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Arctic Cat Inc (NASDAQ:ACAT)

F1Q11 (Qtr End 06/30/10) Earnings Call

Jul 29, 2010 11:30 am ET

Executives

Shawn Brumbaugh - IR, Padilla Spear Beardsley

Chris Twomey - Chairman and CEO

Tim Delmore - CFO and Secretary

Claude Jordan - President and COO

Analysts

Rommel Dionisio - Wedbush Securities

Phil Anderson - Longbow Research

Yasuna Murakami - MC2 Capital Management

Steven Baughman - Divisar Capital

Operator

Welcome to the Arctic Cat, fiscal 2011 first quarter Earnings Call. During today's presentation, all parties will be in a listen-only mode and following the presentation, the conference will be open for questions. (Operator Instructions) As a reminder, this conference is being recorded today, Thursday, 29th of July, 2010.

I would like to hand the conference over to Ms. Shawn Brumbaugh. Please go ahead, ma'am.

Shawn Brumbaugh

Thank you, Josh. 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 first quarter ended June 30, 2010.

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 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 results.

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

Chris Twomey

Thanks, Shawn. Thanks, everyone for joining us today. This morning, I will cover the individual performance of our three businesses during the quarter. Claude Jordan, our President and CEO will review the progress we have made in the operations as we focus on improving profitability and Tim Delmore, our CFO will review the financial performance.

Snowmobiles sales in the quarter are down 4% as we continue to match wholesale and retail sales seasons. It is safe to say that with the warm wet summer the country is experiencing there is no retail demand at this time and we have altered our production and sales activity accordingly.

The North American Snowmobiles retail sales season begins in earnest in September and October and shipments to dealers have been shifted toward those months. For the year, we expect Snowmobile sales to be up 5% based primarily on the stronger orders from international distributors who were negatively impacted last year by currency changes. In spite of the overall weak European economy and as a result of favorable snow conditions, our distributors experienced good retail sales last year and are in a position to increase their orders this year.

We continually monitor North American dealer inventories as one important measure of the overall health of our dealer network. At quarter end, dealer inventories were down 17% compared to the same quarter last year. Even with lower dealer inventories retail sales can increase this year and we will maintain our grow market share.

Sales of ATVs for the quarter were down 13% again as we also shifted ATV sales to dealers later in the year, so that their inventories would continue to decline. Following the success we experienced last year taking ATV orders from our dealers at three separate times, which allowed us to more closely match dealer needs and retail sales, this year we will again visit each dealerships three times during the year to take the 2011 model year orders.

Again this approach will better match dealer orders with actual retail activity. Lower dealer inventory and reduced cost, so that more dollars will be available for retail programs if necessary. We will spread new model introductions over all three order cycles to generate increased retail interest. Our focus will to introduce new products in model segments, which currently show signs of improvement.

Uncertainties in the economy, weak consumer confidence and unemployment figures at near historic levels continue to negatively affect ATV retail sales. The overall rate of decline this year has slowed. However, calendar year, today retail sales in North America for the industry are down about 20%. Arctic Cat retail sales were down only about half as much as the industry. So, we have gained market share.

Retail sales of Prowler UTVs are also down for the year. Dealer inventories are down to a level, which could be negatively impacting retail sales. In July, we began shipping our all new Prowler XTX. This machine is configured for three passengers and is designed to be a heavy duty workhorse. It has a longer wheel base than the regular Prowler and is equipped with power steering and standard equipment.

Although, shipments have only begun in the last month, dealers are already reporting good retail sales activity. We expect this model as well as the newly styled regular Prowler will drive increased sales for the remainder of this year.

Overall, we expect ATV and Prowler sales to dealers and distributors to be down 3% to 6% for the fiscal year. Sales of parts, garments and accessories are down about 4% for the quarter. Sales of parts and accessories are up year-to-date, while we have delayed shipments of garments again to match the retail selling season.

Our dealers began to switch their stores from summer to winter products in August and September and we plan to supply them for that timeframe. For the year, we expect PG&A sales to be up 1% to 3%.

Now I'll turn the call over to Claude Jordan for an in depth review of the company's operations. Claude?

Claude Jordan

Thanks Chris and good morning everyone, as Chris mentioned fiscal year 2011, will be another challenging year, for the power sports industry, as the economy continues to struggle. With this in mind we will continue to focus on numerous operational efficiencies, throughout the business.

By continuing on the same focus, we had in fiscal year 2010, on expense control and margin improvement initiatives, we will be successful, in improving gross margins by 100 to 200 basis points; holding operating expenses flat as a percent of sales; reducing dealer inventory by 20% to 30% and ending the year with more cash in the balance sheet.

In the area of growth margins, we mentioned on our last call, our goal was to improve gross margins in fiscal year 2011, by 100 to 200 basis points. The primary focus of our gross margin improvement, continues to be our supply chain, specifically to lower our material and product cost.

In addition to our increased focus on supply chain, we continue to focus on various engineering cost reduction initiatives. During the first quarter, we have seen improvement in gross margins and all business segments, primarily driven by product mix and new product development, higher selling prices on selected models, currency and lower discounts driven by fewer non current model sales.

These actions have resulted in our gross margin improving in the first quarter by 610 basis points, compared to the same quarter last year, or from 10.9% to 17%. Although we made significant progress in Q1 on gross margin improvement, this is a fairly low volume quarter for the business, and we do not at this time see a need to increase the 100 to 200 basis point improvement target.

In regard to operating expenses, we stated during our last call, our goal was to hold operating expenses flat as a percent of sales for fiscal year 2011. With this in mind, we have continued to focus throughout the business on all aspects of expense control. At the same time, we have continued to invest in new product development, which has resulted in the launch of new products such as the XTX, Heavy Duty Utility Vehicle and new look Prowler Side-By-Side vehicles in Q1, as well as the new power steering models in Q4 of last year.

During the first quarter, we did see an increase in operating expenses, however, a large portion of this was due to timing of 123(NYSE:R) stock based compensation expenses, which Tim will discuss in greater detail. However, these should not have a negative impact on our fiscal year 2011 operating expense goal. We will continue to target flat operating expenses as a percent of sales throughout the year, while at the same time, invest in those areas, we believe will strengthen the business.

Another area of focus, has been working to improve our cash position through improved factory inventory management. Throughout the last 18 months, we have focused on aligning our production with the demands of the market to ensure we were building the proper mix in quantity of products. With the improved planning throughout the business, we have been successful in lowering our overall factory inventory by 31% or from a $127.1 million last year to $88.1 million this year.

These improvements to inventory came from every component of the business. Overall, this improvement in inventory has allowed the business to improve the year-over-year cash position from $7.9 million last year to $58.6 million. Our goal is to continue the same focus going forward while at the same time ensuring we have the right amount and right mix of inventory to meet the needs of our customer.

The final area that we have been working on is, lowering North American 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 our first quarter, we successfully reduced dealer inventory by 23% compared to the same period last year and have decreased dealer inventory by 11% since the March 2010 quarter.

We will continue to stay in focus on reducing dealer inventory, which will allow the business to be well positioned when the economy fully recovers.

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, we will review highlights of our first quarter financial results. Net sales for the first quarter were $63.4 million versus $69.4 million for the same quarter last year.

ATV sales were $27.8 million versus $32.2 million. Snowmobiles sales were $17.1 million versus $17.9 million. Both ATV and Snowmobiles sales are lower, primarily due to continued efforts to better align dealer inventories to consumer demand. Parts, garments and accessory sales decreased 4% to $18.5 million versus $19.3 million, primarily due to the timing of pre-season Snowmobiles garment shipments.

Gross profits for the quarter were $10.8 million versus $7.5 million, the gross profit percentage improved to 17% versus 10.9% last year. The improvement was primarily due to higher margin percentages for all product lines, resulting from continued efforts we have undertaken to rescale our business, product cost reductions, price mix increases and benefits of a stronger Canadian dollar.

Selling, general, administrative expenses increased to $17.7 million versus 16.2 million, primarily due to higher admin expenses resulting from timing differences, Nearly all the company's stock-based compensation is now granted in the first quarter to coincide with the begin of our fiscal year versus grants in the second quarter and prior years. The shift results in recognition of more stock-based compensation expense in Q1 versus Q2.

Our interest income was 18,000 versus 4,000 and interest expense was 3,000 versus 72,000 for the same quarter last year. The company reported a tax benefit of 35% versus a tax benefit of 32% for the prior year quarter.

Our net loss for the first quarter improved to $4.5 million versus $5.5 million last year and diluted loss per share was $0.25 versus $0.33.

Looking at our balance sheet, as of on June 30th, we ended the quarter with $58.6 million of cash, up from $7.9 million at the end of June last year. Receivable are down 19% to $34.7 million, due to slightly earlier shipments of snowmobiles and ATVs and their related collections of those receivables.

As a reminder we get paid within two to three days from shipment from our floor plan partners. We had zero short-term borrowings as of June 30th, 2010. Inventory as Claude mentioned decreased 31% to $88 million from a $127 million and was down in each of our product lines.

Year-to-date, capital expenditures totaled 749,000 and depreciation and amortization was 2.6 million. Arctic Cat continues to estimate sales for fiscal year 2011, in the range of $447 million to $460 million and the company anticipates earnings per share to be in the range of $0.18 to $0.33 for the year.

I thank you operator and now we would like to open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Rommel Dionisio with Wedbush Morgan.

Rommel Dionisio - Wedbush Morgan Securities

Just a couple of quick questions regarding input costs and how they affect gross margins. Could you just talk about raw material prices and freight costs, and how they sort of flow through the income statement during the quarter?

Chris Twomey

I can certainly. In terms of what we are seeing so far, we are actually went into the year, thinking we are going to see some commodity pressure there, where prices were going to jump by may be one or two points. We are actually seeing an improvement in that area there, specifically depending on which categories you look at, but overall probably almost flat year-over-year. So that has actually been a benefit to our plan, versus last year, basically up. I'd say it's almost a wash in terms of the commodity side of things.

Rommel Dionisio - Wedbush Morgan Securities

Is that true for freight as well?

Chris Twomey

Freight, we have actually seen some a little bit, depending on whether it is in bound or not. On the inbound side, we did see some little bit pressure there, but not enough to offsetting me. When I looked back at the major elements of the gross margins areas, certainly currency comes into play, new product development comes into play. Mix, fewer discounts in terms of the non-current sales we had as well.

Tim Delmore

If you also look at your inbound freight in this small quarter, it's going to be subject to possibly more fluctuation whereas your outbound freight is very efficient loads that you are putting together. So if you see a slight increase in Q1, I wouldn't worry about that and I'd want to watch it closely for Q2 and Q3, but outbound is fairly similar to last year. So I think we are comfortable that we are not going to see too much in the freight area as well.

Operator

Our next question comes from the line of James Hardiman with Longbow Research.

Phil Anderson - Longbow Research

Good morning gentlemen. This is Phil Anderson in for James. Good quarter. First off, from a balance sheet perspective, certainly the net cash position here is something that you had talked about some. Just given the credit crunch, is that just caution on your part? If so, where do you think you'll put that cash towards once the economy and credit availability improve?

Chris Twomey

We are going to hang onto our cash, closely watch that cash, wait till the economy improves. Before we do anything, I would say the number one thing that we would do is looking at reinstating the dividend, which we suspended a little over a year ago. The Board reviews that continually at every meeting. That would be certainly one use that we would put the cash to.

Secondly, we've continued to look at possible acquisitions that would extend the existing businesses and we've looked at two or three this year so far, haven't found anything. So we find our balance sheet to be in a position to be used for that. Before we get anything significantly larger we would want to make sure that the overall market had turned in and that we had increased our profitability. So we watch all of those.

Phil Anderson - Longbow Research

Okay. Fair enough. Secondly, it looks like recently a lot of the growth in the power sports market has been not core ATV's, its been in the side by side section, in which you guys were a little bit more hesitant to get into initially. What are your thoughts going forward about the product mix in ATV, specifically between core ATV's and side by sides?

Claude Jordan

We continue to target obviously both new product development on both ATV as well as side by side. There is no doubt that your statement there that the side by side has seen little bit improved growth, obviously overall lower base than the ATV side of the business, but some of that competitors out there, we continue to track what's being done, the sportier side-by-side segment has seemed like it's performed fairly well.

So as we look at it, we just come out with a brand new side by side. On the other in this spectrum more focused on the utility with the XTX, longer chassis on it for smoother ride, power steering and we think that's a significant part of the market that we were underperforming in part previously.

We just recently changed the look of the Prowlers to give it a much sportier look and allow us to move closer to the sportier side of the side-by-side segment. So we continue to invest, we continue to monitor the market trends, but I would certainly agree with you that the specific segments of side-by-side that has performed better in the market place.

Phil Anderson - Longbow Research

Do you have any sort of longer term goals as far as proportion of core versus side-by-side sales?

Claude Jordan

Are you talking about in term of sales, are you talking about in terms of investment from the product development side?

Phil Anderson - Longbow Research

Yes, from a product development standpoint.

Claude Jordan

We went into the year and we thought that the ATV side, we sort of made assumptions in the beginning of the year that the overall ATV industry would be down 10% to 20% this year based on what we are seeing. We continue to believe that. On the side by side segment we did not provide any kind of assumptions in that category. Although, if we look at what's happened in the marketplace, the actuals that we're seeing are probably up slightly depending on which segments you're looking at on the side by side.

Phil Anderson - Longbow Research

Okay, fair enough. Then finally, just looking at your competitors, obviously Yamaha has being having a very difficult time here recently. Are they the biggest share loser with you guys gaining share. If so, I guess who else has benefited from their troubles recently?

Chris Twomey

Generally I can't comment on what the other people are doing. Obviously, as we look at those numbers as far as we're concerned are not information we can probably share. What we generally know is that we have gained share. Even in a declining market we have gained share and that's the position we wanted to stay in and we want to take advantage of anybody who is losing share, giving up the piece of share we like it. We're going to continue to focus on that.

Operator

(Operator Instruction). Our next question from the line of Yasuna Murakami with MC2 Capital Management.

Yasuna Murakami - MC2 Capital Management

Can you elaborate further on the engine deal and the transition from Suzuki to the engine facility?

Claude Jordan

Sure. Basically we have had a long relationship with Suzuki, and as a supplier of our snowmobile engines, they also supplied for a while our ATV engines, they were the exclusive supplier over ATV engines. We moved away from Suzuki on the ATV side for strategic reasons, we have talked about that. Suzuki, clearly saw the market differently than we did on the ATV side, and weren't making the types of engines that we felt that our customers wanted.

We moved away and did things like the thousand, and some other things, the 1000 cc engine that we did, and we did some other things in those categories, and again that was for strategic reasons. That we believe has paid off and allowed us to get into categories that we wouldn't have got into, otherwise. We have developed a absolutely fantastic state of the art, four stroke engine facility in Minnesota here. It's probably the most advanced four stroke engine, recreational vehicle four stroke engine plant in the world.

We have been around, looked at a lot of them. This is really a great operation. We have been working through, of course, all the start up issues, relative to that. We just felt that, we were now ready on the snow side to look at doing some of our own two stroke engines and so worked out a transition plan with Suzuki to continue to buy through the 2014 model year and then begin making our own in Saint Cloud at that time.

Yasuna Murakami - MC2 Capital Management

So you're talking about across the board the full lineup on the snowmobile side to transition fully away, because the press release was not very specific on that?

Claude Jordan

We will transition fully away from Suzuki in the 2014 model year end; we will make some of our engines, in Saint Cloud in that year.

Yasuna Murakami - MC2 Capital Management

Okay. Will there be other engines that will be outsourced elsewhere?

Claude Jordan

Could be yes.

Yasuna Murakami - MC2 Capital Management

So you guys do not see that this is having any kind of effect because it would strike me that this would increase on the margin level somewhere down the line, for R&D and everything else?

Claude Jordan

Well, actually we were paying for that. Any Suzuki, R&D expenses we were paying for and the engines we buy and any tooling. We were paying for when we brought the engines from Suzuki. So those won't change, it may shift. We may see a lower engine cost on the cost of goods side and a slightly higher increase on the operating side for the engineers that we put into this process, but in general the net expense should be the same and we should also be able to conceivably generate lower operating costs at our engine production facility as we push more volume through.

Yasuna Murakami - MC2 Capital Management

Okay. So the facility can handle the volume obviously?

Claude Jordan

Absolutely. The facility was built at a time and designed and equipped when the volumes and ATVs were dramatically larger than they are today. So, right now as it sits today, we can easily accommodate the snow and the ATV in the same facility as ATV volumes increased, which I believe that they will, as ATV engine volume increases I believe that they will when this market turns around.

If need be, we simply knock the backlog down and we can double the size of that plant very quickly, great labor force in the community in Saint Cloud, the community we went to. So we picked that community because of the large potential labor force. So there are literally no restrictions right now within the existing plant and if volumes increases, so we got a great ability to expand and great workforce to deal with.

Operator

Our next question comes from the line of Steve Baughman - Divisar Capital.

Steven Baughman - Divisar Capital

Just to follow up quickly on the previous questioner's line of questioning on Suzuki, Suzuki holds 35% of your stock or something. Can you talk a little bit about what you plan to do with that or what they plan to do with that, given that the business relationship here is going to end over the next several years?

Chris Twomey

I can't speak for Suzuki because I really don't know what they plan to do with it, so any comments I would make would be pure speculation. We have an agreement with them about the disposition of their stock, in other words we have an opportunity to buy it back if we want. They have an opportunity to sell it if they want in the market. So I would assume that maybe overtime they would, but again, that's just an assumption. They have not told me what they intend to do.

Steven Baughman - Divisar Capital

Just so I'm clear, you guys would have an opportunity to repurchase it before they would be allowed to sell it in the market? Is that correct?

Chris Twomey

Yes.

Steven Baughman - Divisar Capital

Okay. So that's possibly one use of cash to an earlier questioner's call.

Chris Twomey

Possibly, yes.

Operator

Thank you. (Operator Instruction) Management I am showing no further questions in the queue. Please continue with any further remarks.

Chris Twomey

I want to thanks all of you for taking the time to join us. As I said in the opening, we are pleased with the progress we are making. We look forward to updating you in the future. Again we've set some goals. We've told what they are and we intend to deliver it just as we done this time. So we look forward to updating you at the end of the next quarter. Thank you.

Operator

Ladies and gentlemen that does conclude the Arctic Cat fiscal 2011 first quarter earnings conference call. If you like to listen to a replay of today's conference, you may do so by dialing in at 1800-406-7325 or 303-590-3030, entering the access code of 4334802. Thank you for your participation, you may now disconnect.

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