Polaris - 10-Q quarterly report FY

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial statements and, therefore, do not include all information and disclosures of results of operations, financial position and changes in cash flow in conformity with accounting principles generally accepted in the United States for complete financial statements. Accordingly, such statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2004, previously filed with the Securities and Exchange Commission. In the opinion of management, such statements reflect all adjustments (which include only normal recurring adjustments) necessary for a fair presentation of the financial position, results of operations, and cash flows for the periods presented. Due to the seasonality of the snowmobile, all terrain vehicle (ATV), motorcycle and the parts, garments and accessories (PG&A) business, and to certain changes in production and shipping cycles, results of such periods are not necessarily indicative of the results to be expected for the complete year.

On September 2, 2004, the Company announced its decision to discontinue the manufacture of marine products. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the marine products division’s financial results are reported separately as discontinued operations for all periods presented.

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004), “Share-Based Payments” (SFAS No. 123R). The statement originally required the expensing of stock options in the financial statements for periods no later than the annual or interim periods beginning after June 15, 2005. In April 2005, the Securities and Exchange Commission extended the implementation date of SFAS No. 123R to the beginning of the Company’s next fiscal year. Based on the change in the implementation date, Polaris expects to implement the statement beginning with its interim financial statements for the first quarter 2006. As of yet the Company has not made a determination of the valuation methodology and, therefore, has not determined the impact to future periods.

Polaris provides a limited warranty for ATVs for a period of six months and for a period of one year for all remaining products. Polaris may provide longer warranties related to certain promotional programs, as well as longer warranties in certain geographical markets as determined by local regulations and market conditions. Polaris’ standard warranties require the Company or its dealers to repair or replace defective product during such warranty period at no cost to the consumer. The warranty reserve is established at the time of sale to the dealer or distributor based on management’s best estimate using historical rates and

trends. Adjustments to the warranty reserve are made from time to time as actual claims become known in order to properly estimate the amounts necessary to settle future and existing claims on products sold as of the balance sheet date. Factors that could have an impact on the warranty accrual in any given period include the following: improved manufacturing quality, shifts in product mix, changes in warranty coverage periods, snowfall and its impact on snowmobile usage, product recalls and any significant changes in sales volume. The activity in Polaris’ accrued warranty reserve for the periods presented, excluding the discontinued marine business, is as follows (in thousands):

During the first quarter 2005, the Company paid the CPSC $950,000 to settle claims alleging that the Company violated the Consumer Product Safety Act dating back to the late 1990’s. Polaris and the CPSC approved the settlement to avoid continuing legal costs associated with protracted litigation.

Polaris accounts for all stock based compensation plans in accordance with the provision of APB Opinion No. 25. Had compensation costs for these plans been recorded at fair value consistent with the methodology prescribed by SFAS No. 123 “Accounting for Stock-Based Compensation,” Polaris’ net income and net income per share would have been reduced to the following pro-forma amounts (in thousands except per share data):

The fair value of each award under the Option Plan is estimated on the date of grant using the Black-Scholes option-pricing model.

Inventories are stated as the lower of cost (first-in, first-out method) or market. The major components of inventories are as follows (in thousands):

 Polaris has an unsecured bank line of credit arrangement with maximum available borrowings of $250,000,000 expiring on June 25, 2009. Interest is charged at rates based on LIBOR or “prime” (effective rate was 3.91 percent at June 30, 2005).

 Polaris has entered into an interest rate swap agreement to manage exposures to fluctuations in interest rates. The effect of this agreement is to fix the interest rate at 7.21 percent for $18,000,000 of borrowings under the credit line until June 2007.

 As of June 30, 2005, total borrowings under the bank line of credit arrangement was $30,000,000 and has been classified as long-term in the accompanying consolidated balance sheets.

In 1996, a wholly owned subsidiary of Polaris entered into a partnership agreement with a subsidiary of Transamerica Distribution Finance (TDF) to form Polaris Acceptance. In January 2004, TDF was purchased by GE Commercial Distribution Finance (GECDF), a subsidiary of General Electric Company. Polaris Acceptance provides floor plan financing to Polaris’ dealers in the United States. Polaris’ subsidiary has a 50 percent equity interest in Polaris Acceptance. The receivable portfolio is recorded on Polaris Acceptance’s books, and is funded 85 percent through a loan from an affiliate of GECDF and 15 percent by a cash investment shared equally between the two partners. Polaris has not guaranteed the outstanding indebtedness of Polaris Acceptance. Substantially all of Polaris’ U.S. sales are financed through Polaris Acceptance whereby Polaris receives payment within a few days of shipment of the product. The net amount financed for dealers under this arrangement at June 30, 2005 was approximately $629,000,000.

Polaris’ investment in Polaris Acceptance is accounted for under the equity method, and is recorded as a component of Investments in finance affiliate and retail credit deposit in the accompanying consolidated balance sheets. The partnership agreement provides that all income and losses of the portfolio are shared 50 percent by Polaris’ wholly owned subsidiary and 50 percent by

GECDF. Polaris’ allocable share of the income of Polaris Acceptance has been included as a component of Income from financial services in the accompanying consolidated statements of income.

A wholly owned subsidiary of Polaris has an agreement with Household Bank, N.A. (Household) to provide private label retail credit financing to Polaris consumers through Polaris dealers in the United States. The receivable portfolio is owned and managed by Household and is funded 85 percent by Household and its affiliates and 15 percent by a cash deposit shared equally between the two parties. The amount financed by consumers under this arrangement, net of loss reserves, at June 30, 2005 was approximately $685,000,000. Polaris’ deposit in the retail credit portfolio is reflected as a component of Investments in finance affiliate and retail credit deposit in the accompanying consolidated balance sheets. The agreement with Household provides that all income and losses of the retail credit portfolio are shared 50 percent by Polaris and 50 percent by Household. Polaris’ allocable share of the income from the retail credit portfolio has been included as a component of Income from financial services in the accompanying consolidated statements of income. Under the terms of the agreement, either party has the right to terminate the agreement if profitability of the portfolio falls below certain minimum levels. Polaris’ financial exposure under this agreement is limited to its deposit plus an aggregate amount of not more than $15,000,000.

Polaris facilitates the availability of extended service contracts and certain insurance contracts to consumers through arrangements with various third party suppliers. Polaris does not have any incremental warranty, insurance or financial risk from any of these third party arrangements. Polaris collects commission fees from these arrangements which are included as a component of Income from financial services in the accompanying consolidated statements of income.

Polaris is a partner with Fuji Heavy Industries Ltd. in Robin Manufacturing, U.S.A. (Robin). Polaris has a 40 percent ownership interest in Robin, which builds engines in the United States for recreational and industrial products. Polaris’ investment in Robin is accounted for under the equity method, and is recorded as a component of Intangible and other assets in the accompanying consolidated balance sheets. Polaris’ allocable share of the income of Robin has been included as a component of Other expense (income) in the accompanying consolidated statements of income.

During the first six months of 2005, Polaris paid $92,096,000 to repurchase and retire approximately 1,525,000 shares of its common stock. As of June 30, 2005 the Company has authorization from its Board of Directors to repurchase up to an additional 1,494,000 shares of Polaris stock.

Polaris paid a regular cash dividend of $0.28 per share on May 16, 2005 to holders of record on May 2, 2005.

On July 20, 2005, the Polaris Board of Directors declared a regular cash dividend of $0.28 per share payable on or about August 15, 2005 to holders of record of such shares at the close of business on August 1, 2005.

Basic net income per share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding during each period, including shares earned under the non-qualified deferred compensation plan for the non-employee members of the Board of Directors (Director Plan) and the Employee Stock Ownership Plan (ESOP). Diluted net income per share is computed under the treasury stock method and is calculated to reflect the dilutive effect of outstanding stock options and certain shares issued under the restricted stock plan.

A reconciliation of these amounts is as follows (in thousands):

Comprehensive income represents net income adjusted for foreign currency translation adjustments and the deferred gains or losses on derivative instruments utilized to hedge Polaris’ interest and foreign exchange exposures. Comprehensive income is as follows (in thousands):

Polaris is subject to product liability claims in the normal course of business. Polaris is currently self insured for all product liability claims. The estimated costs resulting from any losses 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 actuarial analysis tools to assist in determining the appropriate loss reserve levels.

Polaris is a defendant in lawsuits and subject to claims arising in the normal course of business. In the opinion of management, it is not probable that any legal proceedings pending against or involving Polaris will have a material adverse effect on Polaris’ financial position or results of operations.

Accounting and reporting standards require that every derivative instrument, including certain derivative instruments embedded in other contracts be recorded in the balance sheet as either an asset or liability measured at its fair value. Changes in the derivative’s fair value should be recognized currently in earnings unless specific hedge criteria are met and companies must formally document, designate and assess the effectiveness of transactions that receive hedge accounting.

Polaris has an interest rate swap agreement expiring in 2007 related to $18,000,000 of debt that has been designated and meets the criteria as a cash flow hedge. At June 30, 2005, the fair value of the interest rate swap agreement was an unrealized loss of $1,175,000, which is recorded net of tax as a component of Accumulated other comprehensive income (loss) in shareholders’ equity.

Polaris enters into foreign exchange contracts to manage currency exposures of certain of its purchase commitments denominated in foreign currencies and transfers of funds from its foreign subsidiaries. Polaris does not use any financial contracts for trading purposes. These contracts have been designated as and meet the criteria for cash flow hedges or fair value hedges.

At June 30, 2005, Polaris had open Japanese yen foreign exchange contracts with notional amounts totaling U.S. $36,271,000, and an unrealized loss of $1,459,000 and open Canadian dollar contracts with notional amounts totaling U.S. $37,783,000 and an unrealized loss of $567,000. These contracts met the criteria for cash flow hedges and the net unrealized losses, after tax, are recorded as a component of Accumulated other comprehensive income (loss) in shareholders’ equity.

On September 2, 2004, the Company announced its decision to discontinue the manufacture of marine products. In the third quarter 2004, the Company recorded a loss on disposal of discontinued operations of $35,600,000 before tax or $23,852,000 after tax. This loss included a total of $28,705,000 in expected future cash payments for costs to assist the dealers in selling their remaining inventory, incentives and discounts to encourage consumers to purchase remaining products, costs to cancel supplier arrangements, legal and regulatory issues, and personnel termination costs. In addition, there were $8,287,000 of liabilities related to the marine products division at the time of the exit announcement. Total cash outlays of $4,473,000 were made in the second quarter 2005 related to the liabilities. Total cash outlays of $22,327,000 have been made since the marine products division exit announcement.

In addition, the loss on disposal of discontinued operations included $6,895,000 in non-cash costs related primarily to the disposition of tooling, other physical assets, and the Company’s remaining inventory. Non-cash charges totaling $67,000 were made to the accrual in the second quarter 2005. Total non-cash charges of $5,966,000 have been made to the accrual since the marine products division exit announcement.

No adjustments were made to the closedown accrual during the second quarter 2005. Utilization of components of the accrued disposal costs during the second quarter 2005 is as follows (in thousands):

On July 18, 2005, a wholly owned Austrian subsidiary of Polaris (“Polaris Austria”) entered into an agreement to purchase from an institutional investor approximately 24.9% of the issued and outstanding share capital of Cross Holding AG, an Austrian joint stock company whose shares are traded on the Vienna stock exchange and whose name is in the process of being changed to KTM Power Sports AG (“KTM Power Sports”). The purchase price, subject to adjustment depending upon the number of shares of KTM Power Sports issued and outstanding and the related number of shares purchased on the closing date of the transaction, is estimated to be approximately Euros 62.6 million to Euros 68.5 million. The transaction, subject to customary closing conditions and regulatory approval, is expected to close during the third quarter 2005. Additionally, on July 18, 2005, Polaris Austria entered into a Call Option Agreement (“Call Option Agreement”) with Cross Industries AG (“Cross Industries”), the largest shareholder of KTM Power Sports, pursuant to which, among other things and subject to certain conditions, in 2007 either Cross Industries may purchase Polaris Austria’s interest in KTM Power Sports or, alternatively, Polaris Austria may purchase Cross Industries’ interest in KTM Power Sports. The Call Option Agreement is included as Exhibit 2.1 to Polaris’ Current Report on Form 8-K as furnished to the Securities and Exchange Commission on July 19, 2005.

On July 11, 2005, Polaris entered into an amendment (the “First Amendment”) to its Five-Year Revolving Credit Agreement (the “Facility”), dated as of June 25, 2004. The First Amendment provides for borrowings in currencies other than U.S. Dollars and revises certain non-financial covenants. Except as noted, all other terms of the Facility, including but not limited to, the applicable interest rates, maturity date, financial covenants and conditions to borrowing, remain in full force and effect.