Arctic Cat's Winter of Discontent

The snowmobile and ATV maker's shares tumbled Friday after it announced a shortfall in ATV sales. The culprit: A skittish consumer

Now that the Christmas buying spirit is waning, signs of the long-anticipated pullback in consumer spending are beginning to appear, with luxury items like recreational vehicles among the first to show some weakness.

Arctic Cat Inc. (ACAT) cut its sales and profit outlook for the third quarter of fiscal 2008 on Jan. 4, citing lower than expected sales of all-terrain vehicles, or ATVs. Sales for the third quarter, which ended Dec. 31, 2007, are now estimated at $155 million to $160 million, versus a record $228.1 million in the year-ago period and the company's earlier forecast of $170 million to $180 million.

The Thief River Falls, Minn.-based company widened its net loss projection for the third quarter to between 55 and 60 cents per share from a prior estimate of 30 to 37 cents per share, mostly due to the previously disclosed reduction in snowmobile production during the current fiscal year. In the third quarter last year, Arctic Cat reported a profit of 43 cents, which included an income tax benefit of three cents per share.

Analysts polled by Thomson Financial estimated on average a net loss of 32 cents per share on revenue of $174.8 million in the December quarter. The company is scheduled to report its third-quarter results on Jan. 23.

Arctic Cat now expects sales of $645 million to $665 million for fiscal 2008, which ends on March 31, compared with record net sales last year of $782.4 million. The company expects to earn one to seven cents per share for the full year, versus $1.15 per share a year ago. The prior sales estimate for the current fiscal year was $710 million to $736 million, while full-year profits had been pegged at 89 to 95 cents per share.

Shares of Arctic Cat fell by 24.5% to $9.20 on Jan. 4, after hitting a new 52-week low of $9.04 earlier in the session.

"This is a difficult environment overall for the ATV industry" due to higher gasoline prices, consumer credit issues and the sluggish housing market, said Rommel Dionisio, an equity analyst at Wedbush Morgan Securities in Los Angeles. "Keep in mind, ATVs are a discretionary [purchase]."

During a conference call Jan. 4 to discuss the revised outlook, CEO Christopher Twomey said the decline in sales doesn't mean people are using ATVs less than before. Rather, weaker economic conditions are causing people to put off plans to buy new ATVs.

Current model sales would have been higher had the company decided to introduce new products such as the Thundercat and 700 H1 standard ATV in the third quarter instead of the fourth quarter, he said.

Better snow conditions this year than last year should continue to push retail sales, he said. The company plans to run the same number of promotional offers in the fourth quarter as it did a year ago, and Twomey said that will be enough to keep sales up to industry levels.

In Europe, sales are expected to improve in the fourth quarter, since Europe is an on-road summer market, not a winter market, he said.

The only segment of the market that has averted the industrywide slowdown in retail ATV sales has been the large-displacement engine segment, which has shown modest gains, Arctic Cat said in its news release. There continues to be demand for Arctic Cat's large-displacement ATVs and its Prowler utility vehicle, the company said.

On the conference call, Twomey told analysts and investors that demand for the larger vehicles hasn't taken a hit from the drop in consumer confidence because customers who want the latest and highest-performance models likely have more disposable income than regular customers, he said.

"For the regular ATV consumer, average household income is $62,000 to $65,000, while Prowler consumers' average household income is north of $100,000, so I don't think they're affected by the economy in the same way," he said.

In response to weaker sales, the company said it plans to cut its ATV production by about 10% during the fourth quarter, which ends March 31, 2008.

"Our focus today is we're doing everything we can to help dealers sell the inventory they have," Twomey said. "If we can do that, we're in good position for 2009."

Arctic Cat is also trying to cut costs, chiefly through a strategic sourcing initiative that is expected to save $8 million in fiscal 2009, although though lower production volumes may reduce that, Twomey said. The shutdown of a plant in South Dakota is expected to cut operational costs by $1 million per year.

The company also announced its board has authorized a new share buyback program of up to $10 million of its common stock.

New models, including new chassis, advanced 4-stroke engines, and new lower emissions, large-displacement 2-stroke engines account for nearly 80% of the company’s product line and "should provoke excitement and drive market share growth in the segment," analyst Craig Kennison wrote in a research note from Robert W. Baird & Co. on Jan. 4. And although the ATV market is maturing and sales began to shrink in 2006, 40% of ATVs are sold to first-time buyers, which suggests the market still has room for growth, the note said.

Kennison lowered his third-quarter estimate to a net loss of 57 cents per share and his fiscal 2008 outlook to a profit of two cents per share. (Baird expects to receive compensation from Arctic cat for investment banking within the next three months.)

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