The following discussion pertains to the results of operations and financial position of the Company for each of the three years in the period ended December 31, 1998, and should be read in conjunction with the Consolidated Financial Statements and the Notes thereto included elsewhere herein.
RESULTS OF OPERATIONS
1998 vs. 1997
Sales increased to $1.176 billion in 1998, representing a 12 percent increase from $1.048 billion in 1997. The increase in sales was primarily due to higher all-terrain vehicle (ATV) sales, partially offset by a decline in snowmobile sales.
In 1998, Polaris achieved its ninth consecutive year of increased ATV sales. North American sales of ATVs and related parts, garments and accessories (PG&A) of $673.9 million in 1998 were 42 percent higher than $473.2 million in 1997. The increased sales reflect the continued strong growth of the industry as consumers find new and expanded uses for the product. Additionally, management believes that Polaris increased its market share of ATV sales as the result of continued expansion of the popular Sportsman line of ATVs and other new model introductions. The average per unit sales price increased six percent for ATVs in 1998 as the sales mix continued to move to new, higher performance models. Sales of ATVs and related PG&A comprised 57 percent of total Company sales in 1998 compared to 45 percent in 1997.
North American sales of snowmobiles and related PG&A of $374.4 million in 1998 were 16 percent lower than $443.0 million in 1997. The decline is due to lower snowmobile production levels in 1998 in response to poor snow conditions, warmer than normal temperatures in North America, and higher dealer inventories at the end of the 1997-1998 selling season. Sales of snowmobiles and related PG&A comprised of 32 percent of total Company sales in 1998 compared to 42 percent in 1997.
North American sales of personal watercraft (PWC) and related PG&A of $50.4 million in 1998 were 31 percent lower than $73.4 million in 1997. The decrease is attributable to significantly lower production levels of PWC in 1998 to compensate for the increased dealer inventory remaining from the prior season reflecting the reduction of industry growth. Sales of PWC and related PG&A comprised four percent of total Company sales in 1998 compared to seven percent in 1997.
North American sales of Victory motorcycles and related PG&A were $9.9 million in 1998. Victory shipments to our dealers began in July 1998. Sales of Victory motorcycles and related PG&A comprised one percent of total Company sales in 1998, the initial year of production.
International sales of snowmobiles, ATVs, PWC, and related PG&A of $61.7 million in 1998 were five percent higher than $58.7 million in 1997. The increase in international sales was primarily due to an increase in ATV shipments. Polaris continues to focus on international markets as an opportunity for future growth. International sales comprised six percent of total Company sales in 1998, the same as 1997.
Gross profit increased to $278.3 million in 1998, representing a six percent increase over $262.5 million gross profit in 1997. However, the gross profit margin percentage of 23.7 percent in 1998 decreased from 25.0 percent in 1997. The decrease in gross profit margin percentage is primarily a result of the (a) mix impact of the substantial increase in sales of ATVs, which have a lower margin than snowmobiles, (b) negative impact of the Canadian dollar exchange rate when compared to the prior year, (c) initial production rollout of the Victory motorcycles, and (d) reduced pricing on 1998 model ATVs implemented in the Fall of 1997. These negative factors have been partially offset by the continued improvement in overall product quality, which has resulted in a decrease in warranty expenses.
Polaris has continued to invest in new product development, innovation, and product diversification. Research and development expenses were $28.4 million (2.4 percent of sales) in 1998 and $26.7 million (2.5 percent of sales) in 1997. In addition, Polaris incurred tooling expenditures for new products of $2.8 million in 1998 and $19.3 million in 1997. In 1998, 73 percent of sales came from products introduced in the past three years.
Operating expenses in 1998 increased five percent to $178.2 million from $169.4 million in 1997. Expressed as a percentage of sales, operating expenses decreased to 15.2 percent in 1998 from 16.2 percent in 1997. These decreases are primarily attributable to the leveraging effect of higher sales and reduced level of promotional and advertising costs related to assisting dealers in selling their PWC and snowmobile inventories partially offset by a planned increase in advertising expenditures.
Nonoperating expense (income) in 1998 includes a $61.4 million provision for litigation loss related to the settlement of the Injection Research Specialists litigation. This is a one-time charge that should not effect the ongoing operations of the Company. The remaining improvement in nonoperating expense (income) in 1998 from 1997 primarily reflects the positive financial impact of the Company’s equity in the income of Polaris Acceptance.
The provision for income taxes was reduced to a rate of 35.5 percent of pretax income beginning in the third quarter of 1998 from 36.0 percent in prior periods as a result of certain tax planning strategies.
Net income in 1998 was $31.0 million, a decrease from $65.4 million in 1997, primarily as a result of the litigation settlement. Net income as a result of sales was 2.6 percent in 1998, a decrease from 6.2 percent in 1997. Net income per diluted share decreased to $1.19 in 1998 from $2.45 in 1997. Net income adjusted to exclude the litigation settlement increased eight percent to $70.6 million in 1998 from $65.4 million in 1997. Adjusted net income as a percent of sales decreased to 6.0 percent in 1998 from 6.2 percent in 1997. Adjusted net income per diluted share increased 11 percent to $2.72 in 1998 from $2.45 in 1997.
1997 vs. 1996
Sales decreased to $1.048 billion in 1997, representing a 12 percent decrease from $1.192 billion in 1996. The decrease in sales was primarily due to lower PWC, and to a lesser extent, lower snowmobile sales. The Company’s ATV product line posted its eighth consecutive year of increased retail sales.
North American sales of snowmobiles and related PG&A of $443.0 million in 1997 were 13 percent lower than $506.5 million in 1996. The decline is due to lower snowmobile production levels driven by a second consecutive year of relatively flat industry growth. This lower production has enabled Polaris to assist dealers in managing their field inventory levels. Sales of snowmobiles and related PG&A comprised 42 percent of total company sales in 1997 compared to 43 percent in 1996.
North American sales of ATVs and related PG&A of $473.2 million in 1997 were six percent higher than $445.9 million in 1996. The increased sales reflect the continued growth of the industry and Polaris’ ability to provide the consumer with a quality product at a competitive price. Sales of ATVs and related PG&A comprised 45 percent of total company sales in 1997 compared to 37 percent in 1996.
North American sales of PWC and related PG&A of $73.4 million in 1997 were 61 percent lower than $190.4 million in 1996. The decrease is attributable to significantly lower production levels of PWC in 1997 to compensate for the increased dealer inventory remaining from the prior season reflecting the reduction of industry growth. Sales of PWC and related PG&A comprised seven percent of total company sales in 1997 compared to 16 percent in 1996.
International sales of snowmobiles, ATVs, PWC, and related PG&A of $58.7 million in 1997 were 20 percent higher than $49.1 million in 1996. The increase in international sales was across all product lines. International sales comprised six percent of total Company sales in 1997 compared to four percent in 1996.
Gross profit of $262.5 million decreased slightly in 1997 from $263.8 million in 1996. However, the gross profit margin percentage of 25.0 percent in 1997 increased 13 percent from 22.1 percent in 1996. The increase in gross profit margin percentage is primarily a result of (a) continued cost reduction efforts, including expanded domestic engine production, (b) reduced warranty costs, (c) decreases in costs of certain purchased components due to the strengthening of the U.S. dollar in relation to the Japanese yen when compared to 1996, and (d) change in sales mix with less sales of the lower margin PWC product when compared to 1996.
Operating expenses in 1997 increased two percent to $169.4 million from $166.4 million in 1996. Expressed as a percentage of sales, operating expenses increased to 16.2 percent in 1997 from 14.0 percent in 1996. These increases are primarily attributable to the higher level of promotional and advertising costs related to assisting dealers in selling their remaining snowmobile and PWC inventory.
The improvement in nonoperating expense (income) in 1997 from 1996 primarily reflects (a) the positive impact of the Canadian dollar exchange rate hedging activity, (b) the positive financial impact of the Company’s equity in the income of Polaris Acceptance, and (c) lower interest expense resulting from lower average outstanding borrowings in 1997 as compared to 1996.
The provision for income taxes has been recorded at a rate of 36.0 percent of pretax income for each of 1997 and 1996.
Net income increased five percent to $65.4 million in 1997 from $62.3 million in 1996. Net income as a percent of sales increased to 6.2 percent in 1997 from 5.2 percent in 1996. Net income per basic and diluted share increased nine percent to $2.45 in 1997 from $2.24 in 1996.
LIQUIDITY AND CAPITAL RESOURCES
Polaris’ primary sources of funds have been cash provided by operating activities, a $175 million bank line of credit and a dealer floor plan financing program. Polaris’ primary uses of funds have been for cash dividends to shareholders, repurchase and retirement of common stock, capital investments, payment of litigation expenses and new product development.
During 1998, Polaris generated net cash from operating activities of $121.4 million, which was utilized to fund capital expenditures of $61.5 million, cash dividends of $18.6 million and the repurchase of common stock of $37.7 million. During 1997, Polaris generated net cash from operating activities of $102.3 million which was utilized to fund capital expenditures of $36.8 million, investments in affiliates of $2.6 million, cash dividends of $17.0 million, and the repurchase of common stock of $39.9 million. During 1996, Polaris generated net cash from operating activities of $89.6 million, which was utilized to fund capitalized expenditures of $36.8 million, net investments in affiliates of $6.8 million, cash dividends of $16.4 million and the repurchase of common stock of $13.6 million.
The seasonality of production and shipments causes working capital requirements to fluctuate during the year. Polaris has an unsecured bank line of credit arrangement maturing on March 31, 2000, under which it may borrow up to $175 million until March 31, 1999 and $150 million thereafter until maturity. The arrangement provides borrowing for working capital needs and the repurchase and retirement of common stock. Borrowings under the line of credit bear interest, 5.95 percent at December 31, 1998, based on LIBOR or “prime” rates. At December 31, 1998, Polaris had total borrowings under the line of credit of $20.5 million compared to $24.4 million at December 31, 1997. In addition, at December 31, 1998, Polaris had letters of credit outstanding of $7.8 million related to purchase obligations for raw materials.
During 1996, the Polaris Board of Directors authorized the repurchase of up to 1.0 million shares of the company’s common stock. During 1997, the Board of Directors expanded the share repurchase program, authorizing the cumulative repurchase of up to 3.0 million shares. On May 21, 1998, the Board of Directors expanded the share repurchase program, authorizing the cumulative repurchase of up to 5.0 million shares. During 1998, Polaris paid $37.7 million to repurchase and retire 1,090,500 shares. Polaris has 1,932,600 shares available to repurchase under its current Board authorization as of December 31, 1998.
In February 1996, a wholly owned subsidiary of Polaris entered into a partnership agreement with a wholly owned subsidiary of Transamerica Distribution Finance (TDF) to form Polaris Acceptance. Polaris Acceptance provides floor plan financing to Polaris’s dealers and distributors and beginning in 1999 will provide other financial services to dealers, distributors and retail customers of Polaris including retail credit, leasing and extended service contracts. Under the partnership agreement, Polaris’ subsidiary has a 50 percent equity interest in Polaris Acceptance and guarantees 50 percent of the outstanding indebtedness of Polaris Acceptance under a credit agreement between Polaris Acceptance and TDF. At December 31, 1998, Polaris’ contingent liability with respect to the guarantee was approximately $139.0 million.
Polaris has arrangements with certain finance companies, including Polaris Acceptance, to provide floor plan financing for its distributors and dealers. These arrangements provide liquidity by financing distributor and dealer purchases of Polaris products. Substantially all of the sales of snowmobiles, ATVs, motorcycles and PWC (but not parts, garments and accessories) are financed under these arrangements whereby Polaris receives payment within a few days of shipment of the product. The amounts financed by distributors and dealers under these arrangements at December 31, 1998 and 1997, were approximately $384.0 million and $289.0 million, respectively. Polaris participates in the cost of dealer and distributor financing up to certain limits. Polaris has agreed to repurchase products repossessed by the finance companies to an annual maximum of 15 percent of the average amount outstanding during the prior calendar year. Polaris’ financial exposure under these agreements is limited to the difference between the amount paid to the finance companies and the amount received on the resale of the repossessed product. No material losses have been incurred under these agreements. However, an adverse change in retail sales could cause this situation to change and thereby require Polaris to repurchase financed units.
Polaris has made significant capital investments to increase production capacity, quality, and efficiency, and for new product development and diversification. Improvements in manufacturing and distribution capacity include: (a) tooling expenditures for new product development across all product lines of $24.8 million during 1998, (b) An investment of $9.7 million since late 1996 for the construction of a 250,000 square foot state-of-the-art parts, garments and accessories distribution center in Vermillion, South Dakota which was operational by mid-1997, and (c) in 1998, Polaris completed construction and began operating a new 58,000 square foot injection molding facility in Roseau, MN, which required an investment of $11.2 million. Polaris anticipates that capital expenditures, including tooling, for 1999 will range from $65 million to $75 million.
Management believes that existing cash balances, cash flows to be generated from operating activities and available borrowing capacity under the line of credit arrangement will be sufficient to fund operations, regular dividends, share repurchases, and capital expenditure requirements for 1999. At this time, management is not aware of any factors that would have a materially adverse impact on cash flow beyond 1999.
Injection Research Specialists (“IRS”) commenced an action in 1990 against Polaris and Fuji Heavy Industries, Ltd. (“Fuji”), one of Polaris’ engine suppliers, in Colorado Federal Court alleging various claims relating to electronic fuel injection systems for snowmobiles. In October 1998, following the entry of judgment against Polaris for $34.0 million (before pre- and post-judgement interest) and affirmance thereof by the Federal Court of Appeals, IRS, Polaris and Fuji entered into a confidential settlement agreement to settle all outstanding claims between the parties. The resulting provision for litigation loss of $61.4 million has been reflected as non-operating expense in the accompanying consolidated statement of operations for the year ended December 31, 1998. The related payment to IRS was made during the fourth quarter 1998 in connection with entering into the confidential settlement agreement. Polaris no longer uses any of the technology in dispute.
Polaris proforma results adjusted to exclude the provision for litigation loss are as follows:
|
