UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2005

Commission file number: 0-25620

A.S.V., Inc.

Not Applicable

     Check whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

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

     As of April 29, 2005, 13,391,314 shares of the issuer’s Common Stock were issued and outstanding.

Table of Contents

PART I - FINANCIAL INFORMATION

ITEM 1 - FINANCIAL STATEMENTS

A.S.V., Inc.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

     See notes to consolidated financial statements.

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A.S.V., INC.
CONSOLIDATED STATEMENTS OF EARNINGS
(UNAUDITED)

Three months ended March 31,

     See notes to consolidated financial statements.

3

A.S.V., INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Three months ended March 31,

See notes to consolidated financial statements.

4

A.S.V., INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

March 31, 2005

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     A summary of the significant accounting policies consistently applied in the preparation of the accompanying unaudited, consolidated financial statements follows:

Principles of Consolidation

     The consolidated financial statements include the accounts of A.S.V., Inc. (ASV or the Company) and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.

Revenue Recognition

     ASV generally recognizes revenue on its product sales when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable and collectibility is reasonable assured. The Company considers delivery to have occurred at the time of shipment.

Research and Development

     All research and development costs are expensed as incurred.

Interim Financial Information

     The accompanying unaudited, consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (US GAAP) for interim financial information. Accordingly, they do not include all of the footnotes required by US GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal, recurring adjustments) considered necessary for a fair presentation have been included. Results for the interim periods are not necessarily indicative of the results for an entire year.

Warranties

     The Company provides a limited warranty to its customers. Provision for estimated warranty costs are recorded when revenue is recognized based on estimated product failure rates, material usage and service delivery costs incurred in correcting a product failure. Should actual failure rates, material usage or service delivery costs differ from the Company’s estimates, revision to the warranty liability may be required.

     Changes in the Company’s warranty liability are as follows:

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A.S.V., INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Stock-Based Compensation

     At March 31, 2005, the Company had three stock-based compensation plans. The Company accounts for those 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 is 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 grant.

     The following table illustrates the effect on net earnings and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, using the following assumptions. The weighted average fair values of the options granted during 2005 and 2004 were $16.94 and $18.34. The fair value of each option grant is estimated on the date of grant using the Black-Scholes options-pricing model with the following weighted-average assumptions used for all grants in 2005 and 2004, respectively: zero dividend yield; expected volatility of 39.45% and 52.3%, risk-free interest rate of 4.11% and 3.64% and expected lives of 6.10 and 6.90 years.

NOTE 2. INVENTORIES

     Inventories consist of the following:

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A.S.V., INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)

NOTE 3. NEW ACCOUNTING PRONOUNCEMENTS

SFAS 123 (Revised 2004), Share-Based Payment

     This revision to Statement No. 123, Accounting for Stock-Based Compensation, requires the fair value of all share-based payment transactions be recognized in the financial statements. SFAS 123 (Revised 2004) establishes fair value as the measurement objective in accounting for share-based payment arrangements and requires all entities to apply a fair-value-based measurement method in accounting for share-based payment transactions with employees, except for equity instruments held by employee share ownership plans. This Statement is effective for the Company beginning January 1, 2006. The Company anticipates the effect of adopting this Statement could be material, but the impact on its diluted earnings per share for the year ended December 31, 2006 for those share-based payment transactions in existence as of April 29, 2005 cannot currently be calculated.

SFAS 151, Inventory Costs

     This Statement requires the accounting for idle facility expense, freight, handling costs and wasted material be recognized as current period charges. This Statement also requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. This Statement is effective for the Company beginning January 1, 2006. Management does not believe the adoption of this pronouncement will have a material effect on the Company.

NOTE 4. INCOME TAXES

     On October 22, 2004, congress passed the American Jobs Creation Act of 2004 (the Act). The Act provides a deduction for income from qualified domestic production activities, which will be phased in from 2005 through 2010, as well as other tax implications. The domestic production deduction will be accounted for as a special deduction, and as such, will have no effect on deferred tax assets and liabilities existing at the date of enactment. It is not currently possible to predict what impact this Act will have on future earnings, as final implementation information is not expected to be available until later in 2005.

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ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

     ASV designs, manufactures and sells rubber-tracked, all-purpose crawlers and related accessories and attachments. ASV also manufactures rubber-tracked undercarriages, which are a primary component on Caterpillar Inc.’s (Caterpillar) Multi Terrain Loaders (MTL). ASV’s products are able to traverse nearly any terrain with minimal damage to the ground, making it effective in industries such as construction, landscaping and agriculture. ASV distributes its products through an independent dealer network in the United States, Canada, Australia, New Zealand and Portugal. The undercarriages sold to Caterpillar are incorporated by Caterpillar in their MTL products and sold exclusively through the Caterpillar dealer network, primarily in North America.

     ASV experienced a significant increase in sales in the first quarter of 2005 due to several reasons as explained below:

	•	The Company believes there is a greater acceptance of rubber track machines in the marketplace as users experience the benefits that a rubber track machine can provide over a standard wheeled machine.
	•	The number of companies entering into the rubber track machine market has increased in the last few years, thereby contributing to the increased awareness and market acceptance of the products.
	•	ASV has increased its number of product offerings over the past few years thereby making it easier to attract prospective dealers to carry the R-Series Posi-Track product line. In addition, the number of dealers selling the Company’s R-Series Posi-Track product line has increased over the past few years.
	•	The current low interest rate environment has provided for easier financing by end users.
	•	The Company’s results of operations for the three months ended March 31, 2005 include sales of $6.4 million from Loegering Mfg. Inc. (Loegering). On October 4, 2004, ASV closed on its acquisition of Loegering of Casselton, North Dakota in a merger transaction. Loegering is a manufacturer of over-the-tire steel tracks for wheeled skid-steers and also provides attachments for the skid-steer market. Following completion of the transaction, Loegering became a wholly owned subsidiary of ASV.

Critical Accounting Policies

     The following discussion and analysis of the Company’s financial condition and results of operations is based upon its consolidated financial statements, which have been prepared in accordance with US GAAP. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities and expenses, and related disclosures. On an on-going basis, management evaluates its estimates and judgments, including those related to accounts receivable, inventories and warranty obligations. By their nature, these estimates and judgments are subject to an inherent degree of uncertainty. Management bases its estimates and judgments on historical experience, observance of trends in the industry, information provided by customers and other outside sources and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

     Management believes the following critical accounting policies, among others, affect its more significant judgments and estimates used in the preparation of the Company’s consolidated financial statements.

     Revenue Recognition and Accounts Receivable. Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable and collectibility is reasonably assured. The Company has determined that the time of shipment is the most appropriate point to recognize revenue as the risk of loss passes to the customer when placed with a carrier for delivery (i.e., upon shipment). Any post-sale obligations on the part of ASV, consisting primarily of warranty obligations, are estimated and accrued for at the time

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of shipment. The Company generally obtains oral or written purchase authorizations from customers for a specified amount of product at a specified price and considers delivery to have occurred at the time of shipment. ASV maintains an allowance for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of ASV’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

     Inventories. Inventories are stated at the lower of cost or market, cost being determined on the first-in, first-out method. Adjustments to slow moving and obsolete inventories to the lower of cost or market are provided based on historical experience and current product demand. The Company does not believe its inventories are subject to rapid obsolescence. The Company evaluates the adequacy of the inventories’ carrying value quarterly.

     Warranties. The Company provides limited warranties to purchasers of its products which vary by product. The warranties generally cover defects in materials and workmanship for one year from the delivery date to the first end user. The rubber tracks used on the Company’s products carry a pro-rated warranty up to 1,500 hours of usage. While ASV engages in extensive product quality programs and processes, including actively monitoring and evaluating the quality of its component suppliers, ASV’s warranty obligation is affected by product failure rates, material usage and service delivery costs incurred in correcting a product failure. Should actual product failure rates, material usage or service delivery costs differ from ASV’s estimates, revisions to the estimated warranty liability may be required.

     Income Taxes. The Company records income taxes using an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company’s financial statements or tax returns. A valuation allowance is established when management determines it is more likely than not that a deferred tax asset is not realizable in the foreseeable future.

     Stock-Based Compensation. The Company accounts for employee stock-based compensation under the “intrinsic value” method prescribed in Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, as opposed to the “fair value” method prescribed by Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation. Pursuant to the provisions of APB 25, the Company generally does not record an expense for the value of stock-based awards granted to employees.

     The FASB issued an amendment to SFAS No. 123, Share-Based Payment, (“SFAS No. 123R”), which will be effective for public companies in periods beginning after December 15, 2005. We are required to implement the proposed standard no later than the quarter that begins January 1, 2006. SFAS No. 123R eliminates the ability to account for share-based compensation transactions using APB Opinion No. 25, and generally would require instead that such transactions be accounted for using a fair-value-based method. Companies are required to recognize an expense for compensation cost related to share-based payment arrangements including stock options and employee stock purchase plans. The Company anticipates the effect of adopting this Statement could be material, but the impact on its diluted earnings per share for the year ended December 31, 2006 for those share-based payment transactions in existence as of April 29, 2005 cannot currently be calculated.

Results of Operations

     The following table sets forth certain Statements of Earnings data as a percentage of net sales:

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     Net Sales. For the three months ended March 31, 2005, net sales increased 61% to $53.2 million, compared with $33.1 million for the same period in 2004. This increase was primarily the result of four factors. First, sales of the Company’s R-Series products increased 23% due to a greater number of R-Series dealers in 2005 and a full quarter of sales of the RC-60 and RC-85 in the first quarter of 2005 versus a partial quarter in 2004. Sales of R-Series products represented 41%, or $21.6 million, of the Company’s sales in the first quarter of 2005, compared with 53%, or $17.5 million, in the first quarter of 2004. Second, sales of the Company’s undercarriages to Caterpillar for use on their Multi-Terrain Loaders (MTLs) increased 55% in the first quarter of 2005 compared with the same period in 2004. This increase was a result of Caterpillar changing over its production of MTLs to a newer series in the first half of 2004, for which production was less in the first half of 2004. No such changeover occurred in 2005. Sales of undercarriages represented 33%, or $17.5 million, of the Company’s sales in the first quarter of 2005, compared with 34%, or $11.2 million, in the first quarter of 2004. Third, sales from Loegering, acquired in October 2004, totaled $6.4 million for the first quarter of 2005, compared to none in the first quarter of 2004. Lastly, sales of service parts increased 77% during the first quarter of 2005 compared with the first quarter of 2004 due to a greater number of machines and undercarriages in service. The Company anticipates its net sales for 2005 will be in the range of $220-230 million based on its current and projected level of orders for its R-Series Posi-Track products and MTL undercarriages, projected future service parts demand and a full year of sales from Loegering.

     Gross Profit. Gross profit for the three months ended March 31, 2005 increased to $12.8 million, compared with $7.6 million for the same period in 2004, and the gross profit percentage increased to 24.0% in 2005 compared with 22.9% in 2004. The increase in gross profit was due primarily to the increased sales experienced during the first quarter of 2005. The increase in gross profit percentage was due primarily to a shift in the mix of products sold as the Company had increased sales of R-Series Posi-Track products in the first quarter of 2005 over the first quarter of 2004. R-Series products generally carry a higher gross profit percentage than MTL undercarriages. The Company also believes its raw material unit cost reduction project initiated in the first quarter of 2004 as well as operational efficiencies obtained from higher production volumes helped increase the gross profit percentage in 2005. In addition, the inclusion of Loegering’s sales for the first quarter of 2005 helped increase the overall gross profit percentage as Loegering’s products carry a higher gross profit percentage, on average, when compared with ASV’s products. Offsetting these increases were steel surcharges of $1.0 million in the first quarter of 2005, compared with $75,000 in the first quarter of 2004. The Company anticipates its gross profit percentage for 2005 will be in the range of 23.5-24.5% based on the anticipated sales mix for 2005.

     Selling, General and Administrative. Selling, general and administrative expenses increased from $1.9 million, or 5.7% of net sales in the first quarter of 2004, to $3.8 million, or 7.1% of net sales in the first quarter of 2005. The increase was due primarily to the inclusion of Loegering, which does not yet enjoy the same degree of leverage that ASV does. In addition, the Company had increased advertising and promotion costs to promote the technology benefits of the Company’s products, increased sales commissions from increased sales of the Company’s R-Series products and the overall increase in the volume of the Company’s business.

     Research and Development. Research and development expenses increased from $156,000 in the first quarter of 2004 to $428,000 in the first quarter of 2005. The increase was due to the on-going development of new products, including the Company’s newest R-Series product, the RCV, which went into production in April 2005, and additional applications of its track technology. The Company also began the development of a smaller version of the Loegering Versatile Track System product, which is expected to be available in the third quarter of 2005. The Company anticipates its future spending on research and development activities will focus on additional product offerings and additional applications of its track technology.

     Other Income (Expense). For the three months ended March 31, 2005, other income was $320,000, compared with $151,000 for the first quarter of 2004. This increase was due primarily to increased interest income from greater funds available for investment in 2005. Funds increased in 2005 due to proceeds received from the sale of common stock to Caterpillar in January 2004, proceeds received from the exercise of employee stock options and net earnings generated in the first quarter of 2005 and the twelve months ended December 31, 2004.

     Net Earnings. For the first quarter of 2005, net earnings were $5.5 million, compared with net earnings of $3.6 million for the first quarter of 2004. The increase was primarily a result of increased sales with an increased gross profit percentage, offset in part by increased operating expenses and a higher effective income tax rate.

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Liquidity and Capital Resources

     For the quarter ended March 31, 2005, the Company generated $9.1 million of cash and cash equivalents, compared with generating $12 million of cash and cash equivalents for the quarter ended March 31, 2004. During the first quarter of 2005, the Company generated $1.1 million of cash from operations, due primarily to increased profitability and increased payables, offset in part by increased raw material levels to facilitate expected increased production for the remainder of 2005. The Company generated $7.3 million of cash during the three months ended March 31, 2005, primarily from the redemption of certain short-term investments. In 2005, the Company chose to eliminate the use of auction-rate securities from its investment portfolio, which were classified as short-term investments, and replaced them with short-term tax-exempt investments, which are classified as cash equivalents. Financing activities generated an additional $0.7 million due primarily to the exercise of employee and director stock options.

Caterpillar Revenue Recognition/Gross Profit

     The Company recognizes as sales its cost for the MTL undercarriages, as defined in the Commercial Alliance Agreement between the Company and Caterpillar, plus a portion of the anticipated gross profit that Caterpillar expects to recognize upon sale of the MTLs to Caterpillar dealers, when the Company ships undercarriages to Caterpillar. The gross profit percentage that we receive for two of the three undercarriages we currently sell to Caterpillar was reduced by 33% on January 1, 2005, with the overall gross profit percentage on the sale of all three undercarriages expected to exceed 20% for 2005. The gross profit percentage that we expect to receive for the third undercarriage sold to Caterpillar will also be reduced by 33% effective January 1, 2006. Both of these reductions would reduce the amount of gross profit we will recognize on the sale of these undercarriages to Caterpillar if the level of net sales in 2005 and 2006 were to be the same as in 2004.

     The Company’s current Commercial Alliance Agreement with Caterpillar is in effect through October 31, 2005. The Company believes it has a very strong business relationship with Caterpillar and believes the current MTL agreement and product line have served both parties well. The Company believes the existing contract needs to be updated to reflect additional products and new generation undercarriage designs. The Company and Caterpillar are currently working on the details and expect to have a new multi-year agreement completed in the next sixty to ninety days.

Customer Note Receivable

     Included in accounts receivable at March 31, 2005 is a note receivable for $805,000 from a customer. The note bears interest at 6% and is due in 60 monthly installments beginning February 2004. As of April 29, 2005, the customer is current on all amounts owed the Company under this note.

Off-Balance Sheet Arrangements

     The Company has guaranteed the repayment of a note made by a customer to a non-affiliated finance company in payment of amounts owed to the Company by this customer. To determine the value of the financing guarantee, the lending institution provided us with the cost of the financing both with and without the guarantee. This differential was used to determine the amount of the financing guarantee of $35,000. This amount was recorded as a reduction of net sales for the year ended December 31, 2003, when the note and guarantee were entered into. A similar amount has been included in other accrued liabilities at March 31, 2005 and December 31, 2004. The balance of this note at April 29, 2005 was $393,000. As of April 29, 2005, the customer is current on all amounts owed the finance company under this note.

Relationship with Finance Companies

     The Company has affiliated itself with several finance companies that finance the sale of the Company’s products. By using these finance companies, the Company receives payment for its products shortly after their shipment. The Company pays a portion of the interest cost associated with financing these shipments that would normally be paid by the customer, over a period generally ranging from three to twelve months, depending on the amount of down payment made by the customer. The Company is also providing twelve-month terms for one machine to be used for demonstration purposes for each qualifying dealer. In addition, the Company does, from time to time, offer extended term financing on the sale of certain products to its dealers for periods ranging from 90 days to two years.

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New Accounting Pronouncements

     SFAS 123 (Revised 2004) Share-Based Payment. This revision to Statement No. 123, Accounting for Stock-Based Compensation, requires the fair value from all share-based payment transactions be recognized in the financial statements. SFAS 123 (Revised 2004) establishes fair value as the measurement objective in accounting for share-based payment arrangements and requires all entities to apply a fair-value-based measurement method in accounting for share-based payment transactions with employees, except for equity instruments held by employee share ownership plans. This Statement is effective for the Company beginning January 1, 2006. The Company anticipates the effect of adopting this Statement could be material, but the impact on its diluted earnings per share for the year ended December 31, 2006 for those share-based payment transactions in existence as of April 29, 2005 cannot currently be calculated.

     SFAS 151 Inventory Costs. This Statement requires the accounting for idle facility expense, freight, handling costs and wasted material be recognized as current period charges. This Statement also requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. This Statement is effective for the Company beginning January 1, 2006. Management does not believe the adoption of this pronouncement will have a material effect on the Company.

Cash Requirements

     The Company believes cash expected to be generated from operations and its existing cash, cash equivalents and investments will satisfy the Company’s projected working capital needs and other cash requirements for the next twelve months and the foreseeable future.

Forward-Looking Statements

     The statements set forth above under “Results of Operations” and elsewhere in this Form 10-Q regarding ASV’s future sales levels, gross profit percentage, product mix, profitability, expense levels, liquidity and future agreements with Caterpillar are forward-looking statements based on current expectations and assumptions, and entail various risks and uncertainties that could cause actual results to differ materially from those expressed in such forward-looking statements. Certain factors may affect whether these anticipated events occur, including ASV’s ability to successfully manufacture the machines, unanticipated delays, costs or other difficulties in the development and manufacture of the machines, market acceptance of the machines, general market conditions, corporate developments at ASV or Caterpillar, and ASV’s ability to realize the anticipated benefits from its alliances with Caterpillar. Any forward-looking statements provided from time-to-time by the Company represent only management’s then-best current estimate of future results or trends.

Risk Factors

Our revenue and business would be harmed if Caterpillar ceased manufacturing and marketing products under our Loader Alliance Agreement.

     Under the terms of the Alliance Agreement we entered into with Caterpillar Inc. in October 2000, we agreed with Caterpillar to jointly develop and manufacture a five-model line of Caterpillar branded rubber tracked skid steer loaders called Multi-Terrain Loaders (the Alliance Machines). The term of the Alliance Agreement expires October 31, 2005. These new loaders utilize Caterpillar’s skid steer technology and our rubber track undercarriage technology. All five models have been developed and are available to all Caterpillar dealers. The Alliance Machines are assembled in Sanford, North Carolina, at Caterpillar’s skid steer loader facility. The undercarriages are manufactured at our facility in Cohasset, Minnesota.

     The successful manufacturing and marketing of the Alliance Machines entail significant risks as described below:

•

The development and introduction of the Alliance Machines were scheduled on an aggressive timetable and there exists the possibility this time table may not have detected all potential issues regarding the production or function of the machines. For example, in 2002, Caterpillar experienced production issues which caused them to stop production of the Alliance Machines. As a result, we did

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not ship undercarriages to Caterpillar while the production issues were resolved, resulting in decreased revenue to us. Additional production or other issues may be experienced by Caterpillar or us in the future, which could cause our sales of undercarriages to Caterpillar to decrease or terminate while the issues are resolved.

	•	The overall market for rubber track machines is relatively new and the benefits of rubber track machines are not currently widely known. Caterpillar and ASV believe the market potential for rubber track machines justifies the necessary investment in the Alliance Machines. However, there is no assurance the Alliance Machines will attract sufficient demand to warrant their continued production and produce the returns anticipated by us and Caterpillar.
	•	We will be relying significantly on Caterpillar for their continued interest in manufacturing and marketing the Alliance Machines. In 2004, total sales to Caterpillar accounted for 40% of our net sales. If Caterpillar stopped manufacturing the Alliance Machines, or stopped marketing the Alliance Machines to its dealers or Caterpillar dealers did not adequately promote the sale of the Alliance Machines, our revenue would be decreased and our business would be harmed.
	•	As part of the Alliance Agreement, we agreed not to manufacture machines that are similar to and would compete with the Alliance Machines. Also, we may not knowingly sell our undercarriages to any party who shall manufacture, or resell an undercarriage to a party who shall manufacture, a machine that substantially competes with the Alliance Machines. We may, however, continue to manufacture our own models that do not substantially compete with the Alliance Machines.
	•	The Alliance Agreement calls for us to receive a portion of the gross profit on the sale of the Alliance Machines to Caterpillar dealers. Therefore, a portion of our future revenue will be dependent on the success of Caterpillar in selling the Alliance Machines to Caterpillar dealers. In addition, the gross profit percentage that we receive for two of the three undercarriages we currently sell to Caterpillar was reduced by 33% on January 1, 2005, with the overall gross profit percentage on the sale of all three undercarriages expected to exceed 20% for 2005. The gross profit percentage that we expect to receive for the third undercarriage sold to Caterpillar will also be reduced by 33% effective January 1, 2006. Both of these reductions would reduce the amount of gross profit we will recognize on the sale of these undercarriages to Caterpillar if the level of net sales in 2005 and 2006 were to be the same as in 2004.
	•	The Company’s existing Alliance Agreement continues through October 31, 2005. The Company has had on-going discussions with Caterpillar to negotiate a new multi-year agreement and expects to have a new multi-year agreement completed in the next sixty to ninety days. If a new agreement is not able to be negotiated, our revenue would be decreased and our business would be harmed.

Our business could be materially harmed if Caterpillar did not actively support and cooperate with us to provide us with various commercial services.

     As a result of our transactions with Caterpillar, we may rely on commercial services provided by or through Caterpillar for the operation of our business, including marketing, development, warranty and parts services. As a result, to the extent we avail ourselves of these services, we may become dependent upon the cooperation of Caterpillar for the operation of our business.

     In connection with Caterpillar’s purchase of shares of our common stock and a warrant to purchase shares of our common stock in January 1999, we entered into several agreements with Caterpillar, including a Commercial Alliance Agreement, a Marketing Agreement and a Management Services Agreement. These agreements contemplate that we would also enter into several additional agreements with Caterpillar, including a Trademark and Trade Dress License Agreement, Supply Agreements, a Services Agreement, a Technology License Agreement and a Joint Venture Agreement (which agreements, together with the Commercial Alliance Agreement, the Marketing Agreement and the Management Services Agreement, we collectively refer to as the “Commercial Agreements”).

     Although Caterpillar is obligated under the terms of the Commercial Agreements to provide various services to us, including marketing, development, warranty and parts services, the specific obligations of Caterpillar under those agreements are not explicitly defined. Therefore, if Caterpillar chose not to cooperate with us in providing these services, it may be impractical for us to require Caterpillar to provide any such services to the extent necessary to be beneficial to us. If Caterpillar were to decide not to actively support and cooperate with us to provide us with these services, our business could be materially harmed.

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Caterpillar has the ability to influence or control us, which could negatively affect other shareholders and could discourage offers by third parties to acquire us.

     Caterpillar owns approximately 23.4% of the outstanding shares of our Common Stock. Accordingly, Caterpillar has the ability to influence our business and operations to a certain extent. In addition to its rights as a shareholder to influence us, Caterpillar has the right to designate directors for election to the Board of Directors under the Securities Purchase Agreement between us and Caterpillar dated October 14, 1998, proportionate to its stock ownership interest, which increases Caterpillar’s ability to influence us. Currently, one of our nine directors has been designated by Caterpillar, despite the fact that Caterpillar would be entitled to designate two directors, assuming a board comprised of nine directors. If Caterpillar were to exercise its right to designate an additional director, based on its current stock ownership interest, we anticipate that, assuming there were no vacancies on our board, we would expand the size of our board and elect an additional director designated by Caterpillar.