Polaris Inc. (PII) Q3 2018 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to the Polaris 2018 Third Quarter Earnings Results Conference Call. [Operator Instructions]. And please note that today's event is being recorded. I would now like to turn the conference over to Richard Edwards, Head of Investor Relations. Please go ahead.

Thank you, Will, and good morning, everyone. Thank you for joining us for our 2018 third quarter earnings conference call this morning. A slide presentation is accessible at our website at www.ir.polaris.com, which has additional information for this morning's call. Today, you will be hearing remarks 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, which should be considered forward-looking for the purpose of 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 2017 10-K for a more detailed discussion of these risks and uncertainties. Additionally, all references to third quarter 2018 actual results and 2018 updated guidance are reported on an adjusted non-GAAP basis, unless otherwise noted. Please refer to our Reg G reconciliation schedules at the end of this presentation for the GAAP to non-GAAP adjustments. Now I will turn it over to our CEO, Scott Wine. Scott?

Thanks, Richard. Good morning and thank you for joining us. I recently sent an email with the subject like that simply read: tariffs, tariffs, tariffs. The word represents different things to different people, a strategic tool for progress, cost, benefits, protection, challenges, the list goes on. But as we will describe this morning, we are working tirelessly to limit the impact of tariffs on our business, employees and customers and that determination paid off in the third quarter. A strong economy usually comes at a cost, so while we saw the continued benefits of a healthy consumer demand throughout the quarter, the corresponding increases in logistics and commodities were not unexpected headwinds. Innovation is our proven methodology for overcoming obstacles and our new model year '19 vehicles spurred dealer orders and customer traffic in the third quarter. North American retail sales were up slightly versus the plus 13% compare from the prior year period, with RANGERS and midsized motorcycles leading the way. Boat Holdings is maintaining their growth focus during the integration process and drove solid results in the first few months with Polaris. International sales and profitability outperformed with Indian driving growth and our Opole plant boosting profitability. The revitalization effort at Transamerican Auto Parts is making progress, albeit slower than we would like, but strength in our core PG&A business is a positive offset. The 1% increase in third quarter retail sales is not something we normally celebrate but is a tribute to our dealers, our team and the improved product availability afforded by optimized dealer inventory levels that we were able to deliver that against the largest prior year comparison we've had in many years while spending less on promotion. We also kept our logistics cost increases well below market, while leveraging RFM to deliver our best side-by-side on-time delivery performance since we began measuring. The overall North American powersports industry was down, primarily due to weakness in motorcycles and ATVs. Our RANGER and GENERAL product lines continued to perform well, which led ORV to modest growth for the quarter. Indian was up low single digits with strength in Scout and Bobber offsetting industry weakness and declines in Indian heavyweight bikes. Even amid unprecedented promotions by a competitor, in September we surpassed 25% market share in midsized bikes for the first time in our history and look forward to building those riders into lifelong customers. Slingshot retail was down again and while we are working hard to gain traction with our partnerships and grassroot marketing efforts, we do not expect to return to growth until mid-2019 for Slingshot. Bennington posted strong third quarter retail and saw encouraging dealer demand for their new boats. Authenticity is extremely important to brands these days, particularly with the younger demographic we are seeking to attract. Our Indian Motorcycle team and racers took this to heart as they launched the new FTR 1200 in the most authentic way possible. The flat track racer is our first standard bike and perfectly complements our fast-growing midsized segment. It is likely to be at least as popular in Europe as the U.S., so holding a launch in Cologne, Germany in conjunction with INTERMOT, one of the largest motorcycle shows in the world, only made sense. But the FTR story started several years ago when Indian reentered the flat track racing circuit after an absence spanning far too many decades. With newly designed bikes and an Indian heritage rich with racing success, our engineers and riders rebuilt the FTR legend on the track by winning almost always. With the 3-year record of 31 wins out of 35 races and with our top rider, Jared Mees, winning nearly 60% of those races on his way to consecutive series championships, our flat track racing credentials are undisputed. Jared joined me on stage to launch the FTR 1200 and I have never felt better about being upstaged by both a man and a bike. We will not begin shipping the new bikes until spring, but the authentic buzz around the world's fastest production Indian is already reaching a fever pitch. My team and I are spending a great deal of time on tariffs. But given the size, complexity and importance of this issue, finding and implementing countermeasures requires our best efforts. As I mentioned earlier, these efforts have largely been effective so far allowing us to hold our 2018 gross tariff impact to the previous communicated $40 million. Despite its potentially significant impact on our business, we understand and firmly support the administration stated goal of achieving much freer and fairer trade with China. Through recent discussion and analysis, we now believe it is unlikely there will be a short- or medium-term agreement with China on trade issues, and with substantial impact of the 301 list looming, we are considering and taking more aggressive actions. Those actions fall into three primary categories; negotiation, pricing and advocacy, with the objective being to either largely mitigate or obtain relief from the 301 tariff impact. We have successfully negotiated through the NAFTA rewrite and believe the new USMCA agreement will be neutral to Polaris. The more important negotiations are with our suppliers, who we fully expect to absorb their fair share of tariffs. I'm not sure that most Americans understand that Polaris and other American companies are the ones who pay China tariffs. But since we do, we are pushing back on our Chinese suppliers to cover a reasonable portion of these costs. Our approach with domestic suppliers is similar. Polaris will not bear the full burden of these tariffs. While the direct impact of the 232 steel aluminum tariffs was not substantial, because we predominantly buy these metals from U.S. suppliers, these suppliers did use the opportunity to raise prices. We have partially offset these increases as well as List 1 of 301 through adjusting our own prices and negotiating with suppliers. However, addressing the much more severe repercussions of List 3 of 301 is a more daunting task, where we have modeled a path to cover a portion of this with price due to the unintended disparate impact on Polaris and our customers, we are primarily focused on seeking just and fair relief from 301 tariffs. We believe that our situation, being accidentally but disproportionately punished by tariffs because we manufacture so much in the United States, makes Polaris an outlier to the administration's intentions, which offers compelling reasons to consider our case for exemptions. When you also consider that our major foreign-based competitors largely avoid the 301 tariffs, our argument for relief gets much stronger. Our commitment to productivity takes precedence over tariffs, so despite incentives, that encourage different behavior, we will not take short-term actions to sidestep tariff impact. With strong facts on our side and a competitive and capable team seeking constructive solutions, we expect to successfully manage through this. We are proud to have the majority of our vehicles produced in the United States, and we'll very strongly seek to avoid tariff penalties for doing so. With that, I will turn it over to our CFO, Mike Speetzen, for additional details and financial insights.

Thanks, Scott, and good morning. We're pleased with our third quarter results which were driven by a combination of solid sales growth, lower warranty, lower promotional costs and a delay in a portion of the tariff costs that we'd anticipated would impact the third quarter. Third quarter sales were up 12% on a GAAP and adjusted basis versus the prior year. Both contributed 9 points of the growth, while our organic growth of approximately 3% was driven by continued strong ORV, Global Adjacent Markets, International and PG&A demand. Earnings per share for the third quarter, on a GAAP basis, was $1.50. Adjusted earnings per share was $1.86, up 22% from Q3 2017. The improved earnings per share performance was driven by several factors: first, better retail performance, which drove slightly higher shipments and better retail credit income as well as a small amount of shipments that were originally anticipated for Q4. In addition, as I mentioned earlier, we incurred lower than originally expected tariff costs in the third quarter of approximately $8 million due to timing. We do anticipate a portion of these costs to push into Q4. And lastly, lower share count due to lower dilution given share price performance and slightly lower expected taxes provided some favorability. As Scott indicated earlier, we believe dealer inventory levels are appropriate given our current retail outlook and dealer profile targets. If you recall, our dealer inventory at the end of Q3 2017 was much lower than desired, which was highlighted in just about every dealer survey conducted at the time. Our ORV dealer inventory, which represents about 70% of total dealer inventory, was up 14% year-over-year in Q3 2018. It's important to recognize that given the volatility we experienced last year with deliveries, it is more meaningful to compare the retail performance against shipment performance over an extended period of time. You can see from the chart on the lower right that ORV dealer inventory levels are essentially flat when you look at the last couple of years. During that same period, trailing 24-month Retail and company's Shipment performance for North America were in alignment. Looking at this extended period allows for any abnormalities in a given quarter to be viewed in a larger context. Additionally, the feedback we're getting from our dealers through our quarterly survey indicates that the inventory levels are adequate and in fact, some dealers are requesting increased shipments of certain models. Finally, RFM for side-by-sides has been in place for almost a year now and stocking levels are close to being in line with the agreed-upon inventory profiles established in conjunction with our dealers. And I would remind you that we cannot ship above profile without the dealer requesting in advance. Moving to our third quarter segment performance. ORV/Snowmobiles segment sales in Q3 were up 3% on a GAAP and adjusted basis driven by strong ORV demand worldwide. Demand for the new ORV vehicles were strong during the quarter, particularly the new RANGER XP 1000 models. On a year-to-date basis, we gained share in ORV with ATVs gaining share and side-by-side's share flat from a year ago. We're pleased with the momentum we're seeing with our new model year '19 lineup. As anticipated, promotional spending on a per unit basis was down during the quarter on a year-over-year basis and sequentially from the second quarter as new products and more effective use of our promotional spend continued to drive retail sales during the quarter. Snowmobile sales were down in Q3 due to the timing of shipments as a majority of our presold snowmobiles are expected to ship in the fourth quarter of this year compared to last year when a greater proportion shipped in Q3. Adjusted gross profit margins for ORV/Snowmobiles segment were down due to the pressure from tariffs, logistics and commodities as well as a modest negative impact from mix offset somewhat by lower promotions and lower warranty. Motorcycle sales were about flat on a GAAP and adjusted basis, primarily due to continued a weak overall North American motorcycle market, which was down low-teens percent for the quarter. Indian Motorcycles gained market share again despite the weak market, driven by ongoing growth in about midsized bikes and the success of the new Chieftain Limited, which is bringing new riders to the Indian brand in the bagger category. Slingshot was negatively impacted by a recall in Q3, which limited sellable vehicles during the quarter. As expected, our average selling price declined during the quarter, reflecting the continued strength of our midsized motorcycle portfolio, which has lower ASPs than our heavyweight bikes. We continue to experience strong demand outside North America with our international motorcycle sales increasing 18% in the third quarter driven by the Scout lineup. Adjusted gross margin for motorcycles are up year-over-year, driven primarily by lower warranty and promotional costs, which more than offset mix, tariff and commodity headwinds. Global adjacent market sales increased 5% on a GAAP and adjusted basis in the third quarter, driven by continued growth in our Commercial, Government & Defense businesses and continued growth in Polaris Adventures. Adjusted gross margins improved in the segment, driven primarily by volume and mix improvements. Aftermarket sales were up 2% on a GAAP and adjusted basis, driven by our other aftermarket brands, which include Kolpin, KLIM, Pro Armor, Trail Tech and 509. The 21% growth was driven primarily by strong preseason snow orders. TAP sales declined 1% as they were impacted by delayed accessory development and weakness in business-to-business sales in the South and Southwest. The new Jeep and truck accessories are now launching and initial feedback has been very positive. Adjusted gross profit margins for the segment are up due to increased volume and mix and synergies being realized, offset somewhat by increased tariff and logistics costs. Our new Boat segment, which we acquired on July 2, reported sales of $134 million, which is slightly better than our expectations. On a pro forma basis, boats were up 17% year-over-year in Q3. While Boat Holdings will continue to run as a distinct business, the integration of financial processes, insurance plans, et cetera, is progressing on track. We've provided a historical view of sales and gross profit data by quarter for Boat Holdings on our investor website for modeling purposes. Adjusted gross profit margin was in line with our expectations. Our International business continues its strong performance with sales up 10%, up approximately 13% when you remove the unfavorable impact from currency. The strong sales growth trends in the EMEA region continued in Q3 with sales up 17% in the quarter. Latin America was up slightly and Asia Pacific down slightly compared to the prior year. From a product standpoint, all segments increased sales during the quarter and market share gains continued in Indian Motorcycles. Our Parts, Garments and Accessories sales increased 8% during the quarter, driven primarily by ORV and strong accessory growth. Now let me move into full year guidance. We're maintaining our full year 2018 guidance for sales to be up 11% to 12% versus 2017 and for EPS to be in the range of $6.48 to $6.58. Adjusted gross profit margins are expected to decrease in the range of 60 to 80 basis points, also unchanged from our previously issued guidance. Adjusted operating expenses are expected to be down approximately 120 basis points as a percent of sales, which is slightly lower than previous guidance, driven by strategic investments we're making. Financial services is now expected to increase high single digits, up from previous guidance due to improved penetration rates and strong year-to-date retail performance. Share count is now expected to increase approximately 1%, which is lower than previous guidance due to higher anticipated share repurchases and lower dilution impacts. We repurchased 500,000 shares during the quarter and have now repurchased 2.1 million shares year-to-date. We have approximately 4.4 million shares remaining under the board's current authorization, and we expect to be in the market in the fourth quarter repurchasing shares given the current share price. Foreign exchange and interest expense both remain unchanged. Turning to gross profit margin. On a GAAP basis, Q3 gross profit margins were down 30 basis points to 24.3%. On an adjusted basis, our gross margins were down 70 basis points to 24.8% compared to last year, which was better than anticipated, primarily due to the timing of tariff costs flowing through the P&L as we were successful in pushing out some of the tariff-related cost into Q4 and beyond. Improved warranty expense and lower promotional costs were more than offset by mix, the addition of the Boat segment, tariffs and higher logistics and commodity costs. It's important to note that Q3 gross margins, excluding the impact of tariffs and the Boat acquisition, were up 30 basis points consistent with our original guidance comments back in January that margins would begin to improve in the second half of 2018. We've mentioned tariffs several times this morning, because they're top of mind within Polaris. The total impact for 2018 has not changed, primarily because of the tremendous efforts of the team put in to delay a portion of the expected impact. This allowed us to essentially absorb the latest addition to the 301 tariff, List 3 without an increase to the impact to the company. We anticipate a portion of the tariff impacts that were delayed from Q3 coupled with the start of the 301, List 3 tariff will impact the fourth quarter. As a result, while the impact profile looks different than we originally anticipated, we can maintain our total company gross profit margin guidance, which is to see our margins come down 60 to 80 basis points as a percent of sales versus last year. The entire year-over-year reduction in margin is driven by the tariffs and the impact of layering in the Boat business. I know what's on your mind next, what does this mean for 2019? We're not providing any quantitative guidance around the impact of tariffs for next year as we're still working through several countermeasures, as Scott alluded to earlier. We will provide more clarity at our fourth quarter call in January, when we anticipate being able to more completely discuss not only tariffs and the countermeasures we're executing, but also the other aspects of our plan for 2019. Sales and gross profit margin expectations by segment are shown here on Slide 20. The sales changes from the previous guidance are as follows: we now expect ORV/snow sales to be up low double digits, driven by the strong year-to-date sales. Motorcycle sales are now expected to be down low single digits, driven by the weak heavyweight industry and lower Slingshot sales throughout the year. Aftermarket sales are now expected to be up low single digits given the year-to-date results. Gross margin expectations for our segments changed as follows: Motorcycle's gross profit is expected to be down due to lower volume and makes. Global Adjacent Markets' gross profit margin expectations declined primarily due to mix and higher warranty costs. Our operating cash flow performance was down year-to-date through the third quarter as expected, given the timing of accrual cash payments and higher factory inventory needed for model year changeover and execution of RFM. Our outlook for operating cash flow expectations remains unchanged and is expected to be down in the high single digit percentage range. ROIC came in at just over 18%, while still above the competitor average and well above our weighted average cost of capital, we were down approximately 80 basis point driven by the acquisition of Boat Holdings in July. With that, I'll turn it back over to Scott for some final thoughts.

Thanks, Mike. I will use my closing comments to offer some initial thoughts on 2019. Despite the recent increase in market volatility, not to mention interest rates and tariffs, the positive influences on the U.S. economy still outweigh the risks, and we expect GDP growth to continue. We anticipate the powersports industry will perform similarly to this year with ORV growth staying positive, offsetting continued weakness in the motorcycle industry. With that industry backdrop and ongoing product and service innovation across the Polaris portfolio, we anticipate another year of retail growth. We are regularly asked to quantify next year's tariff impact, but at this point we cannot provide an accurate number. Between nearly 50% of our potential impact coming indirectly through our domestic suppliers, ongoing calibration of our mitigation efforts and ambiguity around our ability to gain relief, there is simply too much uncertainty to provide a guess at this time. From our previous comments, the potential damage from 301, List 3 is notable, but so are our mitigation efforts. We have valid reason to believe that our situation warrants some form of relief and are aggressively pursuing this rightful request. Our strategic sourcing initiative is making good progress. Although the cost of validating new suppliers and parts will be high, the savings are well worth the investment, and we look forward to the program benefits beginning to ramp-up in the second half of 2019. We expect continued sales and profitability growth in Boat Holdings as we will provide support to their innovation and productivity efforts. The new leadership team at TAP is driving aggressive actions, and we anticipate improving performance from them throughout the year. Our core PG&A business has built positive momentum and the successful launch of factory choice and continued innovation in products and services will keep it going. I will wrap-up with a simple thank you to our Polaris team. Facing major headwinds and challenges, they have successfully kept us on our full year guidance while driving exciting innovation and product developments specifically designed to broaden our appeal and expand the markets and customers we serve. We have a lot of work to do, but this dedicated competitive team will always put in the effort to win. With that, Will, would you open the line for questions?

[Operator Instructions]. The first questioner today will be James Hardiman with Wedbush Securities.

Let me ask two questions, maybe you could round the edges, give us an indication. If we just think about the magnitude of goods that are being penalized coming into the United States, List 3 is $200 million versus $34 million in List 1, so it's 6x as big. I guess, one way to look at it is, is that a reasonable starting point? I understand that there's a whole lot of countermeasures at play here, but your overall exposure, 6x, is that a reasonable estimate? Or I guess, I don't know if you want to answer that? I guess -- asked another way.

It's not, James. Obviously, part of the reason that we are as aggressive as we are in trying to offset this is because of the disproportionate impact we have, and we only source about 15% of our stuff directly from China, little bit -- right in that range. And then the fact that our domestic suppliers, of which 75% of our suppliers are domestic, but they also source some. And we think that's slightly higher percentage, but not tremendously so. It's just with List 3, as you will notice who was exempted, it was anybody that was direct-to-consumer. Most of these were B2B and in other B2B industries, they can pass those on in the value chain without much significant impact. And in our business, when we buy, we pass it on directly to consumers. So that's why there's significant impact. But -- and I tried to allude to in my remarks, and I'll say it again. We have 3 strategies. We are already implementing some pricing and we've modeled in much more aggressive pricing if we have to use that tool. We are actively negotiating with our suppliers to make sure they maintain their fair share. And we have a tremendous advocacy effort going on to make sure that they're relieved. When you factor what those 3 efforts combined are, it significantly mitigates the impact. And we'll have a better idea of what the gross tariff impact is in January, we'll also have a better idea of what our mitigation actions will uncover, and that is why we're not talking about it now.

That's actually really helpful and you, kind of, answered what was going to be my follow-up question. So 15% of your -- is that your cost of goods sold comes directly from China? And then of the 75% that's coming from domestic suppliers, I don't know, care to venture or guess, how much of that is, sort of, two-step from China?

I intended to say slightly more than the 15% that we directly source.

Oh I see what you're saying, okay.

James, let me just add a little more color to that, because I think Scott said 15%, it's roughly a 50-50 split in terms of what comes direct and what's indirect. Obviously, the indirect piece is a little bit more challenging. But if you back up and think about the $40 million that we've articulated, which obviously has been layering in through the course of the year, about 60% of that is 301 and if you think about the fact that we delayed a fair amount of that out of the third quarter, a lot of that's really hitting more in the fourth quarter. So that gives you a sense of the magnitude. The other piece of information that I gave you, because we've talked about it on our prior calls, because I know the question will come up probably later in Q&A, we've been able to offset about 30% of that $40 million through pricing actions, just to give you a sense of what we've been able to offset as well as what's essentially sitting in our guidance right now, which is just over $0.30 worth of impact to EPS.

Okay, but the 15%, just so we're clear, is direct and indirect?

Yes.

And our next question today would be from Greg Badishkanian with Citi.

Great, yes, just wanted to focus in on the Retail, because I think you had really tough compares last quarter, in the third quarter of last year, mid-teens, let's call it, for ORV. So why do you think -- or what was the key driver of the positive growth this quarter, if you were to maybe prioritize what you think really drove that versus?

James, as you know, Mike and I both referred to it, the fact that RFM is really working. I mean, we've got profiles established with side-by-sides and the availability of product was so much better than it was a year ago throughout the quarter. And really, July and August were remarkably strong and even September, as we started to roll out the new products. We felt good about how Retail is. So ORV was in pretty good shape. I will tell you that Chris Musso and his team, in addition to product innovation, what they're doing with their promotions and efficiency and dealer activation is really giving us the competitive advantage, and I think we're only going to build on that as factory choice rolls out. So that was really, really encouraging, the fact that we were able to post a positive number against a plus 13% compare.

Okay, all right, perfect. The -- let's see so, and also one of your competitors, Arctic Cat, mentioned that they were seeing some integration issues, some company-specific issues when they reported last week. I'm just wondering, is that something that you're seeing? Or are they just not as big of a competitor that you're -- it's going to move the needle for you in a positive direction?

It is the latter.

Okay, all right. And also, just in terms of the oil and Ag market, just a little color there, how much of a contributor that was?

Yes, I think oil was up slightly in the quarter, which is good and I think consistent with the theme around stabilizing. Ag was a little bit negative, but again, I think, some of that is just timing and the compares we have to where we were at last year.

And the next questioner today will be Robin Farley with UBS.

Just circling back to the tariff issue, I wonder if you mentioned -- it's not going to be asked about enough, I'm sure. But maybe you could give a little bit more, sort of, the time frame for when you might have some view on any kind of relief that you might get? Is it possible that you would have some certainty around that before early next year? I know there -- it's an ongoing thing, but just to sort of frame the period where there might be uncertainty for investors?

I mean, whenever you involve politicians in a decision, it adds to the uncertainty. So despite the fact that we believe the facts and story are very much on our side and ultimately requires action out of Washington and that's the discussions we're having. We -- our target, as we've communicated, is to have clarity by the first quarter earnings call. There's no certainty that's the case, but trust that that's the goal.

Okay. Great. And then you also mentioned that about 30% of the tariff impact you're able to offset with pricing and so that's great in theory that would carry through into next year. I wonder if you could -- some of the other things that you've done to mitigate the impact of tariffs, are those things that were, sort of, you were temporarily able to maybe push some expenses back a quarter or 2? Or are there other parts of things that you're doing internally to mitigate other expenses that actually can carry forward into next year as well? Or has it been just kind of trying to move around the timing of some things just to get through 2018 before you know about mitigation from negotiating?

Robin, I appreciate you asking that question, because I want to make it clear. Literally, it is legal and ethical and it doesn't negatively impact our long-term productivity goals, we're going after it. And I will tell you that Ken and his team are really making good progress on -- with domestic suppliers, saying "Hey, we're not taking that price increase or you have to share in it." Or more recently, making sure our Chinese suppliers saying, "Hey, if you want to continue to be a supplier to us, you're going to have to take some of these costs." As Mike said, we've got aggressive pricing actions that we've taken and much more that we've modeled. There's just -- Mike you want to just add anymore?

Yes, a couple of things, Robin. One is, we were conservative when we built in how quickly the tariffs would impact us, and you can imagine where it's direct, we're paying that as the goods come in to customs. It's where the indirect comes in that we've seen probably more of a delay in timing and that's where Ken and his team are working hard to make sure that we're not just letting suppliers come in and push a price increase. So there's a fair amount of work there. I think from a pricing standpoint, outside of the surcharge we did for logistics, which was not in the number I was communicating, the price impacts have largely been in our aftermarket or our Parts, Garment and Accessory business. The 301, List 3, obviously, as we indicated, has a much more substantial impact and that starts to get into price decisions we'd have to make in our Off-Road Vehicle and Motorcycles business. And as you can imagine, that's a pretty complicated process to go through. And as Scott alluded to in his opening comments, we have a disproportionate impact relative to many of our foreign competitors. So we're working through price elasticity and some of those types of things that just take a little bit of more time and a little bit more complicated.

And the next questioner today will be David Beckel with Bernstein Research.

I was curious, just on the share losses this quarter, does that -- I realize there was a difficult comp, but is that in any way associated with a pullback in promotional spending?

It was simply a reduction in -- I mean, the tough comp. And we just -- when you grow that much in a quarter, last year, we had a disproportionately high market share, and we just gave some of that back. No, we -- like I said, we're really pleased with the efforts around the way our digital advertising efforts, our CRM progress, the way we're engaging dealers and managing promos, so we're really encouraged by that. And early signs are, the fourth quarter, we're okay.

Great. And second question, unrelated, on financing partners. Are you seeing any pressure as interest rates rise from them to pass along some of those interest rate increases to the customer? Or let's have a willingness to lend to this part of the -- or the powersports business in general?

No, the financing environment remains strong. You have to remember that the majority of the folks, we have 60%, 70% of our folks buy on credit, half of which is through our own retail partners, half are through retail partners with our dealers. They are highly focused around the payment and the interest rate movements are having very little impact on the overall payment, number one. Number two, we've gotten smart and creative with our promotional programs to help dampen some of that. And so between those 2 things, I think it's pretty much a muted effect right now.

And the next questioner today will be Craig Kennison with Baird.

Scott, I know you have strong relationships with senior policymakers. Do you have reason to believe your advocacy work has traction at this point to provide relief?

Yes, Craig. One of the things we know is that everybody is trying to get their piece of relief, but we've been very aggressive in communicating with both the administration and Congress about the disparate and disproportionate impact we have. And what we've found is everybody understands the story. I mean, it's not like we're going and talking about a story that nobody wants to help. They recognize that punishing a company that invested significantly in American manufacturing footprint that causes them a disparate impact on tariffs, nobody thinks that's the right thing to do. That said, the actual work to get relief is not easy. So it's going to take our best efforts to get there. You might have seen we just hired a new government relations, Ellen McCarthy, in DC. So she's there on the ground every single day carrying the message. Myself and Lucy Clark Dougherty, our new General Council, have been there carrying the message. And they're being receptive to us. But ultimately, those relationships and those messages has to convey in a change and that's what we're working to get.

And as a follow-up, the other -- one of the other buckets was pricing. And I guess my question is on affordability. You've got inflation moving through your supply chain, you've got interest rates moving higher. Are you concerned at all that the affordability of the powersports lifestyle could diminish a little bit as that flows through?

Mike said it earlier, I mean, a lot of our customers buy on credit. So it's the -- when you talk about the affordability, it's an extra few dollars in their monthly payment. So we're not as worried about that. I mean, the strength of the consumer remains strong, and as long as the full burden of tariffs doesn't -- or something else doesn't tip over the economy, we expect our consumers to -- our powersports consumers to remain in the game. And don't forget that as we're getting this inflation that you talked about, we've also got this very large strategic sourcing initiative that we're driving. There's a lag time, because it's so complicated to get those savings, but we certainly expect that to come in and be a beneficiary over time.

And our next questioner today will be Scott Stember with CL King.

Can you talk about Slingshot? I know that, obviously sales have been down over the last year or so and we've had recalls. And Scott, you made comments, you don't expect to see some relief there or an increase in sales until, I guess, the next year. Maybe just talk about what's going on there as far as product innovation and besides the recalls, is there anything else that's been weighing on sales? And what makes you confident that next year will be a better year than this year?

Yes. We are, obviously, not pleased with way Slingshot has gone in the last couple of years. We've got a lot of work being done to refine the product to make it better for consumers and it still attracts interest wherever it's written. There are constraints that we've found to people that want to buy. One is the fact that it takes a full garage stall, so it's not like a motorcycle where people can park it between cars. So we've had to factor that into how we do it. So we've launched it with Polaris Adventures, and it's doing quite well in that environment. But we do have some really good innovation coming with the Slingshot product next year. It's why we talked about feeling better about returning to growth in the second half.

Got it. Maybe just talk about the Boat business with regard to some of these inflationary costs. I know that there is a totally different set of circumstances and suppliers, but maybe just talk about how the Boat business could be impacted. And that's all I have.

Mike's got a really good way of describing -- actually it's -- what's interesting about talking about inflation in Boats is the disparity between how the core powersports industry compares.

Yes, so it's interesting, the boat business is far more of a localized supply chain. The biggest impact was what we saw happening with aluminum. And given the production is highly concentrated in Indiana, but it's, obviously, a heavy U.S. manufactured good. The minute we saw the pricing move, the OEMs were all able to essentially move price. And each of us move in a different way depending on content. But again, you're talking hundreds of dollars, you're talking about boats that either wealthy folks are buying, so it's not going to matter from a price standpoint or boats that are being financed that hit more of the typical demographic. And again, you're talking a matter of $5 to $6 on a monthly payment. So it's really not had much of an impact. I mean, obviously, we're watching the inbound tariffs, retaliatory tariffs in Canada that were levied against boats. But our business is relatively small, so that's been pretty muted.

And our next questioner today will be from Tim Conder with Wells Fargo Securities.

Maybe a little bit of clarification back on the favorite topic here, tariffs. So $8 million, Mike, you said you guys were able primarily through the supply chain to push into Q4. What in total on the incremental 301, List 3 are you anticipating here in Q4, I guess, collective with that $8 million?

Well, I mean, essentially it's a perfect offset, Tim. I mean, we've held the $40 million at a gross level. Some of that is stuff that slid out of Q3, but really the bulk of it is the 301, List 3 coming into effect.

Okay, okay. And then on that, my other question would be, so we've got the List 3, what is left should List 4 come up? And then previous question with Canada here and the EU, do you have any expectations as to when those 232s or some of those retaliatories could be repealed?

Tim, I do know that if you -- and we've had a lot of talks with the administration on the topic. The goal is to get agreements done as they've done with USMCA, get Europe resolved or in an agreement, get Japan resolved in an agreement. Then it's kind of a block, if you will, to help reach a better conclusion in China. That obviously is going to take time, but that is what they're working towards. And we believe that's why our conversations and our focus right now is on 301, because we believe that's where the biggest and longest-term impact is. We think the other issues are going to be resolved.

Okay, and then in the List 4, what's left?

I think it's $269 billion worth of stuff. Now as with the first 2 lists that didn't affect us that much, we think -- and the reason they left is -- the reason that we're not as concerned about List 4 is it's mostly consumer-direct. And that's why they left it off, because they don't want to go after consumer direct and have this huge inflation hit the U.S. customers. So it's going to affect the retailers significantly more than it affects us. And I don't think they want that.

And our next questioner today will be Jaime Katz with Morningstar.

I'm not going to ask you about tariffs. I am going to ask you about profitability in the Motorcycle segment though, and I'm curious if the downtick that's expected in the gross margin is mostly from just lower Slingshot demand? Or if there's something else that's flowing through their timing wise or anything else in the fourth quarter that is acting as a drag on that metric?

That's an insightful question. It is predominantly driven by mix as we continue to see aggressive growth of our midsized business and it's offset by weaker demand, and it's really industry-driven weaker demand in our touring and bagging segments. So -- and those are notoriously weak. Because of RFM, we can't ship what they don't sell and retail sales for the bigger bikes, the more heritage-style bikes was below our expectation. So it really is predominantly a mix slightly tariff-driven, as it's flowing through there, just like it is the ORV business, but predominantly it's a mix issue.

Yes, I mean, Jaime, you got to remember that we've essentially completed the wind down of Victory, which left our Spirit Lake facility without those units and so obviously, as we're continuing to ramp Indian, that will backfill that, but with the heavyweight market being more challenged than we originally expected and with those being higher-margin bikes, you can imagine that that's maybe absorption challenges that we initially thought we had a little bit more substantial.

Yes. That said, the new -- and part of it was the late introduction of our model year '19 product news in Indian. So the new Chieftain is doing very well with consumers, but that is kind of late in the season, and we didn't get too much of that out there. So we believe that our product lineup, when we're on trend, Indian gains significant market share. And we believe with FTR 1200 being an example, we're increasingly on trend with all of our new bike introductions. We're never going to walk away from the heritage bikes, but certainly if consumers are moving more towards a more trend-based styling, we'll be sure to deliver that.

Okay. And then for TAP or after parts segment, I'm assuming that most of the mid-single-digit increase in shipments in the fourth quarter is from that stalled launch of Jeep products, is there anything else we should be thinking of in there?

No, I think that's pretty much it. But our core powersports aftermarket that I referenced being up 21% in Q3, we expect that to continue given the aftermarket for preseason and what will hopefully be a good season of snow sales.

And our next questioner today will be Eric Wold with B. Riley.

Unfortunately, I will go back to quickly on tariffs for 1 question. Just given the countermeasures you've taken on production improvements, price increases, et cetera, are you doing enough so that there's a chance, depending on the level of relief you may or may not get or even general tariff reductions or changes, could you actually see these countermeasures become an overall tailwind to margins kind of in the medium to long term? And then given the comments around affordability with consumers and a few dollars per month on the payment, if you do get relief, would you consider taking prices back down? Or that it's not necessary given that affordability?

We're going to be very careful with what we do with price, and we believe with overall inflation, not just tariff-related, that there is a need for the powersports industry to start to raise prices a little bit. And as the industry leader, we're not afraid to lead on price. We have not yet even begin to think about this turning into a tailwind. But you're right, if we got relief and we've done all of these other countermeasures opportunity, it could be. Ironically, I mean that's where our competitors are right now. So we're just trying to get back to even, and we'll have a competitive advantage. But that's the work we're trying to do.

And just 1 quick follow-up for Mike, the quick-numbers question. The $20 million or so of interest expense in the quarter, anything unusual there to the onetime charge or whatnot associated with the acquisitions or the financing? Or is that the good interest level going forward?

No, it's reflective of -- we essentially had the debt in place at the beginning of July, so I think it's pretty indicative of what to expect.

And our next questioner today will be Joe Altobello with Raymond James.

I guess I wanted to ask about the North America powersports industry broadly. If you look at overall retail, that was growing not that long ago, it was down low singles in the June quarter, now down mid-single, despite what is a pretty healthy macro backdrop. We've got very low unemployment, rising consumer confidence. How do you grow the pie -- or you and the rest of the industry grow the pie, so to speak, beyond the 3.5 million to 4 million powersports participants that we see right now in the U.S.?

Well, Joe, that is, obviously, our competitors are talking about that, we've got consistent efforts on that, and we don't like to talk all that much about some of the stuff we're doing strategically. But trust when Mike said, when OpEx was going up a little bit, it was with strategic investments that those are directly related to what you're asking about is how we expand the pie. I mean, we're not as worried, you've got to think about, it's the heavyweight motorcycle segment that's pulling down the industry right now. And part of the reason that Q3 was a little weaker is simply because Polaris, being the largest player, had a difficult compare and we only grew 1%. So, we've typically been -- helped pull the industry up. So we don't think it's indicative of a trend at all. And our efforts to bring in more women, more minorities, younger people in the industry is a concerted effort going on then within the company. And I think as we move into '19, you'll start to see some of those come to fruition.

Yes, Joe, I'd just point you back to our Retail slide where, I mean, at the end of the day, the market being down as really being driven by motorcycles and it's really being driven on the heavy-weight side. If you look at the core Off-Road Vehicle industry, it was up low single digits and, as Scott referenced with us being the industry leader, up 13% last year and up modestly this year. I think that would still tell you that the off-road vehicles space at least is still pretty healthy.

It's a fair point. And then secondly, I'm sort of forced to ask a tariff question, right?

Not really.

But I will, anyway if you'll excuse me. It looks like you did get some tariff relief on motorcycle components. Is that related to the 301 tariffs? And how much does that help?

No, the retaliatory stuff is the EU and that's where really -- the only place where motorcycles are hit specifically is on EU retaliatory tariffs, which our competitor got a lot of focus from the President on. And that -- yes, we can manage -- we've got -- that is not, I mean it's certainly -- it's noise to us, but it's not a significant concern like the other things we're talking about.

Is there something different you're asking, Joe?

No, but in terms of other tariff update slide, it says the successful exclusion application on motorcycle parts and other components.

Yes, I mean there's -- with the exception of List 3, which I think everybody is putting a lot of pressure on the administration. There's an exclusion process where you can go in and plead your case. And so, we've had instances where we've been successful, but I would caution you that it's relatively small as you can imagine the exclusions have to go through some pretty high hurdles. And, the good news is we were able to get some things through, the bad news is we're still facing a pretty substantial impact.

And the next questioner today will be David MacGregor with Longbow Research.

What you're -- just a question on the FAC, Scott. When you're clearing your prior year carryover inventory, I guess, through this sales event, are your new model year '19 retail sales up year-over-year? And if so, can you say by how much?

Yes, even though we were really, really efficient, in fact, I said the best ever we've had in a model year launch and getting new products out, it is not a significant portion of our -- you think about -- I mean, you started the question with factory authorized clearance. We're not looking -- in fact, some of our competitors do it. We adamantly do not put promotions on new products. Now fair enough, a lot of customers come in and look for something on sale and they buy up the new products, but that was not a -- it's not a significant number that we focus on. We really look at the fourth quarter is where we expect to being able to generate most of our sales. I will tell you though that the introduction of factory choice, which gives the customers and dealers an opportunity to make differentiated vehicles from the factory, was very, very popular, and we think that will be something that helps us going forward.

But you're still -- every year, you're sort of rolling out new product against the backdrop of FAC promotional and carryover inventory, right? So there should be some kind of a year-over-year compare, so I guess I was just trying to get your comment.

Yes, I mean, David, one way to think about it is our inventory position this year, although we're up, is much healthier from a current versus noncurrent. And so I think as you think about the Retail compare that we have and you think about the Retail we've put up in the quarter, that would tell you that we had pretty strong reception of our model year '19. And I referenced it in my prepared remarks around the RANGER XP 1000, which we've seen great success with. We've seen significant retail on not only the core unit but also with the accessories and up-fit capability that it has.

Okay. And then just as a follow-up, I guess, question on you preliminary 2019 outlook, and I realize it's still early, but just wondering if you could comment at least directionally on how you would expect your commodity supply contracts to reset if commodity spot markets kind of remain where they were right now?

Yes, we'll talk about that in January.

And the next questioner today will be Michael Swartz with SunTrust.

I just wanted to talk about motorcycles. I think at the end of the quarter, you said inventories were flat. But can you just give me your commentary about how you're seeing -- how you see that market playing out next year? Can you maybe give us some color around maybe the inventory profile?

Well, the inventory profile is based on what we expect to sell and talk with our dealers on. So if we're currently seeing, and therefore, expecting less of our heritage bigger bikes to be sold, we'll profile less of those in the mix. That said, and as I indicated, the new Chieftain is doing very, very well. We've got Roadmaster Elite out there that we believe is still a good market for us. So as we launch FTR, there's certainly going to be a profile shift to more midsized bikes, which where we're gaining so much market share. We're not at all disappointed in that. But it does mean that -- and we're not done innovating with the heavier bikes. But as we get on trend with our heavyweight bikes, we expect it will be able to grow. But I mean, to answer your question directly, we set profiles based on what we expect to sell and right now, we expect that to be shifting to more of our newer bikes.

And I think, Michael, one way to think of it is, we've been on RFM for a while now with motorcycle business and that means that it reacts pretty quickly if the dealers aren't selling bikes, they're not putting orders into the factory and, I think, that's why you see a tighter alignment around what's happened with Retail with our company sales and the fact that inventories are flat. So I think, if you're talking to Steve Menneto, I think he'd tell you the inventory levels are appropriate and healthy.

And the next questioner today will be Joseph Spak with RBC Capital Markets.

Mike, maybe just to follow-up on that real quick. I think this is another quarter where you've mentioned factory inventory is still high going through some of the RFM stuff. When should we expect that to be completed?

I think what you will see is a tighter alignment by the time we get to the end of the year, Joe. I mean, I think we've had a couple of quarters, Q2 and Q3 specifically, where our inventory levels last year were abnormally low and that's the reason I added some of the comments in my prepared remarks. We went back and looked at where we've been through the course of the last couple of years and, as I mentioned, we've had tight alignment. I mean, just to put it in perspective, you know the inventory levels are up in the third quarter. We under-shipped Retail by several thousand units within the quarter. So yes, when you start pealing the 12% performance in our offered vehicles space back and you look at the underlying Retail, you look at the ASP change, you look at the strength we had in International and PG&A, it shows you that we're starting to get a lot tighter alignment, because we feel like the inventory levels are getting pretty darn close to where they need to be from a profile standpoint.

And I just want to reiterate how RFM works. Now that it's fully implemented across the business, once we set a profile, that's what we ship to. And in fact, the dealer has to specifically request above-profile shipments before we will ship them in. So little bit of quarter-to-quarter noise sometimes because of new product innovation and ultimately dealer stocking, but for anyone to ever suggest that there's anything other than us shipping to demand is not possible.

And then Scott, you mentioned in your opening remarks, commitment to productivity and clearly without the grade productivity, I think the current situation might be even worse. But should we read into that, that you're, sort of, even going through the process of identifying further programs? And if that's true, can you just remind us of, sort of, like an average payback?

Well, I mean, the average payback on most of our productivity initiatives is quite significant, especially the strategic sourcing one, which is still the biggest lever we have. But what we're seeing as we increase volume and start to put these factories operating as much closer to their designed capacity, that's very helpful to us. The design to value work that really Menneto kicked off in Motorcycles, but ultimately is spreading to rescue the business, will also be a nice lever for us. So it is -- it's a multifaceted productivity effort, but more it's a methodology and a mindset as it relates to some of these ongoing commodity and tariff pressures that we're just not going to do stupid things like go setup a new factory to transform something to avoid paying a tariff. I mean, why would we put a new factory in Mexico when the whole purpose of the tariffs is to do more American manufacturing. We're not going to do things like that. That's what I was referring to with our predominant focus on productivity.

I think, Joe, when you think about timing, that gets tricky, changing and going through validation takes us time on a fair amount of our product. And the way I would think about it is, mostly efforts we have underway right now are trying to countervail what could be a substantial increase, given the tariffs have been put in place on both steel, aluminum and the China goods. So tough for us to quantify, that's what we're trying to work through right now and hopefully, we'll be in a much better spot come January to give you guys some insight to that.

And the next questioner today will be Seth Woolf from Northcoast Research.

So just to wrap this up, I guess, on the tariffs for me, taking some of the comments about you guys expect to have better handle on all of this in January. Would that mean that as you go through the process of trying to get an exemption, you would know that by January? Or could it last longer? And then is this an all-or-nothing thing? And if, Mike you said, you've been able to get some relief, I mean, how does that -- those two factors work out?

Well Seth, I mean, I'm sure you've taken a negotiating class. It's impossible to know when the other side is going to give you the result that you desire. I will tell you that, as I said earlier, our goal is to have an answer by the January call. But there's no certainty that, that will happen. But that is exactly we are working towards.

Okay. And then as we -- just the other point of clarification, when we talk about direct and indirect, I think, you said 15% of COGS, that is total COGS, not just the purchase materials?

It will be total COGS and of that 15%, it's roughly 50-50 between what we buy direct and what we buy through U.S. or other suppliers that source some of their components through China.

And the last questioner today will be Gerrick Johnson with BMO Capital.

Last two questions. So you're still pulling out restructuring charges, can you remind us where we are in this journey?

Yes, I think, Gerrick, there were a couple of actions that we announced the wind down of our Indiana Motorcycle business down in Brazil, it's relatively small, but we had some dealer payments. We went through the changes associated with winding down Victory and some of the associated closures and movements associated with that. I think the biggest outstanding item that we have money in there for is some of the work we're doing with the consulting group around our supply chain, and I anticipate that would carry into next year. But that will be a much smaller amount we should, as we get into next year from a Reg G standpoint, have the majority of the EPPL and the Victory Motorcycle wind down off the page. So I think, you're really going to be down to any M&A that we do, the intangible amortization and then probably a smaller amount of restructuring.

Okay, sounds good, Mike. And lastly, sorry for being dense here, but how is List 3 having a disparate impact to Polaris than, say, Honda and ORV or Harley and heavyweight motorcycles?

I'll actually thank you for asking that tariff question. The issue is, Harley is -- we don't -- I mean they're a good -- I mean, a tremendous significant competitor motorcycles. And they're more akin to the same issues that we face. So they're kind of like us, but predominantly what we're talking about is the Off-Road Vehicle, which is our biggest business, as you know, and how that impact is disparate. And if you look, I mean, notwithstanding the smaller Arctic Cat that also has some of the same issues, but really the main competitors in this industry are either Canadian or Japanese. Our Canadian competitor assembles every single 1 of their off-road vehicles in Mexico, thereby avoiding the impact of the 301 tariffs. Our Japanese competitors, most of them, in fact, I think, all of them have assembly plants in the U.S. But as you know, they don't source mostly from China. They source predominantly from their Japanese suppliers. Therefore, they don't pay the tariffs. So ironically, it's just us and whatever Harley is paying that are facing the impact.

All right, that's all of the time we had this morning. I want to thank everyone for participating. And we look forward to talking to you in January on our fourth quarter call. Thanks again, goodbye.

And the conference is now concluded. Thank you for attending today's presentation. You may now disconnect your lines.