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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 & Corporate Secretary

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 Midwest Securities

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 conference call. During today’s presentation all parties 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 to turn the conference over to Ms. Shawn Brumbaugh with Padilla Speer Beardsley. Please go ahead ma’am.

Shawn Brumbaugh

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

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

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 these contained in the statements. These risks and uncertainties are described in today’s news release and in the company’s filings with the Securities & Exchange Commission including the company’s report on Form 10K.

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

Christopher A. Twomey

Thanks everyone for joining us this morning. We are obviously disappointed with the third quarter and full year results. Since entering the ATV business in 1996 Arctic Cat has always outperformed the industries retail sales rate until this year. This year our retail sales are down similar to the overall industries’ low double digit decrease. During the quarter we were unsuccessful in completing our F08 dealer orders in a declining, industry wide ATV retail sales environment.

At the same time we became considered that the year long decline in ATV sales for the industry and Arctic Cat was worsening so we made the decision to cut our Q4 sales and production plan in order to keep our dealer inventories more in line with retail demand. Our dealer inventories at the end of December was well below last year and we still plan to sell more ATVs in Q4 this year than we did last year. However, with the reduction we are announcing today we expect our dealer inventories will be at or 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 waiting for. Retail sales of our Prowler UTV continue to be strong. In Q3 we began shipping our new Prowler XTX which uses our own 700H1 engine with EFI. With this new model we expect Prowler’s retail sales to continue to be strong in Q4 as well.

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

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

Question-and-Answer Session

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

Edward Aaron – RBC Capital Markets

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

Christopher A. Twomey

I think it’s really a little of all of the above. Our sales force was enthusiastic about being able to sell what they had remaining to sell and that was based on prior performance. Our product, our inventories were down as we had shipped less new product. We had outperformed the industry in all prior years and we thought that as our new product came into the market that we would continue that performance. So, all of those things led to the optimism we had for Q3 and Q4. And, what we really saw was a continuation of the decline and from our viewpoint a worsening of the decline in the overall industry sales in the last couple months of the quarter.

Putting all those things together we just felt that it didn’t make sense even with an optimistic sales force it didn’t make sense to go 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 increase our share with the new models we have out there and why build inventory at the dealer level. So, that’s why we decided to make the cut in Q4.

Edward Aaron – RBC Capital Markets

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

Christopher A. Twomey

What do you mean core ATVs?

Edward Aaron – RBC Capital 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 year at the end of the year.

Edward Aaron – RBC Capital Markets

On the snowmobile side it sounds like retails been pretty good with the weather. Can you quantify the 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 from two years ago at this time?

Christopher A. Twomey

I don’t have the exact numbers Ed from two years ago at this time but I can tell you that it is down from two years ago at this time as well. I mean I can’t give you the exact number 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 the inventory is down compared to last year and the year before with confidence.

Edward Aaron – RBC Capital Markets

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

Christopher A. Twomey

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

Edward Aaron – RBC Capital Markets

What can we expect the inventory on the balance sheet to look 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 a very strong balance sheet, decent cash level and again, a strong financial position.

Operator

Our next question comes from Assia Georgeiva from Infinity Research. Please go ahead with your question.

Assia Georgeiva – Infinity Research

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

Christopher A. Twomey

It’s interesting the 700 – the XTX Prowler which uses our 700EFI engine really just started to shift at the end of the quarter kind of end of November all through December time period. A lot of excitement at the dealer level for that model. It takes about a month or so for that to translate into the retail sales and get those carts back into the system. But, our sense is we’re doing well with that at the dealer level – at retail at the dealer level. On the 700H1 standard ATV that does not ship until Q4. So, we took the first engines and put them in Prowlers. These next engines will go into the H1 ATV and that will happen in January, this month of Q4. A lot of enthusiasm at the dealers for that model and at the customers because of the performance difference they see from the other 700s that we’ve had. So, we can produce enough to meet the orders. Good response to the Prowlers XTX which uses the 700 and a good response on the – at this point, a good response from the dealers on the 700 in a regular ATV which will come out in January.

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

I guess I would mention that only for the purpose of saying as we look forward we’re well positioned to sell into that large displacement market with our 700s coming online in January and with our Thunder Cat 1000s coming online late in the fourth quarter. They’ll be coming online in March and we’re doing that in a relatively limited production 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’t really expect much upside in Q4?

Christopher A. Twomey

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

Assia Georgeiva – Infinity Research

Okay but, given you comments today as we go through the quarter there’s a small likelihood given the timing of the shipments that we might 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 great enthusiasm would you be able to adjust your manufacturing and shipment schedule there and possibly ship more snowmobiles in Q4 which I also believe carry a higher margin and possibly provide some upside in that last quarter?

Christopher A. Twomey

At this time it’s impossible to get engines and other things that 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 in December there’s not enough time to get any additional units, get any additional 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 to have the current and non current inventory that exists at our dealers reduced further so that they’re in a better position and better mood to buy when we have our snowmobile dealer show for 09 and that’s going to occur at the end of February. So, really today the focus is on doing everything we can to help our dealers sell that inventory they have both the 08 models as well as the 07 and 06’s that they still that they still have in inventory. If we can reduce that, that puts them in a good position for 09.

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

Assia Georgeiva – Infinity Research

That makes sense. How would you compare the aggressiveness of your program relative to your competition at this point?

Christopher A. Twomey

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

Operator

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

Rommel Dionisio – Wedbush Morgan Securities

Chris, could I just ask for your bigger perspective here on the ATV industry? I mean, as you say the high end performance vehicles are doing quite well and the rest of them aren’t. Is there something going on other than the facts that everyone on this call everyone already knows tightening consumer credit, gasoline prices, consumer spending and all the rest? Do you see the sport fading? Give us a perspective on that a little bit.

Christopher A. Twomey

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

I mean everything that we’ve heard from our dealers, everything that we’ve heard from our customers and everything that 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 was driving the decline.

Operator

Our next question comes from Joe Hovorka with Raymond James. Please go ahead with your question.

Joseph Hovorka – Raymond James & Associates

Most of my questions have been answered 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 in the December quarter?

Christopher A. Twomey

I don’t have that yet Joe. That doesn’t come 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 sales are going to decline more than the 11% in the fourth quarter.

Joseph Hovorka – Raymond James & Associates

Have you seen the first two months yet 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 quarter is going to be done more than what we’ve seen.

Operator

(Operators Instructions) Our next question is a follow up question from 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 credit have you seen any evidence to suggest any real kind of tightening out there by the lenders in the space?

Christopher A. Twomey

No. You know, Ed we haven’t. We have retail credit being available from two different people this year and we’re seeing good volume moving through. We’re not noticing any – we haven’t been told that the credits are worse. The volume in of course December looked very strong on snow and they financed a lot of that. So, I don’t have anything that indicates that the people that are buying have worse credit than they did a year ago or that we’re having a higher decline rate at the retail end.

Edward Aaron – RBC Capital Markets

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

Christopher A. Twomey

No I have not.

Operator

Our next question comes from Mark Atlschwager with Robert W. Baird. Please go ahead with your question.

Mark Atlschwager – Robert W. Baird

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

Christopher A. Twomey

Two things: number one, the last time we gave guidance we knew we had orders to for the remainder of Q3 and Q4. We were optimistic about getting those orders. The orders didn’t materialize again, because of a variety of reasons but I think because of the worsening retail environment. Then again, we looked at it and said, “Look even if you did get the orders. Even if we were successful in selling to the dealers with the declining retail environment we were just creating inventory at the dealer.” So, we just said, “We’re going to cut the production back. We’re not going to try and sell them.”

Mark Atlschwager – Robert W. Baird

So you guys decided just to not ship it to dealers. It wasn’t necessarily the dealers deciding to cancel orders that they had already placed?

Christopher A. Twomey

Right.

Operator

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

James Hardiman – FTN Midwest Securities

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

Christopher A. Twomey

As I think I said before we saw some aggressive promotions on the part of a couple of people in the summer, at least one I can think of. And, when you follow what happens to those aggressive promotions after the promotion stops you see the decline is even greater than the industry. So, we don’t think that aggressive promotions brought new people into the market we think that the aggressive promotions essentially moved up existing buyers and got them to buyer earlier than they may have bought normally. Our promotion environment has been steady. Our promotion environment has been strong. Again, the promotion environment for us has mainly been on non currents in the ATV industry – on the ATV side of the business and we are looking at Q4 as having about the same level of promotion that we had last year and we think that’s enough to keep the sales level with the industry. Again, we don’t think that really over aggressive promotions are going to drive additional sales or drive new sales, they may just move the sales forward.

James Hardiman – FTN Midwest Securities

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

Christopher A. Twomey

It’s very clear to us that primarily 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 in Q3 and 2 we think that our current model sales would have been higher in those quarters and we would have done better. That’s very plain. It’s just really a development issue as to when we could get those products done and to the market.

Operator

Our next question comes from Adriano Almeida with DGHM. Please go ahead with your questions.

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

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

Christopher A. Twomey

Absolutely. We’ve already announced a strategic sourcing initiative which we expect will lower our costs of goods by about $8 million next year. So, that’s one thing and that plan stays in place – slightly lower volumes may have an impact on that. But, we are aggressively pursuing the strategic sourcing program which we think is going to be – which we know is going to be effective. We’ve already seen 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 million next year. That facility – we had excess capacity here so we continue to work on that. And, we just have a number of other programs that are going to lower our costs 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 some point providing the market kind of a longer term guidance as to where you think the earnings power lies?

Christopher A. Twomey

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

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

Like a three year guidance kind of thing?

Christopher A. Twomey

A year or two.

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

How is the effort in Europe going?

Christopher A. Twomey

Our effort in Europe is 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 come on this year. We think Q4 is the time when we expect to see those sales go up so they’re on the plan that we had for them for the year. Because their market is not a winter market obviously it’s on road summer market so we expect our Q4 to be a good quarter for them. Our European effort has not been great it’s been okay.

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

It certainly hasn’t really moved the 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 us some guidance in the last conference call that I believe you said you expected to generate about $20 million in free cash flow for the fiscal year. With this lowering of guidance what does that do to your free cash flow?

Timothy C. Delmore

Obviously our net income is going to 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 the working capital side?

Timothy C. Delmore

We’re still analyzing that. Again, we’re going to end the year with cash and 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’re pretty comfortable that your free cash flow is in positive territory?

Timothy C. Delmore

Again, like I said we’re still analyzing that.

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

Yeah but I’m trying to get a little more.

Timothy C. Delmore

I mean you can take – we’re bringing our income down quite a bit this year based on our new estimates so that 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 $10 million buy back what kind of dictates that from a liquidity standpoint? Would you borrow against a credit facility to do that?

Timothy C. Delmore

That’s an option that we could certainly do. We have lots of room on our credit facility.

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

But, you also have some capacity today 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 philosophically bigger picture here you are managing a company where the stock has been some what disseminated right and has certainly underperformed your public peers. I mean, here the stock’s in the single digits. Does that lead you and the board to kind of think a little bit more out of the box, more creatively about what your true long term strategic alternatives are?

Christopher A. Twomey

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

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

It’s not going lightly that this stock has been disseminated?

Christopher A. Twomey

It is not going lightly at all.

Operator

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

Christopher A. Twomey

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

Operator

Ladies and gentlemen this concludes the Arctic Cat conference call. We thank you for your participation. You may now disconnect and thank you for using AT&T teleconferencing.

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