Arctic Cat Inc. Earnings: Skidding but Not Quite Stuck

As Arctic Cat stares at rising dealership inventory, can its ATV sales rebound? Source: Arctic Cat.

The last few quarters have been filled with fits and starts for Arctic Cat (ACAT), the maker of snowmobiles and all-terrain vehicles. The second period of 2015 was a continuation of this all-too-familiar storyline for investors.

In the sales category, the company racked up double-digit gains versus the prior year. But profit margins took a hit and management lowered the outlook for the remainder of 2015. Investors are hoping that management can kick the slumping all-terrain vehicle, or ATV, segment into high gear during the holiday season.

Where "The Cat" is accelerating...
Let's begin by taking a look at the high-level results and then we can dig into the nitty-gritty details.

Source: Company earnings.

Sales growth was the bright spot in Arctic Cat's report. Although the 10% year-over-year increase was not on par with last quarter's 19% jump, Arctic Cat nonetheless exceeded analysts' sales forecast of $253.3 million.

On the bottom line, too, the results weren't exceptional, but they nonetheless lived up to the expectations. The consensus from analysts called for earnings of $1.18, which Arctic Cat matched on an unadjusted basis and beat handily when nonrecurring warranty expenses were removed from the picture.

So, what were the drivers of the business during the quarter?

For starters, snowmobile sales were up 17% to $157.8 million from $135.4 million, accounting for 60% of overall revenue. At the same time, sales of parts, garments, and accessories increased 15% to $35.1 million. Some ATV sales were also resilient, including the Wildcat side-by-side models, though the ATV category as a whole hit a bump in the road and fell by 4% to $69.6 million.

Looking ahead, management sees "continued gains in snowmobile retail sales and market share" and believes the introduction of 15 new ATV models could help that segment recover. However, the company's outlook was reduced, as I'll discuss here in a moment.

...and where it's stalling
The glaring issue within Arctic Cat's latest quarterly report related to inventory buildup. Simply put, Arctic Cat's dealers were loaded with older ATV models and were hesitant to accept any of the newer models from the company. In industry lingo, "sell-through" to end customers did not match up with the "sell-in" levels Arctic Cat had hoped for.

So, in what should be a wise move going forward, Arctic Cat is adjusting its order expectations to match dealer demand. This will likely put a dent in ATV sales but prevent overly excessive discounting that could hurt margins and the brand.

The second area of concern for the company revolves around margin contraction. Gross profit margin as a percentage of sales dropped from 23% to 21% year over year. The discrepancy was due to increased shipping in the quarter of low-margin vehicles, a nonrecurring warranty charge, and an unfavorable exchange rate fluctuation for the Canadian dollar. Meanwhile, selling, general, and administrative expenses crept higher, from $25.4 million in 2013 to $31 million, due to legal expenses and Canadian currency hedging.

Regarding the legal expenses, the company is working through a couple of lawsuits related to Bombardier Recreational Products' allegations of patent infringement. On this matter, current chairman and CEO Christopher Twomey stated, "We do not believe those patents are valid.
 And even so, we do not believe we infringed those patents."

Looking ahead, management sees "continued gains in snowmobile retail sales and market share" but expects softer ATV sales to take a toll on the top line even more than previously predicted.

Twomey reduced full-year revenue guidance for 2015 by roughly $30 million, from $780 million to a range of $745 million to $755 million. Likewise, the midpoint of the EPS range has been cut from $2.30 to $1.60 per share.

Foolish takeaway
It seems like Arctic Cat could get back on track by reducing dealer inventory and successfully reinvigorating its lineup with new ATV models. However, there's a lot of uncertainty surrounding the company. There was no comment that I came across regarding the selection process for a replacement CEO, but the transition will prove costly for the company: So far, severance charges will cost at least $0.08 per share on the bottom line from just the first half of the year.

For now, Twomey appears to have a solid grasp of what the company needs to do. It's just a matter of executing, and hoping the recreational vehicle market gets a boost.