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 June 30, 2004

Commission File No. 1-16191

 

TENNANT COMPANY

 

Incorporated in Minnesota

IRS Emp Id No. 410572550

 

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  ý  No o

 

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

 

The number of shares outstanding of Registrant’s common stock, par value $.375 on July 30, 2004, was             .

 

 

TENNANT COMPANY

Quarterly Report – Form 10-Q

 

ITEM 1 – Financial Statements

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

(In thousands, except per share data)

 

		Three Months Ended June 30						Six Months Ended June 30
		2004			2003			2004			2003
Net sales		$	128,790		$	110,772		$	247,892		$	223,909
Cost of sales		77,688			65,632			148,773			134,950
Gross profit		51,102			45,140			99,119			88,959
Operating expense:
Research and development expenses		4,370			4,228			8,424			8,408
Selling and administrative expenses		40,249			35,392			79,920			70,861
Total operating expenses		44,619			39,620			88,344			79,269
Profit from operations		6,483			5,520			10,775			9,690
Interest income, net		11			192			99			314
Other expense, net		(432		)	(330		)	(404		)	(326		)
Profit before income taxes		6,062			5,382			10,470			9,678
Income tax expense		2,337			2,146			4,188			3,896
Net earnings		$	3,725		$	3,236		$	6,282		$	5,782
Per share:
Basic earnings		$	0.41		$	0.36		$	0.70		$	0.64
Diluted earnings		$	0.41		$	0.36		$	0.69		$	0.64
Dividends		$	0.21		$	0.21		$	0.42		$	0.42
Weighted average number of shares:
Basic		9,002			8,966			9,008			8,971
Diluted		9,152			9,000			9,167			9,006

 

See accompanying Notes to Condensed Consolidated Financial Statements. 

 

2

 

TENNANT COMPANY

Quarterly Report – Form 10-Q

 

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

(In thousands)

 

		June 30, 2004			December 31, 2003
ASSETS
Cash and cash equivalents		$	20,898		$	24,587
Receivables, less allowances of $5,433 and $5,545 respectively		88,147			85,640
Inventories		52,249			54,682
Prepaid expenses		2,854			2,494
Deferred income taxes, current portion		8,235			8,967
Total current assets		172,383			176,370
Property, plant and equipment, net		62,547			61,121
Deferred income taxes, long-term portion		1,774			1,609
Goodwill		23,415			17,812
Other intangibles, net		1,490			—
Other assets		3,639			1,961
Total assets		$	265,248		$	258,873
LIABILITIES & SHAREHOLDERS’ EQUITY
LIABILITIES
Current debt and collateralized borrowings		$	7,847		$	1,030
Accounts payable, accrued expenses and deferred revenues		60,153			58,477
Total current liabilities		68,000			59,507
Long-term debt		1,649			6,295
Long-term employee-related benefits		28,221			27,455
Total liabilities		97,870			93,257
SHAREHOLDERS’ EQUITY
Common stock		3,386			3,385
Additional paid-in capital		301			355
Unearned restricted shares		(508		)	(551		)
Retained earnings		170,682			168,180
Accumulated other comprehensive loss		(933		)	(338		)
Receivable from ESOP		(5,550		)	(5,415		)
Total shareholders’ equity		167,378			165,616
Total liabilities and shareholders’ equity		$	265,248		$	258,873

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

3

 

TENNANT COMPANY

Quarterly Report – Form 10-Q

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(In thousands)

 

		Six Months Ended June 30
		2004			2003
CASH FLOWS RELATED TO OPERATING ACTIVITIES:
Net earnings		$	6,282		$	5,782
Adjustments to net earnings to arrive at operating cash flows:
Depreciation and amortization		6,346			7,091
Deferred tax expense		282			—
Changes in operating assets and liabilities:
Accounts receivable		(150		)	746
Inventory		4,011			2,740
Accounts payable, accrued expenses and deferred revenue		(1,306		)	(6,917		)
Other current/noncurrent assets and liabilities		478			1,096
Other, net		512			(2,865		)
Net cash flows related to operating activities		16,455			7,673
CASH FLOWS RELATED TO INVESTING ACTIVITIES:
Acquisition of property, plant and equipment		(8,106		)	(4,958		)
Acquisition of Walter-Broadley, net		(6,491		)	—
Proceeds from disposals of property, plant and equipment		1,025			2,667
Net cash flows related to investing activities		(13,572		)	(2,291		)
CASH FLOWS RELATED TO FINANCING ACTIVITIES:
Net changes in short-term borrowings		(193		)	(2,855		)
Payments of long-term debt		—			(5,000		)
Payment of assumed Walter-Broadley debt		(2,516		)	—
Proceeds from issuance of common stock		739			334
Purchases of common stock		(1,211		)	(1,825		)
Dividends paid		(3,780		)	(3,762		)
Net cash flows related to financing activities		(6,961		)	(13,108		)
Effect of exchange rate changes on cash and cash equivalents		389			80
Net decrease in cash and cash equivalents		(3,689		)	(7,646		)
Cash and cash equivalents at beginning of year		24,587			16,356
Cash and cash equivalents at end of period		$	20,898		$	8,710
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES
Collateralized borrowings incurred for operating lease equipment		$	600		$	—

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

4

 

TENNANT COMPANY

Quarterly Report – Form 10-Q

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

 

(1)       Basis of Presentation

 

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 June 30, 2004, the results of our operations for the three and six months ended June 30, 2004 and 2003 and our cash flows for the six months ended June 30, 2004 and 2003.  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, 2003.  The results of operations for the three and six months ended June 30, 2004 are not necessarily indicative of the results to be expected for the full year.

 

Certain prior year amounts have been reclassified to conform with current year presentation.

 

In January 2004, we acquired Walter-Broadley Machines Limited, a cleaning equipment company based in the United Kingdom, with annual sales of approximately $13 million. We paid $6,491 million in the form of cash and debt, subject to certain post-closing adjustments, for all of the stock of Walter-Broadley and assumed $2,576 million in outstanding debt, of which $2,516 million was immediately retired. The acquisition significantly increases our customer base and service coverage in the United Kingdom.  This acquisition is further described in Note 12 to the Condensed Consolidated Financial Statements.

 

(2)       Unusual Items

 

During the first quarter of 2003, we amended the agreement with our U.S. third-party lessor.  Prior to this amendment, the agreement contained a retained ownership risk provision that precluded revenue recognition at the time of shipment for equipment sales to the third-party lessor that were considered operating leases.  The amendment eliminated the retained ownership risk provision and was retroactive to the beginning of the agreement.  This resulted in the recognition of previously deferred revenue of $6,430 in first quarter of 2003, increasing net earnings by $1,796 or $0.20 per diluted share and also resulted in revenue recognition at the time of shipment for U.S. equipment sales under this agreement.

 

In March 2000, we entered into a joint venture with an unrelated third party to develop and market a new product.  During the first quarter of 2003, Tennant and our joint-venture partner agreed to dissolve the joint venture and we decided to permanently discontinue manufacturing the product and to abandon the plan to utilize the related purchased technology.  As a result of the joint-venture dissolution, we recorded after-tax charges totaling $1,215 or $0.14 per diluted share in the first quarter of 2003 related to the write-off of accounts receivable, inventory, intangible assets and the establishment of accruals for certain contractual obligations.

 

5

 

TENNANT COMPANY

Quarterly Report – Form 10-Q

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

 

(3)       Inventories

 

Inventories are valued at the lower of cost (principally on a last-in, first-out basis) or market.  Inventories at June 30, 2004 and December 31, 2003 consisted of the following:

 

		June 30, 2004			December 31, 2003
FIFO Inventories:
Finished goods		$	34,016		$	38,639
Raw materials, parts and work-in-process		39,028			37,179
Total FIFO inventories		73,044			75,818
LIFO reserve		(20,795		)	(21,136		)
LIFO inventories		$	52,249		$	54,682

 

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

 

(4)       Supplemental Cash Flow Information

 

Income taxes paid during the six months ended June 30, 2004 and 2003 were $611 and $1,948, respectively.  Interest costs paid during the six months ended June 30, 2004 and 2003 were $572 and $445, respectively.

 

(5)       Comprehensive Income

 

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:

 

		Three Months Ended June 30						Six Months Ended June 30
		2004			2003			2004			2003
Net earnings		$	3,725		$	3,236		$	6,282		$	5,782
Foreign currency translation adjustments		(360		)	988			(595		)	1,473
Comprehensive income		$	3,365		$	4,224		$	5,687		$	7,255

 

6

 

TENNANT COMPANY

Quarterly Report – Form 10-Q

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

 

(6)       Earnings Per Share Computation

 

		Three Months Ended June 30						Six Months Ended June 30
		2004			2003			2004			2003
Weighted average shares outstanding –  Basic		9,002			8,966			9,008			8,971
Dilutive share equivalents		150			34			159			35
Weighted average shares outstanding –  Diluted		9,152			9,000			9,167			9,006
Net earnings		$	3,725		$	3,236		$	6,282		$	5,782
Earnings per share – Basic		$	0.41		$	0.36		$	0.70		$	0.64
Earnings per share – Diluted		$	0.41		$	0.36		$	0.69		$	0.64

 

 

(7)       Segment Reporting

 

We operate in one industry segment that consists of the design, manufacture and sale of products used primarily in the maintenance of nonresidential surfaces.  The following table sets forth net sales by geographic area:

 

		Three Months Ended June 30						Six Months Ended June 30
		2004			2003			2004			2003
Geographical Net Sales(1)
North America		$	87,772		$	78,082		$	166,638		$	159,265
Europe		28,734			20,994			57,269			42,755
Other International		12,284			11,696			23,985			21,889
Total		$	128,790		$	110,772		$	247,892		$	223,909

 

(1)     Net of intercompany sales.

 

7

 

TENNANT COMPANY

Quarterly Report – Form 10-Q

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

 

(8)       Goodwill and Intangible Assets

 

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

 

		Goodwill			Other Intangibles
Balance, December 31, 2003		$	17,812		$	—
Additions		5,828			1,522
Amortization expense		—			(11		)
Foreign currency fluctuations		(225		)	(21		)
Balance, June 30, 2004		$	23,415		$	1,490

 

The additions to goodwill and other intangible assets during the first six months of 2004 were based on the purchase price allocation of the Walter-Broadley acquisition in January 2004, as discussed in Note 12 to the Condensed Consolidated Financial Statements.  These other intangible assets, consisting of customer lists and the trade name, will be amortized over useful lives ranging from 4 to 20 years, based on the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets.”

 

(9)       Stock-Based Compensation

 

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.  At June 30, 2004, we had six stock-based employee compensation plans, which are described in Note 13 of the 2003 Annual Report on Form 10-K.

 

We have adopted the disclosure-only provisions of SFAS 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” (“SFAS 148”).  SFAS 148 amends the disclosure requirements of SFAS 123, “Accounting for Stock-Based Compensation” (“SFAS 123”).  In accordance with SFAS 123, the fair value of options at the date of grant is estimated using the Black-Scholes option pricing model with the following assumptions:

 

		2004		2003
Expected life in years		7		7
Risk-free interest rate		3.5	%	3.6	%
Expected volatility		32.0	%	25.0	%
Expected dividend yield		2.3	%	2.3	%

 

8

 

TENNANT COMPANY

Quarterly Report – Form 10-Q

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

 

Had stock-based compensation cost been determined using the fair value-based method of accounting under SFAS 123, net earnings would have been reduced to the pro forma amounts indicated below:

 

		Three Months Ended June 30						Six Months Ended June 30
		2004			2003			2004			2003
Net earnings – as reported		$	3,725		$	3,236		$	6,282		$	5,782
Deduct:  Total stock-based employee compensation expense determined under fair value-based method for all awards, net of related tax effects		(337		)	(219		)	(653		)	(457		)
Net earnings – pro forma		$	3,388		$	3,017		$	5,629		$	5,325
Earnings per share:
Basic – as reported		$	0.41		$	0.36		$	0.70		$	0.64
Basic – pro forma		$	0.38		$	0.34		$	0.62		$	0.59
Diluted – as reported		$	0.41		$	0.36		$	0.69		$	0.64
Diluted – pro forma		$	0.37		$	0.34		$	0.61		$	0.59

 

(10)     Warranty Reserves

 

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, anticipated releases of new products and other factors.  Warranty terms on machines range from one to four years.  The changes in warranty reserve balances for the six months ended June 30, 2004 and 2003 were as follows:

 

		June 30, 2004			June 30, 2003
Beginning balance		$	6,018		$	4,519
Additions charged to expense		3,794			4,048
Change in estimate		271			—
Claims paid		(3,652		)	(3,831		)
Ending balance		$	6,431		$	4,736

 

9

 

TENNANT COMPANY

Quarterly Report – Form 10-Q

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

 

(11)     Retirement Benefit Plans

 

Tennant Company has contributed $184 during the second quarter and $396 for the first six months of 2004 to the postretirement medical benefit plan.  We have contributed $28 during the second quarter and $56 for the first six months of 2004 to our supplemental benefit plan.  We expect to contribute approximately $800 to the postretirement medical benefit plan and approximately $100 to the supplemental benefit plan during 2004.  No contributions to the pension plan are expected to be required during 2004.

 

The components of the net periodic cost (benefit) for the three and six months ended June 30, 2004 and 2003 were as follows:

 

		Three Months Ended June 30						Six Months Ended June 30
		2004			2003			2004			2003
Pension Benefits:
Service cost		$	213		$	214		$	443		$	428
Interest cost		422			390			836			780
Expected return on plan assets		(651		)	(623		)	(1,300		)	(1,246		)
Recognized actuarial gain		(176		)	(195		)	(297		)	(390		)
Amortization of transition obligation		(5		)	(6		)	(11		)	(11		)
Amortization of prior service cost		142			143			285			285
Net periodic benefit		$	(55	)	$	(77	)	$	(44	)	$	(154	)
Postretirement Medical Benefits:
Service cost		$	134		$	99		$	236		$	198
Interest cost		344			252			606			505
Recognized actuarial loss		—			3			—			5
Net periodic cost		$	478		$	354		$	842		$	708

 

10

 

TENNANT COMPANY

Quarterly Report – Form 10-Q

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

 

(12)     Walter-Broadley Acquisition

 

In January 2004, we acquired Walter-Broadley Machines Limited, a cleaning equipment company based in the United Kingdom, with annual sales of approximately $13 million. We paid $6,491 in the form of cash and debt, subject to certain post-closing adjustments, for all of the stock of Walter-Broadley and assumed $2,576 in outstanding debt, of which $2,516 was immediately retired. The acquisition significantly increases our customer base and service coverage in the United Kingdom. The acquisition is 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 the acquisition.  A preliminary allocation of the purchase price to assets acquired and liabilities assumed has been recorded as of June 30, 2004.  The purchase price allocation may change for up to one-year subsequent to the acquisition date.  The purchase price allocation may be adjusted based on the final determination of the fair value of assets acquired and liabilities assumed and post closing adjustments. These adjustments are not expected to be material. The components of the purchase price based upon our preliminary purchase price allocation are as follows:

 

 

11

 

TENNANT COMPANY

Quarterly Report – Form 10-Q

 

ITEM 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Financial Overview

 

During the second quarter 2004, net earnings increased 15.1% to $3.7 million or $0.41 per diluted share compared to the same period in 2003.  Net earnings were impacted by:

•      The direct favorable foreign currency exchange impact on net earnings of approximately $0.7 million or $0.08 per dilutive share.

•      A dilutive impact of $0.05 resulting from the acquisition of Walter-Broadley.

•      Growth in net sales of 16.3% to $128.8 million driven by growth in North America and Europe. The acquisition of Walter-Broadley contributed about 2% to net sales while foreign exchange added approximately 2%.

•      A decline in gross profit margins of 1.1% to 39.7% primarily due to increases in steel costs and a write-down of slow moving and excess inventory.

•      An increase in selling and administrative (S&A) expenses of $4.9 million or 13.7% to $40.2 million primarily due to increases in performance-based incentive compensation expense as well as marketing, health care and corporate governance costs. In addition, the Walter-Broadley acquisition increased S&A expenses by $0.9 million while foreign currency effects added $0.8 million.

 

For the six months ended June 30, 2004, net earnings increased 8.6% to $6.3 million or $0.69 per diluted share compared to the same period in 2003.  Net earnings were impacted by:

•      The direct favorable foreign currency exchange impact on net earnings of approximately $1.7 million or $0.18 per dilutive share.

•      A dilutive impact of $0.08 resulting from the acquisition of Walter-Broadley.

•      Growth in net sales of 10.7% to $247.9 million driven by sales increases in North America and Europe. The acquisition of Walter-Broadley contributed about 2% to net sales while foreign exchange added approximately 4%.

•      An increase in S&A expenses of $9.1 million or 12.8% to $79.9 million partially resulting from foreign currency exchange effects of $2.5 million.  The remaining increase is primarily due to an increase in performance-based incentive compensation expense and increased expenses resulting from the Walter-Broadley acquisition.

 

The six-month period ended June 30, 2003 included two unusual items, which contributed net earnings of $0.06 per diluted share to the six-month period.  The recognition of previously deferred revenue of $6.4 million in 2003 increased net earnings by $1.8 million after-tax ($2.9 million pre-tax) or $0.20 per diluted share and also resulted in revenue recognition at the time of shipment for U.S. equipment sales under this agreement.  In addition, a charge totaling $1.2 million after-tax ($2.0 million pre-tax) or $0.14 per diluted share was recognized during the first six months of 2003 resulting from the decision to dissolve a joint venture with an unrelated third party.

 

During the second quarter and first six months of 2004, our results were 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.

 

12

 

TENNANT COMPANY

Quarterly Report – Form 10-Q

 

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 2003 value of the U.S. dollar, the related effect on our results would continue to be favorable in 2004.

 

In January 2004, we acquired Walter-Broadley Machines Limited, a cleaning equipment company based in the United Kingdom, with annual sales of approximately $13 million, as discussed in Note 12 to the Condensed Consolidated Financial Statements.  We paid $6.5 million in the form cash and debt, subject to certain post-closing adjustments, for all of the stock of Walter-Broadley and assumed $2.6 million in outstanding debt, of which $2.5 million was immediately retired. The acquisition significantly increases our customer base and service coverage in the United Kingdom. The acquisition had a dilutive impact of approximately $0.08 during the first six months of 2004 resulting from certain integration costs and a short-term impact on gross profit margins related to purchase accounting, which are substantially complete.

 

Historical Results

 

The following compares the historical results of operations for the three- and six-month periods ended June 30, 2004 and 2003 in dollars and as a percentage of net sales (dollars in thousands, except earnings per diluted share):

 

		Three Months Ended June 30										Six Months Ended June 30
		2004			%		2003			%		2004			%		2003			%
Net sales		$	128,790		100.0		$	110,772		100.0		$	247,892		100.0		$	223,909		100.0
Cost of sales		77,688			60.2		65,632			59.2		148,773			60.0		134,950			60.3
Gross profit		51,102			39.7		45,140			40.8		99,119			40.0		88,959			39.7
Research and development expenses		4,370			3.4		4,228			3.8		8,424			3.4		8,408			3.8
Selling and administrative expenses		40,249			31.3		35,392			32.0		79,920			32.2		70,861			31.6
Profit from operations		6,483			5.0		5,520			5.0		10,775			4.3		9,690			4.3
Interest income, net		11			—		192			0.2		99			—		314			0.1
Other expense, net		432			0.3		330			0.3		404			0.2		326			0.1
Profit before income taxes		6,062			4.7		5,382			4.9		10,470			4.2		9,678			4.3
Income tax expense		2,337			1.8		2,146			1.9		4,188			1.7		3,896			1.7
Net earnings		$	3,725		2.9		$	3,236		2.9		$	6,282		2.5		$	5,782		2.6
Earnings per diluted share		$	0.41		—		$	0.36		—		$	0.69		—		$	0.64		—

 

13

 

TENNANT COMPANY

Quarterly Report – Form 10-Q

 

Net Sales

 

Consolidated net sales of $128.8 million for the second quarter 2004 increased 16.3% compared to second quarter 2003 sales of $110.8 million.  The increase in net sales for the quarter was driven by sales growth in North America and Europe. In addition, the acquisition of Walter-Broadley in January 2004 increased net sales in the second quarter by approximately 2%. Positive direct foreign currency exchange fluctuations, resulting primarily 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 2% in the 2004 second quarter.

 

Consolidated net sales of $247.9 million for the six months ended June 30, 2004 increased 10.7% compared $223.9 million in  2003. Positive direct foreign currency exchange fluctuations increased net sales by approximately 4% for the six months ended June 30, 2004.  The acquisition of Walter-Broadley increased net sales by approximately 2%.  The remaining increase was a result of sales growth in all geographic areas. Net sales for the first six months of 2003 included the one-time recognition of $6.4 million in previously deferred revenue in the first quarter of 2003, as discussed in Note 2 to the Condensed Consolidated Financial Statements.

 

The following table sets forth the net sales by geographic area for the three- and six-month periods ending June 30, 2004 and 2003 and the percentage change from the prior year (dollars in thousands):

 

 

NORTH AMERICA - North American sales for the 2004 second quarter increased 12.4% to $87.8 million compared with $78.1 million in 2003.  Growth in second quarter sales was driven by strong equipment sales resulting from the continued economic recovery in North America and new product introductions during the quarter as well as growth in aftermarket parts and service compared to the same period last year.

 

North American sales for the six months ending June 30, 2004 increased 4.6% to $166.6 million compared with $159.3 million in 2003.  Growth in year-to-date sales was driven by increases in equipment sales resulting from the continued economic recovery in North America as well as growth in aftermarket parts and service compared to the same period last year.  Positive direct foreign currency translation effects contributed approximately 1% to North American sales growth in the first six months of 2004. In addition, the first six months of 2003 included the one-time recognition of $6.4 million of previously deferred revenue discussed in Note 2 to the Condensed Consolidated Financial Statements.

 

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TENNANT COMPANY

Quarterly Report – Form 10-Q

 

EUROPE - In Europe, net sales for the 2004 second quarter increased 36.9% to $28.7 million versus the comparable 2003 period. The acquisition of Walter-Broadley in January 2004 added 13% to Europe’s second quarter sales growth.  Positive direct foreign currency translation effects increased European net sales by approximately 9% in the 2004 second quarter.  The remaining increase was due to sales growth resulting in part from our expanded sales and service coverage in selected countries.

 

Europe’s net sales for the six months ended June 30, 2004 increased 33.9% to $57.3 million versus the comparable 2003 period. The acquisition of Walter-Broadley in January 2004 added 13% to Europe’s year-to-date sales growth.  Positive direct foreign currency translation effects increased European net sales by approximately 13% during the first six months of 2004.  The shipment of a large order to a new European customer, primarily in the first quarter of 2004, contributed approximately 10% to Europe’s year-to-date sales growth.

 

OTHER INTERNATIONAL - - In other international markets, sales for the second quarter of 2004 totaled $12.3 million, up 5.0% from the 2003 second quarter. Positive direct foreign currency translation effects increased sales in other international markets by approximately 6% in the 2004 second quarter.   Second quarter 2004 sales increases in Australia and Asia were offset by weaker demand in Latin America and the Middle East during the quarter.

 

Sales in other international markets for the six months ended June 30, 2004 totaled $24.0 million, up 9.6% from the same period in 2003. Positive direct foreign currency translation effects increased sales in other international markets by approximately 8% in the first six months of 2004.  The remaining increase resulted from stronger sales in several international markets including Asia and Australia.

 

Gross Profit

 

Gross profit margin was 39.7% for the second quarter of 2004 compared with 40.8% reported in 2003.  The decline in gross margin was partially attributable to increases in steel costs during the quarter. A selling price surcharge on certain products was implemented during the second quarter, which partially offset the impact of the increased steel costs.  In addition, gross profit margins were impacted by a write-down of slow moving and excess inventory during the quarter resulting from an ongoing comprehensive analysis of inventory levels.

 

Gross profit margin was 40.0% for the first six months of 2004 compared with 39.7% reported in 2003.  The slight increase in gross profit margins on a year-to-date basis is primarily attributed to a shift in the mix of products sold between periods and foreign currency exchange effects.

 

Operating Expenses

 

S&A expenses in the second quarter 2004 increased 13.7% to $40.2 million from $35.4 million in 2003. Approximately $0.8 million is due to foreign currency exchange effects.  The Walter-Broadley acquisition contributed another $0.9 million to the increase. The remaining increase in S&A expenses is primarily attributable to an increase in performance-based incentive compensation expense, and an increase in marketing expenses to support in-depth market research and product launches scheduled for the second half of 2004. In addition, S&A expense was impacted by higher health care and corporate governance costs compared to the same quarter last year.  S&A expense as a percentage of sales was 31.3%, down from 32.0% in the comparable quarter last year.  The improvement as a percentage of sales is primarily driven by our ability to leverage sales growth.

 

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TENNANT COMPANY

Quarterly Report – Form 10-Q

 

S&A expenses for the six months ended June 30, 2004 increased 12.8% to $79.9 million from $70.9 million in 2003.  Approximately $2.5 million is due to foreign currency exchange effects.  The Walter-Broadley acquisition contributed another $1.7 million to the increase. The remaining increase primarily reflects an increase in performance-based incentive compensation expense.  S&A expense as a percentage of sales was 32.2%, up from 31.6% in the comparable period last year.  This increase is primarily the result of $6.4 million of deferred revenue that was recognized as a result of the amendment of the agreement with our third-party lessor, for which there was no related S&A expense in the first quarter of 2003.

 

Income Taxes

 

The effective tax rates for the second quarter were 38.6% for 2004 and 39.9% for 2003.  The decrease in the effective tax rate between quarters is primarily related to a one-time benefit resulting from the release of a valuation allowance on a foreign capital loss carryforward.

 

The year-to-date effective tax rates were 40.0% for 2004 and 40.3% for 2003.  We expect the effective tax rate to be approximately 41-42% for the full year 2004.  Our estimated effective tax rate for 2004 is based on current forecasts of full-year taxable earnings in domestic and foreign jurisdictions. The effective tax rate for the full year may be subject to change to the extent the forecasts change in total or by taxing jurisdiction or to the extent of changes in tax laws and regulations.

 

Liquidity and Capital Resources

 

The debt-to-total-capitalization ratio was 5.4% at June 30, 2004 versus 4.2% at December 31, 2003.  Cash and cash equivalents totaled $20.9 million at June 30, 2004, compared to $24.6 million at December 31, 2003.  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.

 

During the second quarter of 2004, we entered into a purchase commitment with a third-party manufacturer totaling $3.3 million through January 2005.

 

OPERATING ACTIVITIES - - Operating activities provided $16.5 million of cash during the six months ended June 30, 2004.  In the comparable 2003 period, operating activities provided cash of $7.7 million.  The cash provided from operating activities for the six months ended June 30, 2004 was primarily driven by a reduction in inventories as well as growth in net earnings. The reduction in inventories resulted from our ongoing efforts to reduce inventory levels and the implementation of lean manufacturing principles. Inventory on Hand (DIOH) decreased 23 days to 89 days as of June 30, 2004 compared to the same period last year. For the six months ended June 30, 2003, cash provided by operations was impacted by payments of restructuring liabilities and a one-time royalty obligation.

 

INVESTING ACTIVITIES – In January 2004, we acquired all of the stock of Walter-Broadley for $6.5 million in the form of cash and debt, subject to certain post-closing adjustments as well as assuming $2.6 million in outstanding debt, of which $2.5 million was immediately retired.  The cost of acquisition was paid for through cash and cash equivalents and funds provided by operations. Capital expenditures were $8.1 million during the first six months of 2004 compared to $5.0 million in the same period of 2003.  The increase is primarily attributable to a significant capital project to install a new powder paint system, which is scheduled to be in service by the end of 2004. We currently anticipate full-year capital spending to be in the range of $18 to $23 million.

 

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TENNANT COMPANY

Quarterly Report – Form 10-Q

 

FINANCING ACTIVITIES – During the first six months of 2004, $2.5 million in assumed Walter-Broadley debt was retired. During the first six months of 2003, significant uses of cash included a $5.0 million scheduled debt repayment and the pay down of short-term borrowings in Europe using the proceeds from the sale of office property in the UK.

 

Quantitative and Qualitative Disclosures About Market Risk and Other Matters

 

Our market risk includes the risk of adverse changes in foreign currency exchange rates.  Direct foreign currency exchange fluctuations from a weak U.S. dollar increased earnings per diluted share by approximately $0.18 for the six months ended June 30, 2004 compared with the year-ago period.  We could experience favorable or unfavorable foreign exchange effects for the remainder of 2004, compared with prior year results. 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, 2003.

 

We are subject to exposures resulting from potential price increases related to our purchases of raw materials or other product components.  Recently, increased worldwide demand and other factors have caused prices for steel and related products to increase. Given the worldwide steel market conditions, we anticipate significant price increases in our steel-based raw materials and component parts in 2004. We purchase approximately $11 million of raw or fabricated steel annually and do not maintain an inventory of steel in excess of our near-term production requirements. We also purchase component parts that contain steel.  We continue to focus on mitigating the impact of the anticipated steel price increases through product pricing and negotiations with our vendors. Successful mitigation of the impact will depend upon our ability to increase prices in a competitive market.

 

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.

 

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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:

•      The potential for soft markets in certain regions, including North America, Asia, Latin America and Europe.

•      Geo-political and economic uncertainty throughout the world.

•      Changes in tax laws and regulations including the repeal of the foreign export benefit.

•      Inflationary pressures.

•      The potential for increased competition in our business.

•      The relative strength of the U.S. dollar, which affects the cost of our products sold internationally.

•      Fluctuations in the cost or availability of raw materials.

•      The success and timing of new products.

•      Projections of future financial and operating results.

•      Successful integration of acquisitions.

•      The ability to achieve operational efficiencies, including synergistic and other benefits of acquisitions.

•      Our plans for growth.

 

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

 

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.

 

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TENNANT COMPANY

Quarterly Report – Form 10-Q

 

(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) On May 3, 2001, Tennant Company announced the authorization to purchase up to 400,000 shares of our common stock.  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.

 

For the Quarter Ended 6/30/2004		Total Number of Shares Purchased		Average Price Paid Per Share			Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Maximum Number of Shares that May Yet Be Purchased
April 1 – 30, 2004		352	(1)	$	41.90		—		92,063
May 1 – 31, 2004		16,124		$	37.55		16,124		75,939
June 1 – 30, 2004		—		—			—		75,939
Total		16,476		$	37.45		16,124		75,939

 

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

 

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

 

Tennant Company held its Annual Meeting of Shareholders on May 6, 2004, for the purpose of electing two directors, ratifying the appointment of KPMG LLP as our independent auditors and transacting such other business as would properly come before the meeting. Results of shareholder voting on these matters were as follows:

 

		For		Withhold
1.  Election of two Class III directors for a three year term expiring in 2007:
James T. Hale		8,013,656		518,977
Pamela K. Knous		7,992,541		540,092

 

		For		Against		Abstain		Broker Non-Vote
2.  Ratify the appointment of KPMG LLP as independent auditors for the Company.		7,910,027		294,521		328,085		—

 

There were 9,011,788 shares of common stock entitled to vote at the meeting and a total of 8,532,634 shares (94.68%) were represented at the meeting.

 

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TENNANT COMPANY

Quarterly Report – Form 10-Q

 

ITEM 6 - Exhibits and Reports on Form 8-K

 

(a)       Exhibits

 

Item #		Description		Method of Filing
3i		Articles of Incorporation		Incorporated by reference to Exhibit 4.1 to our Registration Statement No. 33-62003, Form S-8, dated August 22, 1995.
3ii		By-Laws		Incorporated by reference to Exhibit 3ii to our Annual Report on Form 10-K for the fiscal year ended December 31, 1999.
10.3		Tennant Company Restricted Stock Plan for Nonemployee Directors (as amended and restated effective May 6, 2004)		Filed herewith electronically.
10.6		Tennant Company Non-Employee Director Stock Option Plan (as amended and restated effective May 6, 2004)		Filed herewith electronically.
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		Section 1350 Certifications		Filed herewith electronically.

 

(b)       Reports on Form 8-K

 

Form 8-K, dated April 22, 2004, furnishing the news release for the company’s first quarter earnings announcement.

 

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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.

 

				TENNANT COMPANY
Date:	August 6, 2004		/s/ Janet M. Dolan
			Janet M. Dolan
			President and Chief Executive Officer
Date:	August 6, 2004		/s/ Anthony T. Brausen
			Anthony T. Brausen
			Vice President, Chief Financial Officer, and Treasurer
Date:	August 6, 2004		/s/ Gregory M. Siedschlag
			Gregory M. Siedschlag
			Corporate Controller and Principal Accounting Officer

 

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