Arctic Cat Inc. F4Q09 (Qtr End 3/31/09) Earnings Call Transcript

May.28.09 | About: Arctic Cat (ACAT)

Arctic Cat Inc. (NASDAQ:ACAT)

F4Q09 Earnings Call

May 28, 2009 11:30 am ET

Executives

Shawn Brumbaugh – Padilla Speer Beardsley

Christopher Twomey – Chairman, Chief Executive Officer

Claude Jordan – President, Chief Operating Officer

Timothy Delmore – Chief Financial Officer

Analysts

James Hardiman – Ftn Capital Markets

Brandon Taylor – Raymond James

Rommel Dionisio – Wedbush Morgan

Cassandra Stevenson – Keybanc Capital Markets

[Hailey Wolfe – Roxdale Securities]

Operator

Welcome to the Arctic Cat fiscal fourth quarter and full year 2009 conference call. (Operator Instructions) I would now like to turn the conference over to Shawn Brumbaugh with Padilla Speer Beardsley.

Shawn Brumbaugh

Thank you for joining us this morning. I'm Shawn Brumbaugh with Padilla Spear Beardsley. Before the market opened this morning, Arctic Cat released results for its fiscal 2009 fourth quarter and full year ended March 31, 2009. Participating in our call today to review the company's performance, will be Chairman and Chief Executive Officer Chris Twomey, President and Chief Operating Officer Claude Jordan and Chief Financial Officer Tim Delmore. Following their remarks, we will have time for any 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 new 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 results.

Now I'll turn the call over to Arctic Cat's CEO, Chris Twomey.

Christopher Twomey

Thanks everyone for joining us this morning. Fiscal '09 was another challenging and disappointing year for all of us at Arctic Cat. Initially we viewed the 2009 year as one of recovery after we significantly reduced inventories the prior year to better match retail market demand.

Through the first three quarters of the year we were profitable and on plan. However, we could not foresee the incredible shrinking of the economy which occurred in our third and fourth quarters. Because of our continued commitment to the health of our dealer network, we significantly reduced ATV sales in the fourth quarter which resulted in a disappointing loss for the full year.

This morning, I'd like to review the individual performance of our three businesses last year and talk about our expectations for the year ahead. Claude Jordan, our President and COO will review the steps we have already taken and are taking to rescale the business and return it to profitability while at the same time continuing to invest in select product development to position Arctic Cat to be a stronger company as the economy recovers.

Before I begin the business review, let me first tell you some of the economic assumptions we are operating under. First, the U.S. recession ends in the third quarter but growth will be very sluggish. Second, the worldwide recession lags a quarter or two behind the U.S. Third, consumer spending is anemic throughout 2009. Fourth consumer spending on consumer recreational products trails consumer spending in general. And fifth, unemployment tops 9% and remains there into 2010.

These assumptions have guided us as we have planned our fiscal 2010 year. With these assumptions in mind, let me now talk about our businesses. As a result of the extremely poor economy, and historically low consumer confidence, North America industry wide retail sales of snowmobiles decreased 11% for the full year compared to the prior model year.

U.S. sales were down nearly 20% while snowmobile retail sales in Canada actually increased slightly. Arctic Cat North American retail sales outperformed the industry and we gained a point of share.

While the U.S. snowmobile retail sales decrease is significant, they did outperform all other recreational products during the selling season, reflecting the positive impact that normal snowfall has on snowmobile retail sales.

So while unit sales were off particularly for the U.S. dealers, they did report generating service work which helped their profitability through the winter season. Additionally, because of planned lower wholesales shipments to Arctic Cat, our North American dealers ended the year with 13% less inventory than the prior year which was already down more than 30%, all part of our plan to protect and improve the health of our dealer network.

As I mentioned earlier, 2009 was a normal year for ridable snow across most of North America with the exception of the Northwest where snowfall was generally below the prior year. Even though the general economic conditions slowed retail unit sales, snowmobilers showed a strong interest in their primary form of winter recreation. Snowmobilers were riding as evidenced by the increase in license registration and trail permits in most States and Provinces.

As always, in 2009 new product generated a lot of interest and enthusiasm which is the reason we are always focused on finding ways to annually deliver new and different products with less resources created by the shrinking revenues.

For 2010, we introduced a new Power Up 800 cc engine which will cross all model lines, resulting in significant important performance enhancements to this key engine segment. We introduced a 500 cc consumer version of our race machine which has a price and performance level designed to bring younger riders into the sport with a snowmobile that captures their imagination.

Looking ahead to 2010, dealer orders in the U.S. and Canada are lower than last year reflecting not only the lower retail sales experience during 2009, but also showing dealer concerns for how quickly the economy will recover and how rapidly the recovery will be reflected in the recreational product sales.

Even with lower wholesale sales, and lower beginning inventories, dealers should be able to retail enough snowmobiles to achieve our goal of increasing or maintaining our market share in North America. However, by the start of the 2011 model year, we expect inventories to be extremely low which should result in strong dealer orders for the 2011 year. This should also coincide nicely with the economic recovery which we expect to be much stronger next year.

The strengthening U.S. dollar has caused significant retail price increases in the European snowmobile market along with the generally poor economic conditions similar to those experienced in the U.S. Sales to our European distributors have also declined. This is particularly true in Russia which had been a strong growing market for Arctic Cat in the last few years.

Overall, we expect the snowmobile sales in fiscal 2010 to be down between 25% and 32%.

North American ATV retail market continued its four year decline finishing the 2008 calendar year down more than 25%. Retail sales of Arctic Cat ATV's outperformed the market slightly caused by significantly higher sales in Canada. For a variety of reasons, retail sales in the ATV market are more negatively impacted by the general economy than are snowmobile sales as we have seen in the last two years.

At the same time, both products share a couple of important driving forces which positively impact the market for both new products and large displacement, more powerful engines. For example, in the 2009 model year, we introduced the all new Mud Pro for ATV riders who like the extreme challenge of mud racing. Arctic Cat is the only manufacturer with a model specifically designed for this purpose and it has been a hot seller for our dealers.

In the large displacement engine category, Arctic Cat expanded the number of models using its 1,000 engine which was first introduced at the end of the prior year. Overall, this category has also shown strong sales for our dealers.

Another important category that we have focused on is the TRV, an ATV specifically designed for two riders. This is becoming a more important segment of the market as States and Provinces focus on the safety features of this model and as comfortable cruising becomes a more important ATV riding activity.

Despite lower retail sales in fiscal '09, Arctic Cat dealer inventories were down 19% compared to the prior year. Reliable industry statistics don't exist for the Prowler Side by Side vehicle market. However, we believe that while industry retail sales did decline last year, they did not decline as much as the ATV market in general and this was certainly true for Arctic Cat. Similar to ATV's large displacement engines are also important to drive growth in this segment.

So in Q4 of '09 model year, we introduced the Prowler 1000, the largest displacement side by side on the market. Our Prowler 1000 continues to win cross country enduro races which are a strong testimony to its design, engineering and manufacturing.

Our European ATV subsidiary realized a nearly 15% increase in unit sales of on road ATV's during the year in spite of the challenged European economy and the negative currency impact. Although this is still a small part of our sales, we think the business is now on a good footing for continued growth.

In view of the overall North American economic environment, we do not expect ATV and Prowler retail sales to improve over last year. However, we do believe we have begun to see encouraging signs that the retail sales rate decline has begun to bottom out in April and May and we expect a slight uptick by fiscal year end. Overall, we expect our ATV and Prowler sales to be down 18% to 24% for the fiscal year.

Sales of parts and accessories were one bright spot in an otherwise difficult year. While we did see the effects of the dismal economy during the fourth quarter when sales were down 10%, overall sales for the full year were essentially flat, driven mainly by snowmobile related products.

Historically, sales of parts and certain accessories have not been linked as much to unit sales, but rather more to the use of the product, and so we expect this category to not be as negatively affected by the economy as the snowmobile and ATV markets.

In addition this year, we are expanding our product offering at the request of our dealers in both garments and oil to include some additional new products which we expect will increase our sales, and at the same time not affect our core products. For the fiscal year, we expect PG&A sales to be down 4% to 11%.

At this time, I'll turn the call over the Claude Jordan to review the activities we are taking at the company.

Claude Jordan

Good morning everyone. As Chris mentioned, fiscal year 2009 was a difficult year for both the Arctic Cat business and the recreational products industry. Because of the challenging macro economic conditions, we started to implement various actions last quarter, focused on reducing operating expenses, improving gross margins and lowering both the company and dealer inventories.

As you will recall, our first step was to eliminate 108 positions in January. In addition to this reductions, we also implemented a further downsizing yesterday that brings the total reduction to 168 positions. In addition, we have also fully implemented the other cost reductions we discussed on the last earnings call which consisted of reducing all officer base salaries 5%, one week shutdown on business in April another planned shutdown in July, eliminating the company's 401-K match, reducing vacation accruals.

In addition, we have also cancelled the ATV dealer show originally scheduled for June which will lower our operating expenses while at the same time allow us to redirect some of the money to retail programs to assist our dealer network in increasing retail sales.

These new actions combined with the previous identified actions will result in an overall reduction to the operating expenses of 12% to 17% which is slightly better than we stated during our last update in January.

In addition, we are continuing to work on various initiatives aimed at improving our gross margin. A primary focus will be working with our vendors to lower our material and product costs as well as various engineering initiatives that have been ongoing over the last 24 months.

In the area of material costs, we have been able to achieve a significant reduction driven primarily by lower commodity pricing. In addition to improved commodity pricing, we are expecting to see improvement driven by product mix and lower transportation costs.

Based on the savings we've identified to date, we continue to believe that we will be successful in improving the overall gross margin during fiscal year 2010 by up to 300 basis points which is at the low end of the range during our last call. The reason for targeting the lower range is primarily due to the negative impact caused by the reduced volume we were planning for fiscal year 2010.

We will also be working to improve our cash position. The largest single factor in improving cash will be in lowering our finished goods inventory by better aligning our production with the demands of the market. In fiscal year 2009, we were successful in lowering our overall finished goods inventory by 23%.

To achieve this, we implemented additional reviews between sales and production in the second half of last year which enabled us to better align our production with the needs of the market. During fiscal year 2010, we are targeting to further reduce our finished goods inventory.

The final area of focus will be on lowering dealer inventory. By lowering production and aligning the dealer inventory to the needs of the market, we were successful in fiscal year 2009 in reducing ATV dealer inventory by 19% and snowmobile dealer inventory by 13%. In fiscal year 2010, we will continue to further reduce both ATV and snowmobile inventory.

At this time, I'd like to turn the call over to Tim who will review both fourth quarter and year end financials.

Timothy Delmore

I would also like to welcome you to the conference call. Today I'll be reviewing our fourth quarter results, our year end financial performance as well as our revenue outlook for fiscal 2010.

Our fourth quarter and year to date results including non cash good will impairment charge of $1.75 million or $0.10 loss per diluted share in accordance with Statement of Financial Accounting Standards number 142. The non cash good will write down has no impact on our cash flow or liquidity.

Net sales for the quarter were $90.7 million compared to $168.9 million for the same quarter last year. ATV sales were $64.1 million compared to $142.9 million on significantly decreased Q4 ATV shipments as we better aligned dealer inventories to consumer demand.

Snowmobile sales improved to a negative $3.4 million compared to a negative $7.1 million in the prior year quarter due to lower sales incentives. Parts, garments and accessory sales decreased 9% to $30 million from $33 million for the same quarter last year, resulting from lower snowmobile and ATV related parts and accessory sales.

Gross profits for the quarter were $4.1 million versus $25.3 million. The gross profit percentage for the quarter was 4.5% versus 15% for the same quarter last year. The decrease was primarily related to lower ATV volume.

Total general and administrative expenses decreased 13% to $25.7 million versus $29.6 million for the same quarter last year primarily due to decreased Canadian hedge costs and other selling and administrative expenses.

Our interest income was $1,000 versus $40,000 for the same quarter a year ago and interest expense decreased to $74,000 from $166,000. Net loss for the quarter was $16.7 million versus net income of $424,000 for the fourth quarter last year, and the diluted loss per share was $0.93 per share versus $0.02 of earnings a year ago.

Next, I'd like to review Arctic Cat's financial performance for full year fiscal 2009. Year to date sales were $563.6 million versus $621.6 million. The net loss for the year was $9.5 million versus a net loss of $3.3 million for fiscal 2008. The loss per share was $0.52 versus a loss of $0.18 a year ago. Again, keep in mind $0.10 of the $0.53 loss was due to the non cash good will impairment charge.

On a year to date basis, ATV sales were $247.3 million compared to $350.3 million. Snowmobile sales were $207.3 million versus $161.9 million and parts, garments and accessory sales were essentially flat at $109 million versus $109.4 million.

Year to date gross profits were $88.2 million versus $110.4 million. Our year to date gross profit percentage increased to 15.6% from 17.8% due to lower ATV volumes and a more favorable Canadian exchange rate in 2008.

Year to date selling and general administrative expenses decreased 15% to $101.3 million from $119.4 million primarily due to decreased Canadian hedge costs and other selling and administrative costs.

Looking at our balance sheet as of March 31, we ended the year with $11.4 million of cash and zero debt. Inventory decreased to $120.8 million from $127 million, primarily due to decreased ATV finished unit inventory.

Current liabilities $34 million to $79.9 million primarily due to $30 million decrease in accounts payable, a $4 million decrease in accrued expenses mainly in ATV marketing and dealer floor plan expenses. Year to date capital expenditures totaled $14.2 million and depreciation was $28.8 million.

Fiscal 2010 outlook, Arctic Cat estimates sales for the fiscal year ending March 31, 2010 to be in the range of $425 million to $460 million based on ATV sales of $188 million to $203 million, the snowmobile sales to be in the range of $140 million to $152 million and PG&A sales to be in the $97 million to $105 million range.

Given the degree of economic uncertainty affecting the recreational products market, we do not believe it is prudent to project fiscal 2010 earnings per share at this time although we expect improved per share results compared to fiscal 2009.

As we mentioned in our 2010 outlook, we include certain assumptions, a continuation of the weak global economic environment negatively impacting the sale of recreational products, increase of gross margins for us up to 300 basis points, to our low cost servicing, improved commodity pricing and greater efficiencies from manufacturing.

Another assumption is that we will achieve a 12% to 17% reduction in operating expenses and we also intend to improve our cash flow from operations and end the year with more cash on the balance sheet by lowering inventory.

For financial modeling purposes, we aren't giving early guidance but keep in mind the majority of our revenue traditionally occurs in the September and December quarters.

For fiscal 2010, we expect capital expenditures to be in the range of $15 million and depreciation to be approximately $25 million.

Thank you. Now we'd like to open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from James Hardiman – Ftn Capital Markets.

James Hardiman – Ftn Capital Markets

Textron you talked about last call that they're going to be or at least as of then were planning on dropping out of the U.S. finance business. Is there any update in terms of a replacement that you can find? Do you feel pretty confident that you'll be able to find a replacement by summer time?

Christopher Twomey

We're in the process of negotiation with a third party on a multi-year agreement. Just to review our Textron agreement, in the U.S. expires in January of 2010 and our Canadian agreement expires in the spring of 2012 so we are working currently at negotiating a multi-year agreement to replace the U.S. Textron agreement.

James Hardiman – Ftn Capital Markets

You feel pretty confident that that's going to work out, that that agreement will be reached?

Christopher Twomey

We're pleased by the interest the third party has shown in us.

James Hardiman – Ftn Capital Markets

Obviously you don't have any outstanding long term debt, but in terms of your credit agreement, I'm not sure if you gave us an update. I thought that was expiring at the end of this month. Has that been extended? Where do we stand with that?

Timothy Delmore

We are working on and expect to have a 30 day extension from our credit agreement from our current lender, and then we're also in the process of working on a multi-year agreement with another major lender so we are comfortable with our current financing arrangements.

James Hardiman – Ftn Capital Markets

In terms of market share, I just want to be clear. In terms of ATV I think you said you gained share for the calendar year '08. What did that look like during the first quarter? I think the industry was down about 33%. How did you shake out from a retail perspective in the quarter?

Claude Jordan

On the ATV side we were a little bit worse than the industry but just so that you can have an apples to apples comparison, if you look at it from a fiscal year '09 perspective, in other words the first three quarters of the calendar year last year and the first of this year, we were basically flat with the industry. We basically held share.

James Hardiman – Ftn Capital Markets

In terms of side by side, where do we stand in terms of how much does that make of total ATV's of the ATV segment at least that you report, is the assumption going forward that that's going to increase or at least decline at a slower rate during this current fiscal year than the core ATV's for you?

Claude Jordan

The Prowler side of our business side by side, it's a relatively new segment for us. We do see that declining less than the ATV side primarily because we're still building up within the marketplace in terms of the units we have. It's also an area that because it's relatively new, we can go ahead and launch some additional new models which have been received fairly well.

So we are not expecting to see the same level of declines in the Prowler side of the business side by side that we have on the ATV side. And as Chris mentioned during his comments earlier, the first two months of the year, April and May, we've actually seen where things have started to, I can't say level off, but they're certainly not dropping as fast as they were previously.

James Hardiman – Ftn Capital Markets

What does side by side represent of the total ATV at this point?

Claude Jordan

It's probably upwards to 20% in the business depending on the month and the year.

Operator

Your next question comes from Brandon Taylor – Raymond James.

Brandon Taylor – Raymond James

A quick question about your credit facility, at the current size I think it was $30 million at least to the end of May. Is that enough to get you through this season of working capital build?

Timothy Delmore

We will expect to have a higher facility as obviously we go into our summer, our heavy summer production months so our facility will increase.

Brandon Taylor – Raymond James

Do you anticipate that on the new agreement, the new multi-year agreement or do you expect you 30 day extension to kind of be upsized?

Timothy Delmore

We expect the extension to be upsized and also the multi-year agreement to be increased and adequate for a number of years.

Brandon Taylor – Raymond James

Did you have any short term debt at all at the quarter end?

Christopher Twomey

No we did not.

Operator

Your next question comes from Rommel Dionisio – Wedbush Morgan.

Rommel Dionisio – Wedbush Morgan

I was wondering if you could characterize how you feel the financial health of your dealer network is and to what extent you may have seen attrition over the course of the year.

Christopher Twomey

What we've seen over the last, generally as we look at our dealers, historically we would say that we lose up to 10% of our dealer base every year and we replace most of that. We replace that 10%. In the last three or four years, we've seen that number go from 10% to maybe as high as 15% and we are replacing roughly 5% to 10%.

So we have seen a decline in our dealer number over the last four year. What I would say about that is that is in some cases, that is okay because some of the weaker dealers financially are getting out of the business, or if they're not weaker financially, they are just people who weren't focusing on our product in their dealership.

While the overall number is down, I think that the quality of the dealers remains high. We have worked very hard to reduce their inventories because that's certainly one of their biggest expense items in running their business, so we have worked hard to reduce that over the last three years and as you see, as you heard from both the snow and ATV side, we've made significant reductions, and we go back on a regular basis and look at not only average units per dealer but actual units per dealer in their inventory so we can see how they look and the aging of them looks like.

So in general, I would say that we are relatively comfortable with the dealer network and the health of our dealers as they exist today. I think it's really interesting to note that even in the difficult times that we went through last year, you wouldn't expect, or at least some people wouldn't expect that you'd be adding dealers, but both in the ATV and the snowmobile business, we did add probably close to 10% new dealers.

If you lost 10% to 15% and you added 10% back, you're going to net out a loss of as much as 3% to 5%. But in general, even in those difficult times there are people who want to get in this business, see the opportunities, see open new spots as other dealers have gone out of business.

So overall, losing a little more than we would historically have said, losing a little more in the last four years than we would historically have said, but we think we have stronger dealers remaining and we have lower inventory numbers at the dealers that we have remaining.

Operator

Your next question comes from Cassandra Stevenson – Keybanc Capital Markets.

Cassandra Stevenson - Keybanc Capital Markets

On the 300 basis points of improvement, should we still assume that it's spread out fairly evenly over the quarters?

Claude Jordan

It's going to be line with where we have our higher volume months in terms of production and as Tim mentioned, those usually come in the second and third quarter so that's where we'll see most of it, but other than that, I would say it's going to be fairly level.

Cassandra Stevenson – Keybanc Capital Markets

You gave us guidance on revenue which was helpful and we know your expectations in terms of gross margin improvement and operating expense reductions. Is there anything else that we need to consider in terms of uncertainty to your bottom line results going forward?

Christopher Twomey

No I don't think so.

Cassandra Stevenson– Keybanc Capital Markets

In terms of a tax rate, what should we look at for the coming year?

Timothy Delmore

Our tax rate is a little volatile at these levels, so I don't have any specific guidance on the tax rate at this time.

Operator

Your next question comes from [Hailey Wolfe – Roxdale Securities]

[Hailey Wolfe – Roxdale Securities]

Could you amplify on the comments you made about the April/May trends in the ATV market, what you're seeing versus what took place in the first quarter?

Claude Jordan

Generally what we saw was significant decline in first quarter ATV retail sales and as I said in my remarks, we believe the April and May time frame has flattened out. I wouldn't say we're seeing an increase, but the rate of decline has slowed to maybe even stopped and actually we've had a couple of bump up weeks as we track the sales.

So in general we're looking at two month isn't the biggest trend, but in general as we look at that we think that we're seeing a stopping of the decline and a bottoming out and with the possibility of building to a slight uptick by the end of the fiscal year in keeping with an economic recovery which we think will occur in Q3, but still sluggish consumer spending through the entire year.

[Hailey Wolfe – Roxdale Securities]

When you say uptick, are you talking about an uptick in absolute sales or are you talking about the rate of decline being less severe? Are you talking about the market returning to growth?

Claude Jordan

Basically what we've seen has been on the week. We track retails every week and we'll basically look at year to date, we'll look at month to date and we'll look at week to date, the past week on a comp basis. Basically what we're saying there, if retail's dropped at minus 29% on the ATV side in FY '09, what we've seen is a less of a drop, still dropping, but less of a drop.

In some weeks in certain products side by side, we've actually come fairly close to actually positive comping and that may not sound like a great thing, but when you go back through some of the more challenging months that we've had going back to November/December and January, those are some challenging times for both the ATV and side by side business.

So we're not seeing anywhere near those, and we're starting to see a leveling out where we've actually seen down to single digit decreases over the last couple of weeks.

Operator

We have no further questions. I would now like to turn the conference back over to management for any closing statements.

Christopher Twomey

Thank you everybody for joining us. As I said, '09 was a challenging and disappointing year. We have aggressive plans in place to dramatically the performance in '10 even though we have lowered our sales expectations based on the economic assumptions that we've told you.

We look forward to updating you on our quarterly progress. And again, thanks for joining us on the call today.

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