Polaris Inc. (PII) Q2 2017 Earnings Report, Transcript and Summary

Good morning. My name is Krista, and I’ll be your conference operator today. At this time, I would like to welcome everyone to the Polaris Q2 2017 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. [Operator Instructions] I would now like to turn the call over to Mr. Richard Edwards, Head of Investor Relations. You may begin.

Thank you, Krista. And good morning and thank you for joining us for our second quarter 2017 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. During the call, we will be discussing various topics including updated 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 2016 10-K for a more detailed discussion of these risk and uncertainties. Throughout the presentation today, all references to second quarter 2017 actual results and 2017 guidance are reported on an adjusted non-GAAP basis unless otherwise noted. Adjusted refers to GAAP results excluding our TAP inventory step-up adjustments and integration expenses, and the impact associated with the Victory wind-down and some manufacturing realignment costs. We have provided a reconciliation of the adjusted non-GAAP to GAAP results which is shown here on Slide 3 and in the appendix. Now, I’ll turn it over to our CEO, Scott Wine. Scott?

Good morning, and thank you for joining us. Recently I had a conversation with one of our better dealers and was pleased to hear him acknowledge that we were listening to and addressing some of his concerns. Before I could stop smiling, he confidently asserted that he expected us to get back to ignoring him just as soon as we started winning again. His cynical view was difficult to hear, but also quite valuable. While we work to enhance quality, accelerate innovation, drive productivity and improve profitability, we can never stop listening to and delivering value for our dealers and customers. We continue to invest heavily to support our safety and quality initiatives. Progress in these areas often reveals additional issues and this is manifesting itself and further recalls and higher than anticipated warranty cost, which we are aggressively working to abate over time as we apply lessons learnt to our current processes. Fortunately, with higher VIP savings and overall execution improvements, we are largely able to offset these and other headwinds. We were pleased with our side-by-side business returning to retail growth for the first time in six quarters, but disappointed that we did not keep pace with the industry. Our overall ORV retail numbers were pulled down as ATV retail sales and market share declined in a highly promotional ATV industry. And these motorcycles continued to drive growth in a week heavyweight motorcycle market. Retail sales were up 17% as we accelerated share gains and positioned the business well for the second half with our model year '18 bikes coming out next week. Slingshot sales were low and promotional costs were high, which is never a good combination. We have action plans and product news to help turn slingshot around in the second half, but we must engage with more urgency in returning slingshot to grow. The Victory wind-down is on plan and we are continuing to persuade loyal Victory customers to take advantage of the remaining Victory inventory and or try our new Indian bikes. Mike Dougherty’s international business had a strong second quarter, up 12% as Australia posted a record quarter, and Europe and Mexico, continued to outperform. Equally welcome was the performance of our parts garments and accessories business, up 4% in the quarter. TAP sales were solid 6% growth on a pro forma basis and both the integration and synergy plans are ahead of schedule. Second quarter overall retail sales were down 3%. While I will never be comfortable will negative retail numbers the makeup of our performance was reasonably good. The highlight was certainly Indian motorcycle’s broad-based growth, which is important during the high of the riding season. However, slingshot retail weakness, more than offset Indian strength bringing overall motorcycle retail down modestly for the quarter. RZR retail sales turned positive, admittedly against an easier prior year comparable, but it was encouraging to see demand improve sequentially as well. RANGER retail was flat for the quarter, amidst strong competition and heavy promotions. The promotional environment for ATVs also remained high, and we did not match some of the clearance sales that continued in the quarter, leading to lost market share and retail sales down high single-digits. We believe our product news and retail plans and of course easier comparables, will combine to improve our results in the second half. Dealer inventory was down 6% in the second quarter, putting us in solid position for the introduction of our model year '18 vehicles and facilitating a smooth transition to RFM. ORV inventory also dropped 6% led by a double-digit decline in RZR units, and Slingshot inventory was also down as necessitated by lower retail. We continue to project year end dealer inventory to be approximately flat to last year. A hallmark of Polaris vehicles is our industry-leading ride and handling. As our powertrain capability continues to improve, the combination of power and performance and of course some darn good riders is boosting our success at the race track. In our first year of flat track racing, Indian is dominating the field, winning 9 out of 10 AFT races and recording an astonishing 23 out of 30 podium finishes. Not to be outdone, RZR has won over 75% of the races it entered this season reinforcing that we have the highest performing vehicles regardless of the venue. Transamerican Auto Parts had another good quarter, as their deep array of innovative products, strong brands and omni-channel reach contributed 6% sales growth. Integration is preceding slightly ahead of schedule and we have opened four new formal part stores this year including our first store here in Minneapolis earlier this month. The energy savings also funded a new R&D center in Southern California, which will enable [Greg] and his team to further penetrate the off-road vehicle market. With that, I’ll turn it over to our CFO Mike Speetzen.

Thanks, Scott, and good morning. Our second quarter finished slightly ahead of expectations, for both sales and earnings per share despite a highly competitive industry. Second quarter sales were $1.36 billion, up 21% on a GAAP basis and 20% on an adjusted basis from the prior year. This included $209 million of incremental sales from TransAmerican Auto Parts, which more than offset the revenue impact from the Victory wind down of approximately $54 million of sales reported in Q2 of 2016. Organic sales, which adjust for TAP, Victory, and foreign exchange were up 7% including strong PG&A and international growth as well as improvement in company average selling prices driven primarily by off-road vehicles. Second quarter earnings per share on a GAAP basis was $0.97. Adjusted earnings per share was a $1.16 when adjusted for the Victory wind down, TAP integration, inventory step-up cost, as well as the manufacturing network realignment cost booked in the quarter. The increase was driven primarily by improved gross margins, which were somewhat offset by higher operating expenses, due to increased research and development cost to accelerate new product introductions, higher selling and marketing and legal related costs. We anticipate a modest improvement in the global powersports market. This coupled with two quarters of improved execution, has us raising our overall sales guidance range as well as raising the lower end of our earnings guidance range for the year. We now expect total company sales to be up in the range of 12% to 14%. We are increasing our ORV/Snowmobile guidance to approximately flat year-over-year, given the stronger year-to-date performance in side-by-sides, international and PG&A related shipments. We’re lowering our motorcycle guidance to down high teens percent on a GAAP basis, which equates to up mid single-digits, when prior year Victory sales are excluded from 2016 for comparability. The motorcycle revision is due to weaker than expected Slingshot sales year-to-date. And finally, we are increasing our global adjacent markets guidance to up mid single-digits percent. Total company organic sales which is defined as total revenue excluding TAP, Victory sales and the effects of foreign exchange is expected to be in the range of flat to plus 2% for the full year, which has improved from our previous guidance of down 1% to up 1%. Promotional spending is expected to continue at current levels, but we begin the lap similar levels of spending incurred in the second half of 2016. Lastly, we continue to expect dealer inventory to be roughly flat by year-end on a year-over-year basis. Adjusted earnings per share guidance is now expected to be in the range of $4.35 to $4.50, up 25% to 29% compared to the full year 2016 adjusted EPS of $3.48. While, we've increased revenue guidance, we are holding the upper end of our EPS range as volume gains are anticipated to be offset by higher than originally anticipated warranty and legal-related costs. Our first half 2017 EPS finished at $1.91, slightly ahead of our $1.80 estimate provided during our last call. Given our current full year revised guidance, the second half EPS equates to a range of $2.44 to $2.59 per diluted share, which is a significant improvement over the second half of 2016. I’d also add that the cadence for EPS in the second half of 2017 is more heavily weighted towards the fourth quarter with approximately 45% of our EPS occurring in Q3. I’ll cover our gross margin guidance in a moment. So, let me cover some additional revisions. Adjusted operating expenses are now expected to increase in the 60 basis points to 70 basis points range as a percentage of sales versus last year driven by higher R&D expenses, increased variable compensation, and legal-related costs. The income tax rate is anticipated to be approximately 34% for the full year 2017 due to the benefit from the adoption of the new employee share-based accounting standard. And lastly, share count is expected to be down 1% to 2% versus previously issued guidance of about flat with 2016 as we were more aggressive in share repurchases in the first half of 2017 than originally anticipated. Our full year repurchase target has not changed at approximately 1 million shares, but we'll get more benefit from the lower share count given the timing of repurchases. We repurchased 758,000 shares in the first half of 2017 at a total cost of $66 million and we have approximately 6.7 million shares remaining under the Board’s current authorization. You can find a specific guidance for these and other P&L items in the appendix of the presentation. Lastly, Polaris is currently working with the appropriate agencies to review proposed corrective actions and release timing for a handful of pending recalls. These have been contemplated in today’s revised guidance. Gross margins, on a GAAP basis improved 51 basis points to 25.7% in the second quarter, which includes $8.9 million of Victory wind down cost and $4.3 million of manufacturing realignment and network optimization cost. As we indicated last quarter, we are transferring Milford Manufacturing to existing Polaris facilities, taking advantage of our new capabilities and capacity in Huntsville, as well as in Roseau. We are also consolidating GEM assembly with Taylor-Dunn and Pro Armor fabrication into TAP to leverage TAPs capabilities. Our adjusted gross margin increased 160 basis points to 26.8%, reflecting significant gross VIP cost savings and positive product mix, somewhat offset by higher promotional costs. Year-to-date, our warranty expenses are approximately $6 million below the same period in 2016. The warranty expense in the second half of 2017 is expected to be lower in absolute dollars and as a percent of sales in the same period last year. We continue to expect adjusted gross margin improvement in the 180-basis point range for the full year 2017 versus last year, driven by the following; Ongoing gross VIP savings similar to levels achieved in 2016; a reduction of warranty cost incurred as compared to 2016 partially offset by additional quality features, ads which increased product cost; increased promotional cost to protect our brand; and foreign exchange headwinds, although to a lesser extent. On a segment basis, our adjusted gross margin guidance remains unchanged. Now, let me provide a few brief highlights for each of our segments. ORV/Snowmobile segment sales were up 6% in Q2, driven primarily by improved ORV shipments of side-by-sides worldwide and a 5% increase in PG&A related sales. Despite sales being negatively impacted as expected by higher promotional spending, we’re able to recognized higher average selling prices on improved mix. Full year sales for the segment are expected to be about flat. Motorcycle adjusted sales decreased 16% in Q2. Excluding the Victory sales of $54 million report in Q2, 2016, motorcycle sales were up 10%. The company sales of Indian motorcycles were up significantly in the second quarter, driven by new products, with the introduction of the new Chieftain Limited and Elite and new Jack Daniels Chieftain edition. Slingshot sales were down in Q2, partially due to the tough comparables in the prior-year, as we shift additional slingshot models into the channel in anticipation of the move of production from Iowa to Huntsville. We’re not pleased with our performance in Slingshot and are working to increase the awareness of the product, dealer engagement and improve the quality of the vehicle. We’re excited about the model year 2018 product lineup, which will be on display at next week’s dealer show. Motorcycles segment sales are anticipated to be up mid-single digits for the full year as compared to 2016 when Victory sales were excluding. Global Adjacent market sales increased 7% in the second quarter, the growth was primarily driven by our Aixam quadricycle business and Goupil light-utility businesses. We anticipate Global Adjacent market segment sales to be up mid-single digits for the full year. Aftermarket sales, which includes TAP along with our other aftermarket brands, were up significantly primarily due to the addition of $209 million of TAP sales in Q2. TAP results were in line with expectations and integration plans are progressing well. We added four new four-wheel parts retail stores including the first store in the Twin Cities metro area that will open this weekend. Pro forma organic revenue for the aftermarket business was up approximately 7% in Q2. Our operating cash flow performance was down 24% from the first half of 2016 as expected and we anticipate full-year cash flow from operations to be down significantly driven by timing of cash outlays associated with prior year promotional and warranty accrual as well as Victory wind down and manufacturing realignment costs. Net debt at the end of Q2 finished just under $1,938 million for the first time since the acquisition of TAP was completed. Income from financial services was down 1% during the quarter is expected given our wholesale credit receivable balance was down as a result of lower North American dealer inventories in the second quarter. The retail credit environment remained stable with approval rates of 62% for the second quarter of 2017, up two percentage points from Q2 last year and our penetration rates were flat with last year at 30%. Retail income was down in Q2 primarily due to lower retail volume. We continue to expect full-year income for financial services to be about 10% lower year-over-year. With that I’ll turn it back over to Scott for some final thoughts.

Thanks, Mike. As we enter the second half of the year, we’re cautiously optimistic about our end markets. Ag remains weak while oil states are improving, but not yet positive and we still see no signs of the elusive Trump bump. Nevertheless, the global powersports industry outlook is improving for the first time in several years. The highly competitive market is good for consumers and drives us to make better products and deliver improved services which we are assiduously doing. The work that Matt Homan and his team are doing to reposition our offer of vehicle business for growth is impressive and extensive. And our multi-year product plans are innovative and inspiring and while our model year 2018 introductions are very exciting, they are just the tip of the iceberg. Our marketing plans and sales teams are set to drive better traffic and profitability for our dealers. We are not yet where we want to be competitively, but the overall business is improving. Steve Menneto has transformed our motorcycle business since we launched Indian in 2013 and our success with the Indian brand is encouraging, but not yet sufficient. With the launch of the exciting new Scout Bobber last week, we have launched six new bikes in 2017 and will introduce more in the next few days. From digital marketing to industry leading electronic displays, we are adding technology to the styling and performance synonymous with the America’s oldest motorcycle to entice a broad range of customers into the Indian family. Understandably, the external focus from impressive financial community primarily concentrates on our significant recall related activities impact on our cost and market share. Internally, we have emphasized the safety of our vehicles and developing repairs and support of our dealers. We’ve also applied everything we have learnt toward driving improvements in our products and procedures to make Polaris better. Ultimately, this experience will result in a future of higher quality and improve safety, which is good for Polaris and our customers. Better quality, shorter lead times, lower cost are all part of the extensive productivity play that came through sell is driving across it’s expansive global engineering and operations organization. Momentum and savings continue to accelerate as we seek to become an extremely lean and efficient growth company. I’ll look forward to seeing many of you at our Dealer Show and Analyst Meeting in Las Vegas next week. It will provide great opportunity to see firsthand the innovation, dealers, and Polaris team members that combined to make us the global leader in powersports. With that, I’ll turn it over to Christy to open the line for questions.

[Operator instructions] Your first question comes from the line of Robin Farley from UBS. Please go ahead. Your line is open.

Great. Thanks, two questions. One is just -- what is your impression of what industry ATV sales are doing? I’m just wondering how much of the decline there is share loss versus just the ATV industry being challenged. And then also your targets to have inventory flat year-over-year, right at the end of the year, I think you said, I guess what does that say by your expectations for sales going into next year? If you're expecting shipments to be flat this year and seeing retail sales decline and then you want to have your inventory positioned flat which we had it for this year. Is that just being conservative and not expecting any growth in the market next year? Thanks.

Robin, the overall -- we don’t have to guess. We see exactly what the overall ATV industry is and it’s down and we were down slightly more. So, we did lose a little bit of share, but that -- the ATV segment was very highly promotional, driven by one main competitor that was trying to flush our bunch our inventory out that had what I'll call, somewhat ridiculous promotional activity on ATVs and we can’t compete with that. We didn’t try to, but we will certainly be better positioned going into the second half. As far as the end of the year dealer inventory position, you have to remember, we have really good product news coming out that we will ship. A lot of it doesn’t really start going until the fourth quarter. So, there will be a good bit of channel fill and then there is profile establishment as we transitioned to RFM and as we balanced all of that out, we still believe that flat by the end of the year is the right position for us to be with overall dealer inventory.

And I don’t know Robin that I agreed anything into 2018. At this point, I think with RFM go live, were RFM live on ATVs and motorcycles and with that, going live on side-by-side, we’re going to start to be able to ship more closely aligned with retail. So, we just think that that inventory level by year-end is going to give us that same flexibility. So, we’ll have more of a perspective on '18 as we come into the third quarter call.

No. That’s helpful. Maybe just one clarification if I could, I think when you transitioned the ATV business on to that system that if I recall you were able to lower dealer inventory by about 10%. So now if you’re doing that with the side-by-side business, I don’t know if that’s the equivalent of expecting then a sales increase maybe in that sort of flat to up single digit range for next year, even with that flat inventory, is that, I don’t know, if you’d comment on that?

Yeah. What I would say Robin is, we’ve already taken side-by-side down. We’re down 6% in the second quarter. Overall, dealer inventory will tell you that the side-by-side is down significantly more than that. So, we are already at a point where we’re trying to ship at the same cadence as retail. It puts a lot of strain on the manufacturing environment until we go completely live with RFM. But we’ve essentially already put our inventory at the right level, essentially give or take.

Okay. Great. Thanks.

Next question?

Your next question comes from the line of Tim Conder from Wells Fargo Securities. Please go ahead. Your line is open.

Thank you, gentlemen. First of all, just a little clarification, Mike on the FX guidance. That’s still a negative, as you had listed in your presentation. But given the U.S. dollar strengthening, is that down a little less negative for the balance of the year, just a little more color on that? And then on the ORVs, Scott, you’ve got -- you mentioned a competitor doing some crazy blowouts in that and then obviously you guys have easy comps, you got very easy comps here in Q3 at retail. If you kind of parse through that, how are you seeing the core underlying demand. You mentioned the oil still weak, but maybe ags getting a hair bit better, just a little color on that? And my follow-up would be the acquisitions. How big could you go, if a large opportunity arose?

So, Tim let me hit that foreign exchange. We did see a little bit of benefit in the first half, but year-over-year FX was still just under a percentage point drag on the top line. And from a bottom line standpoint, we’ve been out aggressively hedging, so where we’ve seen gains from a FX perspective, we may not have that same reaction from the hedges that we put in place. We took a conservative view for the balance of the year, just given what we’ve seen happening with foreign exchange. And if -- certainly if rates hold where they are today, we would see a small amount of upside, but nothing that would be material in the grand scheme of bearings of the company.

Yeah. And as far as the overall market, the powersports outlook, as I said, it’s the first time in – I don’t' know several years that we have commented that we feel better about the industry and we do. The overall, as I said, in my prepared remarks, the oil segment actually got a little better, but remain negative. It’s the comps were I think down 20 last year second quarter.

So, oil got better, but still not quite positive. Ag actually got worse, and obviously we think over time, that will get better. But overall, those negatives where outweighed by a little bit better sentiment across the rest of the network. So, we felt, reasonably good about that and are optimistic with our product news and better execution going into the second half, it will be okay. As related to our capacity for M&A, obviously, I will tell you it’s significantly higher than our appetite. We even with the TAP acquisition, we maintain a strong balance sheet, we generate a lot of cash, so we’re in good shape.

So how large would you all feel comfortable going if this opportunity was there?

Well, I mean, Tim, we’re sitting just under two turns of EBITDA. Obviously, a comfortable load for the company on an ongoing basis would be probably sitting around 2.5. But as you know when you’re in doing M&A in the initial years, you’re going to potentially blowing up. So, could the company hit around three times EBITDA and be able to quickly de-lever within a year to 18 months, I think, we would be comfortable with that assuming that we didn’t see any markers in the economy that had us concerned.

Okay. Great, gentlemen. Thank you for the color.

Thank you.

Next question?

Your next question comes from Greg Badishkanian from Citigroup. Please go ahead. Your line is open.

Great. Thanks. Just two questions and follow-up to Tim’s question, would you be interested in something in the motorcycle industry or is it other segments if you are to make any type of acquisition?

We don’t have an acquisition strategy, we have a corporate strategy. I think, you guys are well aware of. We strive to be the best in Powersports Plus. We like the global market leadership aspect of our strategy and the adjacent markets have been really good to us so far from an M&A standpoint. So, we’ll it into those three categories obviously. There is some great motorcycle companies out there. We really are happy with what’s going on with Indian that right now, and we believe that’s a great horse to ride.

Okay. And, so, just staying on the motorcycle theme, what’s been your ability to recapture let’s a victory – potential victory riders and diverting those towards the Indian brand, have you had any change in terms of your view of maybe what percent of those consumers will or potential future consumers will end up buying a Indian instead of another bike?

Yeah. There was a lot of raw emotion when we first made the announcement and I think over time we’re seeing people start to realize that and especially with the new Indian bikes that are coming out that we make a great bike there. We targeted about a third that would make the transition so far early on and that seems to be about right, by far the most Victory customers are buying new Victories, I mean they are the best ones helping us flush out this inventory, which is going quite well. But we still believe that we’ll be able to get a third of those over, over time. And maybe -- maybe more, well over a 100,000 Victory customers out there and they’ve had a great experience with those bikes is evidenced by the net promoter scores. So, is they get exposure to Indian perhaps we’ll get more than that, but right now we still feel like that 30% number is about right.

Great. Thank you.

Yeah. Next question.

Your next question comes from the line of Joe Altobello from Raymond James. Please go ahead. Your line is open.

Thanks. Hey guys, good morning.

Good morning.

Scott, you mentioned a few times this morning about the improvement in the outlooks for global powersports, not sure if we’ve gotten a lot the insight into why that is, is it U.S., is it international or both, do you think some of the high and promotional activities enticing new buyers, is it new product? Because if you look at the tier stock basis, the industry is still flat to down and the compares get a little bit tougher in the second half, so I’m just trying to get a little more detail as to what’s driving that, that improved outlook for the industry? Thanks.

Yeah. Well, we’ve seen as I said in my remarks, Australia had a record month, Mexico is still very good, Europe has been better for us. So, the international market has been quite strong, obviously a lot of that’s driven by our Indian success in different parts of the world as well. But, here the core market in North America is really driven by several factors, one is I think the comps are little bit easier, the new products that are coming in are quite good, as I said we think nothing like capitalism and great products to make everybody better and I think consumers are starting to see the benefit of that. And overall, I think in our pockets, not by anyways an overall market trend, but there are pockets have improved outlooks in some parts of the country.

And we’ve seen Joe, some of it come through. Scott mentioned it earlier, the oil regions, while they’re still down, they’re only down about 1%. And if you look back to where we were last year, we were down 22%. And it’s certainly encouraging that industrial production has been -- on a little bit of a role here that it’s improving and when you think about our customer base, those stats play in our favor. So, we use the word slightly, because we want to make sure we moderate it, but at least it looks like things are more positive than they were negative a couple of quarters ago.

Great. Thanks, guys.

You bet. Next question?

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

Hi. This is Brandon Rolle on for David MacGregor. You had talked about the ATV industry growth, could you parse out what the side-by-side industry growth was, first? And also, if possible, breakout what you saw looking at a utility versus reg? Thank you.

Yeah. We don’t typically get into that level of detail. I think as our chart indicated, the upward vehicle segment overall was up mid single digits. We’re encouraged with what we saw in our side-by-side business, we saw more strength in the recreational than we did the utility side as a company. So, that will give you some insight into where we think the growth came from.

Do you have another question, Brandon?

No. That’s it.

All right. Next question?

Your next question comes from the line of Jamie Katz from Morningstar. Your line is open.

Hey. Good morning, guys.

Good morning.

Can you start of by elaborating a little bit more on Slingshot? I’m curious, maybe what hasn’t been resonating with the dealers or what has failed to gain traction as well as in the past. And then maybe how you guys have been thinking about what annualized like normal demand in that category would be, which I’m assuming is lower than maybe what you originally thought when you launched the product.

Yeah. Jaime, the – I mean, let’s look back, I mean that we’ve sold 25,000, 30,000 of these vehicles to-date. So, it’s been a well received product. The early excitement was good. We don’t feel like, in fact we know that we did not get all of the performance and quality attributes right on this vehicle. And we have been working really the last two years to address those. We feel very good that the model year 2018 product is going to be a step function improvement. But overall with the recalls that we had to deal with some of the quality concerns, it just didn’t deliver what it should for our dealers and our customers from that perspective. On a positive side, we’ve now got well over 30 states as in auto cycle. So, you don’t need a motorcycle endorsement to drive it. We understand the target customer significantly better and we are doing a lot of work with a high degree of urgency to make sure we get back to a normalized demand. Now we are still tracking to a what a stable demand looks like below that 13,000 magical number that we believe is necessary to be a long-term sustainable growth in powersports. But we got a lot of work to do, but we still feel like that with the efforts we’re making, we have a good opportunity to grow a new segment of that market.

Okay. And then in the motorcycle category, it looks like for growth margins to be up for the year, they’ll have to tick up pretty significantly in the second half if I’ve done the math right. So, can you talk a little about tick up pretty significantly in the second-half if I’ve done the math right. So, can you talk a little bit about puts and takes and what might help boost that higher?

Yeah. I think the key driver there, Jamie, is going to be the fact that we’re lapping pretty significant recall cost last year that we had with Slingshot. And I think if you look back we’ve recorded a gross margin of 1% in the fourth quarter. So, it’s a matter of lapping that, but I don’t want to understate the benefits that Ken’s team are driving around efficiency and lean in. That’s enabling us to offset partially some of the absorption issues we have from having taken Victory out of the factory. So, there is a lot of great work going on, but we are definitely benefiting from the lack of recall cost that we had last year.

Okay. Thanks so much.

You bet.

Next question?

Your next question comes from the line of Craig Kennison from Baird. Your line is open.

Hey, thanks for taking my question. Scott, you mentioned dealer engagement as a corporate priority and that seems like the right priority to us as well, but in hind side, what do you think went wrong and what are you doing specifically to drive better engagement?

What went wrong was our growth slowed down. I mean as you recall, we’ve not – we didn’t have a downshift in how we interacted with our dealers from say 2013 where we were ranked number one consistently in almost every dealer survey. You did them, so you know, what’s happened from 2013 to now is that our growth has slowed down significantly and we’ve done a lot of recall related cost and pressure on our dealers. And so, they have a heightened sense of awareness of what they should expect from OEM. And I will tell you that when the volume was flowing really good for them and for us, I think it wasn’t the right thing to do, but we both accepted the fact that we weren’t as good as a partner as we could or should be. What Tim Larson and Matt Homan and the teams are doing now, I think where can we be a significantly better partner that helps us and helps our dealers to serve our customers better. And that, there is a lot of work, it’s one of our corporate wide priorities this year. There is detailed action plans and if you were going to be in Vegas next week, I think you will see that we are on the path to improvement there, and we got our ways to go, but we feel good about the directions that we’re heading.

And then as a follow-up, dealers do seem frustrated lately with just a consistency in communication around delivery times. Is that something that Huntsville or other investments in RFM can improve?

No. That’s part of the RFM plan, obviously the primary purpose of RFM is to get lead time shorter and delivery times more accurate, but there is also an element that we are putting in to drive much significantly improve communication and awareness of delivery time. I will tell you that part of the frustration of dealers around delivery is our purposeful effort to take ORV inventory down 6% in the quarter. As we get ready for model year 2018 shipments and ready to transition for RFM, we purposefully try to keep inventory in a position where we could manage it better than we thought their orders could. So, obviously that gets better with RFM and we are excited about what that means for us and our dealers in the second half.

Great. Thanks, Scott.

Next question.

Your next question comes from the line of Joe Spak from RBC Capital Markets. Please go ahead. Your line is open.

Good morning, everyone.

Good morning.

Two questions. I guess, the first one is, I know you sort of talked about, you didn’t really want to get into utility versus recreational, but if you look at some of the data you provided, RZR shipped at a more normal rate, but then rates of dealer inventory was still down double-digits. And then overall, side-by-side are below soon on that it. So, I guess implicit in that, is that RANGER is having a tougher time, is that, is that true and can you just talk a little bit about RZR versus RANGER?

Yeah. Well, remember the comps for raise RANGER were significantly easier than the comps for RZR last year in Q2. So, I think the improved relative performance is really a year-over-year comparison.

Okay.

I hope you’re going to make it to the Vegas next week. One of things that Matt Homan will do is, is make a very clear, let’s not call it a reconciliation, but essentially, we hope described the market and what’s important then and where the things are. And if you make time to attend the reveal, I think you will have a good education in it, and awareness of how these markets play together.

Okay. We’ll look forward to that. And then second just following up I guess on Craig’s question about the dealer. One of the things we’ve ticked up as well is, in terms of some discontent is, it feels like increasingly some of the dealers feel the level of competition between dealers has been too high, and I know again in your remarks you talked about engagement. There seems to be a little bit of a investor narrative that you’re over-dealered, I guess just wanted to give you the opportunity to comment or respond to that [indiscernible]?

Do you want to know that investor narrative or a short thesis?

Investor narrative.

Yeah. Let’s to go with that. I will tell you that, I think the preeminent dealer network in North America is Honda, it’s really extensive, it’s really good. They’ve got a little bit more than we do. We feel really good about our overall dealer network for all off-road vehicles, there is tactical work to be done. As we manage that, we want more better dealers and less bad dealers of course. But we’ve got a very good plan to deal with that. But, I think in aggregate the narrative that there is too many to serve our customers when you have a broad array of products like we have is simply incorrect. That said, the competition between dealers, it doesn’t matter if you have 700 or 1,700, if you have undisciplined dealers, when you don’t follow mapped pricing, you’re going to have some of that. So, one of the efforts that as Matt and his team are driving right now is to make sure that we drive better consistency and performance to protect our brand and protect the pricing at the dealers. And obviously there is a lot of legal ramifications as we try to deal with that and we’re following our efforts very closely. But, obviously, we are comfortable with our dealer network, we like our dealer network, and obviously there is opportunities to improve it and we’re taking those steps.

Thanks. See you next week.

Yeah.

Yeah. Next question?

Your next question comes from the line of James Hardiman from Wedbush Securities. Please go ahead. Your line is open.

Hi. Good morning.

Hi, James.

Maybe a little bit follow-up. I apologize if this is a bit repetitive, but, I just want to crystallize sort of the ORV market share dynamic. It seems by the math that we can do that side-by-side has lost share maybe significant share in the quarter, it seems like things were setup for you to gain share just given what was going on a year ago. I guess, A, they diluted share in side-by-side and B, why would that be the case given what we're comping against?

Right. So, the answer is no and no. No, we did not lose significant share, and no we didn’t expect to gain share given where we are from a product news standpoint. Now as we get into the second half, we have remodeled around 18 products, and all the news that we will announce next week. We feel better about our ability to compete, but we expected and did lose market share in off-road vehicles in the second quarter, it was in our – embedded in our guidance.

But to some clear, you lost share, but not significant share in side-by-side, is that how to think about it?

So, I would say.

Okay. And then my follow-up, so you talked about 2Q, really to your last point 2Q sales and earnings were ahead of your own internal expectations. Can you flush out where exactly, because the ORV retail number down low-single digits, certainly the improvement wasn’t as much as the using comparison there. But you did raise your guidance for that segment on a wholesale basis, so was it maybe ASPs which is certainly been a pleasant surprise I think for us in the first half, was it more sort of how you are thinking about the back half is opposed to 2Q, what be your expectations at least on the ORV side in 2Q and sort of what lead to the raise guidance for the full year?

Yeah. I think Jaime is overall, it’s that we performed better in off-road vehicles and obviously you can read into that, that it was more predominantly around the side-by-side business, so that drives a more favorable ASP environment. That said, we did hold to the overall gross margin improvement of 180 basis point, so you would – one would think that we would see an additional volume leverage, that is begin offset as we indicated in my prepared remarks by slightly elevated warranty versus our expectations. We still anticipate being down substantially from where we were at last year, but we have had a few additional recalls this year that we had to build in and we also suggested that we are up a bit in our operating expenses, which is also offsetting that, some of its legal related, some of it is that we pushed a little bit more into the engineering pipeline, given some of the prior development plans that we want to ramp up here in the second-half.

Great. Thank you. See you next week.

See you.

Your next question comes from the line of David Beckel from Bernstein Research. Please go ahead. Your line is open.

Great. Thanks a lot. I noticed that one slide in particular was missing this quarter the strategic objective slide. Can you – will you be providing an update on your goals next week by chance and is there anything you can share kind of today in terms of what we might be able to expect next week on that front?

Yeah. The absence of the strategic objectives was nothing more than us deciding, we’d like to spend more time on Q&A than talk to a slide that you’ve all seen before. As we said, we will be -- because of the dramatic down shift in our overall market and the elevated recall expenses we had the last year or so, we did say, we’re going to revisit simply because of the CAGR, the financial objectives of our long-term strategic plan. Part of our meeting in Vegas next week is a board strategy session. We will use that board strategy session which happened after the Analyst meeting to talk about what the five-year outlook for players looks like. We obviously feel very good about it. There is a lot of great activity. It’ll probably, be sometime late third quarter, maybe even in the third quarter earnings call, where we actually take what we -- the work we do with the board and digest that into what we think are reasonable financial targets to share with the financial community.

Got it. That’s helpful. And a motorcycle question, I’m wondering given – I know, Indian is doing extremely well, but given the sort of difficult backdrop upon which it operates, are you finding it harder to find motorcycle dealers willing to add an Indian brand. I’m just curious what your current dealer pipeline is looking like now relative to maybe a year or two years ago?

Pipeline looks great. There is a lot more people that want to add Indian, and then we are willing to let have Indian. That said, our -- and I think we said it previously, our focus right now is driving profitability within our Indian dealerships, and the way we do that is drive more volume in those dealerships. And obviously, we are doing that with higher growth, but we have to be judicious and aware and how often we add dealers. So, we are being careful with that and we think by being careful the quality of the dealers we are adding is exceptionally high. So, obviously there is a long way to go in building out the overall dealer network. We’re going to do that carefully, methodically, but there is no lack of demand for people wanting the product.

Great. Thank you.

Your next question comes from the line of Drew Lipke from Stephens. Please go ahead. Your line is open.

Hi. Good morning, guys.

Hi, Drew.

I just – I want to go back to ORV. So, and just unclear, your guide implies whole-good ORV, down slightly in the back half of the year, after just being up roughly 3% in the first half. You’ve got an easier comp in the back half of the year relative to the first half. You talked about dealer inventory being flat, you mentioned by side-by-side shipments being roughly in line, historically second half ORV sales are greater than first half. And you’re talking about kind of improving trends and your ability to compete with the model that 2018 rollout. I am just -- I am trying to reconcile kind of the down slightly on ORV whole-good with all that commentary, is there anything you pointed that I’m really missing here?

Yeah. No, I think you got it right in terms of the shipments that can echo in retail and essentially, we’re calling for things to be flat to slightly down. What you have to remember is, it’s about the two different quarters. We will certainly see a substantial uptick in the third quarter. I would expect to see very positive organics because if you remember in the third quarter of last year coming out of dealer show, within about a month we had stopped shipping to go through the revalidation of our model year 2017 product pipeline, and so we were down substantially. That said, while we didn’t fully recover the year in the fourth quarter, we did have a plus four from shipment standpoint. So, when you combine those two together and you take into account that we had very strong PG&A in the back half of last year, some of which was attributable to the parts that we were shipping in, the kits that we were shipping into the channel to support the recall, those are going to be your two reconciling items. And we are obviously going to push as hard as we can. But essentially aligning with what we think is going to happen in retail, that’s consistent with our outlook in the back half.

Okay. Thanks. And then just my follow-up, I’m curious just on the cost structure, thinking maybe a little bit longer term in terms of what’s more onetime in nature versus, maybe what’s more recurring as we think 2017 and then think 2018, 2019 and thereafter. With the victory wind, down cost that are onetime to gross profit about, I think $ 70 million, you got the TAP which is $15 million, you’ve got elevated warranty cost and now may be a little bit higher on the recall and I don’t know if you actually quantified that incremental recall cost this year. And then maybe what’s more recurring being higher purchase materials, labor cost, increased safety needs maybe continued promotional environment and then the offset on VIP. Can you kind of bridge all that for us thinking maybe longer-term cost structure profit?

Yeah. You said a lot -- I think you spoke faster than I did during the prepared remarks. Well, so here’s how I think about it. I mean as I mentioned our warranty costs are going to be down substantially this year versus where we were last year. The additional warranty that we have this year related to the recalls is relative to our expectations, so as you think about 2018, we would expect to see our warranty cost continue to come down. I wouldn’t suggest that by 2018 we get down to where we were pre the recall activity, I think it’s going to take us a little bit of time and the work that Ken and his team are doing to improve the product quality those things are going to take time to rude and improve out in the warranty rates. What I would point to you though is if you look at Q2, and you look at the fact that we got a 160-basis points worth of margin improvement environment where our promo is eating up a couple of 100 basis points, it just speaks to the power of the VIP initiative and when you think about that coupled with getting more volume through our factories, which admittedly are underutilized from a capacity standpoint. We’re going to be more than able to offset the quality in future ads that we will continue to have and some of that’s already built into to the numbers this years, as we indicated on our gross profit slide. So, we feel very good about the cost setup for the business. We do need some volume to move that through the system, but we think with the activities that we’ve got underway relative to the safety and quality of the product as well as addressing our manufacturing footprint as we talked about earlier and also improving the portfolio performance of the business with the exit of Victory, we feel very good about the profit setup moving out of 2017.

Got it. Thanks, guys.

Next question.

Your next question comes from the line of Seth Woolf. Mr. Woolf, if you could provide your company name, please go ahead. Your line is open.

Hi, guys, Seth from Northcoast. Just wanted to start on the ORV market, ATV is the entire industry seems to be down, it’s underperforming side-by-side significantly, we’ve heard with some of the promotional intensity you’re seeing in side-by-side it’s caused consumers to just look at the value proposition and you’re seeing an acceleration and cannibalization is side-by-side. Wondering if what if you think there is any merit to that or what’s going on? And then what are the implications for margins longer-term, is it still going to be accretive, even if it’s coming from side-by-side, is that are heavily promoted? And then, secondly, Mike I think you said, you said something about warranty getting close to free recall levels. So, just wanted to confirm do you think you can be it back there and it so how long is it going to take? Thank you.

The overall ATV market is, we believe obviously it’s been long-term trend of cannibalization, I mean I think everybody knows there was a million units in 2004-2005 timeframe and it’s come down. We believe it’s about where it’s going to be, there will be times like this where it’s weak and that it will get a little bit better. There is a lack of product news in ATVs, this is not just with plans, but across the news, across the segment. And as you know, innovation really drives dealer traffic and activity in the market. So, most of the innovation is happening in side-by-side, most of the promotional activity is in side-by-side. And I think that’s what’s driving the near-term shift. But we do believe that the overall ATV market is going to be about flat to where it is right now over time.

Yeah. The only thing I would add to what Scott said is, Ag was down 7% in the second quarter versus being down by 1% last year, so that certainly doesn’t help when you think about the consumer base that we sell into. As it relates to warranty, yeah, we’re – obviously we’re striving given all the investments that we’ve made that, we want to at least get back to where we were if not better. But what I would caution you is it’s going to take us a bit of time, so we’re talking more over a strategic planning here than we are here in the next couple of years.

Okay. All right. Thanks, gentlemen, and I will see you guys next week.

Thanks. See you then.

Your final question comes from the line of Gerrick Johnson from BMO Capital Markets. Please go ahead. Your line is open.

Hey, good morning. Can you talk about your experience in Rec/Ut segment? We heard about recreation and utility, but not Rec/Ut and nor with the GENERAL both in the quarter and overall being that it’s a relatively new category from you that you’re now comping against? Thank you.

Yes. GENERAL has been an exceptionally good product for us, we’ve felt like it was open segment of our offerings and we felt like we designed a good product. We’re continuing to improve and refine it over time. So that’s been reasonably good. Obviously, we think there is a lot of opportunity for us to continue to grow that. The segment itself just offers a lot of opportunities for innovation. So, we’re comfortable with what we’ve got there, but we still think there is a lot of opportunities to do better.

Great. So more wide space opportunities I guess in both models. And how about distribution on general?

Distribution is pretty good. Obviously, as we move to RFM in a more disciplined way, it’s our opportunity to keep the inventory levels go and flowing. And really part of our plan is just giving the dealers more of exactly what they want and we think that GENERAL offers a very good opportunity for us to demonstrate how that process will work.

Great. Thanks, Scott.

Okay. Thanks.

That’s all the time we have. We appreciate everyone participating in this morning’s call, and for those of you going to Vegas next week, we got some good things to show until next week. So, we look forward to seeing you there. Thanks again, and goodbye.

This concludes today’s conference call. You may now disconnect.