Polaris Inc (PII) 2015 Q2 法說會逐字稿

Good morning. My name is Stephanie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Polaris second-quarter earnings results conference call.

(Operator Instructions)

Thank you. Richard Edwards, Head of Investor Relations, you may begin your conference.

Thank you Stephanie, and good morning and thank you for joining us for our second-quarter 2015 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.

The speakers today are Scott Wine, our Chairman and Chief Executive Officer; Bennett Morgan, our President and Chief Operating Officer; and Mike Malone, our Chief Financial Officer. Ken Pucel is also here and is available for questions if need be.

During today's call, we will be discussing certain topics including product demand and shipments, sales and margin trends, income and profitability levels, manufacturing expansion initiatives, foreign currency movement and other matters, including specific guidance for expectations for the remainder of 2015, 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.

Now I will turn it over to our CEO Scott Wine. Scott?

Thanks Richard. Good morning and thank you for joining us. While the announcement was made last week, I want to start today's call by again acknowledging and celebrating the remarkable 30-year career of our CFO, Mike Malone. When Mike started with the Company in 1984, Polaris was a $50 million snowmobile manufacturer. He was part of the team that originally took Polaris public in 1987 and has been our stalwart CFO since 1997. Much like Polaris, Mike has diversified and grown throughout the last three decades, but he remained a paragon of conservative values and impeccable ethical leadership that strengthen both our culture and our Company. In sharp contrast with his risk-averse approach to finance, he's an adventurous rider of Polaris vehicles, so I know he and his wife Colleen will set a high bar for life in retirement.

Fortunately, Mike agreed to stay around until the first part of 2016 to guide us through the pending sale of GE's inventory finance business as well as the contract renewals with our retail service providers. We always seek to better leverage our financial services business, and having Mike lead this effort during the CFO transition is a great benefit. Mike Malone established a benchmark for a high horsepower Polaris CFO, so I'm thrilled that we were able to recruit someone of his caliber to succeed him. Mike Speetzen is one of the great many CFOs to come out of the GE Allied Signal finance training ground and has honed his skills across several complex international businesses. His experience leading the spinoff of Xylem from ITT four years ago and successfully serving as their CFO ever since makes this evolution easier. We're excited to welcome Mike to the Polaris team. Mike's first official day as CFO will be August 3, but he is planning to attend our dealer show and analyst meeting next week.

We are once again reporting record sales and earnings for the second quarter with sales of $1.124 billion and earnings per share of $1.49. As you will hear this morning, there is a great deal of positive momentum across the business including extremely high retail performance in June to finish the quarter. However, our results were far from the typical earnings power we expect to deliver, even as we held quarterly operating expense growth below 6% for the first time in more than five years. Motorcycle demand continues to outpace our ability to produce bikes, and Slingshot is looking more like a home run than we anticipated, all leading to strong retail demand across the business.

Asia-Pacific and Latin America had a very robust second quarter largely offsetting continued weakness in our EMEA business. Our overall 11% revenue growth was chiefly driven by similar growth in North American retail sales, both in line with our expectations. Promotions were up sequentially but in line with expectations, which is a positive for us in a very competitive environment.

The growth rate of dealer inventory slowed slightly in the second quarter as we work to bring it back in balance with dealer needs and expectations. We also made steady improvement throughout the quarter on our well-known Spirit Lake paint issues, but it was nowhere near the pace we expected, and the premiums we paid to maximize output and correct system problems were extremely high. While I am immensely frustrated and that's probably an understatement that we have to outsource bikes for paint, ask our team to work excessive overtime and spend countless hours and dollars to meet exceptionally strong motorcycle demand, I also have to acknowledge that the reason we screwed up this paint system implementation largely stemmed from the same culture of frugality, ingenuity and can-do attitude that have made Polaris such a profitable growth engine for decades. We're learning a very expensive lesson, and we will certainly get Spirit Lake and future paint systems right with more engineering and process discipline, but we will not become slow and bureaucratic to be better. We will win with Lean leveraging speed, quality and cost to make our bikes, processes, vehicles and profits world-class.

Despite the additional cost pressures, we're holding and narrowing our full-year guidance. We have an exciting array of model year 2016 product news to introduce next week, and our factories including Spirit Lake are improving their performance throughout the year. Retail performance in the second half should resemble the second quarter, aiding our efforts to moderate dealer inventory levels to mid single-digit growth by the end of the year. Thanks to a combination of better pricing, lower commodity cost and productivity gains, we expect margins to be notably better in the second half than they were in the first. What we expect that the Fed will finally increase interest rates in the second half, we do not anticipate it will be of the size or pace to materially impact our customers or business.

Later today, we have the opportunity to discuss our five-year strategy with the Polaris Board of Directors. Across our business, the opportunities and catalysts for growth are significant. From motorcycles and Slingshot to a bold global plan for off-road vehicles, we expect to keep winning the battle for the best in powersports plus. Steve Eastman is determined to continue PG&A's rapid growth both through innovation and acquisitions while Matt Homan has an aggressive strategy to build his work and transportation business and to create all-new adjacent platforms for growth. Where we expect to win in the years ahead is frequently at the intersection of adjacent markets and global market leadership.

By far the best example of how we expect to achieve this type of growth is the recently launched Multix vehicle developed by our Eicher joint venture. Mike Dougherty and his team did extensive research to create an innovative, affordable vehicle for the nearly 60 million small-business owners in India. Multix has been extremely well received by the Indian press and has generated significant consumer interest. We expect Multix to have a bright future and anticipate the process that generated this game-changing vehicle will continue to bring us new products in new markets for new customers for years to come.

Across our business, our ability to grow consistently and profitably is dependent upon our efforts with customer excellence and Lean. From making our dealers more profitable to delighting our customers with innovative technology, Tim Larson and his team will lead our customer-first strategy while from the industry best-leading lead times to improved quality and performance. Ken Pucel is on a path to deliver 300 to 500 basis points of gross margin expansion over the next five years. Despite the recent market turmoil and news out of China, we do expect that business to continue to grow.

I will now turn it over to Mike -- Bennett, you got this? Turn it over to Bennett for insights into our business units.

Thanks Scott. Good morning everyone. Polaris North American retail share and retail sales accelerated in the second quarter. The 11% increase was driven by excellent motorcycle retail demand and solid ORB contributions in the powersports industry that increased 3%. Our actions to improve dealer inventory are beginning to produce results. Inventory unit levels are down sequentially from the first quarter by 10%, and dealer inventory is now up 15% versus 2014. Specifically, ORV inventory moderated some to low teens percent and should continue to make progress throughout the year. Snowmobiles are up about 40%, but this is related to shipment timing, snowfall last season, and is manageable. Motorcycles are up mid-single digits in aggregate including Slingshot but still far short of demand in every on-road brand, and adjacent market inventory is up mid-single digits. The improvements we have made to ATV RFM, including enhanced individual dealer flexibility measures are helping, and we're making lead time improvements for the process to assist dealers and improve both consumer and inventory responsiveness. By year-end, we continue to expect we will be at mid-single-digit dealer inventory growth.

Lean enterprise is competitive advantage. Lean initiatives are picking up significant traction at Polaris and will make us much better. Product quality is improving, ORV plants are running smoothly and our new Huntsville plant project is progressing right on budget and schedule and will be ready by the beginning of the second quarter of 2016. Unfortunately, Q2 was challenging for our margins and Spirit Lake. Gross and net income margins declined. Despite improved commodities and solid efforts to reduce product cost and control operating expense, we were unable to fully offset ongoing currency pressures, promotional expense in the elevated production cost due to the Spirit Lake paint system. Factory inventory is up 27%, but we still expect to see percent increase moderation as we move throughout 2015.

The Spirit Lake paint system implementation has been one of our most disappointing executions ever. Fundamentally, we made a number of mistakes including our original operational assumptions were too optimistic, two-tone paint and complex graphic demand significantly exceeded our expectations and we did not increase system capabilities as our demand evolved. We compromised an appropriate ramp-up period to try and meet growing Indian demand, and finally, we were too cost-conscious and scoped key capabilities out of the final design. It's been humbling as we acknowledge we have let our consumers, dealers and our shareholders down. We have all hands on deck to improve throughput increase system capacity, we're adding shifts, operating and expanding our legacy paint system and outsourcing where practical like with Slingshot. We're also finalizing plans to upgrade and expand the system further over the next couple of quarters to add capacity. Our second-quarter paint throughput did improve, and we're very confident in our plans and abilities to significantly increase throughput in the second half of 2015, and Ken Pucel is here to answer any additional questions you may have on Spirit Lake.

Moving on to business unit performance, off-road vehicles. Polaris' second-quarter ORV revenue increased just 2%, driven by solid RZR sales globally offset by reduced shipments to improve dealer inventory levels. The average sales per ORV unit was about flat in Q2, and year-to-date ORV revenue is up 6%. We gained share in ORVs in North America, gaining in both ATVs and side-by-sides and building upon our number one positions. Polaris ORV retail sales increased mid-single digits in an industry that increased slower but still grew mid-single digits. Polaris ATV retail sales increased mid-single digits in an industry that grew low single digits, while Polaris side-by-side retail sales grew high single digits, exceeding our industry estimates by roughly 1% to 2%. The promotion and overall competitive environment remains elevated as expected, and as we indicated and planned for, we were more aggressive, and that along with strong retail performances from full-size RANGERs, Sportsman 570s and ACE offset some continued weakness in our value and entry segments. We're less than a week away from our dealer meeting in Las Vegas when we will launch our 2016 model lineup, and we again have excellent product news across our entire ORV portfolio.

Motorcycles. Polaris' second-quarter motorcycle revenue again grew rapidly, up 57% due to big gains in Indian and Slingshot brands partially offset by a decline in Victory. Year-to-date motorcycle revenue is now up 65%. Polaris motorcycles continue to significantly expand North American market share. Overall Polaris second-quarter motorcycle retail sales grew over 80% in a North American midsize and heavyweight motorcycle industry that was flat, so we again gained a sizable amount of market share. Victory retail decline teens percent and share eroded modestly due entirely to production-related product shortages. Victory dealer inventory is down 31% year over year.

Indian sales momentum remains excellent with retail sales up about 100% led by notably improved shipments in retail of the Scout. Indian dealers retailing increased to over 160 with over 220 Indian dealers now signed. Year-to-date Indian dealer sales per unit productivity is excellent, about 4 times that of a Victory dealer, so we are pleased that the buildout of the Indian dealer network and the product line is delivering as we had expected. Both Victory and Indian continue to have strong dealer order demand with extensive order backlogs. Despite increased shipments in Q2 and expected notable improvements in the second half throughput, we're now projecting to be short through the fourth quarter as long as demand remains so strong on both brands. Our model year 2016 motorcycle product launches begin next week in Las Vegas, but expect us to meter our launch news over the upcoming months until we are in a better position to meet existing demand.

Slingshot. Slingshot demand remains hot and greater than our expectations. Product continues to retail as fast as it arrives in the dealer showrooms. As a result, we will execute an additional 10% production line rate increase later in August to help meet consumer and dealer demand. We made significant progress in Q2 with Texas, Indiana, Connecticut and North Dakota approving licensure, and we've already announced our model year 2016 lineup with MSRPs increased 5% to 6% depending on the model.

Snowmobiles. Second-quarter revenues were $19.3 million, up 215% versus 2014. Model year 2016 orders are complete and in total met our expectations. Our best consumer Snow Check period in 13 years led by the new model year 2016 AXYS RMK lineup has us excited for the start of the upcoming fall snow shows and retail season.

Parts, Garments and Accessories. PG&A momentum improved in Q2 with revenue up 17% driven by strength in the US market as well as motorcycles and ORV-related products. Year to date, revenue improved up 15%. All product segments grew, accessories were up 23%, apparel was up 48% and parts increased 9%. Our aftermarket brand portfolio continues to grow with sales up over 50%. PG&A innovation is healthy. Next week we will introduce 500 new model year 2016 accessory and apparel products to our PG&A portfolio, and to meet increasing demand, we're expanding our Vermilion distribution center by an additional 25,000 square feet, and completion is inspected later this quarter.

Global adjacent markets. Global adjacent revenues declined 3% in the second quarter. Year-to-date revenue was up 2% and is up high single digits on a constant currency measurement. North American work and transportation revenue grew high teens percent, continued expansion and success in our direct national account business along with our errands partnership more than offset weakness in the Brutus channel caused by distribution transition and erosion. GEM revenue increased as well, driven by double-digit retail growth work.

European work and transportation decreased high teens percent due primarily to currency weakness and some softness in [goopeel]. The European quadricycle industry is flat year to date with Aixam maintaining its number one market share position. Second-quarter defense sales increased low single digits primarily due to timing of orders. Our order backlog is up over 100% versus the prior year, and our outlook remains strong thanks to increasing DAGR and RZR and international demand.

International. International sales declined 4% in the second quarter with strong growth in motorcycle products in Latin America and Asia Pacific regions more than offset by weak currencies and some weakness in Europe. Year-to-date revenue was down 6%. EMEA region revenue declined 12% due primarily to currency and continued weakness in Russia. Subsidiary revenues were up strong double digits on a constant currency basis.

European powersports industry metrics remain mixed. The European ORV industry is up low single digits year to date driven by small value product growth and aggressive pricing with Polaris remaining number one but down low single digits percent and losing a bit of share. The European motorcycle industry is down upper single digits year to date with Polaris outperforming, up low double digits, and both Indian and Victory gaining share despite the supply constraints. The Opole plant is operating well and will supply the majority of ORV products to the region in the second half.

Latin America revenue continues to soar with second-quarter revenue up 32%, again led by Mexico. Q2 Asia-Pacific revenue increased 15% driven by Indian and RZR products and strong year-over-year growth in China, India and Japan markets. Our largest subsidiary Australia and New Zealand grew despite significant currency headwinds but most importantly registered nice market share gains in both ORVs and motorcycles.

The most exciting news of the quarter for international Polaris was the launch of the Multix. The Multix is the first multi-role personal three-in-one on-road vehicle for the vast Indian market at a very affordable price. It's for business with greater than 1900 liters of cargo carrying capacity. It's for the family with comfortable seating for five with Polaris' legendary suspension capabilities on India's notoriously rough roads, and it's for power with the capability to provide up to 3 kilowatts of electricity or mechanical power generation. Start of production and initial shipments begin the end of this month. We will have 30 dealers by SOP and expect to increase that to about 200 in 2020 based on successful adoption by the marketplace. Multix symbolizes the new Polaris, global diversifying and our first truly developed end market product for a vast emerging economy.

And with that, I will turn it over to Mike Malone.

Thanks Bennett and good morning to everyone. As you know, this will be my last earnings call with Polaris. After 19 years in the CFO seat, 31 years at Polaris and over 80 of these earnings calls, I've determined it's time to start the next chapter of my life and retire from Polaris. I've enjoyed the interaction and relationships developed with our analysts and shareholders over the years, and while this quarter has not been the Company's best executed quarter, I can honestly say that I believe Polaris is in the best financial position that it has ever been during my tenure at Polaris.

Now let me turn to the task at hand, our second-quarter results. While the Spirit Lake paint capacity issue is significant for both the second quarter and the full year, we believe we can overcome these challenges through improved performance and prudent operating expense control in the second half of the year. As a result, we are maintaining the top end of our sales and earnings guidance range and increasing the lower end of the ranges. We now expect sales to grow 10% to 12% for the full year and earnings per share to be in the range of $7.32 to $7.42 per share. The sales guidance for each of our individual businesses remains unchanged. However, we are adjusting our previously issued guidance for the following three P&L items.

Gross margins for the full year are now expected to be about flat with last year's 29.4%. Previous guidance was for gross margins to increase up to 20 basis points year over year. I will give more detail on margins in a moment.

Operating expenses for the full year are now expected to decrease in the 20 to 30 basis point range as a percentage of sales through prudent and responsible cost control measures implemented in response to the margin challenges we face. Income from financial services is now expected to grow high single-digits percent, a slight increase from the previous guidance, primarily resulting from the continued strong performance in the second quarter of our retail credit business due to the increased volume. Our guidance for the remaining P&L line items remains unchanged.

During the 2015 second quarter, the gross profit margin percentage decreased by 166 basis points to 28.4%. Negative currency changes significantly impacted second-quarter gross margins, approximately $18 million compared to the second quarter a year ago. In addition, gross margins were further impacted by $9 million or approximately $0.09 per diluted share of incremental manufacturing costs at our Spirit Lake motorcycle factory. Approximately $20 million of incremental Spirit Lake manufacturing costs are now included in our full-year 2015 guidance.

In addition, sales promotion costs were higher during the second quarter as we increased our promotional activity as previously communicated. We continue to expect gross margins to benefit from higher selling prices, product cost reductions and lower commodity costs offsetting the added manufacturing costs and currency pressures and reinforcing our expectations of finishing the year with gross margins about flat with last year. We expect the majority of the gross profit margin percentage improvement in the second half of 2015 will come in the fourth quarter where we have easier comparisons versus a year ago.

Our expectations for the foreign exchange headwinds have not changed significantly from our first-quarter call. Currencies in the 2015 second quarter had a $41 million negative impact on our total company sales and an $18 million negative impact on pretax income compared to last year. On a constant currency basis for the second quarter of 2015, our sales would have increased about 15%, and our net income would have increased about 16% over the second quarter of last year. Assuming currency exchange rates remain at about the same range as quarter end, we expect that the appreciation of the US dollar will reduce full-year 2015 total reported sales compared to last year by about $140 million to $160 million and reduce pretax income by about $65 million to $75 million.

We have 70% of our remaining second-half 2015 Canadian dollar and Mexican peso cash flow exposures hedged and 60% for the Australian dollar and Japanese yen as well as some initial hedges for calendar year 2016. Most of our hedging activities, gains and losses are reporting below operating income in other expense, along with the currency gains and losses related to foreign cash transfers and certain intercompany transactions. In the second quarter, this resulted in a $2.7 million of expense compared to other income of $1.9 million reported in the second quarter last year. Given our current hedges in place and assuming exchange rates stay in a similar range, we expect that this other expense from currencies will continue in each of the third and fourth quarters of this year.

I will end with a few comments on our balance sheet and cash flow positions. We expect cash flow provided by operating activities for the full year to increase over last year at a slightly higher percentage rate than net income. We continue to expect capital expenditures for the full year to be over $250 million, which includes a portion the cost of our new off-road vehicle manufacturing plant in Alabama. Polaris acceptance receivables from dealers in the US were at $1.1 billion at the end of June, an increase of 25% from a year ago. The year-over-year increase reflects the higher number of units in dealer inventory and the mix change of higher value side-by-sides and motorcycles. We are told that GE expects to announce a decision later this summer related to the sale of the GE Capital portfolio which includes the entity that is our joint venture partner in Polaris acceptance. The retail credit environment remains stable during the second quarter with approval rates of 57% and a penetration rate of 31%.

With that, I will turn it back over to Scott for some final thoughts.

Thanks Mike. Just a few closing thoughts since we want to get to Q&A as quickly as we can. The global economy is a bit unstable as we enter the second half, especially with the swings in the market out of China recently, but we do see the Chinese market equally balanced between risks and opportunities. We have a strong team there and are excited about the acquisition we recently completed in the first quarter. With the path forward identified for Greece and an apparent agreement with Iran, we expect an improving economic environment in Europe, the Middle East and Africa. The US economy is likely to disappoint again in the second half, but we should be up marginally from the sluggish first half.

The oil and ag markets are likely to continue to be weak and extend for a few more quarters, leading to continued moderation in RANGER growth through the back half of the year. We expect both motorcycles and off-road vehicles to gain share in the second half and do so more profitably as our plan to operate more productively. I often refer to this Polaris team as ridiculously competitive and certainly expect better execution across the business as we play to win in the second half.

With that, I will turn it over to Stephanie to open the line for questions.

(Operator Instructions)

Robin Farley, UBS.

Great, thanks. When you talk about the second half retail looking to be up in the 10% range, should we think about that as motorcycle retail accelerating from Q2 levels and off-road moderating from Q2 levels?

No.

I think to add a little more color, Robin, we expect motorcycle retail to continue to remain very strong. We will start anniversarying in the second half some comps against Slingshot and some comps potentially against Scout even though it was rather limited. But we see motorcycle momentum remaining strong, and frankly ORV we expect to remain pretty consistent going forward. I don't think you should expect any moderation from second-quarter retail from an ORV standpoint.

As we have talked about a number of times, the product news that we will reveal next week is probably right in line with what I think our dealers want and our customers want, which certainly should give us momentum as we go through the second half.

Okay, great thanks. And best wishes, Michael. I will see you next week, but we will miss you.

All right. Thank you Robin.

Greg Badishkanian, Citi.

Thank you. Hi guys. First Mike, congratulations on a successful career and your retirement as well.

First question, in terms of the level of promotions that you think you will need to put out there in the marketplace in the side-by-sides and ATVs, do you think in terms of being aggressive, are you going to have to price similar level in third quarter as you saw in the second quarter? And also with respect to that, if you could give us some color on what you saw from your Japanese competitors as the quarter progressed, and then into third quarter, the level of promotions that they were providing?

Yes Greg, this is Bennett. I think from a promotion environment as we said in the remarks, it's been an aggressive environment as we expected. I think competitors are picking their spots as they try to move the products that they've made bets on over the last couple of years on a new product and maybe didn't see all the share gains they wanted to see against our armada. We certainly have seen the Japanese be aggressive, but we've seen the North Americans be aggressive as well. And if it remains elevated, I would tell you our guidance certainly implies and considers that we are in a good position to continue to be what I would call aggressive but balanced as we go into factory authorized clearance and as we roll out our model year 2016s. And frankly with the progress we made on sequential dealer inventory, I think we feel really good about the direction we are heading from where we are with inventory in the field.

Okay. And if you think about your Japanese competitors, how much of their elevated promotions do you think has to do with the yen versus losing share? You did mention your North American competitors are also getting very promotional, so how much did currency come into it and they're using that as an opportunity to pick up share?

Greg, it's Scott. Clearly as we have historically seen when the yen -- when they have the benefit of the yen behind them, the Japanese can be very aggressive. But I will tell you that the reason we are paying so much attention to the Japanese right now is not just because of what they are doing with the yen but what they are doing with product innovation. We have said this for years that we would eventually see more and better innovation especially on the recreational side-by-side, and we're starting to see that.

So I think part of the reason of our optimism as we saw those launches come out starting in the second quarter, we were able to hold our own. And we're certainly seeing them play the yen, probably going to continue to be a very competitive environment in that regard, but I would tell you to watch the product innovation as much as you watch what they are doing with leveraging their currency. They are good, but obviously we feel very comfortable with our product pipeline and what you will see next week.

Great. Thank you very much.

James Hardiman, Wedbush.

Hi, good morning. Obviously I wanted to reiterate what a pleasure it was working with Mike. And good luck in your further endeavors.

Maybe I will start with you, Mike, then. You talked about a $20 million full-year number in terms of some of the Spirit Lake costs, $9 million was in the second quarter. Was any of that in the first quarter, and how should I think about the timing in 3Q versus 4Q?

Thanks James. There was some in the first quarter. It was significantly less than the $9 million, so we didn't feel compelled to bring it up and talk about it, but it did gets significantly worse in the second quarter. It will tail off as we go through the second half of the year, but there is still significant costs that are embedded in both Q3 and Q4. It's getting better, and we're getting our arms around it, but it's still going to be painful in the second half as well.

Great. And circling back to the promotional environment with respect to ORVs, can you maybe flesh out what you are seeing in terms of promotions between ATV, RANGER and RZR and their respective competitors as well as the share trends that you are seeing there? And then I guess bigger picture longer term, are you concerned that you're conditioning customers to expect those promotions and so as we lap some of this next year, it's going to be harder to get them back to paying full price?

Yes James, this is Bennett. I think there were -- you were tricky there, there was a number of questions in one question, but let me see if I can get this.

ATVs has been more elevated year over year than side-by-sides, but again, frankly the battle lines have been drawn there where I think competitors are trying to beat us on the low-end on the value and entry levels. And so that's where they have been throwing most of their promotion at where I think they think they can win. I expect that to moderate, and to put that in perspective, James, from I think what we saw back in the day of 2005, 2006, 2007, 2008, 2009, those levels have moderated. And I don't think we're going to go back to those days because I think in general, competitors, dealer inventory balances in the field are better and it will be normalized.

Side-by-side is up more modestly than ATVs, and that tends to be more across the board. Some competitors are picking on value in the RANGER segments and some guys are promoting on the high-end where they are trying to compete against what we would say would be our superior product. So that's a little more across the board. I expect side-by-sides as it gets more crowded will continue to be aggressive, but when you look at that as a percent of sales in relation to say ATVs or something like that, again, I don't think these things are crazy levels or out of line. Certainly we're very comfortable with our profitability levels at the promotional levels we run, and I don't think we are conditioning customers that you've got to get a smoking hot deal. It's been pretty normal par for the course in powersports for many years, so I think it's business as usual.

Got it. Thanks guys. See you next week.

Tim Conder, Wells Fargo Securities.

Thank you. First of all, Mike, it's been a pleasure over the many years here, and you set a standard that anybody in any industry should aspire to, so congrats. And Mike, I look forward to meeting you in your new role next week.

A couple follow-ups here. In general, gentlemen, little surprised that the North American channel inventories didn't come down a little bit more than they did. And it still appears your goal was achievable by year end, but given the issues on the motorcycles and your desire obviously to get more into the channel but couldn't, it would seem like that would have helped a little bit more. So maybe a little bit more color there.

And then two clarification questions. The cost, Mike, on the paint, is that $20 million for the full year or is that $29 million? And then secondly, the motorcycle market definition, are you still using 1400 or is that now 900 ccs and above? Thank you.

Okay, let's do the clarifications first. The $20 million is the full-year impact.

Okay.

The motorcycle industry hasn't changed from how we define it now that we have a broader lineup, so what we included there, Tim, is essentially every product in the industry that hasn't competed yet. So it's midsize and heavyweight, cruiser, bagger, touring and three-wheel products.

And as for dealer inventory reduction, Bennett, if you go back to the slide he presented, gives you about as much granularity as what's in that number as you could ever want. With the amount of product news, new dealers that we are adding, there's only so much progress we can make throughout the quarter. So we were exactly, literally almost exactly on where plants where we expected to be with dealer inventory.

Now you asked about motorcycle shipments. Had we shipped more motorcycles, we would've retailed more motorcycles, the dealer inventory probably would not have changed very much. But as we communicated, we have a very solid plan throughout the second half of the year to get dealer inventory to that mid-single-digit increase. And again, considering the product news, we feel pretty good about that and more importantly our dealers feel good about that.

Okay, thanks, appreciate the clarification, gentlemen.

Thank you.

Scott Stember, C.L. King.

Good morning, and likewise I want to say it's been a pleasure working with you, Mike, and I wish you the best of luck and have fun in retirement.

Thank you.

I wanted to ask on the motorcycle side, again, it looks like we're going to have another $10 million plus if not more in costs related to some of these bottlenecks in the back half of the year. Can you maybe just talk about what the end result will be once we head into 2016? I know you're not giving guidance there yet, but maybe just give us a little snapshot into how you envision the production of motorcycles and how the paint -- will you be more self-sufficient in paint early on in 2016? And just some of the incremental costs that we should look to go away.

Scott, I will start this and Ken and Bennett can add to it. We're not going to have -- what we expect out of this paint system, and many of you heard me say it -- what we thought we were going to implement was much higher capacity, lower cost and higher quality. That's what we had envisioned. That's what was in our budget, and that's what we expected to be able to deliver.

Almost completely from our own doing -- we outsmarted ourselves, we outsmarted the consultants helping us -- we took design elements out of the system that we now know make it incapable of delivering what we thought it would. So now what Ken and his team have done, we know more about that darn paint system than you would ever want right now. So what we've done is develop a plan that we can start to meet demand throughout the second half of this year.

Going into 2016, we will still be outsourcing some of our products. We've got the old paint system back online, that was a good bit of the cost in the second quarter, and we will start to run this thing as optimally as it currently can run. That cost in 2016 will be dramatically lower than the incremental $20 million we had this year, but it's not going to be back to what we originally thought.

So what we're doing now and it is part of our strategic review with the Board is figuring out what is the right long-term strategy. We do not expect paint to constrain output next year. It would just be a slight drag on margins. But over time, you can bet with our new knowledge we will be able to optimize this system and whatever we do next much better going forward.

Okay, and just a follow-up on the guidance. You're keeping the high end unchanged and talking about how you expect to make some of the shortfalls up in the back half of the year. Can you maybe just frame that out from a gross margin perspective if you were still expecting some elevated costs here for the paint facility, maybe some of the offsetting factors that we could look for that will be embedded in the gross margin line?

Sure. As I said in the call, the gross margins will ramp throughout the second half relative to last year. So we will improve upon the second-quarter performance, third quarter will maybe be flattish or so, and then fourth quarter will be significantly better than last year. If you look at last year's fourth quarter, we had a pretty tough fourth-quarter gross margin impact. Currency was a big part of that in the fourth quarter last year. As we get later in the year, the comps get a little bit better for us.

Got it. That's all I have, and I will see you guys next week.

Thanks Scott.

Drew Crum, Stifel.

Okay, thanks, good morning everyone and best of luck, Mike. So as related to Slingshot guys, where are you in terms of distribution with some of the newly approved states? And I'd be interested in any early success you have seen out of Texas. As a follow-on, just where are you in terms of plans for distribution in Europe and given some of the production issues you were dealing with, have you changed the pace or cadence of dealer adds for Slingshot? Thanks

This is Bennett. We're at about 425 dealers, and that's been increasing frankly as we've gotten state licensure resolutions that we made really nice progress in the second quarter. We have two remaining, Hawaii and Maryland, which frankly they are very small states from a volume standpoint. We still have a few provinces to resolve in Canada. I think the most notable one obviously that we're interested in resolving is Ontario, and we have some progress there, so stay tuned on that front.

The early reads, just like it's been across the country frankly, is our days to retailer improved in the second quarter. I think we got better to shipping to consumer demand as we work some of the kinks out of our system.

Texas has lighted up really good right out of the gate as has every state, and frankly most of the dealers across the union even ones that have been active for six months continue to have demand that is outstripping our ability to supply even as -- we were pretty darn good in the second quarter from a Slingshot standpoint because that was one of the items we had outsourced early from a paint system. And Spirit Lake team did a really nice job of rolling product out there. We will take another production increase in August and will continue to evaluate that as we go forward, but I'd say things look good on the Slingshot front.

You asked about Europe.

We will get there.

We will get there in third and fourth quarter. We have a launch plan and a limited number, and the Europeans are excited and we're building the go-to-market plans. And that will be end market in a limited basis here late in the third quarter and the fourth quarter.

So based on those comments, it doesn't sound like there's any change in terms of the plan to roll out -- add more dealers.

There are many dealers hand raising that would like a shot at Slingshot. We're going to continue to meter that based on our ability to meet demand and make sure we understand the legs that Slingshot has. So again, we continue to build on a high-quality profitable dealer network, which has been our focus. And I think we feel really good about what we've done so far.

Thanks guys.

Joe Spak, RBC Capital Markets.

Thanks, good morning. Congrats Mike. First question is maybe some housekeeping. I know in the Q you usually disclose this, but if we think about the different factors in the quarter, can you give us some indication of what volume was contributed for the quarter?

Yes. I will look that up. Ask your next question.

Okay. The next one would be for Ken. I just want to better understand maybe slide 14. It looks like if I am reading this correctly, you actually start to satisfy some of the backlog in the third quarter and then you get to more in the fourth quarter. I guess the backlog reduction, how do I interpret that? Are you saying total production will be below capacity in the fourth quarter, or you're just eating into some of the backlog? And a follow-on to that, what -- if we extended that chart into 2016, when do we think we are at a right run rate where capacity -- you are able to satisfy all the demand?

Just to be clear, we hope we're never at the point where we can satisfy all the demand.

But Joe, to your first question, we will be biting into that backlog in Q4. That's the first time that our actual build rate is faster than what we believe we will be shifting to orders. The backlog will be being taken down. Next year we're going to be modulating between our new paint system, adding capability back into our old paint system and outsourcing. So we will take all three of those degrees of freedom so to speak to manage to next year's supply and demand, and that's the plan to do that. Over time our strategy is to in-source as much as we can and rely as little as we can on an outsourcing capability.

Okay, so again if I'm reading the chart because it looks like the capacity line in the third quarter even breaks into that backlog a little bit. But is the backlog you think is also increasing in the third quarter, that's why it's not going down overall? I just want to undersigned that line versus the bars.

Honestly Joe, if you saw how many hours we spent on this dog gone chart, you would laugh, and I apologize for the confusion. But essentially what Ken said is accurate. Basically where we are is demand is still very strong in the third quarter and with the model year 2016s. We expect we're going to hold serve. So backlog should be status quo despite how you see that line, and then we will start to make a sizable impact in the fourth quarter. Some of that is frankly seasonality benefit that you get because fourth quarter is a lower demand issue. And I think we will continue to bite into that even further in the first quarter.

Okay, and I guess going back to the first part of the question, where I was really headed is if we look at the 10% to 12% top-line guidance for the year and we know currency is a little bit over [3%]. And you look in the first quarter, product mix was about [10%]. I just want to -- embedded in that, is it still -- for the rest of the year, is the implication that mix and price are a larger driver then volume shipments?

No. The answer to your question specifically in Q2 of the 11% sales growth, 9% of it was volume and currency was minus 4%. So year to date that makes it 10% on volume on a total 13%.

Okay, so if year-to-date volume is about 10% and retail is 10%, then how do the inventories go down if you continue to think retail in the back half will equate to retail in the first half?

Bennett and I actually had this discussion this morning. It's not that dealer inventories on a sequential basis are going to go down dramatically from where they ended Q2, but on a year-over-year basis, where we ended Q2 is where we should be ending Q4. It's just last year's Q4 as we shift in the model year a year ago 2015 product, some of it didn't retail, so that's just how we run the railroad for a long time. I think what you read is exactly right. If we hold serve throughout the second half, where we ended Q2, you will see mid-single-digit growth in dealer inventory.

Okay, thanks for the clarification.

Jaime Katz, Morningstar.

Good morning and congratulations on your retirement, Mike. I think you guys had mentioned on the call that over time you expect to capture 300 to 500 basis points in gross margin improvement from operating efficiencies, which we hadn't had models into our DCF. But I'm curious where you guys see the offsetting factors longer term whether you're going to spend more on R& D or marketing expenses to maintain those net income margins that are north of 10%.

Good question, Jaime. I think we have been really clear about our net income long-term targets because we're going to continue to invest in R&D. Innovation has been the lifeblood of the Company and will continue to be, but I think the offset is primarily going to come from getting into new markets with great products and great long-term profitability perspective but that initially start off as a drag on margins.

If we were consolidating Multix, it wouldn't be great for the first year. Or maybe two. But over time when you get significant volume like those products can yield, we feel really good about it. So I think the 300 to 500 basis points again that's over the strategic planning period is going to be real. Don't look for that to go in Op Ex. I will slit my wrists if we spend that in Op Ex, but -- and R&D will continue to be high but probably not on a percentage basis. So just think about it as our global growth increases, those lower-margin initial products will be the drag on things. And some of that will be acquisitions and some will be organic.

Okay, and then Mike, on the financing contracts that you are working on renewing, can you give us an update on any progress that we might have on that and has there been any thought of bringing any of it in-house at all?

The contracts are up starting this fall, I think it ranges from October to February. So we have quite a bit of time. But we've already been in conversations with all of the retail credit providers, and there is a lot of enthusiasm for our business. So we're having those initial discussions and we're optimistic that we will be able to put those in place and solidify those before I move on in February. Do you want to talk more about --?

When Mike's retirement initially came out, we talked about the EVP of financial services roll that he was going to step into. I think there was some -- oh my gosh, we're going to dive head into the deep end. But what we see as you think about the growth of our business, a lot of our big competitors in all markets have their own in-house financing. We saw very clear in our minds what happened to some in our industry when they got too aggressive and the downturn hit and it didn't end well.

Don't think about us trying to replicate what others do in the industry, but think about us trying to be smarter, make more money, serve our customers better. And what will ever that -- what will never happen, I shouldn't say never but I can pretty much say never -- is we are not going to bring this in-house on our balance sheet. We are addicted to our high returns on invested capital, we like our balance sheet, we are going to spend some of that on M&A. But expect us to explore opportunities to do better, but don't expect us to do a full wholesale takeover and bring this thing in-house on our balance sheet.

That sounds good to us. Thanks for clarifying. See you next week.

Mark Smith, Feltl and Company.

Good morning guys. Mike, ditto on what everyone else has said. First, can you guys walk us through Victory outside of paint issues, your thoughts on that current business, where it is today and opportunities to improve dealer relationships and improve sales long term in that business?

Mark, this is Bennett. I would tell you we've been very pleased with the progress Victory has made over the last number of quarters. We had seen retail and share growth the last few quarters, it was certainly trending up. This new American muscle position that Victory has moved to is resonating with customers and dealers, and we feel it's a space that we can own and have some real success in the upcoming years.

I know the numbers seem disappointing in the second quarter and we're disappointed with them, but Victory dealer inventory's down 31%, and the declines this quarter are 100% related to stockouts and not appropriate levels of inventory of our faster-moving -- complex graphics on Victory. So it's almost getting inordinately hurt with the paint system challenges because we're focusing on moving throughput out.

I think this is a short-term issue. I think long-term you will see us continue to tell you as we go forward a little bit about how we continue to use Indian and Victory as planking strategies moving forward, but we're very committed to a two-brand strategy and feel very good about where the brand is going.

Okay. And second quick question can you guys discuss generally how -- and there's a bunch of them -- the acquired businesses are doing as we look at Kolpin, KLiM, Pro Armor, Hammerhead, Timbersled and on and on? Just talk about how you feel about those businesses and also your appetite for continued acquisitions, especially maybe international ones with the strong dollar?

Mark, obviously we are not batting a thousand on these. I think in aggregate we feel exceptionally good about the returns -- projected returns from our acquired businesses. You mentioned you can't really move all of them -- throw them all into the same bucket. Obviously Indian has been a home run, really smart, I think the best acquisition I've said in a long time, Swiss Auto. What that team out of Bergdorf does for us in our Powertrain business is exceptional.

But what Steve Menneto is doing in the Parts, Garments and Accessories business and it really is a bifurcated strategy now, we're going to drive the heck out of our organic parts business and what we do in-house. And these acquired brands, KLiM is a home run, Kolpin's been great, Pro Armor will give us customization opportunity. So really we feel excellent about that.

Now that we have Matt Homan in the adjacent markets president role, really the opportunities for us to continue to use our balance sheet to drive future profitable growth not just to get bigger, it's pretty exciting. We feel good about what we've done, and we expect to do more and better in the years ahead.

Okay. Thank you.

Jimmy Baker, B. Riley and Company.

Thank you, let me add my congrats and best wishes to Mike on your retirement. Thanks for putting up with my questions over the years, and that includes today.

Thanks Jimmy.

So year to date, your income from financial services is up 28%, but your guidance calls for it to be up only high single digits for the full year, meaning the back half's actually down slightly. I'm just having a hard time understanding why financial services income will be down in the back half given your expectations for retail sales growth and you simultaneously raise the year-end Polaris acceptance receivables expectation.

Yes, part of that, Jimmy, is our expectation of a rising interest rate environment, which dilutes -- in the short-term anyway it dilutes the financial impact on both businesses as those rates get absorbed, so that's part of it. We're also -- as we go through these negotiation processes, there's certain give and take that will go on as well. So we're trying to be a little careful and conservative.

And then the other thing I would tell you is that particularly with the wholesale credit on Polaris acceptance, the comparisons in the second half of last year were very steep. So we are running up against very difficult comps in a year ago when we had some accounting changes that we implemented in the second half of last year that we are comping against.

Okay, that's helpful, and then just lastly, have any of the challenges at Spirit Lake affected the design or timing of any future model year introductions?

Yes, they have. It's been primarily stuff that we really had in the pipe over the last nine months. So yes, as I said in my remarks, we are metering and we have been metering for the last six to nine months and I think expect us to spread that out here over the next year. I don't think long-term it has not slowed us down at all. If we can't meet existing demand, we are being very careful of adding new complexities to Spirit Lake and disappointing customers by creating more demand we can't fill.

To give an example of that, one of the issues that contributed to lack of capacity was the strong consumer demand for two-tone paint. We've got an incredible in-house team. One of our product design guys, we have a really strong team in industrial design, and they come up with some great ideas that customers will love. But we're not about to introduce a bunch of wild new paint schemes that are two-tone that require extra time in the paint system when we can't meet current demand. We are sorting through this. I will say again, it's been immensely frustrating. Great lessons learned though about how we plan, how we execute future paint systems.

Ken and his team are getting it fixed. We're not going to throw additional logs on the fire while they are burning, and as they get this under control, we will start to meter those new paint schemes and new bikes in. We have a lot of demand for motorcycles in our current product line, so we really don't need to fuel that, but we're in this for the long-term. We expect to have an extremely large, extremely profitable motorcycle business. We just missed a gear getting there.

Got it. Thanks very much for the color. I will see you next week.

Gerrick Johnson, BMO Capital Markets

Good morning, Mike, congratulations. You guys talked about retail picking up in June. What was different in June versus April and May? Anything special like weather, promotions, and how is July looking?

I think across the industry you heard people have incrementally better June. The weather was certainly part of it. As we said we were going to be, we were more aggressive with some of the dealer incentives. What we've seen really is a lot more really for the last 18 months or so, within the quarter volatility has been significant. As an example, we started factory authorized clearance last year, so even though we're not up significantly in July, it's off a brutally tough compare. So we feel really good about retail getting into the second quarter.

Second quarter started off a little bit weak for us. Perhaps it was weather, whatnot, but we felt -- it was really a good June. And largely across the board, it was good, and we felt like that was important momentum as we enter the second half and we're leveraging that so far.

Okay, great. And in Latin America, what would your growth have been there in local currency, and what are you seeing in say Brazil, South America? And also, is there anything special in Latin America say swapping distributors for direct distribution in certain markets?

I will try to give you a little color while Mike is looking up the constant currency base. Latin America is good. Mexico has been an absolute home run. It's moved to one of our largest and most profitable subs in a very short time, and we continue to see that ORV demand continue to grow. And we're introducing motorcycles which should have a bright future.

Brazil continues to be a very interesting market. The currencies has been brutal there, but we're making a number of competitive steps that I think will allow us to really grow that market even more significantly than we have over the last few years. And so we're very excited about Brazil.

Argentina has been challenging mostly because of some of the restrictions on importations that the government has imposed, but overall a lot of the other places are distributors. And until they get to a certain size or scale, we will continue to keep those relationships, things are good. Got that, Mike?

Looks like the currency impact is about $2 million in Q2, which on a percentage basis looks to be about a 20% move in currency. Very material.

Okay. Great. Thank you guys.

There are no further questions.

That's the end of the questions we have here. Again we want to thank everyone for participating in today's call, and for those of you who are attending our analyst meeting next week, we look forward to seeing you in Vegas in a few days. Thanks and goodbye.

Thank you. This concludes today's conference call. You may now disconnect.