Arctic Cat, Inc. F1Q10 (QTR End 06/30/09) Earnings Call Transcript

Jul.29.09 | About: Arctic Cat (ACAT)

Arctic Cat, Inc. (NASDAQ:ACAT)

F1Q10 Earnings Call

July 29, 2009 11:30 am ET

Executives

Shawn Brumbaugh – Padilla Spear Beardsley

Christopher A. Twomey – Chairman of the Board & Chief Executive Officer

Claude J. Jordan – President & Chief Operating Officer

Timothy C. Delmore – Chief Financial Officer & Corporate Secretary

Analysts

Scott Hamann – Keybanc Capital Markets

Rommel Dionisio – Wedbush Morgan

[Steve Baumann – Divisor Capital]

Operator

Welcome to the Arctic Cat fiscal 2010 first quarter conference call. During today’s presentation all parties will be in a listen only mode. Following the presentation the conference will be opened for questions. (Operator Instructions) This conference is being recorded today, Wednesday July 29, 2009. I would now like to turn the conference over to Shawn Brumbaugh.

Shawn Brumbaugh

I’m Shawn Brumbaugh with Padilla Spear Beardsley. Before the market opened this morning Arctic Cat released results for its fiscal first quarter ended June 30, 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 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 & 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 A. Twomey

This morning I will cover the individual performance of our three businesses during the quarter, Claude Jordan will review the progress we have made in operations as we focus on returning the company to profitability and at the same time investing in select products to position Arctic Cat to be a stronger company as the economy recovers and Tim Delmore will review our financial performance.

Before I begin the business review let me first tell you the important economic assumptions we used as we made our business plan for the year: number one, the US recession ends in the third quarter but overall growth remains very sluggish; two, the worldwide recession lags at least a quarter or two behind the US; number three, consumer spending is anemic throughout ’09 and 2010, spending on consumer recreational products trails consumer spending in general; and number five, unemployment stays above 9% well in to 2010. Nothing we have seen so far this year would lead us to change any of these assumptions.

With that in mind let me talk about our businesses. Snowmobile sales in the quarter were down 16% as we better matched wholesale and retail sales seasons. North American snowmobile retail sales seasons begin in September and October and shipments to dealers will be shifted towards those months. Snowmobile sales in the quarter were also affected by lower sales to our international distributors who are impacted both by the worldwide recession as well as significant currency changes particularly in Russia which has been a growing market for Arctic Cat in the last few years.

We are closely monitoring dealer inventories as one important measure of the overall health of our dealer network. At quarter end dealer inventories were down 13%. Even with lower dealer inventories, we are optimistic that retail sales could increase during the fiscal year and we will maintain or grow share. As I indicated in our last conference call, we expect snowmobile sales to dealers and distributors to be down for the year between 25% and 32%.

Sales of ATVs for the quarter were down 40% as we also shifted ATV dealers sales later in the year so that dealer inventories would continue to decline and to better match the introduction of our 2010 models with the height of the retail selling season which occurs in September and October. At October end, North American dealer inventories were down 23% compared to last year.

For fiscal 2010 we changed the way we introduce our ATV models to our dealers. This year we will not have one large dealer show where the full year dealer orders are taken. Rather, we will visit each dealership three times during the year and take the 2010 model orders. This new approach will allow us to better match dealer orders and actual retail activity, lower dealer inventories and reduce overall costs so that more dollars will be available for retail programs. Our new 2010 models will be introduced during our second order cycle beginning in August and will include all of our new models for 2010. As I have said in the past, our focus will be to introduce new products in model segments which currently show signs of improvement.

Calendar year-to-date North American industry wide retail sales of ATVs are down about 31% and Arctic Cat retail sales are slightly outperforming the industry. European sales to dealers were up 14.8% last calendar year and continue to do well this year. We are optimistic that we have finally begun to gain some positive traction in that market. Retail sales of Prowler UTVs are down for the year but not as much as core ATVs. Also, retail sales of Prowler has positive comp’d since the first week in May which could be a sign that this market has changed.

Overall, for the year we expect ATV and Prowler sales to dealers and distributors to be down 18% to 24% for the fiscal year. Sales of parts, garments and accessories are up 3% for the quarter reflecting slightly higher shipments of preseason snowmobile parts. For the full year we still expect sales of PG&A to be down 4% to 11%.

Now, I’ll turn the call over to Claude Jordan for a more in depth review of the company’s operations.

Claude J. Jordan

As Chris mentioned, we are planning for a difficult year in fiscal 2010 as both the overall economy and power sports industry continue to struggle. During our last call we explained that during these difficult economic times we plan to focus on reducing expenses, controlling cash and positioning the business to be stronger. As a result of these initiatives we have implemented over the last six months, we have started to see improvement in gross margin for the majority of our business segments as well as improvement in operating expenses.

In regard to operating expenses, we have made significant reductions year-to-date and we continue to identify new areas for further improvement. A few of the reductions have included a reduction in 12% of the work force, along with a week shutdown of the business in April and July and a hiring freeze to include all the critical positions. During Q1 we started to see the results of these expenses reduction initiatives which allowed the overall business to reduce operating expenses by 23%. Operating expense reduction will continue to be a major focus of the business and we will continue to identify new areas for further reduction without impacting our goal of becoming a stronger business as the economy recovers.

In addition to our focus on reducing operating expenses we continue to work on various initiatives aimed at improving our gross margin. Primary focus has been working with our vendors to lower our material and product costs as well as various engineering initiatives. In the area of material costs, we have been able to achieve reductions drive primarily by lower commodity prices. In addition to improved commodity prices, we are also seeing improvements driven by product mix and lower transportation costs.

Over the last three months we have started to see the benefit of our various initiatives aimed at improving gross margin in the majority of our business segments. However, due to the low volumes that we typically have in Q1 we were unable to see the year-over-year improvements in all segments of the business. Based on the improvements we have made and the results of the first quarter, 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.

Another area of focus has been working to improve our cash position. As we have previously stated, our largest single factor in improving cash will be in lowering our finished goods inventory by better aligning our production with demand of the market. In fiscal year 2009 we were successful in lowering our overall finished goods inventory by 23%. During Q1 of fiscal year 2010 we continued this initiative and were successful in lowering our year-over-year finished goods inventory by 41%.

In addition to the reduction of finished goods inventory, we were also successful in further reducing inventory in ATV engines and raw materials. Our goal is to continue this same focus throughout the year to allow us to have the right amount and right mix of inventory to meet the needs of our customers.

The final area that we’ve been working on is lowering dealer inventory. By lowering production and aligning the dealer inventory to the needs of the market we have been successful in reducing the amount of inventory at our dealers. During Q1 we reduced ATV dealer inventory by 23% and snowmobile dealer inventory by 13%. During the remaining three quarters of the year we will continue to further reduce both ATV and snowmobile dealer inventory which will allow the business to be well positioned for when the economy recovers.

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

Timothy C. Delmore

Today I will review our highlights of our first quarter results and our outlook for the full year. Net sales for the first quarter were $69.4 million versus $93.9 million for the same quarter last year. ATV sales were $32.2 million versus $53.8 million. Snowmobile sales were $17.9 million versus $21.4 million. Both ATV and snowmobile sales are lower primarily due to decreased demand caused by the challenging economic conditions and our desire to lower dealer inventories.

Parts, garments and accessory sales increased 3% to $19.3 million versus $18.7 million primarily due to increased pre-season snowmobile parts and accessory sales. Gross profits for the quarter were $7.5 million versus $12.9 million. The gross profit percentage was 10.9% versus 13.7%. Lower margins from finished units related to lower sales volumes offset improved margins from our PG&A business.

Selling, general and administrative expenses decreased 23% to $16.2 million versus $21.0 million primarily due to lower R&D expenses, marketing and advertising as well as lower compensation costs and lower expenses for our European subsidiary. Our interest income was $4,000 versus $72,000 for the same quarter a year ago and our interest expense was $72,000 versus $204,000. Interest income was primarily affected by lower cash levels at the beginning of our fiscal year. Compared to last year, our interest expense is lower due to lower borrowing levels primarily driven by our reduced inventory levels and the company’s efforts to conserve cash.

The company reported a tax benefit of 32% for the quarter versus a tax benefit of 16% for the same quarter last year. Our net loss for the first quarter was $5.9 million versus a $7 million loss and our diluted loss per share was improved to $0.33 from $0.39 per share. Looking at our balance sheet, as of June 30th we ended the quarter with $7.9 million of cash versus $5.8 million for the same quarter last year. We had zero short term borrowings versus borrowings of $12.1 million as of June 30, 2008 and our inventory decreased 19% to $127 million from $156 million. Year-to-date capital expenditures totaled $1.1 million and depreciation was $4.1 million.

We continue to estimate sales for the fiscal year end to be in range of $425 to $460 million based on achieving ATV sales of $188 to $203 million, snowmobile sales in the range of $140 to $152 million and PG&A sales of $97 to $105 million. We continue to expect improved share results compared to fiscal 2009.

Operator, now we’d like to open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Scott Hamann – Keybanc Capital Markets.

Scott Hamann – Keybanc Capital Markets

Just in terms of the gross margin, it looks like to get to that 300 for the year you’re going to need to do a little over 400 basis points for the balance. Can you talk about what some of those buckets are and kind of the relative magnitude of the buckets for the rest of the year?

Claude J. Jordan

Primarily as we’ve mentioned before, I think the biggest bucket we’re going to have is in terms of sourcing and we’ve been working with our vendors in terms of getting reductions across the board and we’ve been fortunate in terms of commodity prices working with us. That’s certainly the number one thing, other than that there are a whole host of things that we’ve been working on, a lot of them are engineering initiatives that we’ve been going over the last 12 to 24 months as well.

The one thing to remember is Q1 is a fairly low volume month for us in terms of production so we’re certainly at a disadvantage in Q1 there. I think we’re going to start seeing some significant improvements here come Q2 and Q3 especially as we start sourcing more of the raw materials for the product and we’re able to ship more.

Scott Hamann – Keybanc Capital Markets

Then just to follow up on that, you have a shutdown that occurred during this month, was there a comparable shutdown last year and is there anything else planned for the balance of this year? And, was there anything last year?

Claude J. Jordan

Last year we did not have a shutdown. We do shutdown our manufacturing typically after March, we start back up in the May/June timeframe. We did not have across the board shutdowns like we did this year but that was part of our planned reduction that we announced earlier this year, we said we would shut down for a week in April and a week in July. Are there further, I would say that would depend on how the year evolves. Right now we’re not stating that we’re going to have any shutdowns in Q3 or Q4 but obviously depending on how the year and how the economy goes that’s certainly something we may consider later on.

Scott Hamann – Keybanc Capital Markets

Then just finally, on the SG&A for the quarter I know you cancelled the dealer meeting and I’m just curious if there were any other one timer type issues in there that caused that number to be a little bit more favorable? Obviously, your implied guidance for the balance of the year is not at the current run rate for the operating expenses, so was there anything in there and what should we expect for the balance of the year?

Timothy C. Delmore

To be honest, I think we feel pretty good in terms of what’s happening on the operating expenses side of the business. There are additional things we’re continuing to look at and it’s going to be a process. As we mentioned, we’re planning on a very difficult FY 2010. Next year we’re still looking to see how next year evolves but, I think it’s going to be an ongoing process where we’re continuing to look for opportunities for further reduction. I mentioned the 12% reduction, that certainly has impacted us and given us some benefits on the operating income side. Some of the other things we’ve done even in terms of the one week shutdown in April and the one week shutdown in July as well. But, to say that there is any one area that has contributed more than others, that would be wrong.

Operator

Your next question comes from Rommel Dionisio – Wedbush Morgan.

Rommel Dionisio – Wedbush Morgan

Just two quick questions, first I think you mentioned in the prepared comments that you’re moving from one dealer show in the ATV business to three visits per year, is there additional costs associated with that, making three proactive visits or is that sort of offset by the fact that you’re not holding a dealer show?

Timothy C. Delmore

Actually, it’s a cost savings for us. Obviously, that’s one of the reasons we’re doing it, it allows us to go ahead and redirect some of the dollars that we’re saving from having a massive show in Vegas. But, the primary advantage that we’re getting here is the fact that our dealers are now able to go ahead and plan ahead and forecast in shorter increments so instead of placing an order in the month of June for the next 12 months the dealers are now able to go ahead and place an order in June, they’re able to go ahead and place another order in August and then another order in January. It’s been very positively received from our dealer network. We have saved some money because obviously there’s not as much cost associated with dealing three way order taking process than there is that one big show we’ve had in Vegas.

Christopher A. Twomey

The other thing I would comment on too is that the process has our district sales managers going to their dealers three times a year which is not any additional cost, they’re travelling to visit those guys anyway on a regular basis. So at least during these three times they will be talking about orders and so I don’t see that that adds any additional costs to it and it’s really the cost savings that Claude talked about.

Rommel Dionisio – Wedbush Morgan

Just as a follow up to that, obviously with orders coming through three times as opposed to one, could you talk a little bit about the manufacturing flexibility you have to address that? Are you in pretty good shape to be able to handle those more frequent orders come in as opposed once?

Claude J. Jordan

That’s definitely been probably the biggest challenge. From the dealers’ perspective as I’ve mentioned it, it was very much a positive thing for them. From our side we’re working with production and sales, meeting throughout the week and this will continue throughout the year, in terms of trying to provide coordination, making sure we’re understanding what’s happening in the market, which units are selling. Because, on our side we have to continue to go ahead and respond to the needs of the market.

But, as we’ve seen on the benefit side it’s also helped us in terms of driving down inventory, our factory inventory which has been a very big plus for us in terms of turning that in to cash. But, the only thing I would say is just improved communication coordination between the sales and production team and making sure we’re able to go ahead and respond as quickly as possible with the needs of the market place.

The other thing I would say on the sourcing side, we do have some items that go out 13 weeks, a few items that go out maybe a little bit more than that but as long as we have a production schedule in place and we’re meeting and we’re changing that as needed we’ve been able to respond so far.

Christopher A. Twomey

I would also comment that this is a great opportunity for us to learn this because going forward this is probably the new normal as we think about how we’re going to be producing in the future. As volumes increase when the economy turns around we’re going to want to still keep this focus on so we have the opportunity to learn it at a slightly slower time but this is the way we need to function going forward. We recognize that and we want to perfect this actually.

Operator

Your next question comes from [Steve Baumann – Divisor Capital].

[Steve Baumann – Divisor Capital]

Just a real basic question, when you talk about inventory at your dealers, I think you said ATV down 23% and snowmobile down 13%, is that just in terms of units?

Timothy C. Delmore

Yes, that’s units.

[Steve Baumann – Divisor Capital]

So on a sort of days of sales or weekly basis, we’d have to do a comparison to what those sales have been?

Claude J. Jordan

Yes. Obviously, you need to take a look at what’s been retailing by model, what’s actually in the dealer network and just basically work backwards in terms of what kind of inventory they have there and what’s been retailing by model. We’re going to see certain things retail a lot faster than other areas. We have certain models that even in a down economy continue to do fairly well. As Chris mentioned, TRVs have done well on the ATV side, our large displacement engines have done well so they’re going to go ahead and turn that inventory a lot faster.

Then, on the side-by-side part of our business, as Chris mentioned, the recreational products is struggling today but over the last I’d say three months or so on the side-by-side part of the business we’re seeing pretty significant retails towards where we have actually positively comp’d over the last nine out of the last 13 weeks on the side-by-side. That area obviously will be turning a little bit quicker than some of the other product categories.

[Steve Baumann – Divisor Capital]

Then just one other sort of administrative question, on your tax rates you guys obviously took a tax benefit in the quarter. Can you remind me what your tax situation is and whether or not you’re actually going to be able to take a refund if you do end up in a loss position for the year?

Timothy C. Delmore

The effective tax rate of 32% or tax benefit of 32% would apply for the whole year. That would be our go forward rate.

[Steve Baumann – Divisor Capital]

If you end up taking a benefit for the full year, are you going to be able to turn that in to a refund or is that going to turn in to a net operating loss carry forward?

Timothy C. Delmore

That would be a carry forward but we are eligible for refunds on a cash basis.

[Steve Baumann – Divisor Capital]

So you’re not worried about your auditors looking at that tax benefit later in the year and suggesting that it’s not certain enough that it’s realizable that they would make you reverse that?

Timothy C. Delmore

No, we’re comfortable with that rate.

Operator

Your next question comes from Scott Hamann – Keybanc Capital Markets.

Scott Hamann – Keybanc Capital Markets

In terms of the retail sales year-to-date, do you have a good feel for how the side-by-side market is tracking relative to the core ATV business?

Claude J. Jordan

It’s not a number that’s reported. Obviously, we get field data back from our sales folks who are out there and they can see other dealers and what’s actually moving but it’s not something that I have data available that says the entire side-by-side industry is moving in a positive direction like ours is. Actually, in terms of the limited data I have, it would probably be that it’s better than the ATV side but still struggling in a very tough economic time.

Christopher A. Twomey

Scott, as I indicated in my comments the side-by-side market is off but our side-by-side market sales at retail are off but not as significantly as are the overall core ATV sales so we are seeing on a year-over-year basis we’re seeing a pickup in the side-by-side differently than the core ATV. As Claude and I both mentioned the last three months have seen some nice positive comps so we’re looking maybe at that as a market that’s changed and by the end of the year we could be back to levels that are closer to the prior year. We don’t know, it’s only three months but the possibility exists, it’s at least a three month trend which is longer than most other trends that we’ve been looking at.

Claude J. Jordan

Scott, one other thing that I would comment just to put this in perspective, if you go back to the March, early April timeframe, the side-by-side business for us, it wasn’t unusual to see a week where we were at -40, -35 and I think that’s probably where the industry was then. We’ve seen this movement over the last three or four months and as Chris mentioned we feel good but we have no way of indicating if that’s going to continue or whether that’s the norm now going forward but we do feel good about where it’s been over the last couple of months here.

Scott Hamann – Keybanc Capital Markets

I appreciate the additional disclosure on some of the line item breakouts, can you give me a feel for what the relative profitability of the ATV business versus the snowmobile business kind of currently is and historically where it was?

Timothy C. Delmore

While we’ve improved our disclosure somewhat we still aren’t totally comfortable talking about the exact profitability of each of our product lines. But again, traditionally snow has been number one, PG&A obviously is number one but on the unit side, snow has been number one followed by ATV and I think they’ve been getting closer together as time has gone on. That’s kind of a general indication there.

Claude J. Jordan

The other thing I would comment there is I think it’s important to note and I think you know this already, that without the unit business you don’t have a clothing business so it’s hard to say, how do you split off the parts, oil, garments, accessories from the unit side. I get it we can do it on a financial side but you’ve got to remember that without the unit side we don’t have that part of the business which is a fairly high margin of business for us.

Scott Hamann – Keybanc Capital Markets

Then just on this new PG&A line that you have, how significant do you think it’s going to be as kind of percentage of the total PG&A? Does it have similar profitability to the current stuff or do you think there could be some margin pressure on that?

Christopher A. Twomey

Essentially we’re talking about the Drift product line and that’s an opportunity that we are just testing this year and so it doesn’t have a huge impact this year on either the top line or the bottom line but what we’ve noticed over the last few years is that a number of the aftermarket companies have come in to our dealerships and offered a garment at a lower opening price point and have been taking some of the sales. So, we’ve just decided that these are our customers, they’d prefer to do business with us, they tell us they’d prefer to do business with us but they need something at that opening price point so we’re trying it out.

We met with our dealers on the snow side at the snowmobile dealer show, we showed them the product, we talked about what we were trying to do and we got a very positive response from them. Again, a lot of them kept telling us, “We want to do business with you, we want the benefits that you offer us in your PG&A programs but we need something at this price point.” We gave it to them, we got their input on the styling, we got the input on the features and we rolled it out to a good response we thought and based on what we’ve seen this year going forward we expect it to be more significant but nothing really significant this year.

Scott Hamann – Keybanc Capital Markets

Finally, Tim just on the currency impact on sales and operating income, do you have that?

Timothy C. Delmore

I don’t have anything specific, we’re hedged at 1.14 Canadian for the year. Most of our revenue is hedged there so we are in good shape there. I don’t think there was a material impact on the Canadian dollar in Q1 however.

Operator

At this time there are no further questions. I’d like to turn the call back over to management for any closing remarks.

Christopher A. Twomey

Again, I’d like to thank all of you for joining us. We look at this quarter as about what we expected it to be. We’ve been focusing on all of the things that Claude outlined, we’re continuing to focus on those. We believe that we will deliver and we look forward to updating you at the end of the next quarter. Thank you very much.

Operator

Ladies and gentlemen this concludes the Arctic Cat fiscal 2010 first quarter conference call. If you’d like to listen to a reply of today’s conference please dial 303-590-3030 or 1-800-406-7325 followed by a pass code of 4124298. ACT would like to thank you for your participation. You may now disconnect.

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