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Executives

Shawn Brumbaugh - IR, Padilla Speer Beardsley

Claude Jordan - President and CEO

Tim Delmore - CFO

Analysts

Lisa Brozewicz - KeyBanc Capital Markets

Mark Smith - Feltl and Company

Craig Kennison - Robert W. Baird

Jake Crandlemire - Ramsey Asset Management

Arctic Cat Inc. (ACAT) F2Q2012 Earnings Conference Call October 27, 2011 11:30 AM ET

Operator

Good day ladies and gentlemen, thank you for standing by. Welcome to Arctic Cat Fiscal 2012 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 27, 2011.

I’d now like to turn the conference over to Shawn Brumbaugh. Please go ahead.

Shawn Brumbaugh

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 the fiscal 2012 second quarter ended December 30, 2011.

Participating in our call today to discuss the company’s performance and outlook will be President and Chief Executive Officer, Claude Jordan; and Chief Financial Officer, Tim Delmore. Following their remarks, we will have time for any questions.

Before we begin, please note that some of the comments made today will be forward-looking statements regarding the company’s expectations of future performance. Such statements are subject to risks and uncertainties and actual results may differ materially from those contained in the statements. These risks and uncertainties are described in today’s 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 to Arctic Cat’s 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 as well as the progress we have made in operation as we continue to focus on sales, profitability and improving our cash position. Following my comments, Tim Delmore, our CFO will review our financial performance.

Overall we are pleased with our financial performance for the quarter especially our double-digits sales and earnings growth. As we mentioned at the beginning of the year, we set out the growth sales in all product categories, improved gross margins, improve earnings per share, generate additional cash and reduced the overall inventory. Through the second quarter, we remain on-track to accomplish each of these.

In regard to individual businesses, snowmobile sales were up 25% for the quarter primarily driven by increased volume and to a lesser degree pricing and mix. Additionally, snowmobile dealer inventory for North America was lower by 12% driven by the excellent snow conditions we experienced last year. With the lower inventory and the increased orders we have taken on the 23 all new peripherals and product line snowmobile models we launched this year, we expect snowmobile sales to be up between 28% to 33%. This increase will be seen in both North America and international markets.

On the retail side we have only one month of snowmobile sales and we are seeing strong growth. However, the majority of these sales are due to the strong preseason snowmobile sales we took earlier this year. The strongest month of snowmobile retail sales will come in our third and fourth quarter. However, we feel confident that fiscal year 2012 will be a strong year for our snowmobile business.

Finally, two of our new model year ’12 snowmobiles have been recognized has led the year for 2012.

On the ATV business, sales increased 4% for the quarter driven primarily by the international sales. Additionally, we continue to focus on matching our wholesale sales to retail sales and we are successful in lower our North American dealer inventory by 24%.

Industry retail ATV sales for North America had another difficult quarter as sales decreased by approximately 12%. During the second quarter our core ATV retail business also decreased, however, we continue to see year-over-year retail growth in our side-by-side business and we are now seeing five straight months of positive growth. During the second quarter our side-by-side retail business grew at over 8%.

Some of the highlights for the quarter included the introduction of the all new Wildcat IV side-by-side vehicles which was introduced in July at the 50th year celebration of the Arctic Cat brand. The Wildcat, will have a 1000 high output V-Twin engine, electronic power steering, led lights front and rear, and an industry leading 17 inches of front travel suspension.

Based on the initial feedback we have received from our dealers and the media, we expect this to be an exciting addition to our model year 2012 line up. We will start shipping the Wildcat in limited quantities in our third quarter, and then in larger quantities in our fourth quarter.

Sales of our parts, garment and accessory business continue to perform well and we are up 13% for the quarter. Increased sales were driven by the pre-seasons snowmobile related parts, garments and accessories. During the quarter we also continued to expand on our e-commerce website for the U.S. market and have just launched the e-commerce website for our Canadian customers.

In regard to operational performance, we stated at the beginning of the year, our focus would be on improving gross margin, controlling our operating expenses and ending the year with more cash in our balance sheet. In the area of gross margins our goal was to increase gross margin by 20 to 60 basis point. During the second quarter, we have seen our gross margin decline by 126 basis points primarily due to product mix and sales incentive on early season snowmobile sales.

We expect product mix to revert itself over the next two quarters and we continue to expect year-over-year improvement to gross margins up 20 to 60 basis points for the year, although, commodity costs will remain a challenge.

In regard to operating expenses we stated at the beginning of the year our goal was to hold operating expenses flat as a percent of sales. With this in mind we have continued to focus throughout the business on all aspects of the expense control. At the same time we have continued to invest in product development which has resulted in launching various new models for both the snowmobile and ATV business. However, the second quarter we were successful in decreasing operating expenses as a percent of sales. Based on our plan for the remainder of the year we now believe that we will be successful in decreasing operating expenses as a percent of sales.

Finally area of focus, as we work into improve our cash position, although we did see year-over-year inventory grow to support our sales growth we were successful in growing our cash position from 80.9 million last year to 96.6 million. As we look forward we will continue to being focused on having the right amount of inventory on hand to support the growth needs of the business, while at the same time continuing to focus on improving inventory turns.

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

Tim Delmore

Thanks Claude. Good morning everyone. I’d also like to welcome you to the conference call. Today I will focus on reviewing the highlights of our second quarter and year-to-date performance and our upgraded guidance for full-year fiscal 2012.

Net sales for the second quarter increased 17% to 204.8 million from 175.8 million for the same quarter last year. Snowmobile sales increased 25% to 114.7 million from 91.5 million. ATV sales increased 4% driven by increased international sales to 58.8 million from 56.6 million. Parts, garments and accessory sales increased 13% to 31.4 million from 27.6 million for the same quarter last year. Sales increased across all product lines with particularly strong snowmobile sales driven by the introduction of our extensive new 2012 snowmobile lineup. A double-digits parts, garments and accessory sales increase was driven by shipments of pre-season snow related PG&A.

Gross profits for the quarter increased 11% to 57.1 million from 51.3 million, the gross profit percentage for the quarter decreased as expected 126 basis points to27.9% from 29.2%. Primarily due to sales incentives on our early season snowmobile sales as well as increased international shipments and product mix. For full-year we still expect gross margins will increase 20 to 60 basis points year-over-year.

Selling, general and administrative expenses increased 1% to 24.2 million from 23.9 million for the same quarter last year, primarily due to increased sales and marketing expenses related to higher sales levels. SG&A expenses as a percent of sales improved to 180 basis points to 11.8% compared to 13.6% for the same quarter last year. Our interest income was 20,000 versus 26,000 and our interest expense was 4,000 versus 7,000 for the same quarter last year.

Our net earnings increased 20% to 21.4 million from 17.8 million. And second quarter diluted earnings per share increased 19% to $1.15 from $0.97 per share.

Next I’d like to review Arctic Cat’s financial performance for the first six months of fiscal ’12. Year-to-date net sales increased 17% to 279.8 million from 239.2 million a year ago. Net earnings increased 43% to 19.1 million from 13.3 million, while diluted earnings per share increased 42% to $1.02 from $0.72.

On a year-to-date basis snowmobile sales increased 22% to 132 million from 108.6 million. ATV sales increased 14% to 96.7 million from 84.5 million; and parts, garments and accessory sales increased 11% to 51 million from 46.1 million for the same period last year.

Our year-to-date gross profit increased 15% to 71.4 million from 62 million. Our year-to-date gross profit percentage was 25.5% compared to 25.9. Although our year-to-date gross profit percentage decreased approximately 40 basis point as we previously mentioned, we continue to expect year-over-year improvement in our gross margin percentage.

Year-to-date, selling, general and administrative expenses increased 1% to 42.1 million from 41.5 million primarily due to higher sales and marketing expenses and R&D expense. Selling, general and administrative expenses as a percent of sales improved to 15% from 17.4% in the same period last year.

Looking at our balance sheet, as of September 30, we ended the quarter with 96.6 million of cash and no short-term borrowings compared to 80.9 million of cash and no short-term borrowings as of September 30, last year. Accounts receivable increased 36% or 25.5 million to 96 million mainly driven by increased international snowmobile shipments to our distributors. Inventory increased 8% to 103.6 million from 95.9 million mainly due to increased snowmobile engines related to our higher Q3 snowmobile production levels. Year-to-date capital expenditures totaled 7.8 million while depreciation was 6.4 million.

Based on our results year-to-date and expectations of future performance, Arctic Cat has raised against full-year fiscal 2012 sales and earnings guidance. We now expect net sales in the range of 530 to 545 million based on snowmobile sales increasing 28 to 33%, ATV sales increasing 5 to 10% and PEG net sales increasing approximately 5%. We now anticipate that fiscal 2012 earnings will be in the range of $1.10 to $1.15 per diluted share. The company’s previous guidance anticipated earnings of $0.94 to $1 per diluted share and sales of 520 to 530 million.

Our outlook includes the following assumptions, our year-over-year gross margins to increase 20 to 60 basis points as we mentioned and operating expenses to be lower as a percent of sales and we continue to expect to increase cash on our balance sheet from increased cash flow from operations.

Regarding foreign currency exposure, the Canadian dollar is our largest exposure and we have significant hedges in place to protect us on the Canadian dollar.

Thank you, operator and now we would like to open it up for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question is from the line of Lisa Brozewicz with KeyBanc Capital Markets. Please go ahead.

Lisa Brozewicz - KeyBanc Capital Markets

In the ATV category how much load do you guys plan on brining dealer inventory before you began shipping in line with demand?

Claude Jordan

Yes, we have actually started to identify that now and we are looking at on a per dealer basis. We still have a couple of areas, couple of regions that are just a little bit high, compared to where we would like it to be. (inaudible) that’s an area that started to bump up now as go out take orders. We are starting to go ahead and start to move the wholesale in line with the retail. So, I would think start seeing probably over the next 12 months.

Lisa Brozewicz - KeyBanc Capital Markets

Great. And then also can you bucket the impact on gross margins just by magnitude in those three separate categories. And then with the sales incentives that you talked about, where they the one-time occurrence?

Claude Jordan

Regarding the buckets I have, I think I just stated there is little bit of each of those buckets and as far as sales incentives this year we had nice proportion of our sales were spring guarantee or what we used to call extra early cat cast unit. So, pre-spoken for a units that were shipped with the greet upon programs. So, that was because of the sales incentive increase.

Lisa Brozewicz - KeyBanc Capital Markets

Okay. And then lastly, can you just give us an update on your capital deployment plan?

Claude Jordan

Our plan for the year as far as CapEx was to have a CapEx in the range of 80 million and with depreciation of 14 million and we are not quite half way there.

Operator

Thank you. The next question is from the line of Mark Smith with Feltl and Company. Please go ahead.

Mark Smith - Feltl and Company

First off I just want to confirm that I heard you right on the revenue guidance, 28 to 33% for snow, 5 to 10 on the ATV and 5% PG&A?

Claude Jordan

That’s correct.

Mark Smith - Feltl and Company

Okay, good. Second, can you guys just give us your outlook on commodities, maybe any look at what you have had just currently?

Claude Jordan

In terms of commodities we went into the year expecting this to be a challenging year; we stated that during the first call, we will give the initial guidance. The commodities are basically tracking where they we thought where we are going to track. These are certain areas I read this come up now, and that’s probably going a little above, but maybe some other commodities are probably not tracking as high as where we thought they would be. So, the initial guidance that we gave plus 20 to plus 60 basis points, we didn’t change it at the end of Q1, because we knew what our bill plan was, we knew our orders were in terms of pre-season and so, we expect Q2 to come in exactly where it's going to and we have a pretty good handle where we think Q3 and Q4 is going to be.

Mark Smith - Feltl and Company

Okay. And of that 20 to 60 bips in improvement. Can you just talk about how much that is maybe any mix shift versus commodities or anything else would factor that?

Claude Jordan

Yes, it's really is across the board. We are getting some in terms of mix, and there are certain units obviously that we saw a great many years of this year that have a higher margins. So, mix would come into play on the other side, the equations, we did take some price issue as well in certain regions, so that authenticated in the play as well. On the down side the commodities were the things that were working against us there. So, I don’t know if I have the exact percentages but certainly mix was one of the bigger one that came into play there.

Mark Smith - Feltl and Company

And then lastly is there any insight you can give us on initial orders of Wildcat and I guess how you feel about that product?

Claude Jordan

I don’t want to share numbers. We were into taking orders for the Wildcat, we were extremely excited and let’s just say after taking orders for one week we remained extremely excited. So, having said that once again we built that into the plan at the beginning of the year, we thought we were going to go ahead and take a large number and we did.

Mark Smith - Feltl and Company

So, the 5 to 10% guidance through the remainder of the year on revenue has (inaudible) what you expect in a Wildcat?

Claude Jordan

Yes it does. And just to put that in perspective when we gave the original guidance on the ATV business we said zero to 2% at the end of Q1 we walked that up to 2 to 5%. And then as Tim just mentioned we are now going to 5 to 10. So, we continue to walk that up each quarter. As the ATV has gotten little bit stronger some of that I’d say is Wildcat, some of that would be as I mentioned during my comments, improved side-by-side Prowler HDX sales that we were seeing on the retail side.

Mark Smith - Feltl and Company

I guess on PG&A can we expect the accessory business to maybe pickup more as side-by-side business continues to grow, if I’m right?

Claude Jordan

I think you can expect, first of all, once again we built this into, the numbers were are seeing on that business. But I think if you look at specific categories, specifically the Wildcat I do think that is a model that is in line with that on a significant number of accessories to it. And so, we work very closely with our PG&A again, when we are developing that product. So, for the first time I think we were able to go ahead and launch a full line of accessory to spent time we are launching the product.

Operator

Thank you. Our next question is from the line of Craig Kennison with Robert W. Baird. Please go ahead.

Craig Kennison - Robert W. Baird

To follow-up on the Wildcat question, can you talk about the rollout in the U.S. versus international and whether there is any timing difference?

Claude Jordan

Craig, the biggest difference between international, when you say U.S. I’ll say U.S. and Canada, North America. The biggest difference is we are going to have to (inaudible) for the European marketplace. So, there will be some opportunities over there and some additional work that needs to be done. Obviously for the off-road version of the Wildcat which is driven certain markets over international markets, Russia for example, some of the Scandinavian countries, we should see some pretty good sales right out of the blocks on the Wildcat.

Craig Kennison - Robert W. Baird

Thanks. And then relative to your distribution strategy, could you comment on how that might evolve as you grow the business and in particular I’m interested in whether for example, you could establish national accounts with potential big buyers like oil company for example, or what your strategy is with respect to mass retail, e-commerce and leverage the international channel whether it's through dealers or through distributors?

Claude Jordan

Thanks Craig, I can probably spend an hour on that try and go ahead and maybe pick and choose on some of them. In terms of direct versions of distributor we had some distributors over in Europe and other parts of the world, where they have been in place for long time, we continue to do very well within, they continue to take market share. Now with that said we do go direct in six countries over in Europe. So, France, Germany, UK, Austria, Italy and Spain. And that model mix that we have or the distribution channel mix that we have today between dealer and distributor, we feel very good about it. As we do penetrate new markets of the world, if it make sense we do take a look in terms of whether we should go direct to a distributor and that’s certainly a top of mind in terms of making that decision in which direction we go. So, that’s the that part of it.

On the e-commerce, we have continued to go ahead and roll out of the U.S. market primarily on the PG&A side. We are going ahead, we just launched the Canadian site, so we will continue to go ahead and expand on e-commerce. Think as we look at if the business going forward it's just convenient way for customers to shop.

In terms of large big box accounts, I think you are aware that we sell through Bass Pro today. It's been a great relationship we sell our ATVs through them and about 60 stores throughout the U.S. and Canada. And it's a great relationship, we leverage off some of their marketing, some of their footsteps going to their stores, we partner with them on a [Nascar]. So, we did give a lot of exposures by going to them and I think that’s been a real big success for us.

In terms of going forward, are there opportunities to do additional things in terms of, I’d say commercial accounts or national accounts It's certainly an area that we have identified, we actually have an open position today for a national accounts position and one of the challenges or opportunities for that person will be to go ahead and continue to grow near the account with Bass Pro but also look for new opportunities for us.

Craig Kennison - Robert W. Baird

And then lastly would you comment on prospects for the military with some of your products.

Claude Jordan

One of the things I will go back to the Wildcat, we have the Wildcat down at show in D.C. and we got a lot of buzz it's been catching a lot of buzz not just on the recreational stock but it's also been catching lot of buzz within the media base on that show we were at. It's an area that we just announced started to target, we have bit a couple of jobs within the last six months and it's an areas I think going forward we will continue to stress.

Operator

Thank you. (Operator Instructions) Your next question is from the line of Jake Crandlemire with Ramsey Asset Management. Please go ahead.

Jake Crandlemire - Ramsey Asset Management

Just on the Wildcat, can you talk about manufacturing capacity there, do you foresee any bottlenecks assuming the launch roll that as you expect any type of potential hiccup that might arise from that. Thanks.

Claude Jordan

Certainly, we would not be on the production side, obviously when you are bringing on a new product much like we did on the snowmobile side this year. You have a supply chain, you are constantly working with suppliers to make sure that they can go ahead and ramp up and meet your needs. But from a capacity side up here, and people referral to manufacturing plant is more than capable of meeting the demand in what we are seeing there.

Operator

Thank you. (Operator Instructions) The next question is a follow-up from the line of Craig Kennison with Robert W. Baird. Please go ahead.

Craig Kennison - Robert W. Baird

Thanks. A quick question. Claude, just on your acquisition outlook, is there anything heating up or do you see anything changing with respect to those opportunities?

Claude Jordan

Nothing, I’d probably go into detail with right now, but one thing I’d say from 50,000 foot overview. We are probably spending a little bit more time in that area now in terms of looking at potential fit and opportunities for the business. Only because if I go back a couple of years ago, certainly we were very internally focused on what can we do in terms of cost controls and things of that nature. As we have gotten the business a little bit, I’d say right at a little bit more, here we are focused a little bit more on the gross side both internally through a product development and also in terms of additional strategic opportunities out there.

Operator

Thank you. There are no further questions at this time. I will turn it back over to Mr. Jordan, for any closing remarks.

Claude Jordan

Okay. Well I appreciate everybody joining us today, as a recap we continue to be excited about fiscal year 2012 especially the launch of our 23 all new snowmobiles and the all new Wildcat support side-by-side vehicle. We believe these products in line with the focus on continued improvement will lead to another solid year for Arctic Cat. We appreciate your time today and look forward to updating you again in January.

Operator

Ladies and gentlemen, this does conclude the conference call. You may now disconnect and thank you for using ATT conference.

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