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Executives

Shawn Brumbaugh - IR, Padilla Speer Beardsley

Claude Jordan - Chairman and CEO

Tim Delmore - CFO

Analysts

Scott Hamann - KeyBanc Capital Markets

Garrett Johnson - BMO Capital Markets

Mark Smith - Feltl and Company

Arctic Cat Inc (ACAT) F1Q 2014 Earnings Call July 25, 2013 10:00 AM ET

Operator

Good morning ladies and gentlemen and thank you for standing by. Welcome to the Arctic Cat Fiscal 2014 First Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue up the question. (Operator Instructions) I would like to remind everyone that this conference call is being recorded today, July 25, 2013. I will turn the conference over to our host, Shawn Brumbaugh. Please go ahead, ma'am. Shawn Brumbaugh.

Shawn Brumbaugh

Thank you, and thank you for joining us this morning. I’m Shawn Brumbaugh with Padilla Speer Beardsley. Before the market opened this morning, Arctic Cat released results for fiscal 2014 first quarter ended June 30, 2013.

Participating in the call today to discuss the company’s performance and outlook will be Chairman and Chief Executive Officer, Claude Jordan; and Chief Financial Officer, Tim Delmore. Following their remarks, we’ll 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 news release and in the company’s filings with the Securities and Exchange Commission. We encourage you to review these documents for description of risk factors that may affect results.

Now I’ll turn the call over to Arctic Cat CEO, Claude Jordan. Claude?

Claude Jordan

Thanks, Shawn. Good morning everyone and thanks for joining us today. This morning I will cover the individual performance of our three businesses during the first quarter of fiscal 2014 as well as the progress we have made in operations as we continue to focus on profitability and operational excellence.

Following my comments, Tim Delmore, our CFO will review our financial performance. Overall, we are extremely pleased with our financial performance for the first quarter. We achieved record sales, net income and earnings per share, on top of record sales and earnings per share in the prior year quarter. Additionally, during the 2014 first quarter, sales increased across all three businesses. As I mentioned on our last earnings call, our priorities this year is to continue to grow sales, improve gross margins, increase earnings per share, generate additional cash and strengthen our balance sheet. Through the first quarter, we are on-track to accomplish each of these.

Additionally, as we look forward, we were excited about our strong new product pipeline and the products we plan to launch over the next 12 months. In regards to the individual businesses, snowmobile sales were up 26% for the quarter, primarily driven by volume, and to a lesser extent improved mix in pricing.

Additionally, we began shipping limited quantities of Yamaha snowmobiles in the first quarter as part of the partnership we announced earlier this year. We will continue to supply additional Yamaha snowmobiles throughout the year with a large portion being shipped in our fiscal third quarter.

Regarding dealer inventory, we did see a slight increase. Our results were primarily due to starting up production earlier to accommodate the additional Yamaha snowmobiles and we expect dealer inventory to decrease later this year as we enter the retail season. As we mentioned during our last call, for model year 2014, we are launching 10 new snowmobiles and two new engines including our first Arctic Cat built engine with 6000 C-TEC2 which will allow us to compete in the 600cc two stroke market segment. This is a new market segment for us and accounts for roughly 18% of the snowmobile industry.

On the snowmobile retail side, we will not see any significant retail sales until October. However, we are once again targeting to take market share this fiscal year and continue to expect overall industry to grow in the low single digits.

For our ATV business, sales increased to 5% for the quarter. Key drivers for the sales increased were the Wildcat X high-horsepower sports Side by Side and our Wildcat four seat model, both of which started shipping during the fourth quarter of last fiscal year. As a reminder, we are comping against a very strong prior year quarter when sales were up 93%, due to the first full quarter of shipping the base Wildcat.

Additionally, we experienced some headwinds due to the soft European economy. Overall, the increase in sales for our ATV and Side by Side business are in line with our expectations and we remain excited about the growth prospects of this business as we head into our new model year. Regarding dealer inventory, we mentioned in May that our objective for the year would be to increase inventory in the 0% to 10% range to allow for continued growth of the business.

During the first quarter, excluding our recently launched Wildcat X and Wildcat 4 models, we have been successful in increasing our dealer inventory in the mid-single digits. As we move forward, we will continue to focus on matching wholesale sales with retail sales and we expect to see increases in inventory, primarily driven by new product launches. For the quarter, North American ATV industry retail sales grew by 2%. While our retail ATV sales underperformed the overall industry, our North American Side by Side retail sales experienced strong growth and gained market share with Wildcat retail sales increasing 47%.

Looking forward, product development will continue to be an area of focus for our ATV and Side by Side business. Next week we will launch our new model year 14 lineup which will include some new models that will allow us to enter some new market segments. Additionally, our plan is to continue to launch new models each quarter of this fiscal year including the Wildcat 50 trail version that we announced at our dealer show last February. With our continued focus on product development, we continue to believe our ATV and Side by Side business will grow between 25 and 29% for the fiscal year.

In addition to both our ATV and snowmobile businesses being up, our parts, garment and accessory business also increased sales by 7% for the quarter. Increased sales were driven by parts and garments, both of which showed strong double digit increases. Looking forward, we expect the expansion of our Wildcat Side by Side lineup to contribute to increased PG&A sales this fiscal year. Additionally, our dealer inventories much improved last year. As a result, we anticipate a solid year for our parts, garment and accessory business.

In regard to operational performance, we stated on our last call that our focus would be on improving gross margins, controlling our operating expenses and strengthening of our balance sheet. We made further progress in each of these areas in the first quarter of 2014. During the first quarter, gross margins improved driven by higher volumes across all product lines, improved mix and product cost reduction efforts. These actions have resulted on our gross margin improving 390 basis points during the quarter. Looking forward, gross margin will continue to be a major focus with additional opportunities in product cost reduction and supply chain.

In regards to operating expenses, we stated in May, our goal was to slightly decrease operating expenses as a percent of sales. With this in mind, we will continue to focus throughout the business on all aspects of expense control. At the same time, we have continued to invest in product development which has resulted in the launch of various new models from both the snowmobile and ATV business. During the first quarter we were successful in decreasing operating expenses as a percent of sales by 30 basis points. The one area that continues to grow is our investment in new product development. During the quarter, R&D expenses increased 18% as we continue to focus on the future. This continued investment will not only provide a return in the current year but also in the future as we launch additional new models and enter new market segments.

The final area of focus has been working to strengthen our balance sheet. During the first quarter, our year-over-year inventory increased to support our sales growth and allowed our business to start snowmobile production earlier than last year. In regards to inventory turns, we once again improved turns from the prior year. As we look forward, we will remain focused on having the right amount of inventory on hand to support the growth needs of the business.

In regards to cash, we ended the quarter with 49 million of cash and short term investments and no debt. Our cash position is up from the prior year quarter by $32 million. Going forward, we will continue to focus on increasing cash and expect to generate positive cash flow this fiscal year. At this time, I would like to turn the call over to Tim, who will review the first quarter financials.

Tim Delmore

Thanks Claude, good morning everyone. I would also like to welcome you to the conference call today. I will review highlights of our first quarter results and updated outlook for fiscal 2014. Net sales for the first quarter increased nearly 9% to 120.8 million versus 111.3 million for the same quarter last year. Sales growth was driven by increased sales across all product lines. ATV and Side by Side sales increased 5% to 76.3 million versus 73 million despite a tough comp over last year's 93% sales increase in Q1. We still remain very confident in ATV and Side by Side sales will be 25 to 29% for the full year.

Q1 snowmobile sales increased 26% to 22.6 million versus 18 million mainly due to the timing of snowmobile shipments. Parts, garments and accessories sales increased 7% to 21.9 million versus 20.4 million primarily due to increased sales of garments, parts and oil. Gross profits for the quarter increased 29.7% to 29.2 million from 22.5 million. The gross profit percentage increased to 24.1% from 20.2% last year. The improvement was primarily driven by higher sales volumes, a favorable product mix and continued success in improving operating efficiency.

Comparative gross margins are expected to moderate in our next two quarters as we supply snowmobiles at lower margins to Yamaha. Selling, general and administrative expenses increased to 20.7 million versus 19.4 million primarily due to increased research and development and compensation expenses. Operating expenses as a percent of sales declined to 17.1% compared to 17.4% in the prior year quarter. We continued our strategy to increase investment and research and development to ensure a strong pipeline of new products.

Our net earnings for the quarter increased to 172% to 5.5 million from 2 million last year and diluted earnings per share increased to $0.40 per share versus $0.14 for the quarter a year ago.

Looking at our balance sheet, as of June 30, we ended the quarter with $48.9 million of cash, up from 17.4 million last year. Our receivables are up 9% to 43.7 million in line with our sales increase and we had zero debt. Inventory increased 6% to 150 million from 141 million mainly due to increased snowmobile inventory due to our earlier started snowmobile production this year.

Year-to-date capital expenditures totaled 2.8 million and depreciation and amortization was 3.4 million. Regarding our full year fiscal '14 outlook, (inaudible) sales in the 754 to 768 million range and we now anticipate fiscal '14 earnings will be in the range of 327 to 337 per diluted share, up $0.10 from our prior guidance of 317 to 327 per share. The increase in guidance is mainly due to improvement in our expected gross margins.

I would like to thank you for your attention and Julie; we would now like to open it up to questions.

Question-and-Answer Session

Thank you. Ladies and gentlemen we will now conduct the question-and answer session. (Operator Instructions). Our first question from Scott Hamann with KeyBanc Capital Markets. Please go ahead.

Scott Hamann - KeyBanc Capital Markets

Just a couple questions on gross margin. Obviously, you're quite a bit higher than we were looking for. Can you kind of maybe give us a breakdown of where that shook out in terms of those buckets that you maybe order of magnitude on the buy and the mix and other stuff?

Tim Delmore

Scott generally, it was just the items, just a little of everything. Volume mix, I don't know if we want to or could characterize one over the other, but it was again, just a nice contribution from all those items.

Unidentified Company Representative

Scott, just a little bit more color there. One of the things we talk about mix, small things. If you are shipping a base Wildcat versus an X or a limited, there is a little bit more margin there and some of those products we're talking about there, the X for example is a newer type product, we're going to retail and wholesale more of those. So you do see a little bit margin coming through on that type of mix. PG&A, parts came in fairly strong due to a fairly late winner so you're seeing a little bit of improvement on mix from the PG&A side as well. So, basically what Tim said, if you looked across the board, volume was strong in all three areas, mix was solid in all three areas and then I would say, some of the things we've done on the product cost side as well continue to come in force.

Scott Hamann - KeyBanc Capital Markets

Okay, because I think the guidance that you gave on gross margin was kind of unchanged down 80 basis and I am just trying to figure out what some of this stuff might be, more sustainable versus kind of being a timing related issue.

Tim Delmore

I think one of the things I would add there is, the reason we said at the beginning of the year that gross margin might be down 80 dips, was primarily because of the Yamaha snowmobiles and a little bit on the Canadian currency. Going back to the Yamaha's I mentioned in my comments earlier, we really haven't started shipping a lot of Yamaha snowmobiles just yet dollar wise, most of them will start hitting around the third quarter and then we'll stay a little of an impact from the Yamaha snowmobiles by then. But in the meantime we are continuing to work on improving gross margins like we have over the last three years.

Scott Hamann - KeyBanc Capital Markets

Okay and just in the (inaudible) TV business, I mean it sounds like the industry has been sluggish but you kind of underperformed the last, I think several quarters. Side by Side has been really good obviously. I mean is there something structurally going on there? Is there some cannibalization of the Side by Side and kind of how are you thinking about that dynamic as you work through your R&D?

Tim Delmore

I don't think there is; at least internally I don't think there is any cannibalization there. I do think that within the industry overall, you're certainly seeing a lot of people that used to go out and buying TV today are considering a Side by Side. And as you look at those two industries, we stated at the beginning of the year, on the retail sales we thought for ATVs will be down in the low single digits between 0 and 5%. On the Side by Side part of the business, it's an area that last year was above 20% and we gave guidance beginning of the year that we thought it would be between 50 and 25%. So there is no doubt that as we looked at our R&D and where wanted to go ahead and enter new market segments. The ROD side, the Side by Side has been a major focus for us. We've also commented that, beginning of the year, there were probably still owning about 15% of all the ROD segments that are out there. We've got a lot of opportunity.

One of the things that I did want to highlight, in terms of our upcoming year, we're continuing to invest a lot in our product development efforts. Next week we'll rollout our model year '14 ATVs and Side by Sides and as I mentioned earlier in my comments, there is going to be some new products in that launch that will take us into some new market segments.

And then the other thing I would comment on, at least stress as I did hit us on my comments, each quarter we are planning on launching multiple new products that will take us in the new market segments for the remainder or this fiscal year. So you’ve got Q2, Q3 and Q4 and we're looking at multiple product launches within each of those.

Scott Hamann - KeyBanc Capital Markets

Okay, and is it safe to say that those product launches are going to include multiple Side by Sides and multiple (inaudible) TVs or is it skewed one way?

Tim Delmore

The only thing, I am not going to get into our product development. I think that's a nice attempt on your part. But let`s just say they will be in our ATV Side by Side business and we've given you some indication, we mentioned in Q4, we're coming out with a 50 inch trail legal Wildcat which we are remaining on track to launch that in the fourth quarter and I think that will be an exciting product but I think some of the other things that are coming out will also be pretty exciting as well.

Operator

Our next question comes from Garrett Johnson with BMO Capital Markets.

Garrett Johnson - BMO Capital Markets

The Yamaha shipments, do you ship those directly to Yamaha dealers? Should they go through some sort of Yamaha intermediary first?

Tim Delmore

They go to Yamaha first.

Garrett Johnson - BMO Capital Markets

And then so is there any way to tell us how your shipments to Arctic Cat dealers performed in the quarter? What I am getting at is, at the end of last quarter you mentioned that North American dealers are up 60% and that snowmobile shipments this year will be flat, yet we are looking at 26% growth in June. Is that mostly because of early Yamaha shipments or how are your shipments looking to Arctic Cat dealers?

Tim Delmore

Yes, couple of things I would point out Garrett is, you have to remember, first quarter for snowmobiles and you can see it in the numbers, is up 26% but there is a fairly small portion of our business if you look at the overall number, we went from roughly $17 million last year to 22 million out of a total 120 million of our Q1 sales, so I wouldn’t get too excited on Q1 in terms of snowmobiles, lot of that timing, as we mentioned before, we went into this year with the expectation of actually lowering our dealer inventory on the snowmobile side. And the fact that it might be slightly up a little bit in Q1, I think you have to wait till we start retailing units based on the plan we put together, I think you're going to see that inventory come back down. So, to me that's a timing issue, nothing more.

Garrett Johnson - BMO Capital Markets

Okay, great and is it possible to give us dealer inventories right now including the new products?

Tim Delmore

I don't have that with me. The other thing, if I was to go ahead, as I mentioned before, snowmobile is up slightly on the ATV Side by Side. We went ahead and pulled out the brand new products that we just started shipping them. It was our first real quarter and if you take those out, we were up mid-single digits.

Garrett Johnson - BMO Capital Markets

Okay and I guess we get the 50 inch vehicle specifications next week sometime?

Tim Delmore

You will not get that next week. You will get some specifications on some of the new products we're coming out within the second quarter with the launch of our model year 2014. We are going to hold off on the specs on the Wildcat 50 as long as possible, there is no doubt that I think there is competitors out there that are dying to get that as well and we'd like to go ahead and probably hold off to that September, October time frame.

Operator

Our next question comes from Mark Smith from Feltl and Company. Please go ahead.

Mark Smith - Feltl and Company

Just want to dig a little bit more into Yamaha we’ll try to beat it to death here. I don't know if you can quantify or give us any insight into how much this is really impacting the business this year. So as I look at it, I think your guidance was originally for snowmobile to be just about flat for the year. So what would snowmobile look like excluding Yamaha and then hook the 80 bps down in gross profit margin, how much of that is Yamaha and maybe how much is engine manufacturing or anything else?

Claude Jordan

Mark couple of things, one, we're not going to split out the Yamaha and our business. In terms of snowmobiles you are correct. We stated at the beginning of the year that we thought that snowmobile sales would be right around flat to the prior year. There is no doubt some of that will include Yamaha snowmobiles within there, but you got to remember we also shipped snowmobiles or Yamaha the prior year, although they were just used models. And so, if they are going to be part of that flat growth then you're going to see our side actually come down, but as I mentioned in our last call, we're also looking at this from a dealer inventory perspective and we are intentionally trying to drive our inventory down.

The second thing I would say is, probably the most exciting product we have coming out this year the 6000 and the 600 two stroke, we're going to build that in very limited quantities and so we're not going to get a full year impact to that this year. That's something that we'll go full production on next year and so we'll see most of the impact next year.

In terms of the other thing, you mentioned in terms of profitability and margin, what we also said, in addition to gross margin coming down, if there were no selling or marketing expenses associated with that so the net margins associated with those Yamaha products are basically flat. We'll lose a little bit on gross margin and we'll pick up a little bit on the operating side.

Mark Smith - Feltl and Company

Can you say, is there anything else going on, on gross profit margin impacting that down 80 bps through the rest of the year besides Yamaha. How is the transition for the 6000 engine manufacturing going and anything else that's moving that number down?

Tim Delmore

Well other than the Canadian dollar, it was a bad comp from last year, but other than that no, we've nothing else to report there.

Mark Smith - Feltl and Company

Okay and then just looking at parts, garments and accessories and sorry if I missed this. If you guys maintained that, I'd think you said previously 5 to 8% guidance.

Tim Delmore

Yes, we did not change our guidance. And just one other comment on gross margin. We're pleased with the start of our year as far as gross margin goes and that is one of the major reasons why we raised our guidance. We are more knowledgeable about our cost and they are heading the right direction. So everything's favorable there.

Claude Jordan

Hey Mark, the other thing I would comment on, as you are looking at it, this first quarter is late quarter for us, probably 15-16% of our overall sales for the year. We'll have a much better feel as we get into second quarter and as we've done in the past, the initial guidance isn't always the final guidance. As we see things improving, we'll communicate and update you on each one of these calls. And if we think things are improving, we'll go ahead and modify accordingly.

Mark Smith - Feltl and Company

And that was my next question was probably your favorite thing to talk about. How much conservatism is built into that 80 bps down.

Tim Delmore

Again, that was a solid number when we gave it. We have more information now and again if you do the math, the gross margin we believe will improve up to 25 bps. So we're heading in the right direction on that, that's what we feel today.

Operator

(Operator Instructions). Our next question comes from Rommel Dionisio from Wedbush. Please go ahead.

Rommel Dionisio – Wedbush

I wonder if you guys could just talk about the supply chain (inaudible) I mean you guys have obviously ramped up the number of skews and the Wildcat line plus with the new Yamaha line coming in, I mean you are doing a great job with the gross margins, we see that this quarter. But simply relatively here, do you expect to bump up on the limit of how much you can expand that facility and maybe look for an alternative manufacturing site as well?

Tim Delmore

So there are a few questions in there. One of the things I would say in terms of our supply chain, within the last 12 months, we've added a new supply chain director. So we've gotten a little stronger there in terms of the personnel side. I think Ross is doing a very good job there. In terms of the number of skews, you're absolutely correct. The Wildcat line up gets its four models now and as you'll see next week, we've announced some new models. That will expand it even further. So not necessarily the Wildcat lineup but maybe other lineups. It's something we're very focused in making sure we manage our skews and working with our supply chain. I would look at it almost the other way as we continue to go ahead and grow the business, increase our volumes, we do have an opportunity to go ahead and leverage that in terms of purchasing with our supply chain and quite honestly I think it's probably one of our biggest opportunities in front of us. If you look at our gross margins last year compared to maybe some of the industry, other folks in the industry, to me I think is a tremendous opportunity for us to continue to get better and improve that gross margin.

In terms of the facility itself, Thief River Falls, we still for the most part are working one shift. We do work some additional shifts on welding. But we've put together the investor presentation we call it page eight there, where we talk about growing to $1.2 billion. We feel more than comfortable with the facility we have in Thief River Falls and its capacity to house and to go ahead and meet that kind of gross. So, near term I don't see an issue for that. It's something we monitor, it’s something we look at. We do recognize that some of our competitors have moved to Mexico. We stated all along we're more than happy in being a product that's assembled in the US and we think we have a good quality product coming out of that facility. It's something we'll monitor as we go along but as we sit here right now, we don't see any need for change.

Operator

There are no further questions at this time. Please continue.

Tim Delmore

I appreciate everybody joining us today. As a recap, we are excited about the strong start to the fiscal year 2014. As we look forward to the remainder of the year, our focus will continue to be on growth, product development and operational excellence. We appreciate your time today and look forward to updating you again in October. Thank you.

Operator

Ladies and gentlemen this concludes the conference call for today. A replay will be available until August 1st, that's 1800-406-7325 and the access code is 463-1843. Thank you for participating. Please disconnect your lines.

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