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ARCTIC CAT INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following management's discussion and analysis of financial condition and results of operations should be read in conjunction with the consolidated financial statements and note thereto included elsewhere in this Annual Report on Form 10-K. Executive Level Overview We continued our improvement in net sales and profitability in fiscal 2011. Fiscal 2011 net sales increased 3.1% to $464.7 million from $450.7 million in fiscal 2010. Fiscal 2011 net earnings were $13.0 million or $0.70 per diluted share compared to a net earnings of $1.9 million or $0.10 per diluted share in fiscal 2010. The increase in net sales was mainly due to increased snowmobile sales and snowmobile related parts, garments and accessory sales. During the fiscal year, gross margins improved 330 basis points, operating expenses as a percent of sales decreased to 17.9%, and operating profits increased to $18.1 million from $1.3 million. In addition, we improved our liquidity by ending the fiscal year with $125.1 million in cash and short-term investments driven by a 24% reduction in factory inventory. Industry-wide retail sales of snowmobiles in North America increased in fiscal 2011 and, similar to last year, snowmobile retail sales out performed many other recreational vehicle categories in North America. While retail sales of snowmobiles are certainly affected by the economic environment, they are also impacted by snow conditions. In the U.S., snow conditions were generally good for the fourth year in a row, which helped snowmobile retail sales out perform many other recreational vehicle categories. During fiscal 2011 we lost two points of market share in North America, however, we were successful in reducing North American dealer inventories 22%. Our focus for fiscal 2012 will be regaining market share with our exciting 2012 model line-up. Industry-wide retail sales of ATVs again declined throughout the year driven by continued uncertainties in the economy, relatively weak consumer confidence and unemployment figures at near historic levels. We expect these same factors to impact retail sales of ATVs during fiscal 2012 as well. Our focus for fiscal 2012 will again be gaining market share in certain segments and reducing dealer inventories. During fiscal 2011, our ATV business gained market share in certain segments in North America and our dealer inventories declined by 23% over the prior year. In view of the current North American economic environment, we do not expect ATV retail sales to improve significantly over last year, although we may see a slight uptick in the ATV market by the end of fiscal 2012 if the economy strengthens. Reviewing fiscal 2011 net sales: Snowmobile sales increased 12% in fiscal 2011 to $182.0 million from $162.9 million in fiscal 2010, primarily due to increased U.S. and international snowmobile shipments. Snowmobiles comprised 39% of our net sales in fiscal 2011. ATV sales decreased 4% in fiscal 2011 to $181.1 million from $188.0 million in fiscal 2010. ATV net sales comprised 39% of our net sales in fiscal 2011. Parts, garments and accessories sales increased 2% in fiscal 2011 to $101.6 million from $99.9 million in fiscal 2010, primarily due to increased snowmobile related parts, garments and accessories. Parts, garments and accessories sales were 22% of our net sales in fiscal 2011. Results of Operations Product Line Sales for the Fiscal Year Ended March 31, Percent of Percent of Change Percent of Change ($ in thousands) 2011 Total Sales 2010 Total Sales 2011 vs 2010 2009 Total Sales 2010 vs 2009 Snowmobile $ 181,965 39 % $ 162,918 36 % 12 % $ 207,280 37 % (21 )% ATV 181,050 39 % 187,953 42 % (4 )% 247,309 44 % (24 )% Parts, garments & accessories 101,636 22 % 99,857 22 % 2 % 109,024 19 % (8 )% Net Sales $ 464,651 100 % $ 450,728 100 % 3 % $ 563,613 100 % (20 )% 18 -------------------------------------------------------------------------------- Table of Contents Product Line Sales During fiscal 2011, net sales increased 3% to $464.7 million from $450.7 million in fiscal 2010. Snowmobile unit volume increased 15%, ATV unit volume increased 0.3%, and parts, garments and accessories sales increased $1.8 million. The increase in net sales is mainly due to U.S. and international sales increases on snowmobile and related parts, garments and accessory sales. During fiscal 2010, net sales decreased 20% to $450.7 million from $563.6 million in fiscal 2009. Snowmobile unit volume decreased 28%, ATV unit volume decreased 34%, and parts, garments and accessories sales decreased $9.2 million. The decrease in net sales for all product lines was mainly due to decreased sales caused by challenging retail market conditions. Cost of Goods Sold for the Fiscal Year Ended March 31, Percent of Percent of Change Percent of Change ($ in thousands) 2011 Total Sales 2010 Total Sales 2011 vs. 2010 2009 Total Sales 2010 vs. 2009 Snowmobiles & ATV units $ 302,783 65.2 % $ 309,217 68.6 % (2.1 )% $ 411,776 73.1 % (24.9 )% Parts, garments & accessories 60,359 13.0 % 58,275 12.9 % 3.6 % 68,665 12.2 % (15.1 )% Total Cost of Goods Sold $ 363,142 78.2 % $ 367,492 81.5 % (1.2 )% $ 480,441 85.2 % (23.5 )% Cost of Goods Sold During fiscal 2011 cost of sales decreased 1.2% to $363.1 million from $367.5 million for fiscal 2010. Fiscal 2011 snowmobile and ATV unit cost of sales decreased 2.1% to $302.8 million from $309.2 million due primarily to ongoing efforts to reduce the cost of our products and distribution costs. The fiscal 2011 cost of sales for parts, garments and accessories increased to $60.4 million from $58.3 million for fiscal 2010 due primarily to increased sales. Fiscal 2010 cost of sales decreased 23.5% to $367.5 million from $480.4 million for fiscal 2009. Fiscal 2010 snowmobile and ATV unit cost of sales decreased 24.9% to $309.2 million from $411.8 million in line with the decrease in unit sales in fiscal 2010 compared to fiscal 2009. The fiscal 2010 cost of sales for parts, garments and accessories decreased to $58.3 million compared to $68.7 million for fiscal 2009. Cost of sales for fiscal 2010 also decreased due to efforts to reduce the cost of our products. Gross Profit for the Fiscal Year Ended March 31, Change Change ($ in thousands) 2011 2010 2011 vs 2010 2009 2010 vs 2009 Gross Profit Dollars $ 101,509 $ 83,236 22.0 % $ 83,172 0.1 % Percentage of Sales 21.8 % 18.5 % 3.3 % 14.8 % 3.7 % Gross Profit Gross profit increased 22% to $101.5 million in fiscal 2011 from $83.2 million in fiscal 2010. The gross profit percentage for fiscal 2011 increased to 21.8% versus 18.5% in fiscal 2010. The increase in the fiscal 2011 gross profit percentage was primarily due to product cost reductions, price increases and a favorable Canadian dollar exchange rate. Gross profit increased 0.1% to $83.2 million in fiscal 2010 from $83.2 million in fiscal 2009. The gross profit percentage for fiscal 2010 increased to 18.5% versus 14.8% in fiscal 2009. The increase in the fiscal 2010 gross profit percentage was due primarily to higher margin percentages for all product lines resulting from the efforts undertaken to rescale the business, reduce the cost of products, pricing increases and a stronger Canadian dollar exchange rate. 19-------------------------------------------------------------------------------- Table of Contents Operating Expenses for the Fiscal Year Ended March 31, Change 2011 Change 2010 ($ in thousands) 2011 2010 vs 2010 2009 vs 2009 Selling & Marketing $ 33,540 $ 33,929 (1.1 )% $ 43,971 (22.8 )% Research & Development 15,029 12,926 16.3 % 18,404 (29.8 )% General & Administrative 34,805 35,045 (0.7 )% 33,904 3.4 % Goodwill Impairment Charge - - - 1,750 - Total Operating Expenses $ 83,374 $ 81,900 1.8 % $ 98,029 (16.5 )% Percentage of Sales 17.9 % 18.2 % 17.4 % Operating Expenses Selling and Marketing expenses decreased 1% to $ 33.5 million in fiscal 2011 from $33.9 million in fiscal 2010, primarily due to lower ATV marketing expenses. Selling and Marketing expenses decreased 23% to $33.9 million in fiscal 2010 from $44.0 million in fiscal 2009 due primarily to lower advertising expenses. Research and Development expenses increased 16% to $15.0 million in fiscal 2011 compared to $12.9 million in fiscal 2010 due primarily to higher compensation and development expenses. Research and Development expenses decreased 30% to $12.9 million in fiscal 2010 compared to $18.4 million in fiscal 2009 due primarily to lower compensation and development expenses. General and Administrative expenses decreased 1% to $34.8 million in fiscal 2011 from $35.0 million in fiscal 2010 due primarily to decreased Canadian hedge costs offset by higher compensation costs . General and Administrative expenses increased 3% to $35.0 million in fiscal 2010 from $33.9 million in fiscal 2009 due primarily to increased Canadian hedge costs. During the fourth quarter of fiscal 2009, we recorded a $1.75 million non-cash goodwill impairment charge. Other Income /Expense Interest income increased to $107,000 in fiscal 2011 from $12,000 in fiscal 2010. Interest expense decreased from $250,000 in fiscal 2010 to $11,000 in fiscal 2011. Interest income was primarily affected by the higher cash levels at the beginning of the fiscal year compared to last year. Interest expense is lower due to lower borrowing levels primarily driven by reduced inventory levels and our improved cash levels. Interest income decreased from $117,000 in fiscal 2009 to $12,000 in fiscal 2010. Interest expense decreased from $1.0 million in fiscal 2009 to $250,000 in fiscal 2010. Interest income was primarily affected by the lower cash levels at the beginning of the fiscal year compared to the last year as well as lower interest rates during fiscal 2010. Interest expense was lower due to lower borrowing levels primarily driven by reduced inventory levels and our improved cash levels. Net Earnings (Loss) Fiscal 2011 net earnings were $13.0 million or $0.70 per diluted share versus a net earnings of $1.9 million or $0.10 per diluted share for fiscal 2010. Net earnings as a percent of net sales were 3% and 0.4% in fiscal 2011 and 2010, respectively. The increased earnings are attributable to improved gross margin and continued efforts to control operating expenses. Fiscal 2010 net earnings were $1.9 million or $0.10 per diluted share compared to a net loss of $9.5 million or $0.53 per share for fiscal 2009. Net earnings as a percent of net sales were 0.4% and (1.7%) in fiscal 2010 and 2009, respectively. The increased earnings are attributable to the reduction in our cost structure through aggressive expense controls, manufacturing efficiencies and low cost sourcing which led to higher gross margins and operating profits in fiscal 2010. Inflation Inflation historically has not significantly impacted our business. We generally have been able to offset the impact of increasing costs through a combination of productivity gains and product price increases. 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 20-------------------------------------------------------------------------------- Table of Contents consolidated financial statements and revenues and expenses during the periods reported. Actual results may differ from those estimates. We reviewed the development and selection of the critical accounting policies and believe the following are the most critical accounting policies that could have an effect on our reported results. These critical accounting policies and estimates have been reviewed with the Audit Committee of the Board of Directors. Revenue Recognition We recognize revenue and provide 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. We have agreements with finance companies to repurchase products repossessed up to certain limits. Our 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, we have 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 We provide for various marketing and sales incentive costs which are offered to our 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 we authorize and communicate new programs to our dealers. We estimate marketing and sales incentive costs based on expected usage and historical experience. The accrual for marketing and sales incentive costs at March 31, 2011 and 2010 was $9.4 million and $7.9 million, respectively, and is included in accrued marketing in our balance sheet. The increase in this accrual was a result of current announced and communicated marketing and sales incentive programs and retail market conditions. Historically, marketing and sales incentive program expenses have been within our expectations. To the extent current experience differs with previous estimates the accrued liability for marketing and sales incentives is adjusted accordingly. Product Warranties We generally provide a limited warranty to the owner of snowmobiles for 12 months from the date of consumer registration and for 6 months on ATVs. We provide 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 our initial estimates could cause accrued warranty costs to materially change. The accrual for warranty costs was $14.1 million at March 31, 2011 and 2010. Historically, actual warranty costs have been within our expectations. Inventories Our inventories are recorded at the lower of cost or market, with cost based on a first-in, first-out basis. We periodically assess inventories for obsolescence and potential excess. This assessment is based primarily on assumptions and estimates regarding future production demands, anticipated changes in technology or design, historical and expected future sales patterns. Our inventories consist of materials and products that are subject to changes in our planned production of future snowmobile and ATV products and competitive market conditions which may cause lower of cost or market adjustments to our finished goods inventory. If market conditions or future demand are less favorable than our current expectations, additional inventory write downs or reserves may be required, which could have an adverse effect on our reported results in the period the adjustments are made. Inventory items that are identified as obsolete or excess are fully reserved on our balance sheet and are generally scrapped. Historically, inventory obsolescence and potential excess costs adjustments have been within our expectations. 21 -------------------------------------------------------------------------------- Table of Contents Product Liability and Litigation We are subject to product liability claims and other litigation in the normal course of business. We insure for product liability claims although we retain a self-insured retention accrual within the balance sheet caption "Insurance" within accrued expenses. 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. We utilize 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 us could have a material impact on our financial condition. Historically, actual product liability and litigation costs have been within our expectations. Stock-Based Compensation We recognize 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. 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. We assess 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 we employ different assumptions, the amount of compensation expense may differ significantly from what was recorded in the current period. Liquidity and Capital Resources The seasonality of our snowmobile and ATV production cycles generates significant fluctuations in our working capital requirements during the year. The following table represents sales and ending inventories by each quarter in the fiscal years ended March 31, 2011 and 2010. First Second Third Fourth Total 2011 Snowmobile $ 17,105 $ 91,525 $ 77,822 $ (4,487 ) $ 181,965 ATV 27,833 56,641 48,559 48,017 181,050 PG&A 18,468 27,646 25,595 29,927 101,636 Total Sales $ 63,406 $ 175,812 $ 151,976 $ 73,457 $ 464,651 Inventories $ 88,069 $ 95,894 $ 77,150 $ 61,478 2010 Snowmobile $ 17,916 $ 85,740 $ 58,665 $ 597 $ 162,918 ATV 32,172 51,726 48,214 55,841 187,953 PG&A 19,281 28,835 24,161 27,580 99,857 Total Sales $ 69,369 $ 166,301 $ 131,040 $ 84,018 $ 450,728 Inventories $ 127,092 $ 133,605 $ 106,264 $ 81,361 As a result of our better matching of ATV production to wholesale and retail demand for ATV units, our finished goods inventory balance decreased as of March 31, 2011 compared with March 31, 2010. Historically, we have financed our 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. We believe current available cash and cash generated from operations together with working capital financing through our available 22-------------------------------------------------------------------------------- Table of Contents line of credit will provide sufficient funds to finance operations on a short and long-term basis. However, there can be no assurance that adequate working capital financing arrangements will remain available or that the costs and other terms of such new financing arrangements will not be significantly less favorable to us than has historically been available. Cash and Short-Term Investments Cash and short-term investments increased to $125,113,000 at March 31, 2011 from $71,062,000 at March 31, 2010 because of improved profitability and working capital management. Our cash balances traditionally peak early in the fourth quarter and then decrease as working capital requirements increase when our snowmobile and spring ATV production cycles begin. Our investment objectives are first, safety of principal and second, rate of return. Financing Arrangements and Cash Flows We have operated since November 2009 under a $60,000,000 secured bank credit agreement for the documentary and stand-by letters of credit and for working capital purposes. We may borrow up to $60,000,000 during June through November and up to $35,000,000 during all other months of the fiscal year. The total letters of credit issued at March 31, 2011 were $9,304,000, of which $6,491,000 was issued to Suzuki for engine and service parts purchases. We have agreements with GE Commercial Distribution Finance in the United States and TCF Commercial Finance Canada in Canada to provide snowmobile and ATV floorplan financing for our dealers. These agreements improve our liquidity by financing dealer purchases of products without requiring substantial use of our working capital. We are paid by the floorplan companies shortly after shipment and as part of our marketing programs, we pay the floorplan financing of our 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 our potential liability for annual repurchases. The aggregate potential liability was approximately $75,558,000 at March 31, 2011. We have incurred no material losses under these agreements. We believe current available cash and cash generated from operations provide sufficient funding in the event there is a requirement to perform under these guarantee and repurchase agreements. In fiscal 2011, we invested $11,761,000 in capital expenditures. We expect that capital expenditures will increase to approximately $18,000,000 in fiscal 2012. Since 1996, we have repurchased over 11,000,000 shares of our common stock. There is approximately $7,581,000 remaining on the January 2008 repurchase authorization. We believe that cash generated from operations and available cash will be sufficient to meet our working capital and capital expenditure requirements on a short and long-term basis. Contractual Obligations The following table summarizes our significant future contractual obligations at March 31, 2011 (in millions): Payment Due by Period Less than More than Contractual Obligations Total 1 Year 1-3 years 3-5 Years 5 years Operating Lease Obligations $ 0.7 $ 0.2 $ 0.4 $ 0.1 - Purchase Obligations(1) 56.8 56.8 - - - Total Contractual Obligations $ 57.5 $ 57.0 $ 0.4 $ 0.1 - (1) We have outstanding purchase obligations with suppliers and vendors at March 31, 2011 for raw materials and other supplies as part of the normal course of business. 23 -------------------------------------------------------------------------------- Table of Contents Certain Information Concerning Off-Balance Sheet Arrangements As of March 31, 2011, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. We are, therefore, not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships. 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 our annual report to shareholders and future filings with the Securities and Exchange Commission, our press releases and oral statements made with the approval of an authorized executive officer, contain forward-looking statements that reflect our 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. In particular, these include, among others, statements relating to our anticipated capital expenditures, sufficiency of funds to finance our operations, retail sales and expansion expectations, raw material and component supply expectations, adequacy of insurance, and the effect of regulations on us and our industry. 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 on Form 10-K. We do not undertake any obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. 24 -------------------------------------------------------------------------------- Table of Contents |