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Arctic Cat Inc. (NASDAQ:ACAT)

F3Q09 Earnings Call

January 29, 2009 11:00 am ET

Executives

Shawn Brumbaugh - Padilla Speer Beardsley Inc.

Claude J. Jordan - President, Chief Operating Officer

Timothy C. Delmore - Chief Financial Officer, Corporate Secretary

Christopher A. Twomey - Chairman and Chief Executive Officer

Analysts

James Hardiman - Ftn Midwest Securities Corp.

Cassandra Stevenson - Keybanc Capital Markets

Brandon Taylor - Raymond James

Craig Kennison - Robert W. Baird

Operator

Good morning ladies and gentlemen and welcome to Arctic Cat Fiscal Third Quarter 2009 Conference Call. (Operator Instructions). This conference is being recorded today, January 29, 2009. I would now like to turn the conference over to Shawn Brumbaugh at Padilla. Please go ahead ma’am.

Shawn Brumbaugh

Thank you and thank you for joining us this morning. I am Shawn Brumbaugh with Padilla Speer Beardsley. On our call today will be Chris Twomey, Chairman and Chief Executive Officer of Arctic Cat; Claude Jordan, President, Chief Operating Officer; and Tim Delmore, Chief Financial Officer. Before the market opened this morning Arctic Cat released results for its fiscal 2009 third quarter and nine months ended December 31, 2008.

Chris will review the company’s performance and Tim will take you through the financials. After that we will have time for your questions.

Before we begin, please note that some of the comments made today will be forward-looking statements regarding the company’s expectations of future performance. Such statements are subject to risks and uncertainties and actual results may differ materially from those contained in the statements. These risks and uncertainties are described in today’s news release and in the company’s filings with the Securities and Exchange Commission.

We encourage you to review these documents for a description of risk factors that may affect our results.

Now I will turn the call over to Arctic Cat’s CEO Chris Twomey. Chris?

Christopher Twomey

Thanks Shawn and thanks everyone for joining us this morning. We are pleased that while the sales for the quarter were slightly below our expectations our earnings were better than expected. This performance was driven by slightly improved gross margins for snowmobiles during the quarter and lower operating expenses as we took specific actions to reduce costs in the difficult retail environment.

As everyone is acutely aware, the retail sales environment for everything including recreational products continued to worsen during the third quarter. Since we do not believe retail sales will improve at all during our fourth quarter, we have decided to significantly lower ATV sales to our dealers in the fourth quarter compared to our plan and the prior year period. This action will negatively impact revenues and profitability for this fiscal year, but it is prudent, based on lower retail sales activities related to the anemic economy, as well as our desire to align dealer inventories with consumer demand.

After I briefly review each of our businesses, Claude will outline the profitability initiatives we have under taken to improve margins, reduce operating expenses and achieve profitability in fiscal 2010.

As planned snowmobile sales were up 51% for the quarter versus the same quarter last year. These sales were driven by lower dealer inventories this year, after the action we took last year, to better align US dealer snowmobile inventories with consumer demand. In addition we saw increased International sales during the quarter as well. As always, both of these increases were helped by the numerous new products we introduced this year.

North American retail sales of Arctic Cat snowmobiles were better than last year through November; however, in December they caught the same retail sales bug that affected all of the other recreational vehicle categories and as a result Arctic Cat retail sales were down slightly on the year-to-date basis through December. Because the snowmobile industry is collecting monthly retail sales data differently this year compared to last year, I am not able to give you any meaningful industry wide retails sales comparisons other than to say that I believe sales for the entire industry are down and that Arctic Cat has fared better than our competitors, giving us a market share increase.

I think it is also worth noting that retail sales of our 2009 current year models are ahead of current model sales for the same period last year, while retail sales on non-current models are behind last year. Most likely this is the result of the exciting new products we introduced as well as the lower number or non-current units which were in dealer inventories to begin this year compared with last year.

As of the end of December US dealer snowmobile inventories are significantly below last year and we expect to end the year in the same favorable position.

As I have already mentioned, retail sales of ATVs in North America continued their more than two-year long decline. Arctic Cat’s North American retail sales are doing slightly better than the industry and we have gained a small amount of share. Despite the overall dismal industry performance, there is some promise in the large displacement to passenger ATV categories which are different than the recreational off-highway vehicles like the Prowler. These categories, along with the standard large displacement ATV’s, have grown throughout the last calendar year while all other categories have shrunk. Our Thundercat 1000, the TRV 1000, are both in these categories and they are beginning to show some positive impact on retail sales.

We do not expect retail sales of ATVs to recover during the fourth quarter and in fact they may get worse due to the continued worsening of the economy. In view of the very weak economic environment we are committed to driving dealer inventories substantially lower at the end of this year compared to last year and that is why we are reducing our fourth quarter sales to dealers.

Through three quarters we are on our financial plan and profitable. While this action will negatively impact Arctic Cat’s financial performance for the full year, and is extremely disappointing to all of us as shareholders, I am convinced it is the right action to take at this time.

Sales of Prowler side-by-side recreational off highway vehicles also slowed during the quarter after being relatively flat for the first three quarters of the calendar year. Our Prowler 1000 XTZ, the first side by side recreational off highway to win the grueling Baja 1000 endurance race last November just began shipping to dealers in late December and should have an impact on retail activities in our Q4.

Besides the first place finish of the Prowler 1000, the Prowler 700 finished second and a stock sport utility Thundercat 1000 finished 5th in a class of highly modified sport performance ATVs. These victories are a real testimony to the engineering and manufacturing quality of these vehicles which clearly sets them apart from their competitors.

Sales of parts, garments, and accessories were down 11% for the quarter compared to last year, but up 4% on the year reflecting our plan to take stronger pre-season orders and ship earlier to be sure our dealers were ready for the in season business.

Lastly, due to the uncertain nature of the retail environment and the companies desire to maintain maximum flexibility, the Arctic Cat board decided to suspend regular quarterly cash dividends. We understand the importance of continuing to invest in the business, albeit at more conservative levels, even in difficult retail environments. This action, again, disappointing to all of us as shareholders, gives us added flexibility. As conditions normalize and future earnings permit the board will look at resuming dividend payments.

Now I would like to turn the call over to Claude to review the profitability initiatives which we have undertake to return the company to profitability next fiscal year. Claude?

Claude Jordan

Good morning, everyone. As Chris mentioned we have started to implement various profitability initiatives to align the business with the current macro economic conditions and more specifically, the retail sales environment for ATVs and snowmobiles. The overall impact the next fiscal year will be an improvement in gross margins of 300 to 400 basis points and a 15% reduction in operating expenses. The initial step, which was announced last week, was to

reduce our overall workforce by 7%.

In addition to this reduction we will also be taking the following steps: all officers will have their base salary reduced by 5%; planned company wide shutdown; slight decompensation and benefit adjustments; reduced vacation accrual and our hiring freeze will remain in place. In addition to these actions we are also working on various initiatives aimed at improving gross margin through FY2010.

The primary focus on gross margin will be working with our vendors to lower material and product costs as well as various initiatives that have been ongoing over the last 24 months. As we mentioned earlier we expect these gross margin improvements to improve gross margin by about 300 to 400 basis points. Besides the actions just described, we will also be working to improve our cash position. The largest single factor in improving cash will be lowering our finished goods inventory by aligning our production with demands of the market, especially in regards to the ATV business.

Year-to-date we have reduced our ATV production by 24% from our initial plan and are continuing to modify production to meet the demands of the market. Our goal by the end of fiscal 2009 will be to lower ATV factory inventory finished units by over 50% from last year. Additionally, we are closely monitoring the inventory of our dealers to ensure they have the correct amount of inventory to meet the needs of their customers while at the same time limiting growth of dealer inventory to categories that are either new models or models that are continuing to grow, such as large displacement engines. That would include the Prowler XTZ, TRV 1000 and Thundercat.

In Q3 we were able to achieve a reduction in US ATV dealer inventory in the high single digits versus the prior year and are planning to double the reduction for our North American ATV dealers by year-end. Given the current environment we believe the actions just described will return the business to profitability next year.

At this time, I would like to turn the call over to Tim who will review the Q3 financials.

Timothy Delmore

Good morning. I would also like to welcome you all to the conference call. Today I will focus on reviewing the highlights of our third quarter financial performance as well as our outlook for the fourth quarter and full year

Net sales for the third quarter increased 9% to $174.7 million compared to $159.6 million for the same quarter last year. Snowmobile sales increased 51% to $90.9 million from $60 million. ATV sales decreased 18% to $57.8 million from $70.1 million. Parts, garments and accessory sales decreased 11% to $26.1 million from $29.5 million for the same quarter last year, primarily due to the timing and shipments of snow related products as the company reported in the fiscal second quarter.

Gross profits for the quarter increased to $21.6 million from $18.2 million. The gross profit percentage improved to 12.4% from 11.4% primarily due to more snowmobiles in the sales mix.

Selling general and administrative expenses decreased 22% to $25.5 million from $32.7 million primarily due to decreased Canadian hedge costs and decreased other selling and general administrative expenses.

Our interest income was $17,000 versus $93,000 for the same quarter a year ago and interest expense was $323,000 versus $448,000.

The net loss for the quarter was $2.7 million versus a loss of $10.5 million for the third quarter last year and the loss per share was $0.15 versus $0.58 loss per share a year ago.

Next I would like to review Arctic Cat’s financial performance for the first nine months of fiscal ’09.

Year-to-date sales increased 4% to $472.9 million from $452.7 million a year ago. Year-to-date net earnings were $7.2 million versus a loss of $3.7 million the same period last year, while diluted earnings per share was $0.40 versus a loss of $0.20.

On a year-to-date basis snowmobile sales increased 25% to $210.7 million from $168.9 million. ATV sales decreased 12% to $183.2 million from $207.4 million. Parts, garments, and accessory sales increased 4% to $79.1 million from $76.4 million.

Our year-to-date gross profits were $84 million versus $85.2 million. Our gross profit percentage was 17.8% versus 18.8%.

Year-to-date selling, general and administrative expenses decreased to $75.5 million from $89.6 million, again primarily due to decreased Canadian hedge costs and decreased other SG&A costs.

Looking at our balance sheet at December 31 we ended the quarter with $5.4 million of cash, $9 million of short-term borrowings, and zero long-term debt. Our accounts receivable increased $16 million to $59.7 million due to an increased North American floor plan receivables, which reflect a few days from shipment and increased sales to Russian and Nordic countries as well as increased North American and PG&A sales.

Inventory decreased to $150 million from $162 million due to lower ATV inventory.

Our year-to-date capital expenditures totaled $11 million. Depreciation was just under $25 million. We expect the full year 2009 capital expenditures to be approximately $19 to $20 million and depreciation to be $29 million.

Arctic Cat anticipates 2009 fourth quarter net sales to be in the $90 to $100 million range compared to $168.9 million last year due to the decrease in ATV sales and a net loss for the quarter estimated to be in the $0.85 to $0.90 loss per share range. That would compare to $0.02 earnings for the same quarter last year.

Looking ahead to full year 2009 we anticipate our net sales to end in the range of $563 to $573 million and a net loss of between $0.46 and $0.56.

Thank you. Now we would like to open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from James Hardiman with Ftn Midwest. Securities Corp.

James Hardiman - Ftn Midwest Securities Corp.

Can you give us an update on your wholesale financing relationship with Textron, given their announcement that they are going to be exiting all of, sort of, power sports in general? And, do you have a replacement lined up for those guys and what is the timetable around that?

Claude Jordan

Our current agreement with Textron in the US ends at the end of calendar year ’09 and in the spring of 2012 in Canada. We are currently talking to a number of providers out there and we have been pleased. There is probably a few more people out there doing floor plan financing than you might think. We don’t have anything to announce yet, but we would see an announcement in maybe mid summer on who our next provider is going to be.

I am aware Textron is selling the part of the floor plan operation we belong to that is profitable and I know Textron is marketing that part of the operation.

James Hardiman - Ftn Midwest Securities Corp.

You feel pretty comfortable that it is going to be one sort of national partner versus trying to fill that gap with a couple of different options?

Claude Jordan

Yes, we would see, you know a national partner; it may or may not be a different partner in Canada, which is something we have done. We have had two different companies one help by helping us in the US and one in Canada.

James Hardiman - Ftn Midwest Securities Corp.

Okay and then in terms of some of your bigger retail partners, there was some scaling back at one of them. I think it was the first quarter last year. We are hearing that they might be getting out of it all together. Is that the case and is that going to have a material impact on you guys going forward?

Claude Jordan

One of our retail partners informed us last year, you are right in the first quarter that they were getting out of the power sports business in about 2/3 of their stores. They have now told us that they intend to exit the power sports business entirely; however, we don’t expect that that will have a negative impact on us going forward into next fiscal year because they didn’t order anything during this fiscal year. So, there won’t be a wholesale impact in F10 since in R09 they didn’t have any wholesale orders from us anyway. They just sold their inventory that they had when they exited the store business last year. So, we don’t expect it to have any impact.

James Hardiman - Ftn Midwest Securities Corp.

Great and then can you just give us an idea of, in talking to your dealers, how many of those guys are going out of business? How many of those guys are ending their relationships with you guys? Where you were say a year ago, what is the size of the dealer base today and where do you expect that to go in 2009?

Timothy Delmore

Where we have seen most of the pressure has been on the ATV side of the business. As we look at, obviously it is a very critical part of our business, but we have seen probably about 5% of our dealer network, excluding the Bass Pros and we are actually adding a few more stores to the Bass Pros side, but right around 5% from last year to where we are as of today.

James Hardiman - Ftn Midwest Securities Corp.

Okay and what is the timing surrounding when these guys would re-up on an annual basis with you? Is it a calendar year agreement or is it at any point a concern? Do you expect further departures in 2009; is there any visibility on that?

Timothy Delmore

It is obviously something we continue to monitor. It is of some concern important to us. We do have our ATV show in June which is where we take a large number of our orders. We also have our March snow show which is where we take our orders as well. So obviously we get a very good indication in terms of ordering dealers at that time, but I am not sure that those are specifically tied to, I think the economy is going to drive when we lose dealers, more so than in specific time versus the shows.

Operator

Your next question comes from Cassandra Stevenson - Keybanc Capital Markets

Cassandra Stevenson - Keybanc Capital Markets

I was wondering on the 10% to 15% of OpEx improvement what exactly is the baseline year for that?

Timothy Delmore

Basically it is took the budget for this year, what we were working with and started to work on the forecast for next year in terms of where we see it, but it is basically coming off the budget for this year.

Cassandra Stevenson - Keybanc Capital Markets

Then with the 300 to 400 basis points of improvement, should that be spread out pretty equally among quarters, or how do we think about that?

Timothy Delmore

It will be spread out fairly evenly. There are different buckets within that 300 to 400. Some of it is tied to specific programs on the tooling cycle and the expense side, other things on sourcing. So I would assume most of it is going to follow the flow of the products, so we will have certain quarters that are that we ship more product than other ones and therefore you will get more dollars, but obviously the same type of percentage.

Cassandra Stevenson - Keybanc Capital Markets

Then in terms of an effective tax rate what should we kind of expect for the year?

Timothy Delmore

Effective tax rate for this fiscal year or next? This fiscal year we will have an effective tax rate of about 46% of benefit.

Cassandra Stevenson - Keybanc Capital Markets

Okay, do you have the forecast for next year?

Timothy Delmore

Next year it will be in the low double digits.

Cassandra Stevenson - Keybanc Capital Markets

Okay and then you were talking about the dealer show in March. Do you have any expectations for that show in terms of how dealers are feeling about future orders?

Christopher Twomey

We don’t really at this point have any sense of it. We have announced the show to the dealers. We have announced that we have got a new product. Again we have invested this year in new products so there is some exciting new product for the dealers to see, dealer sales. Again, while they are down through December, down slightly through December, new product sales continue in January to be strong, so sales of current models continue to be strong in January. So the dealers are retailing. We are going to bring them in and show them exciting new products in new categories.

It is hard to predict, but I think that we are going to see a good attitude on the part of the dealers and they are going to see product to get them excited and I think product that will excite the customers. Again, it is important to focus on the fact that new products, those products which we introduced as new in model year ’09 are outselling the new models that are selling at a faster rate than new models we introduced in ’08. So again, new is driving the business.

Operator

Your next question comes from Brandon Taylor with Raymond James.

Brandon Taylor - Raymond James

I am looking at your historical financials. If you look back to say 2000, 2001, until fiscal year ’07 you were growing sales year-over-year, yet we were seeing predominantly gross margin contraction. I am looking at the 300 to 400 basis points you are talking about getting in 2010. Could you guys give us some more color about where that is going to come from; because you are looking at a declining sales environment, and fixed cost absorption, and things like that. Give me some more color about exactly how it is going to happen.

Claude Jordan

There is a couple of things there. As you look at the historicals’ you have to remember that a lot of the growth we experienced came from the ATV side of the business and the ATV side of the business historically has had a lower gross margin than the sno and definitely the POGA business so as we continue to grow our business around 2001 through 2007 the mix issue would have come into play there to drop the gross margins a little bit.

In terms of where we see the growth in our gross margin next year, sourcing we have a sourcing initiative where we have gone back to our partners and asked for a certain percentage reduction. Obviously that is a significant amount of cost for the business that we source product from. We have certain tooling expenses on the snowmobile side that will be fully through this year; so, we will have a pick up there. We have been working on various engineering opportunities, actually engineering on both the sno and the ATV side, probably for about the last 24 months. Some of those will start to come into play. We are going to be reducing our production lines from three down to two so we can go ahead and move people back and forth on the ATV Prowler lines and small things. We had a dealer incentive trip on the ATV side that was over $1 million. We only do that every three or four years, so things like that we will go ahead and eliminate as well.

As we get into the details of the gross margin the 300 to 400 basis points, we are feeling pretty goof about that number right now. That and the fact that as we look at the mix next year, as we look to Q4 even, the ATV side is the business that has come under pressure more so than sno and POGA is where we get our margin from.

Operator

Your last question comes from Craig Kennison with Robert W. Baird.

Craig Kennison - Robert W. Baird

Chris I wanted to ask you, your in house engine production strategy over the last couple years was really meant to drive margin as you internalize some of those operations, but with the recession and volumes such as they are, how have the economics of that strategy changed? Is there any need to revisit that or is that still a longer-term strategy?

Christopher Twomey

Actually, as I have said, the decision to get into that was strategic in terms of providing us with engineers that we did not think that we could get from our former engine partner, Suzuki, where we bought our ATV engines. Strategically we saw the market differently than they did and we thought we needed to be able to produce the engines that our customers wanted. A perfect example of that is the 1000l, our Thundercat 1000. Again, the large displacement engines, those units with engines over 700cc are really the only segment that is growing and Suzuki isn’t going to have one of those engines at any time in the future, based on our knowledge.

We strategically have product that we know that the customers want and we wouldn’t have been able to buy that from anyone else. So again, the main reason for getting into it was the strategic one of being able to satisfy the customers.

As I have said before, we struggled in terms of the cost side of that and worked hard to get our costs down and I can tell you that wasn’t as successful as I would have liked, although I think we were making great progress, it wasn’t as successful as I would have liked and then all of a sudden the yen went from 107 down to 90 and so that is a significant change. If we were buying engines in yen we would have had almost a 20% increase in the cost of the engines. So, because of the currency not only was it a good strategic decision, but it was a good decision in order to help us improve our ATV margins. Again, part of what Claude reviewed on opportunities to improve our gross margin for next year is covered by that.

In addition to that, we were buying a number of parts. We set out to buy the parts from the best vendors in the world. This is the first time we were in the engine business and so we really went after the best engines manufacturers in the world. A number of those parts came out of Europe and for a while the euro was causing us some difficulty. The euro has now corrected and so we are getting some benefit from the euro as well. The currency, both in the euro and in the yen have really helped to make that engine operation more profitable on the gross margin side and certainly the strategic part of that has been met by the new engines that we have been able to do.

All in all I think that it was a good success both financially and strategically. It has also provided us with an opportunity to understand fully the cost of engines and understand what other opportunities may present themselves in the future.

Craig Kennison - Robert W. Baird

You mentioned Suzuki; they have a large ownership position in your company. Are there opportunities to consolidate or work on projects together or is the direction more like on the engine side where you are evolving away from one another operationally?

Christopher Twomey

We have certainly evolved away from them on the ATV side. On the sno side, at this point we haven’t, but again we understand engines and development, so we continue to always look at all opportunities.

Craig Kennison - Robert W. Baird

Thanks so much and Tim if you wouldn’t mind giving me a call this afternoon I would really appreciate it.

Timothy Delmore

Sure.

Operator

At this time we have no further questions. I would like to turn the call back over to Chris Twomey, please go ahead.

Christopher Twomey

Thanks again everyone for joining us today. Obviously great performance for us through the first three quarters, we were right where we thought we wanted to be. Obviously our fourth quarter actions are disappointing to us, but I think the right thing to do given the overall anemic retail environment out there it is important that our dealers inventory is matched with customer demand and we are absolutely committed to doing that.

I am excited about the profit initiatives that Claude has outlined. We have spent about three months working on these and I am confident that they are there and that we have the opportunity to capture them all. So I look forward to a profitable 2010.

Again, thanks for joining us and we look forward to updating you at the end of Q4. Thank you.’

Operator

Ladies and gentlemen, this concludes the Arctic Cat Fiscal Third Quarter 2009 Conference Call. If you would like to listen to a replay of today’s conference please dial 303-590-3000 or 1-800-405-2236 followed by pass code 11125681.

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Source: Arctic Cat Inc. F3Q09 (Qtr End 12/31/08) Earnings Call Transcript
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