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Arctic Cat, Inc. (NASDAQ:ACAT)

F4Q08 Earnings Call

May 15, 2008 11:30 am ET

Executives

Shawn Brumbaugh – Padilla Speer Beardsley, Inc.

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

Timothy C. Delmore – Chief Financial Officer & Corporate Secretary

Analysts

Scott Hamann – Keybanc Capital Markets

Edward Aaron – RBC Capital Markets

Rommel Dionisio – Wedbush Morgan Securities

Brandon Taylor – Raymond James

Operator

Good morning ladies and gentlemen thank you for standing by. Welcome to the Arctic Cat fourth quarter 2008 earnings 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 today Thursday, May 15, 2008. Now, I’d like to turn the conference over to Shawn Brumbaugh with Padilla Speer Beardsley, Inc.

Shawn Brumbaugh

I’m Shawn Brumbaugh with Padilla Speer Beardsley. Leading our call today will be Chris Twomey, Chairman and Chief Executive Officer of Arctic and with us this morning is Tim Delmore, Chief Financial Officer. Before the market opened this morning Arctic Cat released results for its fiscal 2008 fourth quarter ended March 31st. Chris will review the results of the quarter and then Tim will take you through the financials. After that we will have time for any questions.

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 & Exchange Commission including the company’s report on Form 10K.

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

Christopher A. Twomey

Thanks everyone for joining us this morning. Fiscal 08 was a challenging and disappointing year for all of us at Arctic Cat. It is our first annual loss in the company’s 25 year history. Everyone at Arctic Cat is committed to seeing that this is our last and only annual loss the company experiences. This morning I’d like to review the performance of our three businesses last year and talk about the opportunities that lay ahead of us.

In spite of the overall poor economy and low consumer confidence, North American industry sales of snowmobiles grew in fiscal 08 as a result of the pent up demand driven by some of the earliest and best snow conditions we’ve seen in the last 10 years. It has long been our belief that decline in snowmobile industry retail sales which we’ve seen in the last few years resulted from the lengthening of the buying cycle from an average of three years to six or seven years because customers were simply not using their snowmobiles due to the overall low snow conditions. In spite of the economy, rideable snow drove these customers to buy new sleds this year.

One of our primary objectives for our snowmobile business during fiscal 08 was to reduce dealer snowmobile inventories which had grown to unacceptable levels after unusually poor snow conditions primarily in the Midwest and eastern regions of the US. We successfully accomplished this objective with a plant reduction in fiscal 08 model year production. At fiscal year-end our dealer inventories have been substantially reduced in each US region and overall our dealer inventories are down more than 30%. As a result of lower inventories and an overall stronger retail year dealers are more optimistic than the past few years and as a result we expect snowmobile sales to be up in the 5% to 8% range in fiscal 2009.

We are also seeing similar enthusiasm from the snowmobile customers resulting in spring guarantee orders being up 70% compared to last year. Part of this enthusiasm is driven by the better winter that most snowmobilers experienced this last year and part is driven by exciting new products like the 177 horsepower turbo charged four stroke engine which is in a couple of our new 09 models. This is the largest horsepower engine in the snowmobile industry. In addition our mountain machines are some of the lightest and most powerful in the industry and our utility line of snowmobiles particularly important in the Canadian market has been completed redesigned in to our F3 chassis. Expanding the chassis in to additional categories helps reduce costs, improve margins and offer the customers exciting new products. It is reassuring to see the overall high level of enthusiasm for both our dealers and customers for the snowmobile business.

The overall poor performance of our ATV business was a surprise to us and resulted from a significant decline in the industry’s retail sales throughout the entire year but particularly in the last five months. The weak economy and sagging consumer confidence caused Arctic Cat retail sales to decline at a similar rate to the overall industry. This is the first year since we’ve entered the ATV business more than 10 years ago that we did not outperform the industry and gain market share. I am confident that there is nothing fundamentally wrong with the ATV industry, rather I believe that the disposal income of our core ATV customers have been unfavorably impacted by rising food and gas prices and their confidence, if not their finances directly have been shaken by the housing crisis and overall they’ve decided to simply delay their next ATV purchases.

Prowler side-by-side units continue to sell better than the prior year and retail sales of large displacement ATVs like our Thundercat are also showing retail strength. Customers for both these models have higher annual household incomes than buyers of our core products and don’t seem to be as negatively impacted by the economy. As a result of the production cuts we made last fiscal year, dealer inventories of ATVs have also been reduced. We don’t expect to see ATV retail sales pick up until the overall economy strengthens. For fiscal 09 we expect ATV revenues to be flat to slightly higher base on more Prowler sales, increased international sales and a more expensive product mix driver by the new Thundercat 1000. Our ATV dealer show begins in about two weeks and while we expect core ATV sales in North America to North American dealers to be down we believe that they will be excited by the number of new models which we are offering in segments where we did not participate in the prior year.

Our PG&A business did very well in the fourth quarter with sales up 15%. The increase was driven by sales of snowmobile parts, garments and accessories resulting from increased snowmobile usage during the quarter. For the year, PG&A sales were up driven by both snowmobile and ATV categories. The dealer enthusiasm which we have seen for our snowmobile units is equally evident in the parts, garments and accessory business where preseason orders are up significantly over last year. New products, increased retail activity and lower inventories are driving these increased orders.

Now, I’d like to turn the call over to Tim to review the numbers and following that I’d be happy to answer any questions.

Timothy C. Delmore

Good morning. I would also like to welcome you to the conference call. Today I’ll review our fourth quarter results, our year-end financial performance as well as our outlook for fiscal 09. Net sales for the fourth quarter were $168.9 million compared to $172.6 million for the same quarter last year. ATV sales were $142.9 million compared to $145.8 million. Snowmobiles were a -$7.1 million compared to a -$1.8 million in the same quarter last year due to sales incentives and lower shipments. Parts, garments and accessory sales increased 15% to $33 million from $28.6 million driven by snowmobile related PG&A sales as well as increased ATV PG&A sales. Gross profits for the quarter were $25.3 million versus $26.1 million and the gross profit percentage for the quarter was 15% versus 15.1% for the fourth quarter last year.

Selling, general and administrative expenses increased to $29.6 million from $28.3 million primarily due to increased Canadian hedged costs. Our interest income was $40,000 versus $523,000 and interest expense was $166,000 versus zero for the same quarter a year ago. The income tax benefit for the quarter was $4.8 million compared to $124,000 in the same period last year. The increase tax benefit was driven primarily by the net operating loss and certain other tax projects. The net income for the quarter was $424,000 versus a loss of $1.6 million for the fourth quarter last year and diluted earnings per share was $0.02 versus an $0.08 loss per share a year ago.

Next, I’d like to review Arctic Cat’s financial performance for full year fiscal 08. Year-to-date net sales were $621.6 million versus $782.4 million. The net loss for the year was $3.3 million versus earnings of $22.1 million. The diluted loss per share was $0.18 per share versus earnings of $1.15 per share last year. On a year-to-date basis ATV sales were $350.3 million compared to $431.5 million. Snowmobile sales were $161.9 million versus $247 million down in line with our plans. Parts, garments and accessories sales increased 5% to $109.4 million from $103.9 million driven by the snow related PG&A and also ATV P&A.

Our year-to-date gross profits were $110.4 million versus $131.8 million. Our year-to-date gross profit percentage decreased slightly to 17.8% versus 18.1% due to additional Canadian programs to help compensate for the stronger Canadian dollar. Year-to-date selling, general and administrative expenses were $119.1 million versus $109.9 million again, primarily due to Canadian hedged costs.

Looking at our balance sheet as of March 31st we ended the year with $35 million of cash and zero debt. Inventory increased to $127 million from $99 million primarily due to increased ATV finished unit inventory. Year-to-date capital expenditures totaled $13 million and depreciation was $29.6 million. During the fiscal year we repurchased nearly 624,000 shares under our share repurchase plan.

Looking ahead to full year fiscal 2009 we anticipate net sales to be in the range of $650 to $674 million. We expect earnings per share to be in the $0.18 to $0.28 range. Regarding sales, we anticipate our snowmobile sales to increase 20% to 23%, our ATV sales to be flat to up 2% and our parts, garments and accessories business to grow 4% to 8%. The company’s effective tax rate is expected to be 16% for fiscal 09. We expect capital expenditures to be in the $25 million range and depreciation to be approximately $30 million.

Arctic Cat anticipates first quarter 2009 net sales to be in the range of $85 to $95 million compared to $87.9 million for the first quarter last year. The first quarter net loss is estimated to be $0.50 to $0.60 per share versus a loss of $0.39 per diluted share for the first quarter last year. We expect the first quarter comparison to be negatively impacted by a lower tax benefit caused by an estimated 13 basis points change in the company’s first quarter effective rate compared to the prior year’s first quarter. The company’s effective tax rate was 29% in Q1 of last year, in Q1 this year we estimate it to be about 16%. We anticipate revenues and earnings comparisons in our second and third quarters to be positive driven by increased snowmobile sales as well as increased parts, garments and accessories sales.

I’d like to thank you for your attention and now operator we’d like to open it up for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Scott Hamann – Keybanc Capital Markets.

Scott Hamann – Keybanc Capital Markets

Can you give a little bit more detail on the strategic sourcing initiative? I think in the past you had identified about $8 million in potential savings, is that still a good number to look at? And maybe talk about how that timing flows throughout this year or I guess even next year?

Timothy C. Delmore

Scott, we still are optimistic about the strategic sourcing initiatives. We expected about $8 million for this fiscal year, this coming fiscal year, that probably will be slightly less based on les volume for the year, we had expected a higher volume but we’re still optimistic about that 09 year being in that round $5 to $6 million range. And, we think that we’ve identified significant opportunities going ahead in to 10 and really 11 as well. It’s to a certain extent the strategic sourcing initiatives are offset by increased commodity pricing that we began to see at the end of fiscal 08, in Q4 fiscal 08 and we expect to see going in to at least certainly the first half and maybe the first three quarters of fiscal 09. We’ve got the opportunities, they’re going to be the 09 range that we said was $8, we’ll probably be in that $5 to $6 based on just reduced volume. But, going forward we’ve identified additional opportunities and again, that will be possibly offset by commodity price increases that we’ve just begun to see in the first three months of the calendar year.

Scott Hamann – Keybanc Capital Markets

That’s kind of a gross margin benefit and offset. It looks like you’re embedding some margin improvement, how is that going to flow through SG&A? I mean, where are you cutting some costs out there?

Timothy C. Delmore

For the year actually with the mix the margin looks like it’s flat to down 8% and that will be offset by reduced operating expenses. We’ve got the Canadian hedged costs in their kind of muddying things up.

Scott Hamann – Keybanc Capital Markets

For next year?

Christopher A. Twomey

Yes, for next year the Canadian hedged costs goes away at the current Canadian exchange rates so we’ll see an improvement in the operating expenses as a percent of sales with flat to slightly down margin percents.

Scott Hamann – Keybanc Capital Markets

Then in the international business, what percent of the total was that for the year? And, what kind of stuff are you doing there? Are you seeing any traction in some of the initiatives that you’ve kind of embarked on? And, what’s your outlook for that business in 09?

Timothy C. Delmore

We did see a nice increase in 08 in terms of unit sales in international but nowhere near what we expected it to be. So, in 09 we’re looking for a roughly 25% to 40% increase in our international sales and that’s both of ATV and snow. We think we’ll get a good increase in snow as well as ATV. So I think overall we expect improvement in international from both snow and from ATV.

Scott Hamann – Keybanc Capital Markets

Then just on the buybacks for 09, how should we think about modeling that in? What kind of share count are you using in your 09 earnings?

Christopher A. Twomey

We’re keeping the share count relatively flat. Again, we have the share repurchase plan in place, we have a $10 million plan in place and we’ll consider using it as appropriate.

Scott Hamann – Keybanc Capital Markets

Then finally, just on the orders that you’ve already received that are kind of embedding guidance, at the end of this year there was an order cancellation, I was just curious at how firm these orders are and how easy it is for people to cancel them say if the economy worsens? I mean, is that easy for them to do?

Christopher A. Twomey

On the snow side of the business again, those are the orders that we have in house now and those orders have generally been firm over the last 25 years, those orders have generally stayed very firm. We’re only building to the order, we’re not building any additional units for speculation so if you use one or two dealers or five dealers we can always find someplace to ship those units and that happens. Strange things happen over the year but it doesn’t have a big impact. The impact that came in the fourth quarter of this year was one large multi store retailer who cut their order back dramatically and unexpectedly so we were unable to ship those units to other dealers and it was a big enough number to impact obviously the quarter and the year. Going forward, we’ve spent a fair amount of time with our large multi store retailers and feel comfortable with the projects that we have. They’re only in the ATV business and we feel comfortable with the projections that we have in our model for those two large multi store retailers. We’ll have a good idea in two weeks after we do our ATV, or in about a month after we do our ATV dealer shows. Obviously, when a large multi store retailer cuts a number of stores that can impact it much more dramatically than individual dealers who may make a decision to get out of the business or something could happen to them. But, that kind of a cut does not affect us.

Operator

Our next question comes from the line of Edward Aaron – RBC Capital Markets.

Edward Aaron – RBC Capital Markets

A couple of questions, first of all you mentioned that you assumed core ATVs would be down in your guidance. Can you just give us some idea of the order of magnitude that you’re baking in for that?

Timothy C. Delmore

The core ATVs are down in that kind of broad range of 10% to 20%

Edward Aaron – RBC Capital Markets

That’s assumption for retail? Wholesale?

Timothy C. Delmore

That’s our assumption for wholesale.

Edward Aaron – RBC Capital Markets

Then on the margins, I think you mentioned in response to a previous question that you think the gross margin should be flat to maybe down in 09. I’m trying to understand why that would be based on your sales guidance? Because, you have mid to high single digit sales growth and then you have a higher mix of snowmobile sales which helps from a margin mix perspective and then you also have plans to have a favorable mix shift within your ATV business. So, what is there that’s big enough to offset all of those seemingly positive things for margins?

Timothy C. Delmore

We do have some commodity pressure built in. That is a risk factor this year so that is a margin dampener and maybe a bit more sales incentives.

Christopher A. Twomey

If you looked at the last time the industry saw the commodity price increases a couple of years ago, we didn’t see a significant enough increase in retail prices across the industry to cover the commodity price increases. So, we wanted to bake that in to our plan and be aware of that. As the commodity prices go up we don’t know that we’ll be able to get the price increase at retail. It will really depend at how the entire market responds to those price increases. In prior years we didn’t see the entire market respond so we don’t have just the ability to raise our price to cover those costs unless the industry does.

Timothy C. Delmore

A couple of other factors, we have a couple of currencies that are negative in comparison, the Taiwanese dollar, we buy certain ATVs from a supplier in Taiwan and that’s gone a little bit negative. The Yen has gone a little bit negative on the snowmobile engines. We’re half as hedged through our arrangement with Suzuki. So, those are two other factors that enter in to the margin situation.

Edward Aaron – RBC Capital Markets

Then I also want to ask, the month of March turned out to be a really tough month for a lot of discretionary consumer durable products and it was an awful month for consumer confidence. Arguably some of the consumer confidence stuff seems to have gotten a little bit better in the month of April and I’m just curious to know, you’re kind of half way through the quarter, have you seen any improvement in retail sales relative to what you saw maybe towards the end of the March quarter?

Christopher A. Twomey

On the ATV side of the business which is really all that’s retailing at this point, we’re not seeing any improvement at all. Those ATV retail numbers for the industry have continued to be down for really the first four months of the year at about the same level. We’re doing slightly better than the industry if we look at our overall North America, we’re doing slightly better than the industry in terms of our retail sales but not enough to, when the entire industry is down and you’re just doing slightly better, it doesn’t make you feel that good. We haven’t seen an improvement at all both for the industry and for ourselves. My sense is it’s been a cold spring so while we appreciate the cold weather and the snow for the snowmobile business, the April snows didn’t help our snowmobile business very much and I think have really put a dampener on the ATV sales.

Just to give you a little color, since you’re not up in Northern Minnesota, a lot of the lakes in the Northern part of Minnesota had the ice on last weekend for the opening of fishing. So, it’s been a cold northern spring which I think my have had an impact on the industry. And, on our ATV sales in the south, the weather there with the tornados and all the other things that are going on I think may have also impacted that. So, if consumer confidence is returning and they’re going to return to the market we haven’t seen it for the industry and we haven’t seen it ourselves. But again, I just think the weather has had a negative impact for the first couple of months of spring here.

Edward Aaron – RBC Capital Markets

Finally, just any commentary or color you can give about what you’re seeing in terms of retail financing availability or any changes there? And, in particular just the existing partnerships you have, I believe it’s with Sheffield, how that’s working?

Christopher A. Twomey

We have a couple of partnerships on retail financing both with GE Money and with Sheffield. We are not seeing a significant increase in declining the loans by our customers. The percentage approve continues to be at the same levels that we’ve seen in prior years.

Operator

Our next question is from the line of Rommel Dionisio – Wedbush Morgan Securities.

Rommel Dionisio – Wedbush Morgan Securities

I just wanted to just get an update on the ATV engine sourcing initiatives. I know you’ve thought about really transferring all of your engine production or almost all of your ATV engine production to the US facilities. Are you guys still on track with that or has the currencies changed the timing on that?

Christopher A. Twomey

All of our ATV for the fiscal 09 year we will not buy any ATV engines from Suzuki. We will be producing them ourselves in the St. Cloud facility. We buy some completely built units as Tim mentioned earlier from Taiwan but for the most part the units that we put in to the ATVs that we build here will come from our own plant. We have a few units that will come from our Taiwanese partner, a few engine units that will come from that partner. But, in general most of the engines that we insert in to our ATVs here or build in to our ATVs here will come from our plant in St. Cloud. I was at the plant this week, had an opportunity to observe. We have two lines running, one producing the 700 cc engine and the other producing our 1,000 cc Thundercat engine. The facility looks great, production is great. The first time pass which is our measure of quality is at all time highs so we’re excited about that. We know there are some opportunities to reduce costs in those engines. Some of the parts in the engine are coming from European sources and we’re in the process of moving those. That will occur this fiscal year and as a result we think that there are some cost savings opportunities there.

I think when we look at just the overall issue of building them here versus buying them from Suzuki and the strengthening of the Yen or the weakening of the dollar, depending on how you want to look at it, would have had a significantly more negative impact on our gross margins if we had been buying them from Suzuki this year as we saw in the snowmobile business. So, strategically we’ve gotten in to the engine business for strategic reasons. It was the right reason to do it and we’re now starting to see some of the benefits and there’s more benefits ahead.

Operator

Our next question comes from the line of Brandon Taylor – Raymond James.

Brandon Taylor – Raymond James

Could you give us maybe a little bit of clarity about the kind of breakout between the tax items? Because, I’m just kind of looking at the average tax rate for the trailing three quarters or so and it’s about 30% even with losses. Could you kind of give us I guess an order of magnitude maybe for the carry forwards?

Timothy C. Delmore

I’d say the majority of it is the carry forward and again, the fourth quarter obviously we had a true up in our tax rate factored in the carry forward so you can safely assume the majority was the carry forward benefit.

Operator

Gentlemen there are no further questions at this time. I’d like to turn it back to you for any closing remarks.

Christopher A. Twomey

We’d like to thank everybody for joining us this morning and we look forward to updating you on our progress at the end of Q1 here in about a month and a half. Thanks everybody.

Operator

Thank you ladies and gentlemen. That does conclude our conference for today. If you would like to listen to a replay of today’s conference please dial 1-800-405-2236 or 303-590-3000 using the access code of 11114251 followed by the pound key. ACT would like to thank you for your participation. You may now disconnect.

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