Arctic Cat FY 2008 Guidance Call Transcript

| About: Arctic Cat (ACAT)

Arctic Cat, Inc. (NASDAQ:ACAT)

Guidance Call

January 4, 2008 11:00 am ET

Executives

Christopher A. Twomey – Chairman of the Board, President& Chief Executive Officer

Timothy C. Delmore – Chief Financial Officer & CorporateSecretary

Shawn Brumbaugh – Padilla Speer Beardsley

Analysts

Edward Aaron – RBC Capital Markets

Assia Georgeiva – Infinity Research

Rommel Dionisio – Wedbush Morgan Securities

Joseph Hovorka – Raymond James & Associates

Mark Atlschwager – Robert W. Baird

James Hardiman – FTN MidwestSecurities

Adriano Almeida – Dalton, Greiner, Hartman, Maher & Co.,LLC

Operator


Good morning ladies and gentlemen and thank you for standing by. Welcome to the Arctic Cat conferencecall. During today’s presentation allparties will be in a listen only mode. Following the presentation the conference will be opened for questions. (Operator Instructions) This conference is being recorded Friday,January 4, 2008. I would now like toturn the conference over to Ms. Shawn Brumbaugh with Padilla SpeerBeardsley. Please go ahead ma’am.

Shawn Brumbaugh

Thank you for joining us this morning. I’m Shawn Brumbaugh with Padilla SpeerBeardsley. Leading our call today willbe Chris Twomey, Chairman and Chief Executive Officer of Arctic Cat. Also with us is Tim Delmore, Arctic’sChief Financial Officer.

Before the market opened today Arctic Cat issued its revisedexpectations for the fiscal 2008 third quarter and full year. Chris will review the preliminary results andthen we’ll have time for your questions. Please note that Arctic Cat expects to announce its actual third quarterresults on January 23rd.

Some of the comments made today will be forward-looking statementsregarding the company’s expectations of future performance. Such statements are subject to risks anduncertainties and actual results may differ materially from these contained inthe statements. These risks anduncertainties are described in today’s news release and in the company’sfilings with the Securities & Exchange Commission including the company’sreport on Form 10K.

Now, I’ll turn the call over to Arctic Cat’s CEO, ChrisTwomey.

Christopher A. Twomey

Thanks everyone for joining us this morning. We are obviously disappointed with the thirdquarter and full year results. Sinceentering the ATV business in 1996 Arctic Cat has always outperformed the industriesretail sales rate until this year. Thisyear our retail sales are down similar to the overall industries’ low doubledigit decrease. During the quarter wewere unsuccessful in completing our F08 dealer orders in a declining, industrywide ATV retail sales environment.

At the same time we became considered that the year longdecline in ATV sales for the industry and Arctic Cat was worsening so we madethe decision to cut our Q4 sales and production plan in order to keep ourdealer inventories more in line with retail demand. Our dealer inventories at the end of Decemberwas well below last year and we still plan to sell more ATVs in Q4 this yearthan we did last year. However, with thereduction we are announcing today we expect our dealer inventories will be ator below last year’s levels by year end. Most of the units we are shipping in Q4 are new models like the 366,700H1EFI and Thunder Cat which the dealers and customers have been waitingfor. Retail sales of our Prowler UTVcontinue to be strong. In Q3 we beganshipping our new Prowler XTX which uses our own 700H1 engine with EFI. With this new model we expect Prowler’sretail sales to continue to be strong in Q4 as well.

On a much brighter note retail sales of snowmobiles werevery strong in December as a result of the snow fall that hit the Midwestand East in late November and early December. This snow has gotten customers enthused about the sport and they arebuying snowmobiles from our dealers. Atthe end of December Arctic Cat snowmobile dealer inventory were down 30% fromlast year which was our plan when we lowered our F08 production. With lower inventories at year end we expectdealers to moderately increase their snowmobile orders for next year. Sales of snowmobiles parts, garments andaccessories are also doing well as people use their snowmobiles more this yearcompared to last year when we had little snow.

Now operator I’d like to open the call to questions.

Question-and-AnswerSession

Ladies and gentlemen at this time we’ll begin the questionand answer session. (OperatorInstructions) Our first question comesfrom Ed Aaron from RBC Capital Markets. Please go ahead sir.

Edward Aaron – RBCCapital Markets

I guess I’m trying to understand what really changed interms of the market from last time you had talked to the street because the ATVmarket was pretty weak at retail before kind of the start of this quarter. Is it that – did things get incrementallyworse at retail? Or, were you betting onan improvement at retail? Or, is it justthat maybe you over estimated the dealer appetite for product in light of thecurrent market conditions?

Christopher A. Twomey

I think it’s really a little of all of the above. Our sales force was enthusiastic about beingable to sell what they had remaining to sell and that was based on priorperformance. Our product, ourinventories were down as we had shipped less new product. We had outperformed the industry in all prioryears and we thought that as our new product came into the market that we wouldcontinue that performance. So, all ofthose things led to the optimism we had for Q3 and Q4. And, what we really saw was a continuation ofthe decline and from our viewpoint a worsening of the decline in the overallindustry sales in the last couple months of the quarter.

Putting all those things together we just felt that itdidn’t make sense even with an optimistic sales force it didn’t make sense togo out and sell units to dealers and just increase their inventory. So, we felt that take our production down,take our sales down, take our production down. We have plenty of units at the dealer level to maintain or even increaseour share with the new models we have out there and why build inventory at thedealer level. So, that’s why we decidedto make the cut in Q4.

Edward Aaron – RBCCapital Markets

When you say that you expect dealer inventories to be flatto down in ATVs by the end of your fiscal year is that for total ATVs or isthat just for core ATVs? If that numberwas just a total number what do you expect the core ATVs to look like comparedto same time last year?

Christopher A. Twomey

What do you mean core ATVs?

Edward Aaron – RBCCapital Markets

Excluding Prowler.

Christopher A. Twomey

That is core ATVs then. We expect the core ATVs number will be at or below where it was last yearat the end of the year.

Edward Aaron – RBCCapital Markets

On the snowmobile side it sounds like retails been prettygood with the weather. Can you quantifythe year-over-year change in your retail sales? Then also, you mentioned your inventory down 30% from last year. How does it compare at the dealer levels fromtwo years ago at this time?

Christopher A. Twomey

I don’t have the exact numbers Ed from two years ago at thistime but I can tell you that it is down from two years ago at this time aswell. I mean I can’t give you the exactnumber but I do know that it is down this year. This year I know exactly where we’re at. I didn’t compare it to two years ago but I can tell you that theinventory is down compared to last year and the year before with confidence.

Edward Aaron – RBCCapital Markets

And the question on the year-over-year increase in thesnowmobile retail sales?

Christopher A. Twomey

The month of December saw greater than 20% increase insnowmobile sales at retail.

Edward Aaron – RBCCapital Markets

What can we expect the inventory on the balance sheet tolook like as of the end of this summer when you report your quarter?

Timothy C. Delmore

We’ll update you on that in a few weeks. We do expect to end the year again with avery strong balance sheet, decent cash level and again, a strong financialposition.

Operator

Our next question comes from Assia Georgeiva from InfinityResearch. Please go ahead with yourquestion.

Assia Georgeiva –Infinity Research

Can you tell us what the availability in the Decemberquarter was for the 700EFI and for the Prowler? Are you able to manufacture enough given demand? And, what the sales trends have been forthose types of vehicles.

Christopher A. Twomey

It’s interesting the 700 – the XTX Prowler which uses our700EFI engine really just started to shift at the end of the quarter kind ofend of November all through December time period. A lot of excitement at the dealer level forthat model. It takes about a month or sofor that to translate into the retail sales and get those carts back into thesystem. But, our sense is we’re doingwell with that at the dealer level – at retail at the dealer level. On the 700H1 standard ATV that does not shipuntil Q4. So, we took the first enginesand put them in Prowlers. These nextengines will go into the H1 ATV and that will happen in January, this month ofQ4. A lot of enthusiasm at the dealersfor that model and at the customers because of the performance difference theysee from the other 700s that we’ve had. So, we can produce enough to meet the orders. Good response to the Prowlers XTX which usesthe 700 and a good response on the – at this point, a good response from thedealers on the 700 in a regular ATV which will come out in January.

I think it’s really important though as we look at theoverall ATV market to note that every single segment, as we analysis themarket, every single segment for the entire industry was down except the largedisplacement segment this year. It seemsalmost contrary if lack of disposal income and consumer confidence are drivingthe downturn then why are the more expensive models selling - the only part ofthe industry that is selling above last year and that’s true for us aswell? And, the answer to that I think istwo things: one is what I refer to as hot money these are people who want thelatest and greatest, highest performance, fastest, most powerful and so they’realways buying in that category and that’s what they get when they but in that category. Secondly, I think that disposable income ofthat group may be different than the disposal income. The average ATV buyer has got a householdincome of about $62 to $65,000 and the average disposal income for example ofsomebody buying a Prowler, the household income for a Prowler is north of$100,000. So, I don’t think they’reaffected by the market the same way or by the overall economy by the same wayas the other ATVs.

I guess I would mention that only for the purpose of sayingas we look forward we’re well positioned to sell into that large displacementmarket with our 700s coming online in January and with our Thunder Cat 1000scoming online late in the fourth quarter. They’ll be coming online in March and we’re doing that in a relatively limitedproduction but we expect that that will increase significantly in the 09 year.

Assia Georgeiva –Infinity Research

So, given your production and shipment plans we shouldn’treally expect much upside in Q4?

Christopher A. Twomey

We are going to ship more units in Q4 this year than weshipped last year.

Assia Georgeiva –Infinity Research

Okay but, given you comments today as we go through thequarter there’s a small likelihood given the timing of the shipments that wemight see a positive surprise relative to today’s announcement?

Christopher A. Twomey

Right.

Assia Georgeiva –Infinity Research

My second question deals with the snowmobile picture. Basically, if you’re seeing such greatenthusiasm would you be able to adjust your manufacturing and shipment schedulethere and possibly ship more snowmobiles in Q4 which I also believe carry ahigher margin and possibly provide some upside in that last quarter?

Christopher A. Twomey

At this time it’s impossible to get engines and other thingsthat you would need to do that. I mean,the supply time on engines alone is three months. So, as we look at a hot sales environment inDecember there’s not enough time to get any additional units, get anyadditional material to build those units for sales in the fourth quarter. So, that’s not something we would do. What we would like to do is further push tohave the current and non current inventory that exists at our dealers reducedfurther so that they’re in a better position and better mood to buy when wehave our snowmobile dealer show for 09 and that’s going to occur at the end ofFebruary. So, really today the focus ison doing everything we can to help our dealers sell that inventory they haveboth the 08 models as well as the 07 and 06’s that they still that they stillhave in inventory. If we can reducethat, that puts them in a good position for 09.

Again, we’ve just come out with our programs for theremainder of the quarter – for January and February up until our dealer showand those are all programs really designed to entice customers to come in andbuy current and non current models and reduce our dealer inventory. If we getthat dealer inventory down then we will see the dealers again, in a much bettermood and with a much stronger open to buy position when we go to our dealershow.

Assia Georgeiva –Infinity Research

That makes sense. Howwould you compare the aggressiveness of your program relative to yourcompetition at this point?

Christopher A. Twomey

We have programs that I think are unquestionably the bestprograms on the market right now. Some people have programs similar. Some other manufacturers have programssimilar and some have programs that are less than ours. Our programs this year are very similar interms of dollar amount to what they were last year. The difference is of course this year you’vegot a better snow environment which again when you have rich programs which wehad last year, similar programs this year and good snow that should continue topush retail sales. As we compare to thecompetitors again, some have programs as strong as ours and some don’t.

Operator

Our next question comes fromRommel Dionisio with Wedbush Morgan Securities. Please go ahead with your question.

Rommel Dionisio – Wedbush Morgan Securities

Chris, could I just ask for yourbigger perspective here on the ATV industry? I mean, as you say the high end performance vehicles are doing quitewell and the rest of them aren’t. Isthere something going on other than the facts that everyone on this calleveryone already knows tightening consumer credit, gasoline prices, consumerspending and all the rest? Do you seethe sport fading? Give us a perspectiveon that a little bit.

Christopher A. Twomey

My belief is that it is just allthe things that everybody is well aware of. The consumer credit – I mean again, you’re dealing with people who havein general average household incomes of around $62 to $65,000 a year. I think as they look out and say, “Where’s itgoing?” Their decision to buy a new ATVis one that can be put on the back burner until they get more confidence, untiltheir income increases more than it has. So, in general I don’t see it as people fleeing from the industry, Idon’t see it as people using the product less. There’s nothing that I see that indicates that overall in themarket. And, we try and watch that veryclosely but there’s again, if we look out there and say, “People are buyingdeals.” It’s interesting as we look atthe market and you can see somebody who if you put on a very rich program youcan drag sales forward and then as soon as you stop the program we see salesfall flat so that tells me that there’s a finite number of buyers out therethat are willing to come in and invest their money. A better deal will drag them in but you’renot – at this point just because of everything that’s going on in the industryyou’re not necessarily increasing the number of people that are ready to buy.

I mean everything that we’ve heardfrom our dealers, everything that we’ve heard from our customers and everythingthat we see is just general economy and there’s no real tightening of trails,or loss of trails, or loss of use. There’s nothing external to that that would make you think that that wasdriving the decline.

Operator

Our next question comes from JoeHovorka with Raymond James. Please goahead with your question.

Joseph Hovorka – Raymond James & Associates

Most of my questions have beenanswered but just one about the industry. It was down 11% I guess year-to-date through September. Do you have an update of what it was down inthe December quarter?

Christopher A. Twomey


I don’t have that yet Joe. That doesn’tcome out for another, I don’t know, five days or so. Our sense is that the industry retail sales –if you’re asking me my guess at this point is that the industry retail salesare going to decline more than the 11% in the fourth quarter.

Joseph Hovorka – Raymond James & Associates

Have you seen the first two monthsyet or do you get it all at once?

Christopher A. Twomey

We have seen the first two months.

Joseph Hovorka – Raymond James & Associates

And they are worse than 11?

Christopher A. Twomey

Yeah I would say that the quarteris going to be done more than what we’ve seen.

Operator

(Operators Instructions) Our next question is a follow up questionfrom Ed Aaron with RBC Capital Markets. Please go ahead with your question sir. Mr. Aaron please go ahead with your question.

Edward Aaron – RBC Capital Markets

On the topic of consumer credithave you seen any evidence to suggest any real kind of tightening out there bythe lenders in the space?

Christopher A. Twomey

No. You know, Ed we haven’t. We have retail credit being available fromtwo different people this year and we’re seeing good volume movingthrough. We’re not noticing any – wehaven’t been told that the credits are worse. The volume in of course December looked very strong on snow and theyfinanced a lot of that. So, I don’t haveanything that indicates that the people that are buying have worse credit thanthey did a year ago or that we’re having a higher decline rate at the retailend.

Edward Aaron – RBC Capital Markets

Have you actually seen the statson the delinquency and loss rates in those portfolios?

Christopher A. Twomey

No I have not.

Operator

Our next question comes from MarkAtlschwager with Robert W. Baird. Pleasego ahead with your question.

Mark Atlschwager – Robert W. Baird

Just a follow up question on theguidance. It seemed that the priorguidance was largely based on actual dealer orders not necessarily a projectionof retail. So is it fair to assume thatdealers canceled orders as the quarter progressed? Or, were there just fewer incremental ordersafter your guidance was given?

Christopher A. Twomey

Two things: number one, the lasttime we gave guidance we knew we had orders to for the remainder of Q3 andQ4. We were optimistic about gettingthose orders. The orders didn’tmaterialize again, because of a variety of reasons but I think because of theworsening retail environment. Thenagain, we looked at it and said, “Look even if you did get the orders. Even if we were successful in selling to thedealers with the declining retail environment we were just creating inventoryat the dealer.” So, we just said, “We’regoing to cut the production back. We’renot going to try and sell them.”

Mark Atlschwager – Robert W. Baird

So you guys decided just to notship it to dealers. It wasn’tnecessarily the dealers deciding to cancel orders that they had already placed?

Christopher A. Twomey

Right.

Operator

Our next question comes from JamesHardiman with FTN Midwest Securities. Please go ahead with your question sir.

James Hardiman – FTN MidwestSecurities

Most of my questions have alreadybeen answered. I’m just curious if youcould talk a little bit about the promotional environment in the ATVsegment? We did see some of yourcompetitors especially promotional late summer and was it your sort ofreluctance to follow those promotions that led to slower rates of sales foryour ATVs versus the rest of the industry? And, sort of as we move forward here how do you project that promotionalenvironment to proceed?

Christopher A. Twomey

As I think I said before we sawsome aggressive promotions on the part of a couple of people in the summer, atleast one I can think of. And, when youfollow what happens to those aggressive promotions after the promotion stopsyou see the decline is even greater than the industry. So, we don’t think that aggressive promotionsbrought new people into the market we think that the aggressive promotionsessentially moved up existing buyers and got them to buyer earlier than theymay have bought normally. Our promotionenvironment has been steady. Ourpromotion environment has been strong. Again, the promotion environment for us has mainly been on non currentsin the ATV industry – on the ATV side of the business and we are looking at Q4as having about the same level of promotion that we had last year and we thinkthat’s enough to keep the sales level with the industry. Again, we don’t think that really overaggressive promotions are going to drive additional sales or drive new sales,they may just move the sales forward.

James Hardiman – FTN MidwestSecurities

Do you think that maybe the timingof your new product releases this year versus last year in conjunction withthose pull forward of demand with those promotions hurt you even more than theywould have otherwise had you put out your new products during the difficulttime period?

Christopher A. Twomey

It’s very clear to us thatprimarily our new products are occurring in Q4 this year. The 366, the 700H1EFI and the Thunder Cat,those are all in Q4. Had those been inQ3 and 2 we think that our current model sales would have been higher in thosequarters and we would have done better. That’s very plain. It’s justreally a development issue as to when we could get those products done and tothe market.

Operator

Our next question comes fromAdriano Almeida with DGHM. Please goahead with your questions.

Adriano Almeida – Dalton, Greiner, Hartman, Maher & Co., LLC

I’m wondering what you can do orif you’re prepared to talk about some of the efforts you might launch on thecosts side to offset kind of the lower business level and operate at a higherprofitability level in spite of the weakened markets?

Christopher A. Twomey

Absolutely. We’ve already announced a strategic sourcinginitiative which we expect will lower our costs of goods by about $8 millionnext year. So, that’s one thing and thatplan stays in place – slightly lower volumes may have an impact on that. But, we are aggressively pursuing thestrategic sourcing program which we think is going to be – which we know isgoing to be effective. We’ve alreadyseen some of the impacts of that even as we get ready for F09. We also have some other programs. We closed our South Dakota facility which we expect to save $1 millionnext year. That facility – we had excesscapacity here so we continue to work on that. And, we just have a number of other programs that are going to lower ourcosts as we go forward as well. But, those are two fine examples.

Adriano Almeida – Dalton, Greiner, Hartman, Maher & Co., LLC

Have you guys considered at somepoint providing the market kind of a longer term guidance as to where you thinkthe earnings power lies?

Christopher A. Twomey

We think we’ll be ready to do thatat year end.

Adriano Almeida – Dalton, Greiner, Hartman, Maher & Co., LLC

Like a three year guidance kind ofthing?

Christopher A. Twomey

A year or two.

Adriano Almeida – Dalton, Greiner, Hartman, Maher & Co., LLC

How is the effort in Europegoing?

Christopher A. Twomey

Our effort in Europeis relatively – I would say is relatively flat. We had expected – we had to set up a totally new distribution. We expect that will have some impact. That got done last year and started to comeon this year. We think Q4 is the timewhen we expect to see those sales go up so they’re on the plan that we had forthem for the year. Because their marketis not a winter market obviously it’s on road summer market so we expect our Q4to be a good quarter for them. OurEuropean effort has not been great it’s been okay.

Adriano Almeida – Dalton, Greiner, Hartman, Maher & Co., LLC

It certainly hasn’t really movedthe needle this year yet?

Christopher A. Twomey

No it has not.

Adriano Almeida – Dalton, Greiner, Hartman, Maher & Co., LLC

On the cash flow side you gave ussome guidance in the last conference call that I believe you said you expectedto generate about $20 million in free cash flow for the fiscal year. With this lowering of guidance what does thatdo to your free cash flow?

Timothy C. Delmore

Obviously our net income is goingto be down and that will affect our cash flow. I’m not ready to talk about the exact magnitude of it. But, it will impact our cash flow.

Adriano Almeida – Dalton, Greiner, Hartman, Maher & Co., LLC

But, is there any offset on theworking capital side?

Timothy C. Delmore

We’re still analyzing that. Again, we’re going to end the year with cashand continued strong balance sheets. So,we’re going to be still in a good financial position.

Adriano Almeida – Dalton, Greiner, Hartman, Maher & Co., LLC

So even at this base here you’repretty comfortable that your free cash flow is in positive territory?

Timothy C. Delmore

Again, like I said we’re stillanalyzing that.

Adriano Almeida – Dalton, Greiner, Hartman, Maher & Co., LLC

Yeah but I’m trying to get alittle more.

Timothy C. Delmore

I mean you can take – we’rebringing our income down quite a bit this year based on our new estimates sothat will have a direct impact on our free cash flow.

Adriano Almeida – Dalton, Greiner, Hartman, Maher & Co., LLC

Okay. So, in terms of executing on this new $10million buy back what kind of dictates that from a liquidity standpoint? Would you borrow against a credit facility todo that?

Timothy C. Delmore

That’s an option that we couldcertainly do. We have lots of room onour credit facility.

Adriano Almeida – Dalton, Greiner, Hartman, Maher & Co., LLC

But, you also have some capacitytoday in the event that you’ll want to buy some in the market today, right?

Timothy C. Delmore


Sure.

Adriano Almeida – Dalton, Greiner, Hartman, Maher & Co., LLC

On the balance sheet?

Timothy C. Delmore

Sure.

Adriano Almeida – Dalton, Greiner, Hartman, Maher & Co., LLC

I guess just philosophicallybigger picture here you are managing a company where the stock has been somewhat disseminated right and has certainly underperformed your publicpeers. I mean, here the stock’s in thesingle digits. Does that lead you andthe board to kind of think a little bit more out of the box, more creativelyabout what your true long term strategic alternatives are?

Christopher A. Twomey

We spend a fair amount of timeexactly on that issue both here and at the board level.

Adriano Almeida – Dalton, Greiner, Hartman, Maher & Co., LLC

It’s not going lightly that thisstock has been disseminated?

Christopher A. Twomey

It is not going lightly at all.

Operator

(Operator Instructions) There are no further questions at thistime. I’d like to turn the conferenceback to Mr. Chris Twomey, Chairman & Chief Executive Officer.

Christopher A. Twomey

Thank you very much everyone forjoining us. Again, obviously we are verydisappointed with today’s announcement. However, we think this is the right course to take as we look at theindustry that we’re in and we think about how we’re going to position ourselvesgoing forward in F09. We look forward toupdating you more completely on our call for the quarter end which will occuron the 28th of January. Thanks again everybody.

Operator

Ladies and gentlemen thisconcludes the Arctic Cat conference call. We thank you for your participation. You may now disconnect and thank you for using AT&Tteleconferencing.

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