.

Management evaluates how effectively we utilize two of our key operating assets, receivables and inventories, using Accounts Receivable “Days Sales Outstanding” (DSO) and “Days Inventory on Hand” (DIOH), on a FIFO basis. These metrics are as follows (in days):

INVESTING ACTIVITIES — In the first quarter of 2005, our available-for-sale securities, which were classified as short-term investments, matured generating $6.1 million in cash proceeds. Capital expenditures were $3.7 million during the first three months of 2005 compared to $4.4 million in the same period of 2004. We currently anticipate full-year capital spending to be in the range of $15 to $20 million.

In January 2004, we acquired all of the stock of Walter-Broadley for $6.5 million in the form of cash and debt, as well as assuming $2.6 million in outstanding debt, of which $2.5 million was immediately retired. The cost of acquisition was paid in cash with funds provided by operations.

FINANCING ACTIVITIES — Net cash used by financing activities was $7.3 million during the first three months 2005 and $2.9 million in the comparable 2004 period. During the first three months of 2005, significant uses of cash included a $5.0 million scheduled debt repayment. During the first three months of 2004, $2.5 million in assumed Walter-Broadley debt was retired. In addition, net short-term borrowings increased in the first quarter of 2004 to support operating cash needs in Europe.

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TENNANT COMPANY
Quarterly Report - Form 10-Q

New Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement (“SFAS”) No. 123 (Revised 2004), “Share-Based Payment” (“SFAS No. 123(R)”). SFAS No. 123(R) requires that the compensation cost relating to share-based payment transactions, including grants of employee stock options, be recognized in financial statements. That cost will be measured based on the fair value of the equity or liability instruments at the time of issuance. SFAS No. 123(R) covers a wide range of share-based compensation arrangements including stock options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. The effect of the standard will be to require companies to measure the cost of employee services received in exchange for stock awards based on its grant-date fair value and to recognize the cost over the period the employee is required to provide services for the award.

We had planned to adopt the provisions of SFAS No. 123(R) effective July 1, 2005, as required by the FASB, using the modified prospective transition method for our existing stock-based compensation plans. However, in April 2005, the SEC amended Rule 4-01(A) of Regulation S-X to allow companies to implement SFAS No. 123(R) at the beginning of their next fiscal year. Accordingly, we have elected to defer our adoption of this standard until January 1, 2006.

Quantitative and Qualitative Disclosures About Market Risk and Other Matters

Foreign Currency Risk

Due to the global nature of our operations, we are subject to exposures resulting from foreign currency exchange fluctuations in the normal course of business. Our primary exchange rate exposure is with the Euro, the Canadian dollar, the Australian dollar, the British pound and the Japanese yen against the U.S. dollar. The direct financial impact of foreign currency exchange includes the effect of translating profits from local currencies to U.S. dollars, the impact of currency fluctuations on the transfer of goods between Tennant operations in the United States and abroad and transaction gains and losses. In addition to the direct financial impact, foreign currency exchange has a indirect financial impact on our results, including the effect on sales volumes within local economies and the impact of pricing actions taken as a result of foreign exchange rate fluctuations. We could experience favorable or unfavorable foreign exchange effects for the remainder of 2005, compared with prior year results.

Because our products are manufactured or sourced primarily from the United States, a stronger dollar generally has a negative impact on results from operations outside the United States while a weaker dollar generally has a positive effect. Our objective in managing the exposure to foreign currency fluctuations is to minimize the earnings effects associated with foreign exchange rate changes on certain of our foreign currency-denominated assets and liabilities. We periodically enter into various contracts, principally forward exchange contracts, to protect the value of certain of our foreign currency-denominated assets and liabilities. The gains and losses on these contracts generally approximate changes in the value of the related assets and liabilities.

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TENNANT COMPANY
Quarterly Report - Form 10-Q

Commodity Risk

We are subject to exposures resulting from potential cost increases related to our purchases of raw materials or other product components. We do not use derivative commodity instruments to manage our exposures to changes in commodity prices such as steel or oil and gas.

In the past year, increases in worldwide demand and other factors have caused prices for steel and related products to increase. Given the worldwide steel market conditions, we have experienced cost increases in our steel-based raw materials and component parts in 2004 and 2005. We purchase approximately $55–$60 million of raw and fabricated steel and steel-based component parts annually. We do not maintain an inventory of raw or fabricated steel in excess of our near-term production requirements. We continue to focus on mitigating the impact of the anticipated steel cost increases through product pricing and negotiations with our vendors.

Various factors beyond our control affect the price of oil and gas, including but not limited to worldwide and domestic supplies of oil and gas, political instability or armed conflict in oil-producing regions, the price and level of foreign imports, the level of consumer demand, the price and availability of alternative fuels, domestic and foreign governmental regulation and the overall economic environment. We purchase petroleum-related component parts for use in our manufacturing operations. In addition, our freight costs associated with shipping and receiving product and sales and service vehicle fuel costs are impacted by fluctuations in the cost of oil and gas. If the price of oil and gas continue to increase, our results could be unfavorably impacted in 2005.

Successful mitigation of the impact will depend upon our ability to increase our selling prices in a competitive market.

Other Matters

Management regularly reviews our business operations with the objective of improving financial performance and maximizing our return on investment. In this regard, we continue to consider actions to improve financial performance which, if taken, could result in material nonrecurring charges.

Additional information on market risk is included in the Management’s Discussion and Analysis section of our Form 10-K filing for the year ended December 31, 2004.

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TENNANT COMPANY
Quarterly Report - Form 10-Q

Cautionary Statement Relevant to Forward-Looking Information

Certain statements contained in this document as well as other written and oral statements made by us from time to time are considered “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act. These statements do not relate to strictly historical or current facts and provide current expectations or forecasts of future events. Any such expectations or forecasts of future events are subject to a variety of factors. These include factors that affect all businesses operating in a global market as well as matters specific to us and the markets we serve. Particular risks and uncertainties presently facing us include:

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. 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. For additional information about factors that could materially affect Tennant’s results, please see our other Securities and Exchange Commission filings.

We do not undertake to update any forward-looking statement, and investors are advised to consult any further disclosures by us on this matter in our filings with the Securities and Exchange Commission and in other written statements we make from time to time. It is not possible to anticipate or foresee all risk factors, and investors should not consider that any list of such factors to be an exhaustive or complete list of all risks or uncertainties.

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TENNANT COMPANY
Quarterly Report - Form 10-Q

ITEM 4 – Controls and Procedures

(a) Evaluation of disclosure controls and procedures. Based on their evaluation as of the end of the period covered by this report, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) 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. Disclosure procedures only provide reasonable assurance that the controls will meet their objectives. There can be no assurance that the controls will be effective in all circumstances. Management believes disclosure controls and procedures are operating and effective at the reasonable assurance level.

(b) 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.

PART II - OTHER INFORMATION

ITEM 2 - Changes in Securities, and Use of Proceeds and Issuer Purchases of Equity Securities

(e) During November 2004, an additional 400,000 shares were authorized under the share repurchase program approved by the Board of Directors in May 2001. These 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.

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TENNANT COMPANY
Quarterly Report - Form 10-Q

ITEM 6 - Exhibits

Exhibits

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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 our behalf by the undersigned thereunto duly authorized.

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