Arctic Cat (ACAT) Christopher T. Metz on Q3 2016 Results - Earnings Call Transcript

| About: Arctic Cat (ACAT)

Arctic Cat, Inc. (NASDAQ:ACAT)

Q3 2016 Earnings Call

January 28, 2016 12:00 pm ET

Executives

Shawn Brumbaugh - Director, Investor Relations & Corporate Communications, PadillaCRT

Christopher T. Metz - President and Chief Executive Officer

Christopher J. Eperjesy - Chief Financial Officer

Analysts

Tim A. Conder - Wells Fargo Securities LLC

Scott W. Hamann - KeyBanc Capital Markets, Inc.

Joseph D. Hovorka - Raymond James & Associates, Inc.

Craig R. Kennison - Robert W. Baird & Co., Inc. (Broker)

Jaime Katz - Morningstar Research

Mark E. Smith - Feltl & Co.

Gerrick Luke Johnson - BMO Capital Markets (United States)

Operator

Good day and welcome to the Arctic Cat's Fiscal 2016 Third Quarter Earnings Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Shawn Brumbaugh. Please go ahead.

Shawn Brumbaugh - Director, Investor Relations & Corporate Communications, PadillaCRT

Thank you, Priscilla. Thank you for joining us this morning. I'm Shawn Brumbaugh with PadillaCRT.

Before the market opened this morning, Arctic Cat released results for its fiscal 2016 third quarter ended December 31, 2015. Participating in our call today to discuss the company's performance and outlook will be President and Chief Executive Officer, Christopher Metz; and Chief Financial Officer, Christopher Eperjesy. Following their remarks, we'll have time for questions.

Before we begin, please note that some of the comments made today will be forward-looking statements regarding the company's expectations of future performance. Such statements are subject to risks and uncertainties and actual results may differ materially from those contained in the statements. These risks and uncertainties are described in today's news release and in the company's filings with the Securities 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, Chris Metz. Chris?

Christopher T. Metz - President and Chief Executive Officer

Thank you, Shawn, and thank you all for joining us this morning. Today, I'd like to review the company's performance in the fiscal 2016 third quarter and provide an update on our strategic initiatives. Despite a very challenging marketplace and difficult third quarter comparison, Arctic Cat made continued progress and executed well on our strategies to reposition the business for a return to growth in fiscal 2017 and beyond.

In the fiscal 2016 third quarter, net sales were down 14.3% compared to the prior year. Unfavorable foreign currency exchange reduced net sales by 4.9%. The resulting net loss was $0.18 per share. Contributing to the lower year-over-year fiscal 2016 third quarter results was the timing of shipments. As we lapped the introductions, several new ATV products and pipeline fill of the Wildcat Sport and Wildcat Trail ROV models that shipped in the prior year third quarter. This year, our new mid-year ATV/ROV model shipments will occur in the fiscal 2016 fourth quarter. In total, however, we expect sales for the fiscal 2016 second half to be up.

Among the third quarter highlights, we began to strengthen our dealer network and activate sales through important marketing sponsorships with our new event marketing team. This resulted in positive retail growth. We maintained tight inventory control to allow a return to greater wholesale and retail growth of new products next fiscal year. In addition, the company generated $27 million in operating cash flow that enabled us to strengthen the company's balance sheet and eliminate long-term debt as planned.

Despite our progress, we're lowering our outlook for the remainder of fiscal 2016. This is chiefly due to the intensifying impact of unfavorable foreign currency exchange rates, a softening ATV/ROV retail market industry-wide, and the lack of early season snowfall on snow-related product sales. Still, we expect that our fiscal 2016 fourth quarter sales will increase approximately 40% compared to the year ago fourth quarter, and we anticipate cutting the fourth quarter net loss almost in half.

Our current fiscal 2016 is one when we are rebuilding and repositioning the company. We expect to begin accelerating our sales and earnings power in fiscal 2017. Further, we remain committed to our long-term fiscal 2020 goal to reach over $1 billion in net sales with gross margins in the range of approximately 27% to 28%.

To this end, we are continuing to enhance the speed of our organizational change, efficiency and productivity with a keen focus on our key initiatives to reinvigorate growth. These include dramatically improving our dealer network, ramping up end user focused new products, pursuing OEM partnerships and bolt-on acquisitions and creating a brand marketing powerhouse.

I'd like to briefly update you on our progress against these initiatives in the third quarter. First, our efforts to strengthen our dealer network are starting to gain traction. This is one of our highest priorities. We're developing a top quartile performing dealer network in terms of size, productivity and capabilities in every region in North America. We already have assessed our dealer base and we're in the process of making changes where needed to strengthen our network.

We're setting clear expectations, measuring results and driving accountability. We also are committed to supporting dealer development through training and sell-through marketing programs. We've identified geographic territories where we are either underrepresented or not represented at all. We are aggressively working to fill these territories with top performing dealers that have the ability to increase Arctic Cat's sales volume and market share. As an example, we've added 10 new dealers in just the last 90 days with more to come. Looking out over the next 12 months, we anticipate adding 75 top-tier dealers to our distribution network and we're well underway to achieving this.

Second, we are ramping up on end-user focused new products. We remain in the initial stages of delivering on this with our new product launches and our partnership with Robby Gordon. We're developing end-user focused strategic business units that deliver industry-leading, innovative and profitable new products. We will achieve this through research and development and new product innovation processes that support a dynamic new product pipeline.

Our efforts involve creating a multi-generational product and technology roadmap for ATVs, ROVs and snowmobiles, as well as related accessories. In our snow business, we will launch a larger new product lineup for the 2017 model year at our dealer show in March. Among the new snow products we will unveil is our SVX 450 single-ski snow vehicle. We previewed a prototype of this vehicle in September. With the SVX 450, we're excited to offer the industry's first purpose built OEM snow bike. Snow biking is a growing sport across Western North America and our patented SVX 450 snow vehicle is designed to provide an exciting new riding experience for a whole new category of riders who want the lightest, most affordable vehicle for mountain riding. Arctic Cat will be entering a growing new category with the SVX snow vehicle.

In our ATV and ROV business, you'll recall that we introduced our first wave of off-road vehicles to dealers last August, along with the Robby Gordon's SPEED brand of race inspired side-by-side accessories. At that time, we unveiled seven all new products, including four special addition models built in limited quantities, more powerful Wildcat Sport models and, of course, the all new Alterra ATV brand.

In February, we will begin shipping a second wave of new 2017 ROV and ATV models, including our highly anticipated six-passenger HDX 700 Crew ROV, which has a versatile two-in-one cargo box that transforms into a flatbed along with an industry-leading 1,000 pound cargo capacity. We'll also be introducing our new Prowler 500 that meets the need for a midsize lower-cost utility side-by-side. We'll also be introducing the new Alterra TRV, which is a two-rider vehicle and allows a passenger to sit behind the driver. And we rolled out and will roll out our special addition Wildcat Trail packages for hunters and outdoorsmen. We are pleased with the initial dealer-consumer responses to all of these new products.

Our growth plans for the ATV and ROV business also include expanding our engine facility in St. Cloud, Minnesota. This expansion will enable us to move our dirt products' engineering team into this state-of-the-art research and design center this summer. We'll have a larger testing track and racetrack in St. Cloud as well. Overall, we see significant growth opportunities ahead for our dirt business.

In addition to launching new products, ensuring that our dealers are in a healthy inventory position is a critical part of our growth and our strategies. This will enable a return to wholesale and retail growth of new products next fiscal year. To this end, we continued our effort to lower inventory by curtailing wholesale shipments to dealers. Sequentially, Arctic Cat succeeded in reducing our inventory by $25 million from the end of fiscal 2016 second quarter, primarily in core ATVs. This reduction enabled us to sell new products to dealers without a corresponding rise in overall inventory.

Year-to-date, even with pipeline fill for new products introduced in fiscal 2016, we've reduced total ATV dealer inventory in North America by approximately 4,000 units. We also are focused on driving retail sell-through marketing to move our dealers' inventory and ensure their success. This is where our initiative to create a brand marketing powerhouse comes into play. Arctic Cat's brand promise is to create the ultimate off-road riding experience. Our objective is to deliver passionate and exciting experiences at all customer touch points to drive double-digit retail sales growth every year.

To achieve this, we are enhancing our field marketing, advertising, race sponsorships and team training. Most recently, for example, we announced that Arctic Cat is a 2016 title-sponsor of Tony Stewart's All Star Circuit of Champions Sprint Car Series. Our Wildcat side-by-sides will be showcased at numerous All Star events in racing expeditions and demo rides for race fans. We're excited to begin reaching new end-users at this racing event and others and build our brand.

We're beginning to see a correlation between our enhanced go-to-market strategies and our increased retail sales. Compared to the year earlier third quarter, our total ATV, ROV unit retail sales in the fiscal 2016 third quarter rose mid-single-digits versus an industry that was flat to slightly down. For the calendar year, our retail sales grew low double-digits in core ATVs and high single-digits in ROVs.

Turning to our organizational structure, we also made continued progress in enhancing our culture and talent. We added select professionals in senior roles during the third quarter 2016, who will help us our goals this year and beyond. We especially want to welcome Steve Nadler who started this week as Vice President and General Manager of our parts, garments and accessories business. Steve brings a proven track record of developing and selling innovative consumer products. Most recently he was with Exxel Outdoors, which designs and distributes outdoor recreation brands, such as Sierra Designs and Kelty. I've personally worked with Steve in the past and he's a super addition to the team.

In addition, we welcome a Director of Engineering, a new Treasurer and two Senior Managers of dealer development. We are pleased to be attracting talented individuals to deepen our management bench and help us drive greater performance. Despite our continued progress in each of these stated key strategies, we recognize the significant headwinds in front of us and we'll take appropriate actions to reduce cost and inefficiencies wherever possible. We already have seen good returns on the cost reduction initiatives this year that we put in place.

We have faced difficult market conditions before and we will remain vigilant in controlling costs. At the same time though, we will not stop investing in our key strategic initiatives, each of which is gaining traction and showing promise. We're confident in our strategic plans and we will continue to take actions that enable a return to long-term profitable growth.

With that, I'll turn it over to Chris to review the financials. Chris?

Christopher J. Eperjesy - Chief Financial Officer

Thanks, Chris. Good morning, everyone.

Please note, in my comments today, all references to earnings per share are on a fully diluted basis. Today, Arctic Cat reported a net loss of $2.4 million or $0.18 per share and net sales of $166 million for the fiscal 2016 third quarter ended December 31, 2015. In the prior year quarter, Arctic Cat reported net earnings of $7.5 million or $0.57 per share and net sales of $193.7 million.

Sales of ATVs and ROV side-by-sides decreased 28.5% to $60 million from $83.9 million in the year ago quarter. Compared to the prior fiscal year's third quarter, total ATV/ROV unit sales were up as Chris noted. However, wholesale shipments versus the prior year were down as prior year third quarter included the shipment of several new ATV products and pipeline fill of the Wildcat Sport and Wildcat Trail ROV models.

In comparison, Arctic Cat's new mid-year ATV/ROV model shipments will occur this year in the fiscal 2016 fourth quarter. We continued to curtail the wholesale shipments of core ATV models in the third quarter to support our ongoing effort to reduce core ATV inventory at our North American dealers. As Chris stated, Arctic Cat succeeded in reducing inventory by $25 million sequentially from the end of the fiscal 2016 second quarter, primarily in core ATVs. This enabled the company to sell new products to dealers without a corresponding rise in our overall inventory. Foreign currency translation also negatively impacted the year-over-year ATV and ROV sales comparisons.

Snowmobile sales in the fiscal 2016 third quarter rose 2% to $83.1 million versus $81.5 million in the prior year quarter. Snowmobiles sales increased despite the second year of low snowfall in key regions in the December quarter and unfavorable foreign currency exchange. Parts, garments and accessories sales were down 19.2% to $22.9 million from $28.3 million for the same quarter last year. The decline is primarily attributable to unfavorable foreign currency exchange and lower sales of snow related items stemming from the lack of early winter snowfall as previously mentioned.

Arctic Cat's gross profit margins was 14.6% compared to 18% in the prior-year quarter, stemming from lower sales volume as we continue to work on rightsizing the company's core ATV inventory. Also affecting gross margin was the greater unfavorable foreign currency exchange impact, which reduced gross profit in the quarter by approximately $8.2 million or $0.38 per share.

Let me add a little bit more color on gross margins. Despite lower shipments to reduce our inventory, we have driven strong year-over-year material productivity. We also see continued improvement in our quality, resulting in better warranty costs. Unfortunately, our progress and margin expansion is being mitigated by currency.

Selling, general and administrative expenses were $22.8 million, essentially flat with $22.6 million in the year-ago quarter. SG&A expenses as a percentage of sales were 13.8% compared to 11.7% for the same quarter last year. We continue to focus on lowering discretionary spending while maintaining investments in research and development to ensure a strong pipeline of new products.

The operating loss from the fiscal 2016 third quarter was $5.8 million versus an operating profit of $5.9 million in the same quarter last year, reflecting lower sales volume and unfavorable foreign currency exchange. The company's effective tax rate was 60.1% for the quarter ended December 31, 2015 compared to 29.7% for the year ago period. The increase was due to a larger rate impact from discrete items in the fiscal 2016 third quarter as a result of lower pre-tax earnings. Year-to-date the effective tax rate was 27.2% compared to 24.8% in the prior year. Year-to-date increase in the effective tax rate was primarily due to the lower estimated pre-tax earnings for the full year.

Looking at the balance sheet, Arctic Cat ended the fiscal 2016 third quarter with cash, cash equivalents and short investments totaling approximately $11 million as planned compared to $67.5 million a year ago. The company continued to make investments in the business to lay the foundation for future growth and improved efficiency.

Receivables decreased to $44.3 million from $59.1 million at the end of the prior year quarter, primarily due to the timing of shipments and lower planned sales. Inventory totaled $146 million versus $144 million at the end of the third quarter last year. Capital expenditures in the 2016 third quarter totaled $8 million and depreciation and amortization was $4.9 million. We continue to expect fiscal 2016 capital expenditures to total approximately $35 million to $40 million and depreciation to be approximately $17 million to $19 million, as we invest in modernizing our manufacturing processes at our Thief River Falls and St. Cloud facilities, both in Minnesota and increase our investment in tooling for key new product introductions.

The company generated approximately $27 million in operating cash flow in the fiscal 2016 third quarter, enabling us to eliminate long-term debt of $15.8 million in the fiscal 2016 third quarter as planned. The company now has no long-term debt.

Turning to the dividend, in order to preserve cash for continued investment and returning the company to grow, Arctic Cat's Board of Directors has voted to suspend regular quarterly cash dividends on our common stock effective immediately. Suspending the dividend will conserve approximately $6.5 million in cash annually. The board's decision is prudent given the current macroeconomic and foreign currency headwinds. While we can't predict when these will improve, we expect that as conditions normalize, our future earnings levels will permit resumption of dividend payments.

Taking a look at our full year outlook for the remainder of fiscal 2016, we are lowering our outlook for the balance of the fiscal year chiefly due to the intensifying impact of unfavorable foreign currency exchange rates, a softening ATV and ROV retail market industry-wide and the weather effect on snow related product sales. Still, we expect that fiscal 2016 fourth quarter sales will increase approximately 40% compared to the prior fiscal year's fourth quarter and that we will cut the fourth quarter net loss almost in half.

In fiscal 2017, we expect to begin accelerating our sales and earnings power. Further, we remain committed to achieving our stated goal of reaching $1 billion in sales by the end of fiscal 2020. For the fiscal year ending March 31, 2016, we now estimate full year net sales in the range of $645 million to $655 million with a greater unfavorable foreign currency exchange impact in the range of $32 million to $35 million. We now expect the fiscal 2016 full year net loss to be in the range of $0.25, $0.30 per share, reflecting the worsening unfavorable foreign currency exchange rates, particularly the Canadian dollar as approximately 30% of Arctic Cat annual sales are to Canada.

Foreign currency exchange headwinds are estimated to negatively impact gross profit and reduce net earnings in the range of $1.48 to $1.62 per share, when compared to fiscal 2015 which will be partially offset by the company's hedging strategy. Previously, the company estimated full year net sales for fiscal 2015 in the range of $665 million to $675 million with an unfavorable foreign currency exchange impact on the sales of the range of $27 million to $30 million. At that time, Arctic Cat expected fiscal 2016 full year net earnings to be in the range of $0.05 to $0.15 per share, after factoring in negative foreign currency exchange impact on gross profit and reduced earnings in the range of $1.25 to $1.39 per diluted share.

Our fiscal 2016 full year outlooks includes the following assumptions. Snowmobile sales to dealers down mid-teens as we focus on reducing non-current dealer inventory. Improved snowfall in January has us on pace to grow our retail snowmobile sales, which we anticipate to be up high single digits to low double digits in our fourth quarter.

ATV/ROV wholesale sales up low single digits and PG&A wholesale sales are expected to be down mid-single digits due to adverse weather patterns. We now expect year-over-year gross margins to be down approximately 140 basis points versus fiscal 2015 levels, assuming further unfavorable movement in the Canadian dollar and, to a lesser extent, euro exchange rates for the rest of the year. Our previous guidance anticipated gross margins to be down approximately 80 basis points.

We expect operating expenses as a percentage of sales to decline slightly in fiscal 2016, excluding the Motorfist acquisition, as we move past our one-time expense categories and remain focused on expense management and implementing efficiencies throughout the organization. We are making progress against our goals and we believe that we have tremendous opportunities to improve the company's operations, expand gross margins and enhance our financial performance.

And now, we'd like to open up the call for questions. Priscilla?

Question-and-Answer Session

Operator

Certainly. We'll take our first question from Tim Conder with Wells Fargo. Your line is open.

Tim A. Conder - Wells Fargo Securities LLC

Thank you, gentlemen. I've missed, Chris, my apologies, part of your preamble. The calls have been pretty tight today with a couple other power sports companies. But on the Canadian dollar, what level are you assuming for Q4, either outright or where you have it hedged in at, and then fiscal 2017? And then, regarding SAP, as you guys are making the investments this year in the plant, when do you anticipate the SAP that had been installed by the prior management team, you guys start utilizing that and seeing benefits from that?

Christopher J. Eperjesy - Chief Financial Officer

Hi, Tim. This is Chris Eperjesy. On the first question, we're assuming low $1.40s, so $1.43, $1.44 for Q4. We haven't really talked about fiscal 2017, so I'll leave that till we – after the fourth quarter when we give our guidance and lay out what our expectations are for next year. In terms of our hedging, nothing's changed. We put on hedges, and we would have just put on 20% hedge four quarters out in the low $1.40s. So every quarter we're adding on that incremental 20%.

And on the question on SAP, we're making incremental improvement all the time. So I think that's more of a evolutionary process as opposed to one kind of cliff event. So we had money in the budget this year to make improvements to our systems and we're going to continue to do that next year. So, part of it is the systems improvements and part of it is some of the talent acquisition that Chris talked about, that we've added in the manufacturing plant and in the supply chain and logistics side. So we're starting to see the benefits of that, and I think you're going to see some of that margin expansion next year.

Tim A. Conder - Wells Fargo Securities LLC

Okay and, again, my apologies if you covered this, but from the standpoint of your dealer network, when do you anticipate the heavy lifting as far as the upgrade process to be complete? And then, as it relates to engines, you talked about – in your press release about continuing to increase that mix. How do you see that trending over the next two years, three years, your mix of engines from self-source to Suzuki, to the small portion you do with Yamaha?

Christopher T. Metz - President and Chief Executive Officer

Okay. Hey, Tim, Chris Metz here. Hey, on the dealer side, we're going to continue to invest in helping our dealers as well as expanding our dealer network. So we are putting an enormous amount of focus and resources to match that focus on the dealers today. We've identified hundreds and hundreds of underserved open territories where Arctic Cat is not represented, and we're going after them with a vengeance. And we're going to make sure that where we do add dealers, they complement the current dealer network today. So, you should expect to see us continue to report out on our progress in terms of number of top tier dealers we add and the resources that we invest to support this effort. But we're pretty excited about our efforts there. We added 10 new dealers in the last 90 days and we think we're going to add about 75 in the next 12 months.

In terms of engines, we've come to the strategic conclusion that we need to expand the Arctic Cat offering of engines to help us in areas where we're in need. We've hired a Director of Engineering who is focused solely on engine and engines. And I think what you'll likely see is the outlying part of your two-year to three-year ask, it's probably closer to three years where we'll start to see a much bigger contribution, given the period of time it takes to develop some of the engine technology. And what we're going to do some of this in partnership, too.

Tim A. Conder - Wells Fargo Securities LLC

Okay, okay.

Operator

Thank you. We'll go next to Scott Hamann with KeyBanc Capital. Your line is open.

Scott W. Hamann - KeyBanc Capital Markets, Inc.

Thank you. Good morning. Just following up on the ATV channel inventory commentary, it seems like 4,000 units has been the takeout since the end of the first quarter. And I'm just curious if the 5,000 units to 7,000 units is still the target out there or if something has changed on that front?

Christopher T. Metz - President and Chief Executive Officer

Yeah. So, Scott, Chris Metz here. You're right. I mean, it's been about 4,000 pieces. And given what we've seen in the trends in the industry and the amount of new product we launched, frankly, we're pretty excited to be at 4,000 pieces. You look at our retails for the third quarter, in core ATVs we're up low double-digits which was significantly better than the industry, which helped us keep at that 4,000 level. Now, with the new products we're launching here in February in the fourth quarter, I don't think we're going to get to the 5,000 pieces to 7,000 pieces. And I don't think we need to.

When we laid out the original projections of 5,000 pieces to 7,000 pieces down, I think we misunderstood, in our minds, the impact of growing both our retail and potentially our dealer base which are going to require more inventory as well as the impact of new products. But what I can tell you is in addition to units we're really peeling back the ratio of current to non-current in our dealers' showrooms and on their shelves, because that really gives you an indication of health. And so, just last year as an indication, we had a much, much, much of our non-current product who's sitting in two year, three year, four year old model year product. This year, or I would say better than 90% of our non-current products, are model year 2015, were in a much healthier position.

Scott W. Hamann - KeyBanc Capital Markets, Inc.

Okay, understood. And then in terms of the snow, you gave a few numbers there. Can we get a season to date kind of industry number, and then where your retails are; and just maybe some quantification on where your retail inventory sits for the snow business?

Christopher T. Metz - President and Chief Executive Officer

Sure. So, I mean like the rest of the industry; very, very concerned with the snow patterns. And so when you look at season to date through December, we were tracking at about the industry average which was down 20%. We like how January started. And we put in our projections of what we'd need to see January and February and March do to close out the season. And if we hit those projections, we feel like we'd be in a good inventory position. Through the first 30 days, we're tracking better. Now, I don't know what's going to happen with snow in February and March, but we like where we're at right now. But like the rest of the industry, we remain cautious because we need to see continual snow, but our retail's picked up dramatically in January.

Scott W. Hamann - KeyBanc Capital Markets, Inc.

Okay. And then my last question is just around some of the plant investments and initiatives. You talked a little about St. Cloud. Can you give us some timing around that and then some of the progress you made at Thief? And just with the CapEx numbers you highlighted this year, I mean how should we think about the need for additional capital on these projects moving into fiscal 2017? Thanks.

Christopher T. Metz - President and Chief Executive Officer

Sure. It's kind of good question. So I'll take Thief River Falls first, because we've invested a lot of time and energy and money in the paint line. It's going great. And so, we'll be coming up online here in February and you should start to see some contributions to our margin line next fiscal year because of the paint line.

As it relates to St. Cloud, we've decided over the past 90 days that we're going to throw a flag down and create a world-class research and development center in St. Cloud, where engines are built today. And we feel like being a suburb of the twin cities will allow us to augment the talent that we have in R&D with more talent. And we'll be able to attract talent easier because of that location, it's a super facility. And so the investments we're going to make there are both in head count to support R&D on the real product side, as well as some of the physical assets they're going to need to do the research and development work. We're constantly looking for good payback CapEx projects, which we will probably detail for you all more at the end of our fiscal year, but we've got a couple that we're looking at hard right now that have good paybacks that we'll gladly invest the CapEx in.

Operator

Thank you. We'll move next Joe Hovorka from Raymond James. Your line is open.

Joseph D. Hovorka - Raymond James & Associates, Inc.

Thanks, guys; couple of questions here. One is, what's your average Canadian dollar through December for the year?

Christopher J. Eperjesy - Chief Financial Officer

Average Canadian dollar through December for the year is slightly above, probably $1.30.

Joseph D. Hovorka - Raymond James & Associates, Inc.

$1.30, okay. And then, where are you hedged so far for fiscal 2017?

Christopher J. Eperjesy - Chief Financial Officer

So we're hedged out through the first three quarters and had different rates for each of the quarters. So, we're hedged out into Q3 which would be a 20% hedged; and of course, it would have been put on this quarter at the low-$1.40s and then walking back to 40% and 60%. And again, those hedges would have been put on 20% over the last three quarters.

Joseph D. Hovorka - Raymond James & Associates, Inc.

So, they would be obviously higher than the $1.30, right?

Christopher J. Eperjesy - Chief Financial Officer

Correct.

Joseph D. Hovorka - Raymond James & Associates, Inc.

But not quite $1.40. So, if we stay at, let's say, $1, whatever, low-$1.40s to mid-$1.40s and we're going to comp against that $1.30, it's almost a 10% move in the currency year-over-year and if you got $20 million; or I mean $200 million of sales with $20 million of incremental headwinds next year, can you be profitable in 2017, let's say, at C$1.44?

Christopher J. Eperjesy - Chief Financial Officer

I mean what I'll say is that's our goal, Joe.

Joseph D. Hovorka - Raymond James & Associates, Inc.

Yeah.

Christopher J. Eperjesy - Chief Financial Officer

So that's what we're working on. We think we have a lot of things that are kind of being lost in the numbers because of the currency impact. Chris touched on that there is margin expansion that's been hidden in those numbers, the raw material productivity around things we're doing in the plant and other efficiencies that will have a full year impact next year as well as the paint line coming on with some other things. So, certainly our goal for next year and we'll elaborate more and confirm that at year-end is to be able to be profitable, yes.

Joseph D. Hovorka - Raymond James & Associates, Inc.

Right. Okay. So when I look at it – because if I take that, that's a 300 basis point hit to gross margins. What you're saying is that the things that you're capable of doing should be 300 basis points or better to offset that and then some – just so I'm clear on that?

Christopher J. Eperjesy - Chief Financial Officer

You know I'll trust your math, Joe, because I haven't done the math...

Joseph D. Hovorka - Raymond James & Associates, Inc.

Okay.

Christopher J. Eperjesy - Chief Financial Officer

... (33:27) but I don't have it in front of me, but you're assuming a $1.30 comparison and that's not a fair comparison because that was a year-to-date number you asked me for. If you take into account where we're at right now and assume that for the fourth quarter, you're up closer in the mid-$1.30s, so it'd be less of an impact than you're talking about versus our...

Joseph D. Hovorka - Raymond James & Associates, Inc.

Okay.

Christopher J. Eperjesy - Chief Financial Officer

... (33:46) for this year, but directionally, yes.

Joseph D. Hovorka - Raymond James & Associates, Inc.

Okay. That's there, yeah. It should just up, like you're saying.

Christopher J. Eperjesy - Chief Financial Officer

Yeah.

Joseph D. Hovorka - Raymond James & Associates, Inc.

Okay. And then, on Scott's question about the 4,000 unit reduction in inventories, and we've kind of been there since I think June-ish, and I know you say you've grown dealers, and that makes sense that you're going to have to fill those a bit with product, but at the same time I mean the off-road vehicle market has clearly weakened significantly since June. Would that not argue that you would want less inventories out there, that is, maybe they're working against, right. You see what I'm saying, like you got to fill some of these new dealers, but in total because the market's now down low-single instead of up mid-single that your base case of inventories would be lower?

Christopher T. Metz - President and Chief Executive Officer

Yeah. But Joe you got to remember the fact that the industry is down mid singles, but we're up. And so our...

Joseph D. Hovorka - Raymond James & Associates, Inc.

Well, right. Yeah. But we're also up because we're discounting heavily, right. We can't make an assumption that that's your debt's not sustainable. It's sustainable once you get new product but it's not sustainable here, right?

Christopher T. Metz - President and Chief Executive Officer

Joe, our first quarter promotional activity because the No Brainer was dramatically higher and since that time we've actually underspent industry, and we've grown our retail positively.

Joseph D. Hovorka - Raymond James & Associates, Inc.

Okay.

Christopher T. Metz - President and Chief Executive Officer

I don't know how long that can continue, and clearly if the economic environment continues to decline, then our retail is going to slow down as well. But all I can tell you is that we're growing our retails and not having to over promote to do it, we're being aggressive and we're up sequentially, and up year-over year in our rebate, in our incentives, but it's not terrible.

Joseph D. Hovorka - Raymond James & Associates, Inc.

Okay.

Christopher T. Metz - President and Chief Executive Officer

So – but anyway, we feel good because of the ratio of current to non-current. I mean, when we sit down and talk to our dealers, they feel like our best dealers are in much healthier position from an inventory standpoint.

Joseph D. Hovorka - Raymond James & Associates, Inc.

Okay. And on snowmobiles, where were your dealer inventories at the end of December versus last year?

Christopher T. Metz - President and Chief Executive Officer

Yeah. So our dealer inventory was up for sure. And so, it was up because our retails were down, I said, about 20%. So, we had more inventory clearly than we wanted and our dealers are nervous. January is certainly helping and it's across the board. So we look at our dealer sell-through in snow across the east, the central, the west in Canada, and in all regions, they're all up double-digits significantly in January.

Joseph D. Hovorka - Raymond James & Associates, Inc.

At retail, yes.

Christopher T. Metz - President and Chief Executive Officer

At retail.

Joseph D. Hovorka - Raymond James & Associates, Inc.

Yeah. And I think I'm trying to get over (36:31), I think Polaris is talking about something like 20% or 20%-plus increase in dealer inventories at the end of December, but they're also seen obviously increase sales through with the snowfall, and that's coming down to the point where it's like maybe up mid-teens. Is that the same kind of level of magnitude that we're talking about here at Arctic Cat?

Christopher T. Metz - President and Chief Executive Officer

I would say that's a safe number, yeah.

Joseph D. Hovorka - Raymond James & Associates, Inc.

Okay. And then just one last question, when you look at the balance sheet going into 2017, would you expect to borrow on a seasonal basis in 2017, like we did here in 2016?

Christopher J. Eperjesy - Chief Financial Officer

Yes, Joe. This is Chris – Chris Eperjesy. Yes.

Joseph D. Hovorka - Raymond James & Associates, Inc.

Okay. Okay. Great. Thanks guys.

Christopher J. Eperjesy - Chief Financial Officer

Thanks, Joe.

Operator

Thank you. We'll move next to Craig Kennison with Robert W. Baird. Your line is open.

Craig R. Kennison - Robert W. Baird & Co., Inc. (Broker)

Good morning. Thanks for taking my question as well. In the press release, you talked about an OEM partnership and your hopes of pursuing more activity in that regard. Any update to share as you start to plan your CapEx as well?

Christopher T. Metz - President and Chief Executive Officer

Hey Craig, all I can say at this point is – because it's not something we're ready to disclose publicly, we're making a lot of progress on the OEM front. And this has been going on really since last spring where we're in discussions, we're in active product development cycle, and at the appropriate time we're going to come out and share, as we can, where we are on this. All I can tell you at this point is that we're excited about a couple of different OEM partnerships and we're working on it hard.

Craig R. Kennison - Robert W. Baird & Co., Inc. (Broker)

Thanks. And I guess as we look at your decision to spend on the engine side and really commit to your own production there, does that imply you're less willing to partner on the OEM side in the same way that you've partnered with Yamaha for snowmobiles?

Christopher T. Metz - President and Chief Executive Officer

No, not at all; not at all. In fact, we're really happy with our Yamaha partnership. It's a real win-win. We expect that to continue. They're great partners of ours. And this isn't – when you look at our engines today that Arctic Cat produces out of St. Cloud, it's a pretty substantial number. We're just talking about increasing it and taking a couple of key areas that we want to be prime in; but by no way is it going to affect our OEM partnerships that exist today, because they help us to a great extent.

Craig R. Kennison - Robert W. Baird & Co., Inc. (Broker)

Thanks. And finally, you mentioned the desire to add 75 dealers. Is that a net or a gross number, and what was the year-end figure, again, on that?

Christopher T. Metz - President and Chief Executive Officer

Yeah. That's a gross number, and we are stating that for our calendar year. So, as we know...

Craig R. Kennison - Robert W. Baird & Co., Inc. (Broker)

Thank you. Do you know what the net number would be?

Christopher J. Eperjesy - Chief Financial Officer

I don't, I don't. But I know that we've got fair bit of determinations behind us. And so, I don't know what the net number would be, but that would be a gross number and we feel good about that. We don't think there's going to be a lot of leakage at all.

Craig R. Kennison - Robert W. Baird & Co., Inc. (Broker)

Great. Hey, thank you.

Operator

Thank you. And we'll take our next question from Jaime Katz with Morningstar. Your line is open.

Jaime Katz - Morningstar Research

Hi, guys. Good morning. I just wanted to put a different spin on some of the inventory questions, which is how do you guys think about protecting the brand? You're obviously shipping into a very difficult environment, and how do you balance thinking about shipping the newest products with preventing discounting on, I guess, stale inventory?

Christopher T. Metz - President and Chief Executive Officer

Well, there's a mindset that's been built into the industry for years and years, and it's also in the auto industry, that non-current product gets promoted. And so, that creates door openers and loss leaders, sometimes, for our dealers, but for the most part it creates door traffic. The new products are margin-building and create excitement. And so, the more new products we have, the better our margins are for our dealers. And so, we're excited to get those out in the marketplace.

Jaime Katz - Morningstar Research

Okay. And then, is there anything that has driven footfalls better in the dealerships, either financing or marketing? What has been working the best to motivate consumers?

Christopher T. Metz - President and Chief Executive Officer

So we've done a couple of the things here. We've changed our promotional activity a little bit, where we've gotten more than just rebate-driven. We've done some other things that allow our dealers to sit down with a potential consumer and give them the opportunity to take it in different forms rather than just rebates. So it's more creative and it allows more individual dealing, I guess, if you will.

The second piece is marketing. A big strategy of ours is creating a marketing powerhouse, and we've put marketing event brand ambassadors out in the field and we're attending and activating where our consumers are at races and what have you. So a big part of what we're doing is tying ourselves with our dealers, going to events and creating excitement and energy at these events, and we think that's contributing a great deal to the foot traffic as well as the increased retails.

Jaime Katz - Morningstar Research

Thanks.

Operator

Thank you. We'll move next to Mark Smith with Feltl & Company. Your line is open.

Mark E. Smith - Feltl & Co.

Good morning, guys. First off, I just wanted to ask on PG&A. It came in light of our expectations here in the quarter, especially given the acquisition in the spring of Motorfist. Was this due primarily to unfavorable weather or is there something else going on within PG&A that slowed that down? And then, your guidance implies a pretty solid fourth quarter. Is that primarily driven by some better weather in January?

Christopher T. Metz - President and Chief Executive Officer

Yes, on both accounts, Mark. When we look at what we're forecasting for the year, our snow business is going to be largely where we forecasted. It's going to be right on. And as we said before, we got to see continued good snowfall just to make sure that that product sells through. Our ATV/ROV business, right on budget. It's the PG&A business that frankly has caught us off guard a little bit and it's a 100% because of weather. It's down versus budget and down versus last year because of the snow-related impact on PG&A. And unfortunately, that just has really dampened the impact of Motorfist I mean, we walked out of the show last year our snow show, we added a 100 new dealers. For Motorfist. It was a great, great beginning. And what's happened is a lot of their business is in lack of snow areas this year and it's really hurt them. But we're still really, really excited about Motorfist. If you haven't used the product, I encourage you to use it. It's awesome. And we got a really good team there. We're excited about the prospects of it, but it's down for the same reasons. And when we look for a little bit of recovery here in the fourth quarter, it is because we're expecting better snow like we're seeing here in January.

Mark E. Smith - Feltl & Co.

On that, how much of your PG&A guidance for Q4 is accessories that will be shipped with more off-road vehicles here in Q4, because it seems like a pretty big ramp to be able to just have it be weather here in a couple of months period?

Christopher T. Metz - President and Chief Executive Officer

Hey, Mark when you started looking at our PG&A business, we really got a factor into, yeah some of the new products that we're launching that attach to the real product that we're launching. So we're going to get an impact from launching new products and then that's where it's predominantly going to come from.

Mark E. Smith - Feltl & Co.

Okay. And then lastly and this has been asked a couple of times, but the guidance for off-road vehicles seems to imply your possibly best or second best quarter on record for sales of off-road vehicles. Given the current environment and in inventories coming down 4,000 pieces not quite the 5,000 pieces to 7,000 pieces that we'd hoped or looked for earlier in the year. How do you adjust by shipping that much off-road product here in Q4?

Christopher T. Metz - President and Chief Executive Officer

Well most of the increase we're seeing in Q4 is new products. So we're entering into some categories where we're filling white space for us, the crew being a perfect example of that, so we're not looking to over ship and put our dealers in a tough situation. So, yeah if you really take Q3, Q4 combined, and you look at the second half versus second half last year, we're up but not nearly the 40% we're stating in fourth quarter.

Secondly, I want to make sure I'm not painting too rosy of a picture. I wouldn't, by any means, say that our retail numbers are at record levels. We're happy to be outperforming the industry. But like everybody else, we're seeing a tough, tough environment, and we're scratching and clawing to get the type of retail growth that we're getting. We know that some of our core ATV retails are up, because we launched the new Alterra and we're getting some help there. And we're going to continue that with the TRV we're launching. But our ROV business has slowed down a bit. I mean, you all know that we're lacking horsepower on the Wildcat side and that's been hurting our ROV business a bit, which we're going to correct in 2017. So on balance, we're happy with where we're at. But we know it's a tough environment. I mean, January is evidence of it. I mean, the real business is tough and we're going to have to fight to continue to see our retails grow.

Mark E. Smith - Feltl & Co.

Last question, just modeling, maybe for Chris Eperjesy. As we look at tax rate here in Q4, is there may be more of a benefit that you guys get from R&D tax credit or anything else in Q4 that maybe helps you to get to that bottom-line guidance?

Christopher J. Eperjesy - Chief Financial Officer

No. I mean most of that because it's a discreet item, would have occurred in Q3, so the quarter that just happened. So I think it's still fair for future years when you get close to breakeven, that number becomes less and less meaningful. I still think mid-30% effective tax rate is a reasonable assumption to use but the majority of the R&D tax credit would have flowed through this quarter.

Mark E. Smith - Feltl & Co.

Great. Thank you.

Operator

Thank you. We'll go now to Gerrick Johnson from BMO Capital. Your line is open.

Gerrick Luke Johnson - BMO Capital Markets (United States)

Great. Thank you. I wanted to ask you about your new sponsorships, the All-Star Circuit Stadium side-by-side et cetera. How much are these adding to marketing expense on an annual basis? And then also, how do you measure the success of these initiatives in growing a brand and driving sales?

Christopher T. Metz - President and Chief Executive Officer

Yeah. So, Gerrick, the cost of the investment for some of these activities is not tremendous, but the impact is potentially very exciting. I mean so you take something like the sponsorship that we're doing right now, in fact all of them are not big expenses. It's how we want to activate and how we want to tie dealers and everything else which is really where we get the benefit from it. But if you guys think of NASCAR sponsorship or something like that, this isn't even close to that. I mean this is low expenditure type of stuff. But we're excited about it. I mean it's a great opportunity for us to showcase our vehicles and more we can tie our dealers in absolutely positively the better off we are.

And so we measure our success in a number of different ways. I mean we want to tie dealers in. so dealers have to be actively involved in it. And two in keeping with our experiential nature, we want to demonstrate the product and we want people to test drive the product. And we find that there's a correlation between showing up at these events and activating with users, demonstrating the product and driving the product, and we've got KPIs around each of these activities, and we can see the correlation with sales.

Gerrick Luke Johnson - BMO Capital Markets (United States)

Okay. Great. Thank you very much.

Christopher T. Metz - President and Chief Executive Officer

Thank you, Gerrick.

Operator

And we have no further questions at this time. I'd like to turn the call back to CEO, Chris Metz, for closing remarks today.

Christopher T. Metz - President and Chief Executive Officer

Okay. Thank you. We've recognized the significant challenges in front of us with a softening power sports marketplace, a stronger U.S. dollar, and lack of early season snowfall. However, our key strategies of improving and expanding our dealer network, developing revenue and margin expansion from new products, and creating a marketing powerhouse remain intact. We've made progress in each of these three areas and expect to build continued momentum going forward.

We're pleased our dealer inventory remains significantly lower, our core ATV retails grew in calendar year 2015, and exciting new Arctic Cat products are on track to be launched over the next 12 months. We expect new products will begin to contribute meaningful in the fiscal 2016 fourth quarter. We will continue to balance the investments needed for revenue and margin growth with a keen focus on continuously improving our efficiencies in a difficult macroeconomic environment. We look forward to updating you in May on our 2016 fourth quarter results and our fiscal 2017 outlook. Thank you for your time today and for your questions.

Operator

Thank you. This does conclude today's program. Today's program will be available for replay until February 4, 2016. To access this replay, please dial 888-203-1112 or 719-457-0820 and enter replay code 2203624. Once again, this does conclude today's program. Thank you for your participation. You may disconnect at any time.

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.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!