Polaris Inc. (PII) Q4 2016 Earnings Report, Transcript and Summary

Good morning. My name is Kim, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Polaris Q4 and Full Year 2016 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Richard Edwards, Head of Investor Relations, you may begin your conference, sir.

Thank you, Kim. And good morning and thank you for joining us for our 2016 fourth quarter and full year earnings conference call. A slide presentation is accessible at our website at www.polaris.com/irhome, which has additional information for this morning's call. Today, you will be hearing prepared comments from Scott Wine, our Chairman and Chief Executive Officer, and Mike Speetzen, our Chief Financial Officer. Ken Pucel, our Executive Vice President of Operations, Engineering and Lean is also here to answer questions. During the call, we will be discussing various topics, including our 2017 guidance, which should be considered forward-looking for the purposes of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those projections in the forward-looking statements. You can refer to our 2015 10-K for a more detailed discussion of these risks and uncertainties. A couple of items I want to point out before we began. Throughout the presentation today, our references to 2016 actual results and 2017 guidance are reported on an adjusted non-GAAP basis unless otherwise noted. Adjusted refer to GAAP results minus the following. Our TAP inventory step-up purchase accounting adjustments, TAP acquisition cost and innovation expenses, and the impact associated with the Victory wind down in 2017. In addition, beginning in 2017 we have established a new reporting segment called aftermarket, which includes TAP, plus our five after-market brands, 509, KLIM, Kolpin, Pro Armor and Trail Tech that were previously included in our ORV Snowmobile and Motorcycles reporting segments. 2016 sales and gross profit results have been reclassified to account for the fourth segment beginning in 2017 for comparison purposes. We have provided a reconciliation of adjusted non-GAAP to GAAP results which is shown on this Slide 5. With that, I will turn it over to CEO, Scott Wine. Scott?

Thank you, Richard. Good morning and thank you for joining us. 2016 was a difficult and challenging year for Polaris but we undoubtedly became a better company and will demonstrate that in 2017. While prospect have certainly improved for our powersports customers to enjoy better economic environment, Polaris is entering 2017 with a strong commitment to returning to profitable growth through consistent execution and aggressive innovation. As anticipated, our fourth quarter adjusted earnings were weak down 31% from the prior year period to $76.1 million. Sales were actually up 10% aided by $109 million that came with the mid quarter close of TAP. Core sales were flat as both ORV and snow had slightly higher shipments compared to an easy prior year comp, offset by motorcycle shipments that were down 35%. Two factors drove a significant drop. Slingshot sales were severely constricted by the fourth quarter recall, and both Victory and Indian faced artificially fourth quarter shipment comps from the prior year that were related to the clearing of the paint related backlog. Although it belongs on another slide, I must point out here that Indian motorcycle retail was up almost 20% in the fourth quarter. Full year 2016 sales were down 4% at $4.5 million and adjusted net income dropped 50% to $226 million. In this environment growth was illusive but not absent. Parts, garments and accessories is up nearly 4% largely driven by recall-related part sales. Acquisitions also helped with TAP and Taylor-Dunn together contributed approximately 3% sales growth. Overall motorcycle sales were up 1% as solid growth for Indian and Victory was offset by nearly 10% decline in Slingshot. Our international business was flat as our teams in Mexico and Australia drove growth that offset a difficult European market and currency. Off-Road Vehicles were down over $300 million year-over-year as on top of recall-related shipment reductions we also lost market share and negative mix impact, battled unhelpful currencies and reduced dealer inventory. Mike will cover margins and earnings in appropriate detail, but I want to mention the less visible but very important progress the team made with VIP and inventory. Despite lower volumes we generated more than $150 million of gross VIP savings netting a 1.5% cost decrease that will yield real benefits as volume returns. In other sign that our lean initiatives are gaining traction, our team drove year-over-year decreases in both factory inventory and dealer inventory for the first time since 2009. Despite our earnings decline, we generated operating cash flow of $572 million up 30% over 2015. Fourth quarter retail sales improved sequentially but the 4% year-over-year decline trailed our expectations. Off-Road Vehicle market share remained under pressure but progress in learning throughout the quarter provided subtle indication that both retail and market share performance will improve in 2017. Indian Motorcycles continue to outpace the industry with retails up nearly 20% in the quarter and slightly higher than that for the year. Victory and Slingshot retail was down for the fourth quarter lowering overall motorcycle retail performance to down mid-single digits. Snow benefited from a strong December performance recovering to almost flat for the quarter. We maintained our focus on dealer inventory ending year down 8% and putting us below our 2014 year-end level. We are well-positioned to transition our side by side business to RFM in the second half of 2017, which will enable our dealers to carrying more of the right vehicles, turn their overall inventory faster and know with confidence that they will have and when they will have the right products to sell. Motorcycle lean times continue to improve throughout the year and the Spirit Lake now operating at a very high level of performance we anticipate ongoing performance in 2017. Our recent announcement to exit the Victory brand was undeniably the right strategic and financial decision but that clarity did not lessen the blow felt by our many loyal and passionate customers. We share their pain at the same visceral level but with cumulative losses exceeding $100 million in growing we could not continue to invest in the brand. This poor financial performance does not attract from the awards for quality and industry-leading factor [ph] motorsports that Victory enjoyed up to the very end. And with better than industry retail growth in 2016, Victory went out with style and performance that defined its bikes. I view the 18 years of blood, sweat and tears we poured in the Victory of the investment and education required to successfully bring the legendary Indian motorcycle brand back to industry prominence. We will invest more in Indian to accelerate and expand our product introductions and innovation and you will see the fruits of that investment over the next few years. We owe it to Victory and its diehard fans to make our focus and investments payoff. We aggressively addressed product quality throughout 2016 executing 13 safety bulletins that came at significant cost but we have and will invest if necessary to make our vehicles safe for our customers. In 2016 we conducted a thorough review of all model year 2017 Off-Road Vehicles in addition to the extensive retroactive review that covered previous model years. We learned a great deal in the process and are putting that knowledge to use as we continue to strength in our global safety and quality function and set aggressive corporate safety and quality improvement goals for 2017. We're making solid progress on the two main RZR recalls with approximately 70% of the 900 cc - 1000 cc RZR and over 80% of the RZR Turbo recalls completed. Safety and quality remains our top priority but we know we still have much work to do. We will continue to closely monitor our vehicles performance and when we discover an issue that needs to be addressed, we'll act swiftly to keep our customers safe. Completing the Transamerican auto parts acquisition in November marked a momentous day for Polaris and TAP. Our complementary cultures and shared passion for Off-Road certainly make this an attractive deal but the long-term growth opportunities and synergies are even more alluring. TAP's CEO Greg Adler and Steve Eastman have pulled together a top notch integration team and they have been hard at work to identify and deliver a $20 million cost synergy target. We did not allow growth synergies to justify the acquisition but the teams are eagerly pursuing product, pricing and accelerated retail expansion opportunities that offer strong returns and growth potential. During times of distress or crisis either or both of which arguably describe Polaris last year, it is imperative to have a longer-term vision and strategy to serve as a guide. We remain firmly committed to our goals of expanding our lead in powersports and becoming a more global diverse and profitable lean enterprise. While our vision to fuel the passion of our global customers with innovative high-quality vehicles products and services remains worthy and relevant. Though our strategy is intact after the significant financial retrenchment we experienced in 2016, we no longer expect to meet our 2020 financial target of 10% net income margin. The $8 billion revenue goal requires a 15% compound annual growth rate. So that is a significant stretch but still possible. We will use our strategic planning process this year to evaluate our plans and likely outcomes and will update our longer-term financial targets in July. With that, I’ll turn it over to our CFO, Mike Speetzen.

Thanks Scott and good morning everyone. Before I get started let me cover a couple of administrative items. As Richard indicated beginning in 2017, we will be providing guidance for our fourth segment called aftermarket which includes all of our previously owned aftermarket brands combined with our newest business TAP. Second, all our guidance comments will be on an adjusted basis consistent with our Q4 results we have removed the impact of TAP purchase accounting for inventory step-up, acquisition closing and integration cost. In addition, our guidance does not include any of the one-time costs associated with the Victory wind down. Total company sales for 2017 are expected to be up in the range of 10% to 13% from the full-year 2016. The 2017 sales growth includes the following assumptions; foreign exchange is again expected to be a headwind in 2017 of approximately 30 million for the full-year. We've reflected no whole-good sales for the Victory business in 2017 and have forecasted only a minimal amount of PG&A revenue consistent with the ongoing support for the existing Victory fleet. We have forecasted a full-year sales from TAP of 775 million to 800 million which represents a 665 million to 690 million increase from the sales recorded in 2016. Lastly, organic sales for 2017 are anticipated to be in a range of down 1% to up 1% which assumes the overall powersports market as stable to down slightly and dealer inventory levels remain approximately flat. You will note that we calculated the organic growth by adjusting the 2016 actual revenue to remove the Victory whole-good sales made in 2016, adjust for the negative effect of foreign exchange, and adjust for the TAP revenue recognized in 2016 to determine the organic growth baseline. Adjusted earnings per share for 2017 are expected to be in a range of $4.25 to $4.50 up 22% to 29% compared to the full-year 2016 adjusted EPS of $3.48. Our 2017 earnings per share guidance assumes the following; consistent with our guidance when we announced the acquisition we have built in $0.25 to $0.30 per share for the full-year 2017 effective TAP. This includes interest associated with the acquisition, as well as intangible amortization but excludes the impact of one-time purchase accounting associated with a step-up of inventory, as well as one-time acquisition and integration costs. Consistent with what we said in our third quarter earnings call, we have built in a $20 of nonrecurring costs included in 2016 as a benefit in 2017. Partially offsetting this benefit is the mid-teens increase in our R&D expense, higher variable compensation costs and $0.20 per share foreign exchange headwind. Netting these headwinds against out our nonrecurring benefit yields $0.50 to $0.60 per share positive impact to EPS for 2017. Lastly we reflected the impact to earnings of our organic sales performance to be a range of minus $0.08 per share to a positive $0.22 per share. We have included the benefit of VIP, as well as the drag from higher promotional costs associated with the current powersports market dynamics and these estimates. It's important to note that our guidance assumes that our earnings growth is heavily weighted toward the second half of 2017 as the majority of the benefit from the elimination of a one-time costs incurred in the first and second quarters of 2016 is being offset by higher promotional spend and increase research and development expense. While firsthand sales are anticipated to increase given the addition of TAP, we anticipate that first half EPS to be about flat to last year. Improved margins and earnings per share performance materializes in the second half of 2017 with improved sequential sales performance as we anniversary the delayed vehicle shipments, lap higher promotional spending and realize the substantial benefit from the elimination of the one-time costs incurred in the second half of 2016. Lastly the currency rates for both Euro and the Canadian dollar which have the largest currency impact to our financials are assumed to be below averaged 2016 levels which we anticipate will negatively impact our results. As a reference, a $0.01 change in the Canadian dollar represents approximately $4 million impact to revenue and pretax income. For the euro, $0.01 movement impacts revenue by 3 million and pretax income by $1.5 million. The rate assumed in our full-year guidance for the Canadian dollar is approximately $0.74 to Canadian dollar and we've assumed the dollar €6 to Euro. On a segment reporting basis, sales expectations are as follows; ORV/Snowmobile sales are expected to be down low single digits given a competitive industry and high promotional costs. Motorcycle sales are anticipated to be down low double digits percent compared to reported 2016 segment motorcycle sales given the Victory wind down. On a comparable basis, adjusting out the victory whole-good sales in 2016, sales of Indian and Slingshot are expected to be up low double-digit percent in 2017. Global adjacent markets sales are expected to be up low single digits percent on strong work and transportation sales and a new aftermarket segment sales are expected to be up significantly with the addition of TAP. Now let me provide more details around each of our segments. ORV/Snowmobile segment sales were down 9% in Q4 driven primarily by ongoing weak market trends in the powersports market and continued competitive pressures. Sales were also impacted by higher promotional spending as we protected the brand and remained competitive against heightened industry promotional spending levels. These competitive pressures and higher promotional spending levels are expected to continue in 2015. This in addition to our market that is anticipated to be stable to down slightly as is projecting the company sales to be down low single digits. Motorcycle sales decreased 35% in Q4 as motorcycle shipments were down compared to a strong production and shipment quarter in 2015 as we recovered from delivery issues experienced at our Spirit Lake, Iowa facility. In addition, our plan final paint system upgrade at Spirit Lake required a shutdown of the production lines in Q4 which impacted production levels. Lastly Slingshot sales were also lower as the announced recall impacted sales and shipments in the fourth quarter. Our 2017 guidance for Motorcycles assumes that overall motorcycle market remains weak but that both Indian and Slingshot outpace the market and gain market share. Globally adjacent market sales increased 10% in the fourth quarter driven by the Taylor-Dunn acquisition higher sales in our defense business. In 2017, the global adjacent market group is working to further leverage its current global portfolio and technologies to drive topline growth in the low single digits range. In 2016 our aftermarket brands were reported in their respective reporting segments of ORV/Snowmobiles and Motorcycles. TAP closed on November 10, 2016 therefore we recorded 109 million of sales in the fourth quarter of 2016 and the segment named other. As we previously mentioned, beginning in 2017 we will be reporting a fourth segment called aftermarket. For 2017 comparability purposes, we have provided 2016 sales on a reclassified basis which includes TAP along with other aftermarket brands at KLIM, Kolpin, Pro Armor, Trail Tech, and 509. Historical data under the new reporting structure and pro forma 2016 TAP sales will be available on our website. Moving on to gross margins. On an adjusted basis margins were down 165 and 370 basis points for the fourth quarter and full-year 2016 respectively reflecting higher promotion and incentive costs, higher warranty expense and negative currency impacts from the quarter and full year. Despite these headwinds we continue to make solid progress on our VIP cost improvement initiatives adding approximately 150 basis points which help to offset a portion of the previously mentioned headwinds. For full-year 2017, we are expecting adjusted gross margins to improve from 2016 levels increasing approximately 180 basis point which is driven by a reduction of one-time warranty costs incurred in 2016, representing approximately 160 basis points favorable impact to gross margin in 2017. And we anticipate a level of gross VIP savings somewhere to levels achieved in 2016. However the reduction of one-time cost in VIP savings are partially offset by negative foreign-exchange increase promotions to protect our brand and quality and safety feature ads. On a segment reporting basis, 2017 gross margins are expected to perform as follows; ORV/Snow and Motorcycles are anticipated to improve, global adjacent markets gross margins are anticipated to be about flat and aftermarket gross margins up slightly compared to 2016. Let me highlight a few additional expectations for 2017. Adjusted operating expenses are expected to increase in the mid-teens percent range on a dollar basis due to increase research and development expense, the addition of operating expenses from acquisitions and higher variable compensation cost in 2017 somewhat offset by lower legal related costs. Income from financial services is expected to decline about 10% in 2017 reflecting lower average dealer inventory levels. Interest expense is expected to more than double due to the increased debt related to funding the TAP acquisition. I would also add that we have factored in the impact of multiple rate increases in 2017 to our variable rate debt. The income tax rate is anticipated to be approximately 34.5% for the full year 2017 and our operating cash flow performance is expected to be down significantly from 2016 driven by timing and cash outlays associated with the recall and legal activity from 2016, as well as the one-time cash outlays from the Victory wind-down in 2017. Lastly our share count is expected to be flat with 2016 as we intend to offset management equity issuance with ongoing share repurchases. Our share repurchase authorization stands at 7.5 million as of year-end 2016 providing ample flexibility to support additional repurchases should the opportunity present itself. With that, I'll now turn it back over to Scott for some final thoughts.

Thanks Mike. After significant investment in people, processes, new business and new products, Polaris is better positioned to return to growth in 2017. Our culture was forged by a long history of challenges, failures and great win and that spirit of innovation and competitiveness which defines us is fundamental to our success now more than ever. The prospect of lower taxes, a better regulatory environment and a focus on factory and oil production are potential benefits of the new administration that can help our customers and our business. The impact of that possible upside must be balanced with the risks, affinitive tariffs and trade rules that could potentially make our costs much higher and our vehicles more expensive for our customers. While the economic comment is volatile, we can say with confidence that powersports customers should benefit from a very competitive industry that will introduce more new vehicles and offer consumer friendly promotion. This competition is heightened in part by our powersports industry that we expect to be flat or slightly down in 2013. We are taking bold steps to improve service for our customers and dealers and investing more than ever in research and development with the strong focus on developing the performance and technology needed to spur growth for our Off-Road Vehicle business. That growth is contingent upon enhance safety and quality and as I noted previously, we believe we now have the people and processes in place to drive us to industry-leading performance. We will certainly face additional challenges along the way but will respond faster, better and more sustainably than ever before. We're excited to have TAP as part of Polaris and encouraged by the progress of the integration and prospects to accelerate aftermarket growth together. We share cultures and customers and are bias towards growth and believe the overall parts business will be another great Polaris brand in our expanding portfolio. Indian Motorcycles is the legendary brand and it's track record of solidly outpacing the industry continued in 2016. With confidence based on a growing line of great bikes, strong dealers and loyal customers we're increasing our commitment to the Indian brand as Victory rise into the sunset with industry-leading customer satisfaction that stem from wonderful designs, high performance and ironclad reliability. We will adding to our already impressive Indian line-up in the coming months and years and will honor and embody the Victory legacy. Now that we are free to invest even more in the Indian brands, the pace and breadth of innovative new bikes will accelerate and the resurgence of the Indian brand will continue to gain momentum. One of the less visible but vitally important drivers underlying Indians impressive market performance is our RFM system and as we roll it out for Off-Road Vehicles in 2017, we expect to deliver the same sort of competitive advantage there as well. Bringing RFM to ORV has made possible by our new Huntsville facility, which has also become a beacon for our lean journey alongside the ongoing success of our VIP initiative. Ken Pucel and his team continue to advance this program and their innovative ideas and value creating concepts has spread to every level of Polaris. While the raw cost savings are notable in and up themselves, as we see volume begin to increase the magnitude of these improvements will truly be revealed. We enter 2017 with more vehicles, brands and businesses than ever before and our focus on the fundamentals of safety, quality, delivery and cost will benefit every aspect of Polaris. I'm proud of our team for their perseverance and passion and look forward to working with them this year to make Polaris great again. With that, I will turn it over to Kim to open the line for questions.

[Operator Instructions] Your first question comes from the line of Greg Badishkanian with Citi. Your line is open.

Two questions here. First, what was the impact from elections on the overall industry in your retail sales, did you mentioned that things - I believe you mentioned things progressed throughout the quarter?

Greg, we heard a lot of dealers and customers talk about the benefit but we didn't see any of it happens. For track across the dealer network was light and we - both the oil and ag sectors that we watch very closely were no better than the fourth quarter than they were throughout the year. So, we did not see any actual benefit, it was just the prospects of the benefit that we heard from our customers and dealers.

Okay. So by fourth quarter or December versus before the elections there was no difference, it was similar trend?

No difference.

Okay. And then oil and ag markets, when do you start to really benefit from easy compares?

Good question. Oil and ag for us continue to weaken. Fourth quarter was a little bit better than what we had seen in Q2 and Q3. I think we were down, I'll call it below teens for oil and ag and then - for oil and then ag was down high single digits. Our expectation as we go to next year is we're not going to see a material improvement in those markets. We do feel like there's an opportunity for oil to stabilize given what we're hearing in terms of the rig count slowly improving and employment levels starting to improve. If that were to happen we would anticipate that being more of a second half dynamic but again we're not banking on that in our guidance.

Okay, good. Thank you very much.

And your next question comes from the line of Jaime Katz with Morningstar. Your line is open.

Good morning guys. I'm curious how you guys are thinking about gross margins for the ATV and ORV segment in the year ahead. It looks like a lot of the benefit that you’re getting is from – from these one-time expenses coming off but gross margins had compressed pretty significantly in the segments. So I'm curious if you would be willing to comment on that and maybe how you’re thinking about that progression improving over time?

I think Jaime the way to think about it is, we anticipate the margins being up from where they were in '16, I mean the warranty cost alone gives you the benefit but as we mentioned a promo cost is elevated in the first half relative to where we were in the first half of 2016. As we get into the back half two things happen, one we start to lap the high promo cost so that stops being a headwind and then we also start to see volumes improving slightly. So we should be able to see incremental leverage coming at that point and then obviously the work that Ken is doing from a VIP standpoint also plays into that. We are going to continue to fight foreign-exchange and our Off-Road Vehicle business is heavily weighted towards Canada and as we've got it forecasted right now about half of our FX exposures coming from Canada, and that's fairly evenly spread throughout the years. We don't anticipate that abating much by the time we get to the second half.

Okay. And then I’m curious you guys hired a buyback at the end of the summer to really focus on quality assurance, and I'm wondering if there are any early lesions you could share with us and maybe on what you guys might be implementing to improve quality over the year ahead given the number of recalls that occurred over the last year.

Hiring Joel Houlton who is a - Polaris Veteran came from the aerospace industry has a lot of wisdom and knowledge and that's been very helpful for us as we’ve kind of built out this safety and quality organization. There were so many activities going on to improve safety and quality throughout 2016 and what we've done with Joel in that position now, is to start to bring structure and rigor to how we execute that. One real benefit that we see it for an example is our post-sales surveillance where as incident happen in the field how much faster we see them and then can react to them and then ultimately build the lessons learned for those into our other activities. Our thermal expertise says it's obviously improved as we study what's happened in the field and how we design our vehicles and just across the board, we are taking every single step that we can to make our vehicle safer and higher quality for our customers and I'm proud of work we've done but there is a lot more to do.

And your next question comes from the line of Drew Lipke. Please state your company name. Your line is open.

Hi guys, this is Drew Lipke with Stephens. Thanks for taking the time. The first question I had just to previous question there just with the higher quality of the competitive side-by-side offerings that we're seeing and lot of competitors having closed the gap in lot of ways with RZR and RANGER, would you say that promotional environment and maybe the need for higher R&D spending is more transitory in nature or as we look out more medium term kind of 2018 and beyond is this something that you expect to remain I guess, I guess what are your expectations in ORV around incremental margins in light of this new environment?

Well I say in the immediate environment as we focused dramatically on ensuring that we get quality and safety right that we're going to have to rely a little bit more on promotions than we have previously. We do believe that that's transitory. Across all of our businesses there is a cycle of investment and we happen to be right now and a heavy investment cycle for our side-by-side business. We're really encouraged about our near term prospects for the RANGER business and with RZRs we got a little bit longer cycle but we will continue to improve our quality. Our performance is always industry leading, I mean to this day, I would put the performance of our RZR platform up against anybody in the industry. But we do have opportunity to improve the quality and reliability of our vehicles and I think we will not wait for a model year change for that to happen, we will continue to make those investments. But the work that Matt Homan and his team are doing to reposition our offered vehicle business for competitiveness using all of the attributes they have whether it's R&D spend, promotion spend, advertising, dealer support we're encouraged by that but it's - the significant R&D investments that you refer to will be more transitory in nature for the next couple of years.

Drew the only other thing I would add to what Scott said is remember that we have got Huntsville coming online, so here in the near term as volume start to improve, we will see the incremental margins getting better year-after- year also compounded by the lean work that's being done not only there but also at Monterey.

Okay, that's helpful thanks. And then just in motorcycle, what were the cost associated with that paint line shutdown and the recall in the quarter, what was kind of more one-time in nature there?

Yes, I mean the recall cost it's just to clarify overall as a company, we did incur some one-time legal and recall costs in the fourth quarter but we also had some favorable pick-ups from stock base and compensation perspective, so effectively it's netted to zero. Really what you can see Drew is the 1.5% gross margin that we recorded in Motorcycles is a direct reflection. The cost, we captured most of the cost for the paint system in our capital budget for the year, it was really the fact that we didn't have motorcycle volume going through the factory but yet continue to have ticking cost associated with the overhead.

I will say this is not a complete rebuild like we have done previously what John Dansby has done since he took over that Spirit Lake facility to make our paint system there really a competitive advantage for us and he just saw an opportunity to continue to add to that capability to be better at lower cost and higher quality and we took advantage of his advice.

And your next question comes from the line of James Hardiman with Wedbush Securities. Your line is open.

Hi, good morning. Just help me walk through the last few months obviously you were hoping for an improved or better retail growth in ORVs in the fourth quarter, ultimately where did that fall short was that an industry thing, was it a timing thing maybe with the RZR Turbo, how should I think about the delta there between where you thought ORVs would be in and where they ultimately end up?

Yes I mean ORVs are down mid single-digits as we indicated on the call we were anticipating having positive retail and I think it was back to Scott’s earlier comment, we really didn’t see the cadence change dramatically through the course of the quarter. So I think there is a piece of this that was market but certainly you can argue that there is a little bit of overhanging from all the recall activity.

Got it. And then if we could rewind may be to when you brought down the guidance in September some of that was recall, some of it was promotional obviously the recall stuff we’re adding back but it seem like a good chunk of that I think half of it at the time was identified as basically opportunity cost associated with the delayed model year '17 shipments. It doesn’t seem like we’re assuming that we get any of that back in 2017. I guess how should I think about that and obviously it's way early to start thinking about 2018 but is there any loss earnings power from 2016 that you might not get back in '17 but might still be there for you to get back in 2018 and beyond.

Yes, so I guess James if I go back to when we brought guidance down the one aspect that we are reflecting in here and I think we have been pretty consistent is the $120 million that's, 70% of that’s warranty the balances legal related and other cost. So, we are reflecting that consistent with what we discussed in our last call there are investments that we're making specifically around R&D to make sure from a competitive standpoint, we maintain the number one position that we have today. I think when you look at the revenue bring down that we had and I would just point you to the fact that, our retail was down for the year and Off-Road Vehicles call it, high single digits and our inventory was down 11%. That's indicative effect that we brought our inventory down to levels that we felt would be supporting the RFM implementation as we came into 2017 and that’s why you don’t really see that coming back and when you couple that with a powersports market that we feel is stable to slightly down that puts a fair amount of pressure. So, thinking about the revenue coming back is really not something to add back into the equation I think that’s probably where the different comes. I think as it goes to the leverage rebound in '18, I think it gets back to some of the earlier comments. I mean we’re obviously going to continue to make investments in R&D but if the volumes comes back, we’re not going to be investing dollar per dollars you got leverage there. In addition to that, as Huntsville continues to ramp when we get more volume through their from an Off-Road Vehicle standpoint, the efficiencies multiply and then when you add in the work that Ken has down around VIP for the past couple of years, any volume that we get through from more what we've been is going to create incremental leverage. So, I know it's early to think about '18 but we are optimistic in terms of those factors playing in.

Next question comes from Joseph Spak with RBC Capital Markets. Your line is open.

Good morning everyone. First question is, I just wanted to better understand some of the puts and takes on the bridge on Slide 16. So, you have in that one bucket VIP volume mix promo, I thought I heard the gross VIP savings would be similar to '16 which would be about, a 1.50. So, I think there was something pretty flat organic growth so, is that big offset to that $1.50 all promotion or is there also some negative or deleverage from the victory line down in that number.

Yes, there is no negative leverage per say. The majority of what we’ve got factored in as the impact of the promotional cost. When we talk about VIP, we do talk about gross, one of the elements that we are containing with as we move into 2017 we didn’t talk to it specifically but as we are seeing things like higher commodity prices coming through, all those things get offset against that VIP, as well as promo. So, we're effectively counting on the upper end of that range getting about a 32% drop rate at the other end of the range where we potentially gets the volume decline while accounting on a decremental margin of 14 which speaks to the actions that we would comment to and undertake to make sure that we’re pulling the appropriate level of cost up to minimize the impact the bottom-line from the revenue decline.

Okay. And just why - if that were shared overhead between like on paint between the Motorcycles and now the volumes lower wise they're now deleverage there?

There is deleverage but in the grand scheme of things it's not material given the work that we’ve got here.

And your next question comes from the line of Tim Conder with Wells Fargo Securities. Your line is open.

Thank you. Good morning gentlemen. First of all on Victory maybe of the following on a couple of prior questions there. So you talked about cumulative Scott I think you mentioned 100 million loss a little bit over that and that was one of the main reasons to make the change you did. What was the loss in 2016 and I guess maybe the questions been danced around here is how much of that loss do you anticipate flowing to the bottom line of savings avoidance of that loss versus the redeployment. And then the second question is Granite the current tax policy timing of implementation and so forth lot of uncertainty right now in that. Could you for the RZR and the general sales that you have in the U.S. could those - what you need for the U.S. could that be shifted from Monterey into Alabama and therefore that also gives you additional volume leverage in Alabama and gives the flexibility optionality versus may what happened with NAFTA or border adjustment or so forth.

Wow, let’s start with the latter question first Tim. We built Huntsville initially because we were tapped out at capacity across our plant network. So two years ago, we would not have had the opportunity with - our volumes having declined and the improvements in productivity that Ken and his team have driven across our plant network, we could squeeze that end, but it would be inefficient and not a very wise move and we will lobby against any such rules to the extent that we can along with many other industries that will be negatively impacted. But yes we could make that work. It would just not be good for our business or customers. And in fact to the Victory question, we’re not going talk about this the specific losses we never have. We don't do that by brand and don't think of the $100 million as a fixed cost. We were just trying to indicate a magnitude of the loss and as we said in our initial release and it continued over the most recent years. As we look forward there was a requirement to make the Victory bikes compliant and more competitive to make another significant investment in that brand and that caused us to take positive valuate and when we did that we saw that that a similar dollar investment in Indian would provide a significantly better return and that’s ultimately what drove that. There is a benefit certainly in 2017 we have included that in our guidance. So it's not something that’s going to materially stand out and pop something but Mike can you add any color to that.

Yes and I guess what I would add to that Tim is as we look out over – obviously we’ve disclosed the one-time cost that we anticipate having with the shutdown. We anticipate we’ll recover that call it in the next four to six years. So I mean just gives you a sense that it's – I mean it’s a decent amount of money but relative to the overall company it's not going to move the needle.

And your next question comes from the line of Seth Woolf with Northcoast Research. Your line is open.

Good morning. Just a couple of quick question, could you - I think I missed it, you spoke to kind of expectation for market share in the ORV segment. I know you talked about the market itself but usually you provide a little color and I think you mentioned it but I missed it?

As we indicated we are expecting the industry to be continue and potentially be increasingly competitive. We are expecting the industry to be somewhat flat and we [Technical Difficulty]

Ladies and gentlemen this is the operator please standby.

Seth did you get any of that before we got off.

Seth you there?

Well his line probably closed.

Kim are you there?

Yes I am, please go ahead.

Let's go to the next call.

Thank you. And Dave Beckel with Bernstein Research. Your line is open.

Good morning, guys. I was wondering just touching back on the Mexico or the Monterey question that was purged earlier. Could you possibly frame for us the magnitude of ORV units that are produced in Mexico and ultimately sold in the U.S.?

The vast majority of our RZR products are produced out of our Monterey facility. And the U.S. percentage of that is two-thirds or higher. So it’s a big number.

Got it. That's a very helpful. Thanks. And as a follow-up I was just wondering…

It’s very hurtful?

What’s that Scott?

It’s very hurtful if they were do something like that, but our position on this is that, there is a lot of really smart people in new administration. Congress understands economic issues very well. We do not believe that they’re going to take an action that could be that detrimental to the U.S. economy. So we’re watching it closely but confident that rational heads will prevail.

Got it. And this is a quick follow-up, can you updates on how many Indian dealers are currently are in the U.S. and a couple of months ago I guess a month ago you updated us on your expectations for dealer growth over the next three to five years. How many dealers are you of that sort of 1.5 times improvement, how much of that relates to U.S. dealer growth?

Well we’re right at about the 200 dealers, we purposely gotten away from providing specific target because we don't want to add dealers to create growth. We want to make sure that our dealers are growing profitably as we are and we want to make sure that we’re adding the right dealer at the right time. So we’re right at that 200 mark right now and that’s about half way to where we think will be in the 350 or 400 range over time. What was the second part of the question?

I guess the Indian dealers? You got it.

Yes, I think you got it.

Did that answer your question? All right next question Kim.

The next question comes from Craig Kennison with Baird. Your line is open.

Taken my question, the first has to do with dealer inventory. Clearly you made a lot of progress in 2016, but based on our checks dealer ROI still seems to be under pressure. Do you think inventory is at the right level today and where would you expect it at the end of 2017.

Yes, we think the aggregate inventory level is essentially right. We think that there are opportunities to improve the inventory levels for some model, but that is - we don't believe that is the main driver of dealer profitability at this point. We believe that with our appearing online we will not take another step down in dealer inventory but will make sure that we have the right inventory at the right time to give our dealers more of a competitive advantage over time. But there is a lot of things that we need to do it’s how we manage warranty, it’s how we manage and deliver our promotion costs. And ultimately it’s getting back to providing volume growth and I think if you look at the plans that Matt Homan on the business side and Tim Larson on the marketing and sales side, they really done a good job of identifying those opportunities where we can help our dealers along with us to get back to profitable growth and you’ll see us take a lot of those steps in 2017.

Craig we survey our dealers much like you guys do and we are getting increasing feedback that that is becoming more of a benefit. I just also point out that it does take time for that to work through the system given that we do cover floor planning for a period of time. And so for them to be able to feel that and see the consistent delivery is going to be important as we go through 2017 and as I indicated in my prepared remarks we anticipate dealer inventory to be in flat for the year.

And then just following up on the credit side, you mentioned in the press release that you had a higher penetration rate in the retail credit portfolio. What's driving that and do you see that unfolding again in 2017 or have we reached a peak in credit availability? Thanks.

Some of that comes from the way we stir our promotional programs. It also comes from the fact that we brought performance finance online as we launched at the dealer show back in Nashville and that partnership has taken off and done quite well. We do anticipate that that will improve, but I think the rates of improvement are going to diminish work. Overall financial services income as I indicated is going to be under pressure next year. The bulk of that is being driven by the dealer inventory position, but we do anticipate lapping more aggressive retail penetration that we have in 2016.

And your next question comes from the line of Robin Farley with UBS. Your line is open.

Great, just wanted to clarify a couple things and they were parts of the call where it was cutting out. So hopefully this is something you adjust but when you talk about having under review your longer-term targets. Is that more due to so reviewing your organic growth targets or reviewing your M&A strategy or both and then I also have a question on your 2017 guidance that may be all that you take that one first?

Robin really that was a realization that with the significant change in currencies and with the significant cost we've incurred with the 2016 recall activity. We did not see a clear path based on the CAGR required which is close to 25% to get to that 10% net income target. I mean that's a very, very high bar for any manufacturing company and you know previously when we were at 8% moving up we thought top in our ability to get there but as we’ve taken this step back that no longer appears to be something that we could reasonably feel any confidence that we could get to. As I mentioned on the prepared remarks, our $8 million revenue target it’s a goal that we have but really it's the strategic objectives that are important to us much more so than the dollars. And we are very focused on being the best in powersports plus robbing our global business but we will not be holding to $8 billion just because it’s out there we will absolutely not make bad investment decisions just to hit a target. But at 15% sales growth, I mean that’s a reasonable target that we could achieve if things turned around. So with that understanding that the net income target is not likely possible and the revenue target is less likely we’re going to just use 2017 our normal strategic planning process in conjunction with our Board of Directors to evaluate what the new right target for the company are and we will bring those out in July.

Okay, that's helpful, thanks. And then just on your 2017 EPS guidance and I’m just trying to square with your - you mentioned that organic sales guidance are basically flattish in 2017. Because if we back out the buck 20 and sort of the one-time recall cost and if back out the accretion from the TAP that you had quantify previously it’s kind of suggesting kind of organic earnings down like 15% to 20% with. So I guess I wanted to ask I appreciate that you may be being conservative of your guidance and all that but just trying to think does that sound about right that it just lower the impact of the factors you mentioned promotional cost and FX that is getting kind of flat sales to earning down 15% to 20% on a kind of same-store basis. And then also I guess kind of questioning your Off-Road shipment guidance down 9% because you mentioned that your inventory levels at the end of the year are already where you kind of want them to be in anticipation of RFM and so just - since you’re anniversarying a period where you couldn't even ship your new model here for about two months, it seems like anticipating further shipments cuts when you’ve already adjusted for RFM just trying to think about why you wouldn’t see – why you would expect to see additional declines in shipments there?

Mike, I'm letting you answer that one.

So Robin you referenced 9% that was referencing back to 2016 our guidance for ORV is down was single digits in 2017 and I think that just reflect over the comments we made around the powersports market and as Scott indicated that we’re going to continue to have the competitive dynamics coupled with higher promotional costs. I think I just stir you back to the Slide 16 in the deck. We bucketed some things differently, but I think if you were to pull over things like R&D in fact that we’re investing up to 30 million more higher compensation costs as variable comp plans start to potentially kick back into place the foreign exchange and the higher promo, that does certainly put pressure on the organic improvement that we’re seeing in the business.

And your next question comes from the line of David MacGregor with Longbow Research. Your line is open.

Good morning. I had a question for you on Slingshot and it seems as though we’re kind of looking at negative growth I appreciate the fourth quarter you're up against kind of roller comp. But it just gauging from the guidance it doesn’t sound like you're terribly optimistic on Slingshot volumes. And at this point I guess you’re wondering if you’re seeing anything in the order book patterns that are back or to something that you give confidence in Slingshot. Or just where does the confidence come from in terms of your ability to create a profitable success with this product?

Well Slingshot has been a profitable business for us. We are encouraged by what is profitability for us and for our dealers. The quality and recall issues that we’ve had to deal with are unhelpful actually, but we are projecting growth in 2017 and now that Steve Menneto has just Slingshot and in Indian and to focus on, we are comfortable that we will bring out the rights vehicles and products to get this business to be able to drive growth, long-term profitable growth for the company. I will tell you that I have always said that in this industry you really need to get to that 12,000 or 13,000 unit volume number before you have confidence that you got a long-term growth business. Victory never got there. We got to push Slingshot there. The biggest single issue or opportunity we have is that awareness for the vehicle and for the brand is still below 20% in the powersports industry. So what you'll see throughout 2017 is continued focus on improvement of quality and performance of the vehicle, but also a concerted effort to expand the awareness. And for some of you that might have seen the International Race of Champions that are pretty exciting race over the weekend where Slingshot was one of the premier events. So certainly lots of opportunities but work to do.

And David I'd just point back to my comments that we do anticipate growth coming out of Slingshot in 2017.

Right. So just with respect to your comments on 12,000 to 13,000 volume can you see where you are now with regard or with respect to that target?

And good day less.

Okay. Second question just regard to the promotional environment and it was a lot going on out there. Are you getting a sense that buyers are getting promo fatigue here and they’re maybe slightly less responsive and are you confident to your ability to enforce MSRPs?

Yes on the MSRP absolutely, we have team that actively manages that and there is always going to be areas where issues occurring we’re quick to address those. I think from effectiveness standpoint it’s probably a mix bag I would tell that our team is quite adapted at monitoring the programs and making adjustments. We actually did quite a bit of that in fourth quarter. We’re not just going to spend money when we don't see a reaction coming from it. At the end of the day for us, the key is going to be putting the best products out there and having the most technology power, suspension travel. So we’ll continue to focus on adding, we think we've got the ability to tailor our programs to be highly effective with consumers.

And your next question comes from the line of Joe Altobello with Raymond James. Your line is open.

Good morning. Thanks guys. Two quick ones if I sure I guess first one with the housekeeping and just to clarify the U.S. 900 cc in a motorcycle industry data you sited in your release this morning of less of the decline that does not include Slingshot just want to confirm that. And then secondly in terms of ASP it sounds like we can offer vehicles, that was flat in the fourth quarter. Could you talk about the puts and takes for 2017 between list prices, product mix et cetera. Thanks.

The motorcycle share data does include Slingshot in the 900 and above. And then can you repeat your question on the average selling price?

Yes sure. Just trying to see that what ASPs does look like in 2017 given a lot of puts and takes you guys had with prices and the mix impact with we call as obviously impacting 2016 mix. Thanks.

I mean for offer vehicles we ended the year down fourth quarter was flat because we are lapping a lot of activities from last year. We anticipate ASP probably be under pressure as we head into next year we’ve got higher promo levels and probably some mixed dynamics that play out there. For Motorcycles, we think ASPs are going to be up and that really is driven because Slingshot improves. It deeply impacted in the fourth quarter just given what we'd seen in terms of the recall impact.

Next question comes from the line of Jimmy Baker with B. Riley & Company. Your line is open.

Hi, good morning. Thanks for sneaking me in. I just got a follow-up on the dealer inventory commentary, so you highlighted that Polaris North American dealer inventory is back below 2014 levels. I understand you might have the data that quantify this but in your view how much of that reduction in Polaris ORV inventory was more space share loss to competitors that multiline versus an absolute reduction in all lines of inventory within your distribution?

Obviously as competitive as we are, we watch that for a space very, very closely. We've not seen a material impact on poor space any segment of the country, any segment of our dealers. Obviously there is a fairly aggressive effort from some of our competitors to get into our dealers but typically we are not the one that getting upward space in fact we're almost never the ones to do upward space nor are we the ones that dealerships are dropping product line which is happening - or dropping brands all together. So we're not seeing that. Most of our - you think about, we decreased inventory while we broadened our product line. So really it is been an opportunity for us and that’s what we're trying to do with RFM. We've done it with ATVs, we've done with motorcycles, we'll do it by side-by-side but we are taking many steps to work with our dealers to make sure that we are making their poor space more productive for us and ultimately we think that's what will make sure that we continue not to lose poor space.

Okay. That's encouraging and then just lastly from an Indian product planning perspective. Does the Victory wind down the removal of any and all cannibalization risk open up any possibilities there that that you might have not previously pursued with the dual brands?

Yes, obviously there is a whole lot of different opportunities and challenges that we evaluated to do this but there was cannibalization across we saw that for sure and there was some characteristics of the Victory bikes and trust me I have received many correspondence from the loyal and passionate victory riders. But they were just great motorcycles and I think in times the benefits of that bike brought some people that would have bought as Indian over the Victory and this is the large case where they just don't want that other brands to purchase and we’re really alternative. So certainly there was more cannibalization than we would have liked there any we think it's an opportunity to get some of that back.

And your next question comes from the line of Mark Smith with Feltl & Company. Your line is open.

Hi guys, just looking at our capital structure and cash flow statement here, you guided CapEx down but also operating cash flow down pretty significantly. You are excluding acquisitions and share buybacks, can you guys be self funding or will be few addition of that to kind of fund the businesses here?

At this point we don't anticipate additional debt. We think there is an opportunity as we get through the course of the year to both deleverage from an earning standpoint, as well as have the opportunity if you want to redeploy cash but at this point we don’t see taking on additional debt. Could we go through and we characterize some of our debt, I mean we do have a disproportion amount that's variable rate today so we may take some of those actions but I don't think you’ll see the capital structure change dramatically.

And then second just, I don’t know if you guys have talked about growth rate expectations for the aftermarket business from excluding TAP and also including that, kind of what kind of growth rates you are expecting this year?

Yes we really haven't but I think it's safe to assume kind of low to mid-single digits for that core Polaris previous aftermarket segment.

And your next question comes from the line of Gerrick Johnson with BMO Capital Markets. Your line is open.

Good morning, guys. You covered the time ground, I was just a follow-up on something that Jaime asked about the dealership relations. After the recalls, how are you dealing relations it seems as though you're saying and you haven't lost any shelf space or poor spaces I should say you haven't seen any dealers drop off. So how are they feeling about their Polaris business right now?

Yes, we still have work to do on that regards. Mike talked about the fact that we do regular surveys and sentiment - overall sentiment is not where we wanted to be. I will say that obviously we did way more recall activities than we wanted to but we did - I think actually improve sentiment somewhat with how we handle the recall. Some of our dealers made a good bit of money, they brought a new customers back into their shops and that I think we actually handled reasonably well but during that process we also saw many other opportunities where we can improve the relationship and the services that we provide to our dealers and that's going to be one of our big corporate priorities going into 2017. So it's not a competitive advantage for us right now our dealer relationships and we’re going to try to reverse that going into the year.

Thank you.

And your final question comes from the line of Chris Krueger with Lake Street Capital. Your line is open.

Good morning. Just one question. Over the last decade or more, Polaris and your competitors have sold a lot of ORVs. Can you comment on how we should look at the used market and if that’s playing a role in the weakness in 2016?

We like to use markets as evidenced by our purchase at TAP. We've got a very large growing business as Steve Eastman got. So we really like the growing piece of especially side by side but overall the aftermarket. I would tell it’s not a one one-size-fits-all because in the recreational sport side-by-side segment, the secondary market is not very big people ride them pretty hard and a lots of the transaction are happening from person-to-person rather than going back to a dealership. Honestly with the recall activity we may see a little bit more of a pickup in used vehicles up there but that is not - nothing like the motorcycle industry where the used market pricing defines what happens in the category. We still see at the net opportunity for us to sell aftermarket parts significantly greater than any negative impact we get from used taking the way new buyers.

All right, thank you.

I want to thank everyone for participating in the call this morning. And I apologize for the technical difficulty we had little bit earlier. We look forward to talking to you next question. Thanks and good bye.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.