ITEM 1. BUSINESS
Arctic Cat Inc., a Minnesota corporation, (the “Company” or “Arctic Cat”), is based in Thief River Falls, Minnesota. The Company operates in a single industry segment and designs, engineers, manufactures and markets snowmobiles and all-terrain vehicles (ATVs) under the Arctic Catâ brand name, as well as related parts, garments and accessories. The Company markets its products through a network of independent dealers located throughout the United States, Canada, and Europe and through distributors representing dealers in Europe, the Middle East, Asia and other international markets. The Arctic Cat brand name has existed for more than 45 years and is among the most widely recognized and respected names in the snowmobile industry. The Company trades on the NASDAQ Global Select Market under the symbol ACAT.
Industry Background
Snowmobiles - The snowmobile, developed in the 1950’s, was originally intended to be used as a utility vehicle, but today the overwhelming majority of the industry’s sales are for recreational use. Between the late 1950’s and early 1970’s, the industry expanded dramatically reaching a peak of over 100 manufacturers and a high of nearly 495,000 units sold to retail customers in North America in 1971. Today the number of major industry participants has decreased to four, Arctic Cat, Bombardier Recreational Products (BRP), Polaris and Yamaha. The Company believes there are currently more significant barriers to entry into the snowmobile market than existed in the 1970’s. These barriers include increased brand loyalty, long-standing dealer and distributor networks and relationships, limited engine sources, cost of four stroke engine development, manufacturing and engineering expertise and higher initial start-up costs. Industry-wide snowmobile sales to retail customers in North America were approximately 130,000 units for the 2008 model year.
All-Terrain Vehicles (ATVs) - The ATV industry evolved from the three-wheel model that was developed in the early 1970s to the four-wheel models that are sold today. The most popular ATV use is general recreation, followed by hunting/fishing, farm/ranch use, hauling/towing, transportation, and commercial uses. From 1970 to 1986, the number of ATVs retailed in the United States continued to grow until reaching an initial peak of 535,000 units in 1986. From 1987 to 1991, the number of ATVs sold declined to a low of approximately 147,000 units. Industry wide sales were 637,000 units in the United States and 88,500 units in Canada in calendar 2007. Major competitors in the industry include Honda, Yamaha, Kawasaki, BRP, Polaris and Suzuki.
Products
Snowmobiles - The Company produces a full line of snowmobiles, consisting of 41 models, marketed under the Arctic Cat brand name, and designed to satisfy various market niches. The 2008 Arctic Cat models carry suggested U.S. retail prices ranging from $5,499 to $12,699, excluding a youth model which is sold at a suggested U.S. retail price of $2,249. Arctic Cat snowmobiles are sold in the United States, Canada, Scandinavia and other international markets.
The Company’s 2008 year snowmobile models are categorized as Performance, Mountain, Crossover, Touring and Utility. The Company markets: Performance Arctic Cat models under the names F series and Jaguar ; Mountain models under the name M series; Crossover models under the name Crossfire; Touring models under the names Panther, and T series; and Utility models under the name Bearcat. In addition, to encourage family involvement in snowmobiling, the Company offers a youth snowmobile marketed under the AC120 name.
The Company believes the Arctic Cat brand name enjoys a premier image among snowmobile enthusiasts and that its snowmobiles have a long-standing reputation for quality, performance, fuel management, style, comfort, ride and handling. Arctic Cat snowmobiles offer a wide range of standard and optional features which enhance their operation, riding comfort and performance. Such features include hydraulic disc brakes, remote starters, heated seats and a technologically advanced front and rear suspension. Arctic Cat is the industry leader in fuel management technology offering an electronic fuel injection (EFI) system on most of its snowmobiles. The Company was the first in the snowmobile industry to utilize four stroke engines to reduce emissions. The Company subsequently introduced a snowmobile with a turbo charged four-stroke inter-cooled engine, and for the 2007 model year, the first four-stroke engine designed specifically for a snowmobile.
Arctic Cat focuses on new product development in order to grow its market share and introduces at least one new model every year. These new models are consistently the Company’s best sellers in their respective category. In the 2008 model year, approximately 80 percent of the Company’s snowmobile sales were from models or model variations not available three years earlier. Some recent examples of the success of Arctic Cat’s new products include the following: American Snowmobiler voted the 2008 TZ1 LXR the best touring sled for 2008, Sno X Magazine voted the 2008 TZ1 LXR the best touring sled ever, Affinity Powersports Media voted the 2008 Z1 Turbo Best of Class, Snow Tech Magazine voted the 2007 Arctic Cat the best riding and handling sled, and Supertrax Magazine voted the 2007 Arctic Cat Jaguar the best Twin Spar chassis sled. Racers riding Arctic Cat snowmobiles won numerous events in the 2008 model year including the Winter X Games Snocross Gold Medal, The Alaskan Iron Dog Race, the WPSA Powersports Snowmobile Tour Pro Stock Points Championship, the USCC Triple Crown points championship, and both
the Improved class and Mod class King titles at the Jackson Hole Hillclimb.
For the last three fiscal years ended 2008, 2007 and 2006 snowmobiles accounted for 26%, 32% and 32%, respectively, of the Company’s revenues.
All-Terrain Vehicles (ATVs) - In December 1995, the Company introduced its first ATV. Since that time the Arctic Cat line has grown to 24 models. Features like fully independent front and rear suspensions, hydraulic disc brakes, hi-low range transmission, long travel suspension with high ground clearance, MRP Speedracks, automatic transmissions, selectable 2WD/4WD shaft drive, locking differentials, newly introduced electronic fuel injection and a large fuel tank, all make Arctic Cat ATVs consumer friendly. The Company has special two rider models that provide a proper alternative for customers that want to ride double. The 2008 Arctic Cat ATV models carry suggested U.S. retail prices ranging from $3,599 to $10,499, excluding youth models which are sold at suggested U.S. retail price ranging from $1,799 to $2,299.
The Company introduced its new Prowler UTV into the utility ATV vehicle segment in 2006. The Prowler utilizes the Company’s 650cc and 700cc engines, a rear cargo box, dual bucket seats as well as Arctic Cat’s renowned long travel, suspension and ride characteristics. In fiscal year 2008 the UTV line consisted of three models with retail prices of $9,499 to $10,999.
In 2007 Arctic Cat introduced the industry’s first diesel ATV, capable of using biodiesel fuels and in 2008 the Company introduced the Thundercat 1000, the ATV with the largest displacement in the industry.
Arctic Cat has continued to expand into international markets by focusing on new product development, adding new distributors, entering new territories, and developing new markets. In July 2005, the Company acquired a 100% interest in a European company that markets ATVs which utilize the Company’s base ATV models. The Company completed this acquisition to further expand its ATV model offerings and strengthen its European presence.
Arctic Cat believes its ATVs are recognized for their power, durability, utility, suspension, style and are well received within the market. In 2005, ATV Illustrated voted the Prowler the best new UTV for sport and utility purposes. In 2006, All Terrain Vehicle Magazine awarded the Arctic Cat 250 the best entry level ATV and the Arctic Cat TRV as the best value. Farm Industry News awarded the Arctic Cat 400 4X4 best ground clearance in class. In 2007, ATV Magazine crowned the Arctic Cat Prowler XT the best trail recreational side-by-side. In 2008, ATV Magazine nominated the Thundercat as ATV of the Year and All Terrain Vehicle Magazine voted the Prowler XTX 700 as Best UTV in the Industry. Also in 2008, Affinity Powersports Media voted the Thundercat “Best in Class”.
For the last three fiscal years ended 2008, 2007, and 2006 ATVs accounted for 56%, 55%, and 54%, respectively, of the Company’s revenues.
Parts, Garments and Accessories - The Company is the exclusive provider of genuine Arctic Cat snowmobile and ATV parts, garments and accessories. Included are replacement parts and accessory items to upgrade Arctic Cat snowmobiles such as electric start and reverse kits, luggage racks and bags, backrests, machine covers, windshields, and colored accessories. Other items include maintenance supplies such as oil and fuel additives, track studs and carbide runners. Arctic Cat ATV parts and accessories include winch kits, snow plow kits, MRP Speedrack accessories, portable lights, utility bags and maintenance supplies.
The Company offers snowmobile garments for adults and children under the “Arcticwear” label. Suits, jackets, pants and accessory garments are offered in a wide variety of styles and sizes combining fashion with functional utility designed for the demands of snowmobiling and other winter activities. The Arcticwear line of clothing also includes pull-overs, riding gloves, hats, helmets, boots, gear bags, sweatshirts, T-shirts, and caps. The colors and designs of many of these items are coordinated with specific Arctic Cat snowmobile models.
The Company offers ATV garments under the “Arcticwear ATV Gear” label. This line of clothing is geared toward function and comfort and includes suits, jackets, gloves, helmets, gear bags, sweatshirts, T-shirts, and caps.
For the last three fiscal years ended 2008, 2007 and 2006 parts, garments and accessories accounted for 18%, 13% and 14%, respectively, of the Company’s revenues.
Manufacturing and Engineering
Arctic Cat snowmobiles and most ATVs are manufactured at the Company’s facilities in Thief River Falls, Minnesota. The Company’s European subsidiary has performed a portion of the manufacturing of the road ready ATVs for the European market. A Taiwanese company manufactures 50cc to 366cc ATVs for Arctic Cat. The Company also has a facility in Bucyrus, Ohio which houses its parts, garments and accessories distribution operations. The Company has strategically identified specific core manufacturing competencies for vertical integration and has chosen outside vendors to provide other parts. The Company has developed relationships with selected high quality vendors in order to obtain access to particular capabilities and technologies outside the scope of the Company’s expertise. The Company designs component parts often in cooperation with its vendors, contracts with them for the development of tooling, and then enters into agreements with these vendors to purchase component parts manufactured utilizing the tooling. In its vertically integrated operations, the Company manufactures foam seats, seat covers and machines, welds and paints other components.
The Company completes the total assembly of most of its products at its facilities in Thief River Falls. Manufacturing operations include robotics as well as digital and computer-automated equipment to speed production, reduce costs and improve the quality, fit and finish of every product. The Company believes that most raw materials used in its manufacturing process and most component parts, with the exception of engines are available from multiple alternative vendors on relatively short notice at competitive prices.
Suzuki Motor Corporation (“Suzuki”) has manufactured snowmobile engines and through fiscal 2008 certain ATV engines for the Company pursuant to supply agreements which are automatically renewed annually unless terminated. During late fiscal 2005, the Company began manufacturing certain of its own designed ATV engines as part of a strategic first step in a new engine program. The Company believes that having the capability to design and manufacture its own ATV engines will enable Arctic Cat to offer customers more choices, provide excellent value, lower Japanese yen currency exposure and enhance its long-term competitive position. In 2007, the Company transitioned its engine manufacturing from the Thief River Falls facility to its new facility in St. Cloud, Minnesota. Beginning in fiscal 2009, substantially all the Company’s ATV’s will use engines that are produced from the Company’s engine facility or purchased separately or as part of the 50cc to 366cc units the Company receives from a Taiwanese supplier.
The Company and Suzuki have enjoyed an excellent relationship since the Company’s inception. Suzuki purchased approximately 31% of the Company’s then outstanding capital stock in July 1988, prior to the Company’s initial public offering in July of 1990, and is currently the Company’s largest shareholder with approximately 34% of the Company’s outstanding capital stock. If Suzuki were ever to cease supplying snowmobile engines to the Company, such an interruption could materially and adversely affect production and results of operations. While notice of termination of the supply agreement may be given annually, effective termination of supply would take at least one model year and the Company believes it could take up to two model years for the Company or a new engine supplier to be in a position to manufacture the Company’s specially designed snowmobile engines. As a consequence, the Company regularly evaluates alternative snowmobile engine supply sources.
Since the Company began snowmobile production, it has followed a build-to-order policy to control inventory levels. Under this policy, the Company only manufactures a number of snowmobiles equivalent to the orders received from its dealers and distributors, plus a number of uncommitted machines used for dealer and market development, in-house testing and miscellaneous promotional purposes.
Most sales of snowmobiles to retail customers begin in the early fall and continue during the winter. Orders by dealers and distributors for each year’s production are placed in the spring following dealer and distributor meetings. Snowmobiles are built commencing in the spring and continuing through late autumn or early winter.
Retail sales of ATVs occur throughout the year with seasonal highs occurring in the spring and fall. The Company builds and purchases ATVs throughout the year to coincide with expected dealer and consumer demand.
The Company is committed to an ongoing engineering program dedicated to innovation and to continued improvements in the quality and performance of its products as well as new product introduction. The Company currently employs 150 individuals in the design and development of new and existing products, with an additional 32 individuals directly involved in the testing of snowmobiles and ATVs in normal and extraordinary conditions. In addition, snowmobiles and ATVs are tested in conditions and locations similar to those in which they are used. The Company uses computer-aided design and manufacturing systems to shorten the time between initial concept and final production. For fiscal years ended 2008, 2007, and 2006, the Company spent approximately $16,143,000, $17,756,000, and $17,067,000, respectively, on engineering, research and development. In addition, utilizing their particular expertise, the Company’s vendors regularly test and apply new technologies to the design and production of component parts.
Sales and Marketing
The Company’s products are currently sold through an extensive network of independent dealers located throughout the United States, Canada, and Europe and through distributors representing dealers in Europe, the Middle East, Asia and other international markets. To promote new dealerships and to service its existing dealer network, the Company also employs sales representatives throughout the United States and Canada.
The Company’s dealers enter into an annual renewable contract and are required to maintain status as an authorized dealer in order to continue selling the Company’s products. To obtain and maintain such status, dealers are expected to order a sufficient number of snowmobiles and/or ATVs to service their market area adequately. In addition, the dealers must perform service on these units and maintain satisfactory service performance levels, and their mechanics must complete special training provided by the Company. Dealers are also expected to carry adequate levels of inventory of genuine Arctic Cat parts and accessories. As is typical in the industry, most of the Company’s dealers also sell some combination of motorcycles, marine products, lawn and garden products and other related products.
The Company utilizes distributors outside the United States and Canada to take advantage of their knowledge and experience in their respective markets and to increase market penetration of its products. Canadian sales are made in Canadian dollars, nearly all of which is financed through certain Canadian financial institutions. Most sales to
distributors outside North America are made in U.S. dollars and are supported to some extent by letters of credit.
The Company’s sales and marketing efforts are comprised of dealer and consumer promotions, direct advertising and cooperative advertising programs with its dealers. Each year, the Company and its distributors conduct dealer shows in order to introduce the upcoming year’s models and to promote dealer orders. Marketing activities are designed to promote directly to consumers. Products are advertised by the Company in consumer magazines and through other media. In addition, the Company engages in extensive dealer cooperative advertising, on a local and national level, whereby the Company and its dealers share advertising costs. Each season the Company produces promotional films, product brochures, point of purchase displays, leaflets, posters and banners, and other promotional items for use by dealers. The Company also participates in consumer shows and rallies with dealers and sponsors independent racers who participate in snowmobile races throughout the world. In order for its dealers and distributors to remain price competitive and to reduce retail inventories, the Company will from time to time make available to them rebate programs, discounts, or other incentives. In order to build brand loyalty the Company publishes and mails, during the year, magazines called Pride (snowmobile) and Ride (ATV) to registered owners of its products.
The Company places strong emphasis on identifying and addressing the specific needs of its customers by periodically conducting dealer and consumer focus group meetings and surveys.
The Company warrants its snowmobiles and ATVs under a limited warranty against defects in materials and workmanship for a period generally ranging from six months to one year from the date of retail sale or for a period of 90 days from the date of commercial or rental use. Repairs or replacements under warranty are administered through the Company’s dealers and distributors.
Competition
The snowmobile and ATV markets are highly competitive, based on a number of factors, including performance, ride, suspension, innovation, technology, styling, fit and finish, brand loyalty, reliability, durability, price and distribution. The Company believes Arctic Cat snowmobiles and ATVs are highly regarded by consumers in all of these competitive categories. Certain of the Company’s competitors are more diversified and have financial and marketing resources which are substantially greater than those of the Company.
Regulation
Both federal and state authorities have vigorous environmental control requirements relating to air, water and noise pollution that affect the manufacturing operations of the Company. The Company endeavors to insure that its facilities comply with applicable environmental regulations and standards.
Certain materials used in snowmobile and ATV manufacturing that are toxic, flammable, corrosive or reactive are classified by the federal and state governments as “hazardous materials.” Control of these substances is regulated by the Environmental Protection Agency (EPA) and various state pollution control agencies, which require reports and inspection of facilities to monitor compliance. The Company’s manufacturing facilities are subject to the regulations promulgated by, and may be inspected by, the Occupational Safety and Health Administration.
Various states and other governmental agencies have also promulgated safety regulations regarding the use of snowmobiles and ATVs. The Company has supported laws and regulations pertaining to safety and exhaust emissions. The Company believes that the adoption of any pending laws or regulations would not negatively affect its products to any greater degree than those of its competitors.
The EPA adopted regulations affecting snowmobiles and ATVs for model years 2006 and beyond. The Company believes that it is and will be in compliance with these regulations. The Company supports balanced and appropriate programs that educate the customer on the safe use of its products and protect the environment.
The Company is a member of the International Snowmobile Manufacturers Association (ISMA), a trade association formed to promote safety in the manufacture and use of snowmobiles, among other things. The ISMA is currently made up of Arctic Cat, BRP, Yamaha, and Polaris. The ISMA members are also members of the Snowmobile Safety and Certification Committee (SSCC), which promulgated voluntary safety standards for snowmobiles. The SSCC standards, which require testing and evaluation by an independent testing laboratory of each model category produced by participating snowmobile manufacturers, have been adopted by the Canadian Ministry of Transport. Following the development of the SSCC standards, the U.S. Consumer Products Safety Commission denied a petition to develop a mandatory federal safety standard for snowmobiles in light of the high degree of adherence to the SSCC standards in the United States. Since the Company’s inception, all of its models have complied with the SSCC standards.
The Company is a member of the Specialty Vehicle Institute of America (SVIA), a trade association organized to foster and promote the safe and responsible use of ATVs manufactured and/or distributed throughout the United States. The Company is also a member of the Canadian Off-Highway Vehicle Distributors Council (COHV), as well as the All-Terrain Vehicle Association Europe (ATVEA).
Effects of Weather
While from time to time lack of snowfall in a particular region of the United States or Canada may adversely affect snowmobile retail sales
within that region, the Company works to mitigate this effect by taking snowmobile orders in the spring for the following winter season. In the past, weather conditions have materially affected snowmobile sales and there is no assurance that weather conditions will not materially affect the Company’s future sales of snowmobiles, ATV’s and parts, garments and accessories.
Employees
At March 31, 2008, the Company had 1,630 employees including 380 salaried and 1,250 hourly and production personnel. The Company’s employees are not represented by a union or subject to a collective bargaining agreement. The Company has never experienced a strike or work stoppage and considers its relations with its employees to be excellent.
Intellectual Property
The Company makes an effort to patent significant innovations that it considers patentable and owns numerous patents for its snowmobiles, ATVs and other products. Trademarks are also important to the Company’s snowmobile, ATVs and related parts, garments and accessories business activities. The Company has a program of trademark enforcement to eliminate the unauthorized use of its patents and trademarks, thereby strengthening their value. The Company believes that its “Arctic Cat” registered trademark is its most significant trademark. Additionally, the Company has numerous registered trademarks, trade names and logos, both in the United States and internationally.
Available Information
The Company is subject to the reporting requirements of the Securities Exchange Act of 1934 and its rules and regulations (the “1934 Act”). The 1934 Act requires the Company to file reports, proxy statements and other information with the Securities and Exchange Commission (the “SEC”). Copies of these reports, proxy statements and other information can be read and copied at: SEC Public Reference Room, 100 F Street, N.E., Washington D.C. 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains a website that contains reports, proxy statements, and other information regarding issuers that file electronically with the SEC. These materials may be obtained electronically by accessing the SEC’s home page at http://www.sec.gov.
The Company has a website at www.arcticcat.com, the contents of which are not part of or incorporated by reference into this annual report. The Company makes its annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K and amendments to those reports, available on its website, free of charge, as soon as reasonably practicable after such report has been filed with or furnished to, the SEC. The Company’s Code of Conduct, as well as any waivers from and amendments to the Code, are also posted on the Company’s website.
EXECUTIVE OFFICERS OF REGISTRANT
Mr. Twomey has been Chairman of the Company since 2003, President and Chief Executive Officer of the Company since 1986 and a director since 1987. Mr. Twomey is also currently serving as a director of The Toro Company.
Mr. Delmore has been Chief Financial Officer of the Company since 1986 and has been Corporate Secretary of the Company since 1989. Mr. Delmore, a CPA with seven years of prior public accounting experience, joined the Company in 1985 as Controller.
Mr. Blount has been Vice President - Human Resources since 1996. Mr. Blount has over 30 years of Human Resource experience in the manufacturing field. Prior to joining the Company, Mr. Blount worked as Vice President-Human Resources for a Minnesota-based company.
Mr. Ray has been Vice President - Operations since 2004; prior to that he served as the Company’s Vice President - Manufacturing since 1992 and has over 30 years of manufacturing experience. Before joining the Company he served eight years as Vice President of Manufacturing for a Minnesota-based company.
Mr. Skime has been Vice President - Research and Development of the Company since its inception in 1983 and has been employed in the snowmobile industry for over 40 years.
Mr. Tweet has been General Manager - ATVs since 2006 and prior to that was Vice President - New Product Development since 1992 and Vice President - Marketing since its inception in 1983 to 1992. Mr. Tweet has been employed either in the snowmobile or ATV industry for over 30 years.
Ms. Walker has been General Manager, Parts, Garments and Accessories and Sales since November 2007. Prior to joining the Company, Ms. Walker had been with a Minnesota-based company, 3M for 26 years, most recently serving as General Manager of Building Safety Solutions.
ITEM 1A.
ITEM 1A. RISK FACTORS
The following are significant factors known to the Company that could adversely affect the Company’s business, financial condition, or operating results, as well as adversely affect the value of an investment in the Company’s common stock. These risks could cause Arctic Cat’s actual results to differ materially from its historical experience and from results predicted by forward-looking statements. All forward-looking statements made by Arctic Cat are qualified by the risks described below. There may be additional risks that are not presently material or known. You should carefully consider each of the following risks and all other information set forth in this annual report.
The Company’s products are subject to extensive federal and state safety, environmental and other government regulation that may require the Company to incur expenses or modify product offerings in order to maintain compliance with the actions of regulators.
The Company’s products are subject to extensive laws and regulations relating to safety, environmental and other regulations promulgated by the U.S. and Canadian federal governments and individual states and provinces as well as international regulatory authorities. Although the Company believes that its snowmobiles, and ATVs have always complied with applicable vehicle safety and emissions standards and related regulations, there can be no assurance that future regulations will not require additional safety standards or emission reductions that would require additional expenses and/or modification of product offerings in order to maintain such compliance. Although the Company is unable to predict the ultimate impact of adopted or proposed regulations on its business and operating results, the Company believes that its business would be no more adversely affected than those of its competitors by the adoption of any pending laws or regulations.
A significant adverse determination in any material product liability claim against the Company could adversely affect its operating results or financial condition.
Accidents involving personal injury and property damage occur in the use of snowmobiles and ATVs. Claims have been made against the Company from time to time. It is the Company’s policy to vigorously defend against these actions. The Company presently maintains product liability insurance on a “per occurrence” basis (with coverage being provided in respect of accidents which occurred during the policy year, regardless of when the related claim is made) in the amount of $10,000,000 in the aggregate, with a $10,000,000 self-insured retention. While Arctic Cat does not believe the outcome of any pending product liability litigation will have a material adverse effect on its operations, no assurance can be given that material product liability claims against Arctic Cat will not be made in the future. Adverse determination of material product liability claims made against Arctic Cat could adversely affect its operating results or financial condition.
Significant repair and/or replacement with respect to product warranty claims or product recalls could have a material adverse impact on the results of operations.
The Company provides a limited warranty for a period of six months for its ATVs and one year for its snowmobiles. The Company may provide longer warranties in certain geographical markets as determined by local regulations and market conditions. Although the Company employs quality control procedures, sometimes a product is distributed which needs repair or replacement. The Company’s standard warranties require the Company or its dealers to repair or replace defective products during such warranty periods at no cost to the consumer. Historically, product recalls have been administered through the Company’s dealers and distributors and have not had a material effect on the Company’s business. See Note A of Notes to Consolidated Financial Statements in this annual report.
Changing weather conditions may reduce demand for certain Arctic Cat products and negatively impact net sales.
Lack of snowfall in any year in any particular region of the United States or Canada may adversely affect snowmobile retail sales and related parts, garments and accessories sales in that region. There is no assurance that weather conditions will not materially affect the Company’s future sales of snowmobiles, ATVs, and parts, garments and accessories.
The Company faces intense competition in all product lines, from competitors that have greater financial and marketing resources. Failure to compete effectively against competitors would negatively impact the Company’s business and operating results.
The snowmobile and ATV markets in the United States and Canada are highly competitive. Competition in such markets is based upon a number of factors, including performance, ride, suspension, innovation, technology, styling, fit and finish, brand loyalty, reliability, durability, price and distribution. At the dealer level, competition is based on a number of factors including sales and marketing support programs (such as sales incentives and cooperative advertising). The Company’s competitors are more diversified and have financial and marketing resources which are substantially greater than those of the Company. In addition, the Company’s products compete with many other recreational products for the discretionary spending of consumers and to a lesser extent, with other vehicles designed for utility applications. If the Company is not able to effectively compete
in this environment, its business and operating results will be negatively impacted.
Termination or interruption of supply arrangements could have a material adverse effect on the Company’s business or results of operations.
Suzuki Motor Corporation (“Suzuki”) has manufactured snowmobile engines and through fiscal 2008 certain ATV engines for the Company pursuant to supply agreements which are automatically renewed annually unless terminated. During late fiscal 2005, the Company began manufacturing certain of its own designed ATV engines as part of a strategic first step in a new engine program. The Company believes that having the capability to design and manufacture its own ATV engines will enable Arctic Cat to offer customers more choices, provide excellent value, lower Japanese yen currency exposure and enhance its long-term competitive position. In 2007, the Company transitioned its engine manufacturing from the Thief River Falls facility to its new facility in St. Cloud, Minnesota. Beginning in fiscal 2009, substantially all the Company’s ATV’s will use engines that are produced from the Company’s engine facility or purchased separately or as part of the 50cc to 366cc units the Company receives from a Taiwanese supplier. The Company and Suzuki have enjoyed an excellent relationship since the Company’s inception. Suzuki purchased approximately 31% of the Company’s then outstanding capital stock in July 1988, prior to the Company’s initial public offering in July of 1990, and is currently the Company’s largest shareholder with approximately 34% of the Company’s outstanding capital stock. If Suzuki were ever to cease supplying snowmobile engines to the Company, such an interruption could materially and adversely affect production and results of operations. While notice of termination of the supply agreement may be given annually, effective termination of supply would take at least one model year and the Company believes it could take up to two model years for the Company or a new engine supplier to be in a position to manufacture the Company’s specially designed snowmobile engines. As a consequence, the Company regularly evaluates alternative snowmobile engine supply sources. While the Company anticipates no significant difficulties in obtaining substitute supply arrangements for other raw materials or components for which it relies upon limited sources of supply, there can be no assurance that alternate supply arrangements will be made on satisfactory terms.
General Economic Conditions and Certain Other External Factors
Companies within the snowmobile and ATV industry are subject to volatility in operating results due to external factors such as general economic conditions and political changes. Specific factors affecting the industry include:
· Overall consumer confidence and the level of discretionary consumer spending;
· Interest rates and related higher dealer floorplan costs;
· Adverse impact on margins of increases in raw material and transportation costs which companies are unable to pass on to dealers without negatively affecting sales; and
· Fluctuation in foreign currency exchange rates.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2.
ITEM 2. PROPERTIES
The following sets forth the Company’s material property holdings as of March 31, 2008.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Accidents involving personal injury and property damage occur in the use of snowmobiles and ATVs. Claims have been made against the Company from time to time. It is the Company’s policy to vigorously defend against these actions. The Company is not involved in any legal proceedings which it believes will have the potential for a materially adverse impact on the Company’s business or financial condition.
Product liability insurance is presently maintained by the Company on a “per occurrence” basis (with coverage being provided in respect of accidents which occurred during the policy year, regardless of when the related claim is made) in the amount of $10,000,000 in the aggregate, with a $10,000,000 self-insured retention. The Company believes such insurance is adequate.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to the shareholders during the fourth quarter of fiscal 2008.
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The Company’s common stock is traded on The NASDAQ Global Select Market under the NASDAQ symbol “ACAT”. Quotations below represent the high and low sale prices as reported by NASDAQ. The Company’s stock began trading on NASDAQ on June 26, 1990.
As of June 2, 2008, the Company had approximately 386 stockholders of record, including the nominee of Depository Trust Company which held 11,244,503 shares of common stock.
Cash Dividends Paid
Cash Dividends are declared quarterly and have been paid since 1995.
Company Purchases of Company Equity Securities
The following table presents the total number of shares repurchased during the fourth quarter of fiscal 2008 by fiscal month, the average price paid per share, the number of shares that were purchased as part of a publicly announced repurchase plan, and the approximate dollar value of shares that may yet be purchased pursuant to the Company’s stock repurchase program as of the end of fiscal 2008:
(1) The Company has in the past maintained publicly announced stock repurchase programs which have been approved by the Board of Directors. On October 26, 2006, the Company announced that the Board of Directors approved a $20 million repurchase program and on January 4, 2008, the Company announced that the Board approved an additional $10 million stock repurchase program. Pricing under this program has been delegated to management. There is no expiration date for this program.
(2) Number of Shares purchasable at closing price of the Company’s common stock on the last trading day of the month.
The Company purchases Company common stock primarily to offset the dilution created by employee stock option programs and because the Board of Directors believes investment in the Company’s common stock is an excellent use of its excess cash.
The Company has executed the Company stock purchases in accordance with Rule 10b-18 of the Securities Exchange Act of 1934. There have been no other purchases of the Company’s common stock.
Item 6.
Item 6. Selected Financial Data
QUARTERLY FINANCIAL DATA (unaudited)
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Executive Level Overview
Fiscal 2008 net sales decreased 21% to $621.6 million from $782.4 million in fiscal 2007. The fiscal 2008 net loss was $3.3 million or $0.18 per diluted share compared to net earnings of $22.1 million or $1.15 per diluted share in fiscal 2007. The decrease in net earnings was mainly due to decreased sales of ATVs and snowmobiles caused by challenging retail market conditions for ATV sales and the planned reduction of fiscal 2008 snowmobile production to align inventory with retail demand. During the year the Company repurchased nearly 624,000 shares of the common stock and ended the fiscal year with $35 million in cash and short-term investments.
The Company’s product lines consist of ATVs, snowmobiles and parts, garments and accessories.
ATV sales decreased 19% in fiscal 2008 to $350.3 million from $431.5 million in fiscal 2007. ATV net sales first surpassed snowmobile net sales in fiscal 2004 and are the Company’s largest product line, comprising over 56% of net sales in fiscal 2008. Snowmobile sales decreased 34% in fiscal 2008 to $161.9 million from $247.0 million in fiscal 2007 primarily due to the planned reduction in snowmobile production to align dealer inventory with retail demand. Snowmobiles comprised 26% of the Company’s net sales in fiscal 2008. Parts, garments and accessory sales increased 5% in fiscal 2008 to $109.4 million from $103.9 million in fiscal 2007 driven primarily by snowmobile parts and accessories. Parts, garments and accessory sales were 18% of the Company’s net sales in fiscal 2008. The following discussions should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this annual report.
Results of Operations
Fiscal 2008 vs. Fiscal 2007 - During fiscal 2008 net sales decreased 21% to $621,568,000 from $782,431,000 in fiscal 2007. ATV unit volume decreased 25%, snowmobile unit volume decreased 37% and sales of parts, garments and accessories increased 5% or $5,489,000. ATV unit volume decreased primarily due to declining industry wide ATV retail sales. Snowmobile unit volume decreases were largely due to the Company’s planned 30% reduction in fiscal 2008 snowmobile production to align dealer inventory with retail demand.
Gross profit decreased 22% to $110,429,000 in 2008 from $141,794,000 in 2007. The gross profit percentage for fiscal 2008 decreased to 17.8% versus 18.1% in 2007. The decrease in the 2008 gross profit percentage was mainly due to additional Canadian sales incentives to help compensate for the stronger Canadian dollar as well as lower sales volumes.
Selling, general and administrative expenses increased 8% to $119,142,000 in 2008 from $109,861,000 in 2007. Selling, general and administrative costs increased primarily due to increased Canadian currency hedge costs. As a percent of net sales, operating expenses were 19.2% in 2008 compared with 14.0% in 2007.
Operating profit (loss) decreased 127.3% to $(8,713,000) in 2008 from $31,933,000 in 2007. As a percent of net sales, operating profit (loss) were (1.4%) in 2008 compared to 4.1% in 2007. The decrease in operating profit is attributable to decreased gross profit and increased operating expenses.
Interest income decreased 44.5% to $632,000 in fiscal 2008 from $1,139,000 in fiscal 2007. Interest expense increased 3.9% to $1,066,000 in fiscal 2008 from $1,026,000 in fiscal 2007. Interest income was primarily affected by the higher cash levels at the beginning of our fiscal year compared to last year, and lower cash balances during the third and fourth quarters of fiscal 2008 due primarily to higher working capital needs.
The net loss was $3,259,000 or $0.18 per diluted share versus net earnings of $22,070,000 or $1.15 per diluted share for fiscal 2007. Net earnings (loss) as a percent of net sales were( 0.5%) and 2.8% in 2008 and 2007, respectively. The decrease in net earnings (loss) is attributable to decreased sales and increased operating expenses.
Fiscal 2007 vs. Fiscal 2006 - During fiscal 2007 net sales increased 6.8% to $782,431,000 from $732,794,000 in fiscal 2006. ATV unit volume decreased 1.8%, snowmobile unit volume decreased 4.9% and dollar sales of parts, garments and accessories increased $4,101,000. The Company believes the continued increase in ATV net sales is due to higher end product offerings led by the Prowler UTV. Snowmobile unit volume decreased because of lower dealer orders related to less than normal snowfalls during the prior winter season in certain key regions in North America.
Gross profit increased 3.9% to $141,794,000 in 2007 from $136,510,000 in 2006. The gross profit percentage decreased to 18.1% versus 18.6% in 2006. The decrease in the 2007 gross profit percentage was mainly due to increased snowmobile sales incentives.
Selling, general and administrative expenses increased 5.9% to $109,861,000 in 2007 from $103,775,000 in 2006. Selling, general and administrative costs increased primarily due to increased operating cost of the European subsidiary and increased product liability and litigation accruals. As a percent of net sales, operating expenses were 14.0% in 2007 compared with 14.2% in 2006.
Operating profits decreased 2.4% to $31,933,000 in 2007 from $32,735,000 in 2006. As a percent of net sales, operating profits were 4.1% in 2007 compared to 4.5% in 2006. The decrease in operating profits is attributable to increased operating expenses.
Interest income decreased to $1,139,000 in fiscal 2007 from $1,556,000 in fiscal 2006. Interest expense increased to $1,026,000 in fiscal 2007 from $105,000 in fiscal 2006. Interest income was primarily affected by the lower cash levels at the beginning of our fiscal year compared to last year. Interest expense was also affected by the lower cash balances that resulted in increased borrowings from the Company’s line of credit during the first and second quarters of fiscal 2007 compared to the same period last year.
Net earnings decreased to $22,070,000 or $1.15 per diluted share from $23,746,000 or $1.20 per diluted share for fiscal 2006. Net earnings as a percent of net sales were 2.8% and 3.2% in 2007 and 2006, respectively. The decrease in net earnings is attributable to increased operating expenses.
Critical Accounting Policies
The preparation of the consolidated financial statements in accordance with accounting principles generally accepted in the United States requires management to make certain estimates and assumptions that affect the amount of reported assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and revenues and expenses during the periods reported. Actual results may differ from those estimates. The Company reviewed the development and selection of the critical accounting policies and believes the following are the most critical accounting policies that could have an effect on the Company’s reported results. These critical accounting policies and estimates have been reviewed with the audit committee of the Board of Directors.
Revenue Recognition - The Company recognizes revenue and provides for estimated marketing and sales incentive costs when products are shipped to dealers and distributors pursuant to their order, the price is fixed and collection is reasonably assured. The Company has agreements with finance companies to repurchase products repossessed up to certain limits. The Company’s financial exposure to repurchase products is limited to the difference between the amount paid to the finance company and the resale value of the repossessed products. Historically, the Company has not incurred material losses as a result of repurchases nor has it provided a financial reserve for repurchases. Adverse changes in retail sales could cause this situation to change.
Marketing and Sales Incentive Costs - The Company provides for various marketing and sales incentive costs which are offered to its dealers and consumers at the later of when the revenue is recognized or when the marketing and sales incentive program is approved and communicated. Examples of these costs include: dealer and consumer rebates, dealer floorplan financing assistance and other incentive and promotion programs. Adverse market conditions resulting in lower than expected retail sales or the matching of competitor programs could cause accrued marketing and incentive costs to materially increase if the Company authorizes and communicates new programs to its dealers. The Company estimates marketing and sales incentive costs based on expected usage and historical experience. The related marketing and sales incentive costs accrual is included in accrued marketing in the Company’s balance sheet. To the extent current experience differs with previous estimates the accrued liability for marketing and sales incentives is adjusted accordingly.
Product Warranties - The Company generally provides a limited warranty to the owner of snowmobiles for twelve months from the date of consumer registration and for six months on ATVs. The Company provides for estimated warranty costs at the time of sale based on historical rates and trends and makes subsequent adjustments to their estimate as actual claims become known or the amounts are determinable. Adverse changes in actual warranty costs compared to the Company’s initial estimates could cause accrued warranty to materially change.
Product Liability and Litigation - The Company is subject to product liability claims and other litigation in the normal course of business. Arctic Cat insures for product liability claims although it retains a modest self insured retention accrual within the balance sheet caption Insurance. The estimated costs resulting from any losses over insured amounts are charged to operating expenses when it is probable a loss has been incurred and the amount of the loss is reasonably determinable.
The Company utilizes historical trends and other analysis to assist in determining the appropriate loss. Adverse changes in the final determination of product liability or other claims made against the Company could have a material impact on the Company’s financial condition.
Stock-Based Compensation
The Company recognizes stock based compensation based on certain assumption inputs within the Black-Scholes Model. These assumption inputs are used to determine an estimated fair value of stock based payment awards on the date of grant and require subjective judgment. The Company accounts for stock based payment awards in accordance with Statement of Financial Accounting Standard No. 123(R), Share Based Payments (SFAS 123(R)). Because employee stock options have characteristics significantly different from those of traded options, and because changes in the input assumptions can materially affect the fair value estimate, the existing models may not provide a reliable single measure of the fair value of the employee stock options. Management assesses the assumptions and methodologies used to calculate estimated fair value of stock-based compensation on a regular basis. Circumstances may change and additional data may become available over time, which could result in changes to these assumptions and methodologies and thereby materially impact our fair value determination. If factors change and the Company employs different assumptions in the application of SFAS 123(R) the amount of compensation expense associated with SFAS 123(R) may differ significantly from what was recorded in the current period.
Liquidity and Capital Resources
The seasonality of the Company’s snowmobile production cycle and the lead time between the commencement of snowmobile and ATV production in the early spring and commencement of shipments late in the first quarter have resulted in significant fluctuations in the Company’s working capital requirements during the year. Historically, the Company has financed its working capital requirements out of available cash balances at the beginning and end of the production cycle and with short-term bank borrowings during the middle of the cycle. The Company believes current available cash and cash generated from operations together with its available line of credit will provide sufficient funds to finance the Company on a short and long-term basis.
Cash and Short-Term Investments
Cash and short-term investments decreased to $35,063,000 at March 31, 2008 from $75,277,000 at March 31, 2007 because of the fiscal 2008 net loss and increased inventories. The Company’s cash balances traditionally peak early in the fourth quarter and then decrease as working capital requirements increase when the
Company’s snowmobile and spring ATV production cycles begin. The Company’s investment objectives are first, safety of principal and second, rate of return.
Financing Arrangements and Cash Flows
The Company has a $75,000,000 unsecured bank credit agreement for the documentary and stand-by letters of credit and for working capital purposes. Total working capital borrowings under the credit agreement are limited to $60,000,000 during the last five months of the fiscal year. The total letters of credit issued at March 31, 2008 were $7,367,000, of which $5,746,000 was issued to Suzuki for engine and service parts purchases.
The Company has agreements with certain finance companies to provide snowmobile and ATV floor plan financing for the Company’s North American dealers. These agreements improve the Company’s liquidity by financing dealer purchases of products without requiring substantial use of the Company’s working capital. The Company is paid by the floor plan companies shortly after shipment and as part of its marketing programs the Company pays the floor plan financing of its dealers for certain set time periods depending on the size of a dealer’s order. The financing agreements require repurchase of repossessed new and unused units and set limits upon the Company’s potential liability for annual repurchases. The aggregate potential liability was approximately $45,222,000 at March 31, 2008. The Company has incurred no material losses under these agreements. The Company believes current available cash and cash generated from operations provide sufficient funding in the event there is a requirement to perform under this guarantee and repurchase agreement.
In 2008, the Company invested $15,466,000 in capital expenditures. The Company expects that capital expenditures, will increase to approximately $27,000,000 in fiscal 2009. Since 1996, the Company has repurchased over 11 million shares of common stock. There is approximately $10,000,000 remaining on the January 2008 repurchase authorization. The Company believes that cash generated from operations and available cash will be sufficient to meet its working capital, regular quarterly dividend, share repurchase program and capital expenditure requirements on a short and long-term basis.
Contractual Obligations
The following table summarizes the Company’s significant future contractual obligations at March 31, 2008 (in millions):
(1) The Company has outstanding purchase obligations with suppliers and vendors at March 31, 2008 for raw materials and other supplies as part of the normal course of business.
Forward-Looking Statements
The Private Securities Litigation Reform Act of 1995 provides a safe harbor for certain forward-looking statements. This annual report on Form 10-K, as well as the Company’s Annual Report and future filings with the Securities and Exchange Commission, the Company’s press releases and oral statements made with the approval of an authorized executive officer, contain forward-looking statements that reflect the Company’s current views with respect to future events and financial performance. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results or those anticipated. The words “aim,” “believe,” “expect,” “anticipate,” “intend,” “estimate” and other expressions that indicate future events and trends identify forward-looking statements. Actual future results and trends may differ materially from historical results or those anticipated depending on a variety of factors, including, but not limited to the risk factors described in Item 1A of this annual report. The Company does not undertake any obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Inflation, Foreign Exchange Rates and Interest Rates
Inflation historically, has not significantly impacted on the Company’s business. The Company generally has been able to offset the impact of increasing costs through a combination of productivity gains and product sales price increases.
During fiscal 2008, approximately 15% of the Company’s cost of sales was purchased from Japanese yen denominated suppliers. The majority of these purchases were made from Suzuki, who supplies engines for the Company’s snowmobiles and ATVs. The Company has an agreement with Suzuki for snowmobile engine purchases to share the impact of fluctuations in the exchange rate between the U.S. dollar and the Japanese yen above and below a fixed range contained in the agreement. This agreement renews annually. During fiscal 2008, the exchange rate fluctuation between the U.S. dollar and the Japanese yen had a modest negative impact on the Company’s operating results. From time to time the Company utilizes foreign exchange cash flow hedging contracts to minimize the impact of exchange rate fluctuations relating to ATV engine purchases. During 2008, the average contracted forward exchange rate on these cash flow hedges was approximately 118 (Japanese yen to the U.S. dollar). At March 31, 2008, there were no Japanese yen forward exchange contracts outstanding.
Sales to Canadian dealers are made in Canadian dollars with the U.S. dollar serving as the functional currency. During fiscal 2008, sales to Canadian dealers comprised 27.5% of total net sales. During fiscal 2008, the exchange rate fluctuation between the U.S. dollar and the Canadian dollar had no material impact on operating profits. During 2008, the Company utilized cash flow hedges to mitigate the variability in Canadian exchange rate changes relating to Canadian dollar fund transfers to the United States. During 2008, the average contracted forward exchange rate on these cash flows hedges was approximately $1.10 (Canadian dollar to U.S. dollar). At March 31, 2008 there were Canadian dollar forward exchange contracts outstanding with a notional amount of $30,599,000.
Sales to European on-road ATV dealers and distributors are made in Euros with the Euro serving as the functional currency. During fiscal 2008, sales to European on-road ATV dealers comprised 5.0% of total net sales. During fiscal 2008, the exchange rate fluctuation between the U.S. dollar and the Euro had no significant impact on operating profits. During 2008, the Company did not utilize any hedges to mitigate the variability in the Euro exchange rate and at March 31, 2008, there were no foreign exchange contracts outstanding for the Euro.
The fair values of the Canadian dollar hedge contracts at March 31, 2008 represented an unrealized gain of $211,000. A ten percent fluctuation in the currency rates as of March 31, 2008 would have resulted in a change in fair value of the Canadian dollar hedge contracts of approximately $3,060,000.
Interest rate market risk is managed for cash and short-term investments by investing in a diversified frequently maturing portfolio consisting of municipal bonds and money market funds that experience minimal volatility. The carrying amount of available-for-sale debt securities approximate related fair value and the associated market risk is not deemed to be significant.
The Company is a party to an unsecured bank line of credit arrangement under which it may borrow an aggregate of up to $75 million. The total letters of credit issued at March 31, 2008 were $7,367,000 of which $5,746,000 was issued to Suzuki Motor Corporation for engine and service parts purchases. Interest is charged at variable rates based on either LIBOR or prime. Because the interest rate risk related to the line of credit is not deemed to be significant, the Company does not actively manage this exposure.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial Statements, Notes, and Report of Independent Registered Public Accounting Firm appear on pages 21 through 32. Quarterly financial data appears in Item 6.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
The Company’s management, including the Chief Executive Officer and Chief Financial Officer, have conducted an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15 under the 1934 Act as of March 31, 2008. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in the reports it files or submits under the 1934 Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
There have been no significant changes in internal controls over financial reporting during the fiscal quarter ended March 31, 2008 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
MANAGEMENT’S REPORT OF INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of Arctic Cat is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Securities and Exchange Act of 1934. The Company’s internal control system was designed to provide reasonable assurance to the Company’s management and Board of Directors regarding the preparation and fair presentation of published financial statements.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of March 31, 2008. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. Based on the assessment management believes that, as of March 31, 2008, the Company’s internal control over financial reporting is effective based on those criteria.
The Company’s independent registered public accounting firm has issued an audit report on our assessment of the Company’s internal control over financial reporting. This report appears below.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders of Arctic Cat Inc.
We have audited management’s assessment, included in the accompanying Management’s Report included in Item 9 of this
Form 10-K, that Arctic Cat Inc. and subsidiaries maintained effective internal control over financial reporting as of March 31, 2008, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Arctic Cat Inc. and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Arctic Cat Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of March 31, 2008, based on criteria established in Internal Control-Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Arctic Cat Inc. and subsidiaries as of March 31, 2008 and March 31, 2007, and the related consolidated statements of operations, shareholders’ equity, and cash flows for
each of the three years in the period ended March 31, 2008 and our report dated June 10, 2008 expressed an unqualified opinion on those consolidated financial statements.
/s/ GRANT THORNTON LLP
Minneapolis, Minnesota
June 10, 2008
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information included under the heading “Election of Director,” “Election of Director - Board Committees,” “ Election of Director - Code of Conduct” and “Beneficial Ownership of Capital Stock-Section 16(a) Beneficial Ownership Reporting Compliance” in the Company’s definitive Proxy Statement for the Annual Meeting of Shareholders to be held August 7, 2008, is incorporated herein by reference.
Pursuant to instruction 3 to Item 401(b) of Regulation S-K, information as to executive officers of the Company is set forth in Item 4A of this Annual Report.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
The information included under the heading “Executive Compensation and Other Information” in the Company’s definitive Proxy Statement for the Annual Meeting of Shareholders to be held August 7, 2008, is incorporated herein by reference.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information included under the heading “Beneficial Ownership of Capital Stock” and “Beneficial Ownership of Capital Stock - Equity Compensation Plan Information” in the Company’s definitive Proxy Statement for the Annual Meeting of Shareholders to be held August 7, 2008, is incorporated herein by reference.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Information with respect to certain relationships and related transactions, appearing under the heading “Executive Compensation and Other Information-Certain Transactions” and “Election of Director - Director Independence” in the Company’s definitive Proxy Statement for the Annual Meeting of Shareholders to be held on August 7, 2008, is incorporated herein by reference.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is incorporated by reference to the information set forth under the heading “Proposal 2. Ratification and Appointment of Independent Registered Public Accounting Firm” in the Company’s definitive Proxy Statement for the Annual Meeting of Shareholders to be held August 7, 2008.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Documents filed as part of report
1. Financial Statements.
The following consolidated financial statements of the Company and its subsidiaries are filed as part of this Form 10-K:
Form 10-K
Reference Page
(i)
Consolidated Balance Sheets as of March 31, 2008 and 2007
(ii)
Consolidated Statements of Operations for the three years ended March 31, 2008, 2007 and 2006
(iii)
Consolidated Statements of Shareholders’ Equity for the three years ended March 31, 2008, 2007 and 2006
(iv)
Consolidated Statements of Cash Flows for the three years ended March 31, 2008, 2007 and 2006
(v)
Notes to Consolidated Financial Statements
29-37
(vi)
Report of Independent Registered Public Accounting Firm
2. Schedules filed as part of this Form 10-K.
The information required to be disclosed within Schedule II - Valuation and Qualifying Accounts is provided within the Consolidated Financial Statements of the Company, filed as part of this Form 10-K.
3. Exhibits
Method of Filing
3(a)
Amended and Restated Articles of Incorporation of the Company
(3)
3(b)
Restated By-Laws of the Company
(1)(10)
4(a)
Form of specimen common stock certificate
(1)
4(b)
Rights Agreement by and between the Company and Wells Fargo Bank Minnesota, N.A., dated September 17, 2001
(4)
10(a)
Purchase/Supply Agreement dated as of March 1, 1985 between Suzuki Motor Co., Ltd. And the Company, and related Agreement on Implementation of Warranty Provision.
(1)
10(b)
Form of Employment Agreement between the Company and each of its executive officers.
(1)
10(c)
Floorplan Repurchase Agreement dated July 13, 1984, between the Company and ITT Commercial Finance Corp.
(1)
10(d)
Floorplan Repurchase Agreement dated as of June 15, 1988, between the Company and ITT Commercial Finance, a division of ITT Industries of Canada, Ltd.
(1)
10(e)
Discretionary Revolving Credit Facility, dated as of June 6, 1997, between the Company and Wells Fargo Bank Minnesota, National Association.
(3)
10(f)
2002 Stock Plan
(5)
10(g)
Form of Incentive Stock Option Agreement for 2002 Stock Plan
(7)
10(h)
Form of Non-Qualified Stock Option Agreement for 2002 Stock Plan
(7)
10(i)
Form of Director Non-Qualified Stock Option Agreement for 2002 Stock Plan
(7)
10(j)
Program Agreement, dated as of January 20, 2003, by and between Arctic Cat Sales Inc. and Textron Financial Corporation (Confidential treatment pursuant to 17 CFR Sections 200.80(b) and 240.246-2 has been granted for certain portions of this exhibit. Such portions have been omitted herein and have been filed separately with the SEC.)
(6)
Method of Filing
10(k)
Repurchase Agreement, dated as of January 20, 2003, By and between Arctic Cat Sales Inc. and Textron Financial Corporation
(6)
10(l)
2007 Omnibus Stock and Incentive Plan
(8)
10(m)
Form of Incentive Stock Option Agreement for 2007 Omnibus Stock and Incentive Plan
(8)
10(n)
Form of Non-Qualified Stock Option Agreement for 2007 Omnibus Stock and Incentive Plan
(8)
10(0)
Form of Director Stock Option Agreement for 2007 Omnibus Stock and incentive Plan
(9)
10(p)
Form of Restricted Stock Agreement for 2007 Omnibus Stock and Incentive Plan
(9)
10(q)
Form of Stock-Settled Appreciation Rights Agreement for 2007 Omnibus Stock and Incentive Plan
(9)
Subsidiaries of the Registrant
(2)
Consent of Independent Registered Public Accounting Firm
(2)
31.1
Section 302 Certification of Chief Executive Officer
(2)
31.2
Section 302 Certification of Chief Financial Officer
(2)
32.1
Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
(2)
32.2
Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
(2)
(b) Exhibits
Reference is made to Item 15(a) 3.
(c) Schedules
Reference is made to Item 15(a) 2.
(1) Incorporated herein by reference to the Company’s Form S-1 Registration Statement (File Number 33-34984).
(2) Filed with this Form 10-K.
(3) Incorporated herein by reference to the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 1997.
(4) Incorporated by reference to Exhibit 1 to the Company’s Registration on Form 8-A filed with the SEC on September 20, 2001.
(5) Incorporated by reference to Exhibit 99.1 to the Company’s Registration on Form S-8 filed with the SEC on September 6, 2002.
(6) Incorporated herein by reference to the Company’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2003.
(7) Incorporated herein by reference to the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2005.
(8) Incorporated herein by reference to the Company’s Current Report of Form 8-K filed August 14, 2007.
(9) Incorporated herein by reference to the Company’s Current Report of Form 8-K filed April 7, 2008.
(10) Incorporated by reference to the Company’s Current Report on Form 8-K filed December 19, 2007.
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 13th day of June, 2008.
ARCTIC CAT INC.
/s/CHRISTOPHER A. TWOMEY
Christopher A. Twomey
Chairman of the Board of Directors, President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated.
Signature
Date
/s/ CHRISTOPHER A. TWOMEY
June 13, 2008
Christopher A. Twomey
Chairman of the Board of Directors, President, Chief Executive Officer
(Principal Executive Officer)
/s/ TIMOTHY C. DELMORE
June 13, 2008
Timothy C. Delmore
Chief Financial Officer
(Principal Financial and Accounting Officer)
/s/ ROBERT J. DONDELINGER
June 13, 2008
Robert J. Dondelinger, Director
/s/ MASAYOSHI ITO
June 13, 2008
Masayoshi Ito, Director
/s/ SUSAN LESTER
June 13, 2008
Susan Lester, Director
/s/ WILLIAM G. NESS
June 13, 2008
William G. Ness, Director
/s/ GREGG A. OSTRANDER
June 13, 2008
Gregg A. Ostrander, Director
/s/ DAVID ROBERTS
June 13, 2008
David Roberts, Director
/s/ KENNETH J. ROERING
June 13, 2008
Kenneth Roering, Lead Director
Consolidated Balance Sheets
The accompanying notes are an integral part of these statements.
Consolidated Statements of Operations
The accompanying notes are an integral part of these statements.
Consolidated Statements of Shareholders’ Equity
The accompanying notes are an integral part of these statements.
Consolidated Statements of Cash Flows
Supplemental disclosure of non-cash investing and financing activities:
As of March 31, 2008 and 2007, the unrealized gain on securities available-for-sale, net of tax was $0 and $2,000.
As of March 31, 2008 and 2007, the unrealized gain on derivative instruments, net of tax was $133,000 and $569,000.
As of March 31, 2008 and 2007, property and equipment purchases of $0 and $1,279,000 were included in accounts payable.
The accompanying notes are an integral part of these statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
A SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Arctic Cat Inc. (the “Company”) operates in a single industry segment and designs, engineers, manufactures and markets snowmobiles and all-terrain vehicles (ATVs) under the Arctic Cat® brand name, and related parts, garments and accessories principally through its facilities in Thief River Falls, Minnesota. The Company’s products are sold through a network of independent dealers located throughout the United States, Canada, and Europe and through distributors in Europe, the Middle East, Asia and other international markets.
Use of Estimates
Preparation of the Company’s consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect reported amounts of assets and liabilities, related revenues and expenses and disclosure about contingent assets and liabilities at the date of the financial statements. Actual results could differ from the estimates used by management.
Principles of Consolidation
The consolidated financial statements include the accounts of Arctic Cat Inc. and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
Cash and Equivalents
The Company considers highly liquid temporary investments with an original maturity of three months or less or variable rate demand notes with put options exercisable in three months or less to be cash equivalents. Cash and equivalents consist primarily of commercial paper and put bonds. As of March 31, 2008 and 2007, the Company had approximately $10,000,000 and $4,000,000 of cash located in foreign banks primarily in Canada. The Company’s cash management policy provides for bank disbursement accounts to be reimbursed on a daily basis. Checks issued but not presented to the banks for payment are included in cash and equivalents as a reduction of other cash balances. Checks written in excess of bank balance at March 31, 2008 in the amount of $5,347,000 were classified as accounts payables.
Fair Values of Financial Instruments
Except where noted, the carrying value of current financial assets and liabilities approximates their fair value, due to their short-term nature.
Short-Term Investments
Short-term investments are reported at fair value and include trading securities, with unrealized gains and losses included in net earnings, and available-for-sale securities, with unrealized gains and losses reported as a separate component of shareholders’ equity. The Company utilizes the specific identification method in accounting for its short-term investments.
Accounts Receivable
The Company’s accounts receivable balance consists of amounts due from its dealers and certain finance companies. The Company extends credit to its dealers based on an evaluation of the dealers’ financial condition. The Company’s collection exposure relating to accounts receivable amounts due from certain dealer finance companies is limited due to the financial strength of the finance companies and provisions of its existing agreements. Accounts receivable is presented net of an allowance for estimated uncollectible amounts due from its dealers. The Company estimates the uncollectible amounts considering numerous factors, mainly historical trends as well as current available information. The Company’s allowance for uncollectible accounts was $952,000, $815,000 and $966,000 at March 31, 2008, 2007 and 2006. The activity within the allowance for uncollectible accounts for the three years ending March 31, 2008 was not significant. Accounts receivable amounts written off have been within management’s expectations.
Inventories
Inventories are stated at the lower of cost or market, with cost determined using the first-in, first-out method.
Derivative Instruments and Hedging Activities
The Company enters into forward exchange contracts to hedge the variability in foreign exchange rates related to purchase commitments denominated in Japanese yen for ATV engines and transfers of Canadian dollar funds to the United States of America. The contracts are designated as, and meet the criteria for, cash flow hedges. The Company does not enter into forward contracts for the purpose of trading. Gains and losses on forward contracts are recorded in accumulated other comprehensive income (loss), net of
tax, and subsequently reclassified within 12 months into cost of goods sold upon the sale of ATV units or into operating expense upon completing transfers of Canadian dollar funds.
As of March 31, 2008, the Company had open Canadian dollar forward exchange contracts maturing April 2008, with notional amounts totaling $30,599,000 and fair value assets and liabilities, netted in accounts receivable of $211,000 at March 31, 2008. The related amount reported within other comprehensive income (loss), net of tax was $133,000. There were no open Canadian dollar forward exchange contracts at March 31, 2007. As of March 31, 2007 the Company had open Japanese yen forward exchange contracts, maturing through February 2008, with notional amounts totaling $38,120,000 and fair value assets and liabilities of $903,000 included in accounts receivable at March 31, 2007. The related amount reported within other comprehensive income (loss), net of tax was $569,000. There were no open Japanese yen forward exchange contracts at March 31, 2008.
Property and Equipment
Depreciation is provided in amounts sufficient to relate the cost of depreciable assets to operations over their estimated service lives, using the units of production method for tooling and the straight-line method for all other property and equipment. Repairs and maintenance cost that are considered not to extend the useful life of the property and equipment are expensed as incurred. Tooling is amortized over the life of the product, generally three years. Estimated service lives range from 15 - 20 years for buildings and improvements and 5 - 7 years for machinery and equipment. Accelerated and straight-line methods are used for income tax reporting.
Goodwill and Intangibles
Goodwill and intangibles are reviewed for impairment at least annually. An impairment charge is recognized when the calculated fair value of a reporting unit, including goodwill, is less than its carrying amount. The Company performed the analysis as of March 31, 2008 and 2007 which indicated that no goodwill impairment existed.
The changes in the carrying amount of goodwill and other intangibles included in goodwill, intangibles and other assets for the year ended March 31, 2008 and 2007 are as follows:
As required by SFAS No. 142, intangibles with finite lives will continue to be amortized. Included in other intangible assets are customer relationships, a homologation license, and a non-compete agreement. Intangible assets before accumulated amortization were $1,950,000 at March 31, 2008 and 2007. Accumulated amortization was $591,000 and $376,000 at March 31, 2008 and 2007. Amortization expense is expected to be approximately $215,000 in fiscal years 2009 and 2010, $147,000 in fiscal 2011, $94,000 in fiscal 2012, and $83,000 in fiscal 2013. The net value of other intangible assets is included as a component of goodwill and other intangibles in the accompanying consolidated balance sheets.
Product Warranties
The Company generally provides a limited warranty to the owner of snowmobiles for twelve months from the date of consumer registration and for six months on ATVs. The Company provides for estimated warranty costs at the time of sale based on historical rates and trends and makes subsequent adjustments to its estimate as actual claims become known or the amounts are determinable. The following represents changes in the Company’s accrued warranty liability for the fiscal years ended March 31,
Insurance
The Company is self-insured for employee medical, workers’ compensation, and product liability claims. Specific stop loss coverages are provided for catastrophic claims. Losses and claims are charged to operations when it is probable a loss has been incurred and the amount can be reasonably estimated.
Revenue Recognition
The Company recognizes revenue and provides for estimated marketing and sales incentive costs when products are shipped
to dealers and distributors pursuant to their order, the price is fixed and collection is reasonably assured. Shipping and handling costs are recorded as a component of costs of goods sold at the time product is shipped.
Marketing and Sales Incentive Costs
At the time product revenue is recognized the Company provides for various marketing and sales incentive costs which are offered to its dealers and consumers. Examples of these costs, which are recognized as a reduction of revenue when the products are sold, include: dealer and consumer rebates, dealer floor plan financing assistance and other incentive and promotion programs. Generally, the Company records costs related to these marketing programs at the later of when the revenue is recognized or when the sales incentive or marketing program is approved and communicated for products previously shipped. Sales incentives that involve a free product or service delivered to the consumer are recorded as a component of cost of goods sold. The Company estimates the costs of these various incentive and marketing programs at the time of sale or subsequently when programs are approved and communicated based on historical experience. To the extent current experience differs with previous estimates the accrued liability for marketing and sales incentives is adjusted accordingly.
Dealer Holdback
The Company records a dealer holdback program liability at the time certain products are shipped to its dealers. If the products subject to the holdback program are sold within the program time period, the Company refunds a portion of the original sale price, referred to as dealer holdback, to the dealer. The Company’s dealer holdback program liability, included within the accounts payable, as of March 31, 2008, 2007 and 2006 was $17,493,000, $19,998,000, and $17,321,000. The increases and decreases from March 31, 2006 to 2008 were principally related to qualifying additional products, the period of coverage under the program and the timing of payments.
Research and Development
Research and development costs are expensed as incurred and are reported as a component of selling, general and administrative expenses. Research and development expense was $16,143,000, $17,756,000, and $17,067,000 during 2008, 2007 and 2006.
Advertising
The Company expenses advertising costs as incurred, except for cooperative advertising obligations arising related to the sale of the Company’s products to its dealers. The estimated cost of cooperative advertising, which the dealer is required to support, is recorded as marketing expense at the time the product is sold. Cooperative advertising was $5,004,000, $6,841,000, and $6,996,000, in 2008, 2007 and 2006. Total advertising expense, including cooperative advertising, was $24,072,000, $23,671,000, and $23,482,000 in 2008, 2007 and 2006.
Stock Based Compensation
At March 31, 2008, the Company had stock based compensation plans, all previously approved by the shareholders. Stock options granted under these plans generally vest ratably over one to three years of service, have a contractual life of five to ten years and provide for accelerated vesting if there is a change in control, as defined. At March 31, 2008, the Company had approximately 1,491,380 shares available for future grant under its stock option plans.
On April 1, 2006, the Company adopted Statement of Financial Accounting Standard No. 123(R), Share Based Payments (SFAS 123(R)), which requires the fair value of all share based payment transactions, including stock options, be recognized in the income statement as an operating expense, based on their fair value over the requisite service period. The Company has elected the modified prospective transition method in applying SFAS 123(R). Accordingly, periods prior to adoption have not been restated. Under this transition method, the Company applies the provisions of SFAS 123(R) to new awards modified, repurchased, or cancelled after April 1, 2006. Additionally, the Company recognizes compensation cost for the portion of awards for which the requisite service has not been rendered (unvested awards) that are outstanding as of April 1, 2006, as the remaining service is rendered. The compensation cost recorded for these awards will be based on their grant-date fair value as calculated for the pro forma disclosures required by SFAS 123(R). At March 31, 2008, the Company had $2,569,000 of unrecognized compensation costs related to non-vested stock options that are expected to be recognized over a weighted average period of approximately two years.
For the fiscal years ended March 31, 2008 and 2007, the Company recorded compensation expense of $2,063,000 and $2,170,000 related to the adoption of SFAS 123(R), which has been included in selling, general and administrative expenses. The Company’s total stock based compensation related expense reduced both basic and diluted earnings per share by $0.07 and $0.08 for the fiscal years ended March 31, 2008 and 2007.
Prior to adopting SFAS 123(R), the Company accounted for these plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock based employee compensation cost was reflected in net earnings, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of the grant.
Additionally, prior to adopting SFAS 123(R), the Company presented all tax benefits resulting from the exercise of stock options as operating cash flows in the consolidated Statement of Cash Flows. SFAS 123(R) requires that cash flows from the exercise of stock options resulting from tax benefits in excess of recognized cumulative compensation cost (excess tax benefits) be classified as financing cash flow. For the fiscal years ended March 31, 2008 and 2007, the total income tax benefit from the exercise of stock options classified as financing cash flows was $475,000 and $89,000.
The following table illustrates the effect on net earnings and earnings per share had the fair value based method been applied to the comparable period in the prior fiscal year ended March 31, 2006:
The fair value of each stock option award was estimated on the date of grant using the Black-Scholes options pricing model. The following assumptions were used to estimate the fair value of options:
The weighted average fair value of options granted during each of the following years ended March 31:
See Note K for additional disclosures regarding stock option plans.
Net Earnings Per Share
The Company’s diluted weighted average shares outstanding include common shares and common share equivalents relating to stock options, when dilutive. Options to purchase 1,362,617, 942,500, and 571,500, shares of common stock with weighted average exercise prices of $20.57, $22.37 and $24.41 were outstanding during 2008, 2007 and 2006, but were excluded from the computation of common share equivalents because they were anti-dilutive.
Weighted average shares outstanding consist of the following for the years ended March 31,
Foreign Currency Translation
The Company’s sales and marketing activities with Canadian dealers are denominated in Canadian currency with the U.S. dollar serving as the functional currency. The Company’s sales and marketing activities with European on-road ATV dealers and distributors are denominated in the Euro with the Euro serving as the functional currency. Assets and liabilities denominated in Canadian currency and the Euro are translated using the exchange rates in effect at the balance sheet date. Revenues and expenses are translated at the average foreign exchange rates in effect for the period. Exchange gains and losses relating to the Canadian currency and Euro currency are reflected in the results of operations and as a component of other comprehensive income.
Comprehensive Income
Comprehensive income represents net earnings adjusted for the unrealized gain or loss on derivative instruments, debt securities
classified as available-for-sale and foreign currency translation adjustments and is shown in the consolidated financial statements of stockholders’ equity.
Accounting Policy and Disclosure Changes
In February 2007, the Financial Accounting Standards Board (FASB) issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. This Statement permits entities to measure most financial instruments at fair value if desired. It may be applied on a contract by contract basis and is irrevocable once applied to those contracts. The Standard may be applied at the time of adoption for existing eligible items, or at initial recognition of eligible items. After election of this option, changes in fair value are reported in earnings. The items measured at fair value must be shown separately on the balance sheet. The effective date is the beginning of fiscal year 2009. The cumulative effect of adoption would be reported as an adjustment to beginning retained earnings. We have not yet determined the impact that the implementation will have on our results of operations or financial condition.
In March 2008, the FASB issued No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (SFAS No. 161”), which will require increased disclosures about an entity’s strategies and objectives for using derivative instruments; the location and amounts of derivative instruments in an entity’s financial statements; how derivative instruments and related hedged items are accounted for under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities;” and how derivative instruments and related hedged items affect its financial position, financial performance, and cash flows. Certain disclosures will also be required with respect to derivative features that are credit-risk related. SFAS No. 161 is effective for the Company beginning January 1, 2009 on a prospective basis. The Company does not expect this standard to have a material impact on its consolidated results of operations or financial condition.
In September 2006, the U.S. Securities and Exchange Commission staff issued Staff Accounting Bulletin No. 108 (SAB 108), Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. SAB 108 eliminates the diversity of practice regarding how public companies quantify financial statement misstatements. It establishes an approach that requires quantification of financial statement misstatements based on the effects of the misstatements on each of the company’s financial statements and related financial statement disclosures. SAB 108 must be applied to annual financial statements for their first fiscal year ending after November 15, 2006. The adoption of SAB 108 did not have a material impact on our financial condition or results of operations.
In September 2006, FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurement (SFAS 157). This standard clarifies the principle that fair value should be based on the assumptions that market participants would use when pricing an asset or liability. Additionally, it establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. SFAS 157 is effective for financial statements issued for the fiscal years beginning after November 15, 2007. We have not yet determined the impact that the implementation of SFAS 157 will have on our results of operations or financial condition.
In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes (“FIN 48”), which clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes.” FIN 48 describes when an uncertain tax item should be recorded in the financial statements and for how much, provides guidance on recording interest and penalties and accounting and reporting for income taxes in interim periods. FIN 48 was adopted by the Company as of April 1, 2007. The adoption of FIN 48 did not have a material impact on the Company’s financial position or results of operations.
B SHORT-TERM INVESTMENTS
Short-term investments consist primarily of a diversified portfolio of municipal bonds and money market funds and are classified as follows at March 31:
Trading securities consists of $25,006,000 and $38,707,000 invested in various money market funds at March 31, 2008 and 2007, respectively, while the remainder of trading securities and available-for-sale securities consists primarily of “A” rated or higher municipal bond investments. The amortized cost and fair value of debt securities classified as available-for-sale was $350,000 and $353,000, at March 31, 2007. At March 31, 2008 no available-for-sale debt securities were being held. The unrealized gain on available-for-sale debt securities is reported, net of tax, as a separate component of
shareholders’ equity. The contractual maturities of available-for-sale debt securities at March 31, 2007, were all within one year.
C INVENTORIES
Inventories consist of the following at March 31:
D ACCRUED EXPENSES
Accrued expenses consist of the following at March 31:
E ACQUISITION
In July 2005, the Company acquired a 100% interest in a European company that markets ATVs which utilize the Company’s base ATV models. The Company completed this acquisition to further expand its ATV model offerings and strengthen its European presence. The Company invested $3,464,000, net of cash acquired, to acquire a 100% interest resulting in an excess purchase price over the estimated fair value of net assets was approximately $1,750,000. Allocation of the acquisition costs is as follows:
F FINANCING
The Company has a $75,000,000 unsecured bank credit agreement for documentary and stand-by letters of credit and for working capital purposes. Total working capital borrowings under the credit agreement were limited to $60,000,000 during the last five months of the fiscal year. The credit agreement is due on demand and expires July 27, 2009. Interest on the working capital borrowings is payable monthly at alternative interest rates, at the Company’s election. The Company was in compliance with the credit agreement covenants or obtained non-compliance waivers. At March 31, 2008, there was $7,367,000 issued letters of credit outstanding and no working capital borrowings outstanding. Of the issued letters of credit outstanding, $5,746,000 was issued to Suzuki Motor Corporation (Suzuki) for engine and service parts purchases (see Note H). Outstanding letters of credit will be repaid over the following six months in accordance with the credit agreement and any such renewal.
G RETIREMENT SAVINGS PLAN
The Company’s 401(k) retirement savings plan covers substantially all eligible employees. Employees may contribute up to 50% of their compensation with the Company matching 100% of the employee contributions, up to a maximum of 3% of the employee’s compensation. The Company can elect to make additional contributions at its discretion. Total Company matching contributions were $1,451,000, $1,513,000 and $1,522,000 in 2008, 2007 and 2006. There were no discretionary contributions made during 2008, 2007 and 2006.
H RELATED PARTY TRANSACTIONS
The Company purchases engines and service parts from Suzuki, owner of the Company’s Class B common stock. Such purchases totaled $73,689,000, $113,975,000, and $131,965,000 in 2008, 2007 and 2006. The purchase price of the engines and service parts is determined annually. The Company has an agreement with Suzuki for snowmobile engine purchases to share the impact of fluctuations in the exchange rate between the U.S. dollar and the Japanese yen above and below a fixed range contained in the agreement. This agreement renews annually.
The Company is dependent on Suzuki for the near term supply of most of its engines and related service parts. An interruption of this supply could have a material adverse effect on the Company’s
operations. Certain raw materials and services are purchased from vendors in which certain of the Company’s directors are officers or significant shareholders. In 2008, 2007 and 2006, these transactions aggregated $148,000, $127,000 and $2,580,000.
I INCOME TAXES
Income tax expense (benefit) consists of the following for the years ended March 31:
The following is a reconciliation of the Federal statutory income tax rate to the effective tax rate for the years ended March 31:
The cumulative temporary differences between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes under the liability methods are as follows at March 31:
On April 1, 2007, the Company adopted Financial Accounting Standards board Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”) which clarifies the accounting for income taxes by prescribing the minimum threshold a tax position is required to meet before being recognized in the financial statements as well as a guidance on de-recognition, measurement, classification and disclosure of tax positions. The adoption of FIN 48 by the Company resulted in no cumulative effect of accounting change being recorded by the Company as of April 1, 2007. The Company had liabilities recorded related to unrecognized tax benefits totaling $4,164,000 and $4,510,000 at March 31, 2008 and 2007. At March 31, 2007 the liability was classified as income taxes payable. The March 31, 2008 liability was classified as an offset to income taxes receivable in the accompanying condensed consolidated balance sheets in accordance with FIN 48. The Company recognizes potential interest and penalties related to income tax positions as a component of the provision for income taxes on the consolidated statements of operations. The Company had reserves related to potential interest and penalties of $718,000 and $704,000 recorded as a component of the liability at March 31, 2008 and 2007. The entire amount of the liability at March 31, 2008, if recognized, would affect the Company’s effective tax rate. The Company does not anticipate that total unrecognized tax benefits will significantly change during the next twelve months. With few exceptions, the Company is no longer subject to federal, state, or foreign income tax examinations for years prior to 2004. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
J COMMITMENTS AND CONTINGENCIES
Dealer Financing
Finance companies provide certain of the Company’s dealers with floor plan financing. The Company has agreements with these finance companies to repurchase certain repossessed products sold to its dealers. At March 31, 2008, the Company was contingently liable under these agreements for a maximum repurchase amount of approximately $45,222,000. The Company’s financial exposure under these agreements is limited to the difference between the
amount paid to the finance companies for repurchases and the amount received upon the resale of the repossessed product. Losses incurred under these agreements during the periods presented have not been material.
Litigation
The Company is subject to legal proceedings and claims which arise in the ordinary course of business. Accidents involving personal injury and property damage occur in the use of snowmobiles and ATVs. Claims have been made against the Company from time to time. It is the Company’s policy to vigorously defend against these actions. The Company is not involved in any legal proceedings which it believes will have the potential for a materially adverse impact on the Company’s business or financial condition, results of operations or cash flows.
Leases
The Company leases buildings and equipment under non-cancelable operating leases. Total rent expense under all lease agreements was $924,000, $1,404,000 and $853,000 for fiscal 2008, 2007, and 2006. Future minimum payments, exclusive of other costs required under non-cancelable operating leases at March 31, 2008 are approximately $165,000 in each of the fiscal years 2009 through 2015.
K SHAREHOLDERS’ EQUITY
Stock Option Plans
The Company has stock option plans that provide for incentive and non-qualified stock options to be granted to directors, officers and other key employees. The stock options granted generally have a five to ten year life, vest over a period of one to three years, and have an exercise price equal to the fair market value of the stock on the date of grant. At March 31, 2008, the Company had 1,491,380 shares of common stock available for grant under the plans.
Transactions under the plans during each of the three years in the period ended March 31, are summarized as follows:
Options exercisable at March 31 are as follows:
The following tables summarize information concerning currently outstanding and exercisable stock options at March 31, 2008:
Options Outstanding
Options Exercisable
Class B Common Stock
Suzuki owns all outstanding shares of the Company’s Class B common stock. At the option of Suzuki, the Class B common stock is convertible into an equal number of shares of the Company’s common stock. The Class B shareholder is entitled to elect one member of the Company’s Board of Directors but cannot vote for the election of other directors of the Company. The Class B shareholder can vote on all other matters submitted to the common shareholders. The Class B common stock participates equally with the common stock in all dividends and other distributions duly declared by the Company’s Board of Directors. The Class B common shares are converted into an equal number of shares of common stock if: Suzuki owns less than 15% of the aggregate number of outstanding common and Class B common shares; the Company becomes a non-surviving party due to a merger or recapitalization; the Company sells substantially all of its assets; or Suzuki transfers its Class B common stock to any person.
In addition, the Company has a Stock Purchase Agreement with Suzuki that prohibits the purchase of additional shares of the Company’s common stock unless, following such purchase, Suzuki’s ownership is less than or equal to 32% of the aggregate outstanding shares of common and Class B common stock. The Company has the first right of refusal to purchase any shares Suzuki intends to sell. Suzuki has agreed not to compete in the manufacture of snowmobiles or related parts so long as it supplies engines to the Company or owns at least 10% of the aggregate common and Class B common shares outstanding.
Preferred Stock
The Company’s Board of Directors is authorized to issue 2,050,000 shares of $1.00 par value preferred stock in one or more series. The board can determine voting, conversion, dividend and redemption rights and other preferences of each series. No shares have been issued.
Shareholders’ Rights Plan
In connection with the adoption of a Shareholders’ Rights Plan, the Company created a Series B Junior Participating preferred stock. Under terms of the Company’s Shareholder Rights Plan, upon the occurrence of certain events, registered holders of common stock and Class B common stock are entitled to purchase one-hundredth of a share of Series B Junior Participating preferred stock at a stated price, or to purchase either the Company’s common shares or common shares of an acquiring entity at half their market value. The Rights related to this plan expire September 17, 2011.
Share Repurchase Authorization
The Company invested $10,763,000, $19,773,000 and $14,931,000 during 2008, 2007 and 2006 to repurchase and cancel 623,800, 1,134,800 and 726,500 shares of common stock, pursuant to Board of Directors’ authorizations. Included in the 2007 repurchases are 615,000 shares of Class B stock from Suzuki Motor Corporation, repurchased for $10,781,000 or $17.53 per share. At March 31, 2008, authorization to repurchase $10,001,000 or approximately 1,372,000 shares remain outstanding.
L SEGMENT REPORTING
Sales to foreign customers, located primarily in Canada, amounted to $248,601,000, $228,008,000 and $204,132,000 in 2008, 2007 and 2006. The Company has identifiable long-lived assets of approximately $2,751,000 and $2,869,000 located in Canada and Europe at March 31, 2008 and 2007.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders of
Arctic Cat Inc.
We have audited the accompanying consolidated balance sheets of Arctic Cat Inc. and subsidiaries as of March 31, 2008 and March 31, 2007, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the three years in the period ended March 31, 2008. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Arctic Cat Inc. and subsidiaries as of March 31, 2008 and March 31, 2007 and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended March 31, 2008 in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note I to the consolidated financial statements, the Company adopted Financial Accounting Standards Board Interpretation No. 48; Accounting for Uncertainty in Income Taxes, effective April 1, 2007.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Arctic Cat Inc.’s internal control over financial reporting as of March 31, 2008, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated June 10, 2008 expressed an unqualified opinion on the effectiveness of Arctic Cat Inc. and subsidiaries internal control over financial reporting.
/s/ GRANT THORNTON LLP
Minneapolis, Minnesota
June 10, 2008
ARCTIC CAT INC. EXHIBIT INDEX
EXHIBIT NUMBER
METHOD OF FILING
3(a)
Amended and Restated Articles of Incorporation Of the Company
(3)
3(b)
Restated By-Laws of the Company
(1)(10)
4(a)
Form of specimen common stock certificate
(1)
4(b)
Rights Agreement by and between the Company and Wells Fargo Bank Minnesota, N.A., dated September 17,
(4)
10(a)
Purchase/Supply Agreement dated as of March 1, 1985 between Suzuki Motor Co., Ltd. And the Company, and related Agreement on Implementation of Warranty Provision.
(1)
10(b)
Form of Employment Agreement between the Company and each of its executive officers.
(1)
10(c)
Floorplan Repurchase Agreement dated July 13, 1984, between the Company and ITT Commercial Finance Corp.
(1)
10(d)
Floorplan Repurchase Agreement dated as of June 15, 1988, between the Company and ITT Commercial Finance, a division of ITT Industries of Canada, Ltd.
(1)
10(e)
Discretionary Revolving Credit Facility, dated as of June 6, 1997, between the Company and Wells Fargo Bank Minnesota, National Association.
(3)
10(f)
Stock Plan
(5)
10(g)
Form of Incentive Stock Option Agreement for 2002 Stock Plan
(7)
10(h)
Form of Non-Qualified Stock Option Agreement for 2002 Stock Plan
(7)
10(i)
Form of Director Non-Qualified Stock Option Agreement for 2002 Stock Plan
(7)
10(j)
Program Agreement, dated as of January 20, 2003, by and between Arctic Cat Sales Inc. and Textron Financial Corporation (Confidential treatment pursuant to 17 CFR Sections 200.80(b) and 240.246-2 has been granted for certain portions of this exhibit. Such portions have been omitted herein and have been filed separately with the SEC.)
(6)
10(k)
Repurchase Agreement, dated as of January 20, 2003, By and between Arctic Cat Sales Inc. and Textron Financial Corporation
(6)
10(l)
Omnibus Stock and Incentive Plan
(8)
10(m)
Form of Incentive Stock Option Agreement for 2007 Omnibus Stock and Incentive Plan
(8)
10(n)
Form of Non-Qualified Stock Option Agreement for 2007 Omnibus Stock and Incentive Plan
(8)
10(0)
Form of Director Stock Option Agreement for 2007 Omnibus Stock and incentive Plan
(9)
10(p)
Form of Restricted Stock Agreement for 2007 Omnibus Stock and Incentive Plan
(9)
10(q)
Form of Stock-Settled Appreciation Rights Agreement for 2007 Omnibus Stock and Incentive Plan
(9)
Subsidiaries of the Registrant
(2)
Consent of Independent Registered Public Accounting Firm
(2)
31.1
Section 302 Certification of Chief Executive Officer
(2)
31.2
Section 302 Certification of Chief Financial Officer
(2)
32.1
Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(2)
32.2
Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(2)
(1) Incorporated herein by reference to the Company’s Form S-1 Registration Statement (File Number 33-34984).
(2) Filed with this Form 10-K.
(3) Incorporated herein by reference to the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 1997.
(4) Incorporated by reference to Exhibit 1 to the Company’s Registration on Form 8-A filed with the SEC on September 20, 2001.
(5) Incorporated by reference to Exhibit 99.1 to the Company’s Registration on Form S-8 filed with the SEC on September 6, 2002.
(6) Incorporated herein by reference to the Company’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2003.
(7) Incorporated herein by reference to the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2005.
(8) Incorporated herein by reference to the Company’s Current Report of Form 8-K filed August 14, 2007.
(9) Incorporated herein by reference to the Company’s Current Report of Form 8-K filed April 7, 2008.
(10) Incorporated by reference to the Company’s Current Report on Form 8-K filed December 19, 2007.