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Arctic Cat (NASDAQ:ACAT)

F2Q2011 Earnings Call

October 28, 2010; 11:30 am ET

Executives

Chris Twomey - Chairman & Chief Executive Officer

Claude Jordan - President & Chief Operating Officer

Tim Delmore - Chief Financial Officer

Shawn Brumbaugh - Padilla Speer Beardsley

Analysts

Rommel Dionisio – Wedbush Morgan

Brandon Taylor – Raymond James Financial

Dennis Scannell – Rutabaga Capital

Operator

Good day ladies and gentlemen and thank you for standing by. Welcome to the Arctic Cat’s fiscal 2011 second quarter earnings conference call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator Instructions) This conference is being recorded today Thursday, October 28, 2010.

I would now like to turn the conference over to Shawn Brumbaugh. Go ahead ma’am.

Shawn Brumbaugh

Thank you. 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 its fiscal second quarter ended September 30, 2010. Separately, the company also announced its leadership succession plans.

Participating in our call today to discuss these items would 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 to future performance. Such statements are subject to risks and uncertainties and actual results may differ materially from those contained in the statements. 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’ll turn the call over Arctic Cat’s CEO, Chris Twomey. Chris.

Chris Twomey

Thanks Shawn. Thanks everyone for joining us this morning. As Shawn referred to, we this morning released a press release covering the company’s succession plans and I want to bring your attention to the fact that after 24 years as Arctic Cat’s CEO, I plan to retire at the end of December 2010. And the Board has selected Claude Jordan as President and CEO effective January 1, 2011. To ensure a smooth transition, I will remain as Executive Board Chair.

I’ve had the opportunity to work closely with Claude for more than two years and have the utmost confidence that under his leadership, Arctic Cat will continue to grow profitably and enhance shareholder value. Claude has a tremendous understanding of all aspects of our business, our products, and our customers, as well as an immense drive to win and that’s a great combination. And given the strong team he has to work with here at Arctic Cat, I am truly excited about the future potential of this company.

This morning, I will cover the individual performance of our three businesses during the quarter. Claude will review the progress we have made on the operations as we focus on improving profitability, and Tim Delmore our CFO will review our financial performance.

We are pleased with our financial performance for the quarter, particularly our double-digit earnings gains, as well as our Snowmobile and ATV sales increases. On the year-to-date we’ve continued to improve gross margins and we are working on holding operating expenses flat as a percent of sales. We have also continued to hold or gain share in both product lines and have lowered our dealer inventories.

Snowmobile sales for the quarter are up 7%, primarily on increased international sales. We continue to focus on matching the wholesale and retail selling seasons in North America, so more of our sales to those dealers will be made in Q3, when the retail activity is the greatest.

Certain of our North American dealers have already reported good retail sales activity in October and the weather is starting to cooperate across North America this week including blizzards in Montana and Western North Dakota.

It’s important to remember that the strongest Snowmobile retail months in North America began in November. Overall for the year, we now expect our Snowmobile sales to be up as much as 10% to 12% based primarily on stronger international orders. We continue to monitor North American dealer inventories as one important measure of the overall health of our dealer network.

At quarter end, our dealer inventories were down 15%, compared to the same time last year. Even with the lower inventories, retail sales can increase allowing us to maintain growth share. Sales of ATVs rose 9% in the quarter, driven by sales of our new Prowler HDX, which is a side-by-side model designed more for the utility market than the recreation market, which is currently served by our newly designed Prowler.

Sales in the quarter were also positively impacted by increased international sales in both ATV’s and Prowlers. We continue to closely monitor retail sales in the ATV area, so that we can better manage wholesale and retail activity with our goal to again reduce dealer inventories.

Year-to-date ATV and Prowler inventories are down 23% and we have maintained market share. For the year, we now expect our ATV sales to be about flat with last year, based on stronger international sales and only slightly lower North American sales.

So far this year, we have introduced seven new models of ATV’s and Prowlers and made significant changes in three other models. During the remainder of the year, we will introduce three more new models in segments where we are currently underperforming and we expect to see market share gains as a result.

Sales of parts, garments and accessories are down 4% for the quarter and the year-to-date, primarily due to the timing of shipments. For the year, we still expect our PG&A sales to be up 1% to 3%.

And now I’ll turn the call over to Claude, to review the company’s operations. Claude.

Claude Jordan

Thanks Chris. Good morning everyone. As Chris mentioned, the second quarter of fiscal year 2011 was a solid quarter with solid sales increase for both Snowmobiles and ATV’s, as well as continued improvement to the overall profitability of the business. As we stated at the beginning of the year, our focus would be on improving gross margins, controlling our operating expenses, reducing full factory and dealer inventories, and ending the year with more cash on our balance sheet.

In area of gross margins, our initial 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 second quarter, we have seen improvement to gross margin in all business segments, primarily driven by new product development, higher selling prices on select models, currency and lower discounts driven by fewer non-current model sales.

These actions have resulted in our gross margin improvement in the second quarter by 200 basis points, compared to the same quarter last year or from 27.2 % to 29.2%. And year-to-date we have seen our gross margin improve by 350 basis points or from 22.4% to 25.9%.

Based on the improvement, we’ve seen year-to-date, combined with the projected improvement, we expect to see over the next two quarters, we believe that our overall fiscal year 2011 gross margin improvement will be 200 to 300 basis points, up from our initial estimates of 100 to 200 basis points.

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 product development, which has resulted in launch of new products such as the HDX heavy duty utility vehicle and power steering on Prowler side-by-side vehicles in the second quarter.

During the second quarter, we did see an increase in operating expenses in terms of dollars. However, we were successful in lowering operating expenses as a percent of sales. We will continue to target flat operating expenses and, as a percent of sales throughout the year while at the same time investing in those areas that 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 21 months, we are focused on aligning our production with the demand in the market to ensure we were building the proper mix and quantity of products.

With the improved planning throughout the business, we have been successful in lowering our overall factory inventories by 28% or from $133.6 million last year to $95.9 million this year. These improvements to inventories 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 $11.2 million last year to $80.9 million this year. 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 inventories to meet the needs of our customers.

We continue to believe, we will be successful in the intermediate year with more cash than the end of last year.

The prime area that we have been working on is lowering North American dealer inventories. By lowering production and lowering the dealer inventory to the needs of the markets, we have been successful in reducing the amount of inventory at our dealers. During the second quarter, we successfully reduced dealer inventory by 20% compared to the same period last year and we will continue to stay in focus when reducing dealer inventory, which will allow the business to be well positioned as the economy recovers.

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

Tim Delmore

Thanks Claude. Good morning everyone. I would also like to welcome you to the conference call. Today, I will focus on reviewing highlights of our second quarter and our year-to-date financial performance. Net sales for the second quarter increased 6% to $175.8 million from $166.3 million for the same quarter last year. Snowmobile sales increased 7% to $91.5 million from $85.7 million.

ATV sales increased 9% to $56.6 million from $51.7 million. Parts, garments, and accessory sales were down slightly to $27.6 million, compared to $28.8 million primarily due to the timing of shipments.

Gross profits for the quarter increased 13% to $51.3 million from $45.2 million. The gross profit percentage for the quarter improved 200 basis points to 29.2% from 27.2%, primarily due to higher margins for all product lines resulting from continued efforts on product cost reductions, price increases, and benefits of a stronger Canadian dollar.

Selling general and administrative expenses increased 3% to $23.9 million from $23.3 million for the same quarter last year, primarily due to higher R&D expense, sales and marketing expense, and compensation expense offset to some extent by decreased Canadian hedge costs.

Our interest income was 2600 versus zero for the same quarter a year ago; interest expense was 7000 versus 175,000. Net earnings increased over 20% to $17.8 million from $14.8 million. Second quarter diluted earnings per share increased 20% to $0.97 from $0.81.

Next I would like to review our performance for the first six months. Year-to-date net sales increased 1.5% to $239.2 million from $235.7 million a year ago. Net earnings increased 51% to $13.3 million from $8.8 million, while diluted earnings per share increased 50% to $0.72 from $0.48.

On a year-to-date basis, Snowmobile sales increased 5% to $108.6 million from a $103.7 million, ATV sales increased 1% to $84.5 million from $83.9 million. Parts, garments and accessory sales were $46.1 million, compared to $48.1 million again due to the timing of shipments.

Our year-to-date gross profits increased 17.5% to $62 million from $52.8 million. Our year-to-date gross profits percentage improved to 25.9% from 22.4%, again primarily due to continued efforts on product cost reductions, price increases and the strong Canadian dollar.

Year-to-date selling general and administrative expenses increased 5% to $41.5 million from $39.5 million, primarily due again to R&D expense, sales and marketing expenses comp and cessation costs and partially offset by the Canadian hedge cost we talked about.

Looking at our balance sheet as of September 30, we ended the quarter with $80.9 million of cash and no short-term borrowings compared to $11.2 million of cash and no short-term borrowings as of September 30 last year.

Accounts receivable increased 3% to $70.5 million inline with our sales increase and as Claude mentioned inventory decreased 28% to $96 million from $134 million and was lower for each of our product lines.

Our year-to-date capital expenditures totaled $3.4 million and depreciation was $8.2 million. Based on our results year-to-date and expectations for future performance we are raising our full year fiscal ’11 sales and earnings guidance.

Arctic Cat now estimates fiscal 2011 net sales to be in the range of $453 million to $463 million, and we anticipate our earnings per share will now be in the range of $0.40 to $0.55 per diluted share. This increase was driven by increased international revenue as well as increased gross margins resulting from favorable commodity cost and lower sales incentives than plans.

The company’s previous guidance anticipated fiscal 2011 earnings of $0.18 to $0.33 per share on sales of $447 million to $460 million. Okay, thank you for your attention and operator would you now open it up for questions.

Question-and-Answer Section

Operator

Thank you, sir. We will now begin the question and answer session. (Operator Instructions) Our first question comes from the line of Rommel Dionisio with Wedbush Morgan, go ahead please.

Rommel Dionisio – Wedbush Morgan

Yes, thanks very much. I wonder if you can just comment on commodity price pressure the impact that might have on gross margins going forward?

Chris Twomey

We really have and we’ve waited this year, I think we are going to get a couple points on the commodity side and quite honestly we have been managing it fairly well. We see a slight increase, so we are not at zero compared to last year.

That is only up slightly. Obviously going forward, lot of it will depend on the economy and how the economy heats up, we will certainly, we continue to watch multiple factors on the economy side and what that’s going to do to commodities. So, this is certainly one of the things that we think we are very much aware of.

Rommel Dionisio – Wedbush Morgan

Okay, thanks very much.

Operator

(Operator Instructions) And our next question comes from the line of Brandon Taylor with Raymond James Financial. Go ahead sir.

Brandon Taylor – Raymond James Financial

Hi, good morning guys.

Chris Twomey

Hi, Brandon

Brandon Taylor – Raymond James Financial

I was wondering if you could break out, I guess give a little more color on the gross margin, gains maybe broken out by mix, efficiency, commodities et cetera?

Tim Delmore

What we have said in the past was, we got contributions from all of those areas and we didn’t point to one particular area, but nice contributions from each one of those areas.

Chris Twomey

One thing we did mention in terms of mix, obviously we saw that our PG&A business went down, so I’d say, mix probably did not contribute nor did some of the other areas that we touched on earlier whether it was currency, price, engineering cost reductions, and supply chain across the board of all contributors.

Brandon Taylor – Raymond James Financial

Okay, and one other things, could you guys give us some color on retail? I think I may have missed it right at the beginning, I apologize.

Chris Twomey

Yes, basically it’s too early to tell on the snow part of the business. Just since the really big snow retail months begin in November, but I think it’s roughly 12%, 13% of the sales are made in October. We have gained a little share in snow, but again October is not indicative of what goes on in retail market.

On the ATV side of the business the retail environment has remained very challenging still. We’ve said that we now believe the market for the year is going to be down 15 to 20 points and we still expect to gain a little share for the year.

So, I haven’t seen any great improvements in the ATV side of the business at all and too early to tell on the snow. I am optimistic on the snow side of the business and some of the things that we’ve heard about early October sales at dealers but, again, they are all anecdotal and we just don’t have a good sense of it. Love the blizzards in Western North Dakota and Montana that really gets people excited and gets the retail and dews is kind of flowing again, so.

Brandon Taylor – Raymond James Financial

Okay, thanks guys.

Operator

(Operator Instructions) And we do have a question from the line of Dennis Scannell with Rutabaga Capital. Go ahead please.

Dennis Scannell – Rutabaga Capital

Yes, good morning gentlemen.

Chris Twomey

Hi Dennis.

Dennis Scannell – Rutabaga Capital

Excellent job. I just want a answer is that what is, I think Claude and Tim and Chris will both throw this back at me, its just a nonsense question but the inventories you look about as low as I’ve ever seen them at this time of the year. And certainly just your net working capital is picking up at cash is about as low as I’ve ever seen it. And it looks like you did benefits, the working capital did benefits by your current liabilities decrease, I guess in tables get little higher than it was, last year. But you have enough inventories to meet that Snowmobile demand if it does come through in November, December and January. I mean, you guys are confident that you’ll be able to get the floods [ph] to your customers if the snow happens as we all hope it does?

Chris Twomey

Yes Dennis, the Snowmobile business is still on a build order basis. So those orders were completed with our dealers and distributors at the end of April and that production schedule is locked and loaded. We will produce, we know exactly what we will produce, we know exactly what we will sell and we know who we’ll sell it to, and if so, you can see, as I said our international sales will be up.

We think there is a real opportunity there because actually their sales were down last year, because of currency. So we see them restocking their inventory in the U.S. and in the North American side both U.S. and Canada.

We know the dealer inventories are low, and we know that their orders for this year and when we put those two together we still see an opportunity to increase retail sales and again lower dealer inventory.

We really feel comfortable that we are doing a good job of matching dealer orders and with retail activity and in fact, in today’s new environment, we are actually in a situation where we may not be willing to take orders from dealers say going forward, if we didn’t think that they could sell in a retail because this business of building units and having them ship the dealer inventory and then having us become part of a rebate or a ongoing interest payment just doesn’t make sense.

Now, having said that, we want to make sure to have enough inventory to sell through but we monitor that Dennis on a weekly basis and we feel real comfortable with where we are at and we are kind of liking the feeling and our understanding in the sense we have of those businesses.

Dennis Scannell – Rutabaga Capital

Excellent, well, I got to say that the performance is phenomenal and particularly in this kind of economic environment to have a balance sheet where it is and the your operating efficiencies, and make it a kind of gains that you guys are demonstrating. It’s truly impressive. So, congratulations to all of you and the entire team.

Chris Twomey

Thank you very much.

Operator

And our next question is a follow-up question from the line of Rommel Dionisio with Wedbush Morgan. Go ahead sir.

Rommel Dionisio – Wedbush Morgan

Yes thanks. I just want to ask about financing. If you guys have just seen any trends you can update us on with regard to the financing partners and terms, and credit scores and the down payment that sort of thing?

Tim Delmore

On the retail financing side, obviously we track it. In terms of approval rates, the same over the last couple of weeks we’ve seen a slight uptick. But quite honestly I don’t know if a, couple of weeks makes for a trend there. In terms of the approval rates today we are running at about 60%.

So, we feel pretty good, that’s really if I go back to last year, 60% is sort of inline with that, I mean we’ve been as low as the mid 50s and occasionally we will get up around high 60s even 70%, but the retail financing has worked out well for us and we are seeing the approval rates that we felt that they were going to be there.

Rommel Dionisio – Wedbush Morgan

Okay, great, thanks very much.

Operator

(Operator Instructions) And it appears there are no further questions. I’ll turn it back to management for any closing remarks.

Chris Twomey

Thank you very much operator and thank you all of you for being with us here this morning. It’s been my immense pleasure over the last 20 years to update you on a quarterly basis about Arctic Cat’s progress and I feel absolutely confident going forward that we’ve got a great team that will continue to bring great results. So thanks again and Claude and Tim will look forward to talking with you in January.

Operator

Ladies and gentlemen, this does conclude your call for today. If you wish to listen to a replay of today’s conference, you can dial 303-590-3030 or 1800-406-7325 and the access code is 4379096 with the # mark. Thank you for your participation. You may now disconnect.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

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