Polaris Inc (PII) 2016 Q2 法說會逐字稿

Good morning. My name is Michelle and I will be your conference operator today. At this time, I would like to welcome everyone to the Polaris Q2 2016 earnings call.

(Operator Instructions)

I would now like to turn the call over to Mr. Richard Edwards. Please go ahead.

Thank you, Michelle, and good morning, everyone, and thank you for joining us for our 2016 second-quarter earnings conference call. A slide presentation is accessible at our website at www.polaris.com/IRhome, which has additional information for this morning's call.

Today you will be hearing prepared comments from Scott Wine, our Chairman and Chief Executive Officer; Mike Speetzen, our Chief Financial Office. Ken Pucel, our Executive Vice President of Operations, Engineering, and Lean, is also to here to answer questions.

During the call today, we will be discussing certain topics, including product demand and shipments, sales and margin trends, income and profitability levels, and other matters, including more specific guidance for our expectations for 2016, which should be considered forward-looking for the purposes of the Private Securities Litigation Reform Act of 1995.

Actual results could differ materially from those projections in the forward-looking statements. You can refer to our 2015 10-K for a more detailed discussion of those risks and uncertainties. Now I'll turn it over to our CEO, Scott Wine. Scott?

Thanks, Richard. Good morning and thank you for joining us. Polaris generated a lot of news in the second quarter but the ratio good to bad was out of balance. Our hardships, which I will discuss in plenty of detail, were very public, but on the plus side, Indian continues to grow and gain market share, demand for our new GENERAL is exceeding expectations, and our Huntsville plant is ramping up production of both RANGERS and Slingshot.

Another piece of positive news came in early June when our Victory Empulse took second place at Isle of Man. While we are certainly pleased with the progress and performance of our electric bikes and their advanced lithium-ion powertrains, it struck me that we were celebrating something other than winning, which is not the attitude that made Polaris the world leader in powersports.

We play to win. We emphasize winning the right way rather than just claiming victory. As we work through a series of fire-related recalls and battle through an increasingly competitive market, our team is also preparing to play more aggressive offence in the second half and inspire a few more favorable news ratios.

Second-quarter sales were up 1% to $1.13 billion, aided by another strong quarter in motorcycles, up 23%, and a boost from adjacent markets in their first full quarter with Taylor-Dunn. Polaris defense sales were up nicely, as our innovative DAGOR vehicle was gaining traction with and orders from more Department of Defense customers. Parts, garments, and accessories and international both saw revenue increases of 5% in the quarter, although the headline was certainly the 6% drop in ORV snow sales.

We cannot accurately allocate the impact of the RZR recall on retail sales but we do know that it curtailed demand in the quarter. We also estimate that we lost a few points of side-by-side market share, which was not unexpected but is unacceptable. Net income and earnings per share were down sharply, 29% and 27%, respectively, as we incurred significantly warranty-related costs and continued to face currency and mix headwinds.

In sharp contrast to a year ago when we were battling through the Spirit Lake paint problems, Ken Pucel's lean and VIP efforts are providing much-needed savings and quality improvements that will continue to increase. Our efforts to improve inventory management are paying dividends, pushing cash flow up more than 280% in the quarter.

The extensive and ongoing product recalls related to fire risks on our vehicles impact every Polaris stakeholder in some way, but our primary focus is on our customers, keeping them safe, completing their safety bulletins so they can ride, and rebuilding their trust and confidence in Polaris. As we work aggressively to accomplish these goals, we have become much smarter about the thermal risks across our product lines, which drove additional recalls in the second quarter.

We have discovered gaps in our design, development, and manufacturing processes, and are urgently addressing these gaps, while also working to improve our post-sale surveillance process to increase our speed of response when issues occur. We have more work to do and we will move forward with urgency to continue to mitigate safety issues for our customers.

Mike Speetzen will discuss the impact on our financial results, which include our best understanding of future thermal-related costs that are both probable and estimatable. I want to provide a bit of additional color on the recent promotion of Craig Scanlon to Chief Marketing Officer and the realignment of Slingshot into Steve Menneto's motorcycle business.

Both of these moves were made to more productively support growth, not for defensive reasons. Craig played a vital role in building the RZR branded business and has overseen off-road vehicle marketing for the past eight years. As we look to expand the global reach of the Polaris brand and optimize how we leverage technology and tools to drive growth, there is no one I trust more than Craig to make this happen.

We will seek to marry his in-depth knowledge of our industry and Company with leading-edge analytics and talent to create more impactful, efficient, and measurably effective marketing processes. For Slingshot to grow at an accelerate pace, it requires infrastructure. As Craig shifted his focus from product launch to profitable growth, he realized that most of the framework and resources he needed were present in Steve Menneto's motorcycle business and the synergies between the two would allow us to begin reaping the benefits almost immediately.

Steve's extensive and experienced sales organization will help us expand customer awareness and improve lead conversion, and the advances being made in lean and cost down will readily transfer. Likewise, our motorcycle engineering and product management teams are already finding opportunities to apply their wealth of knowledge to Slingshot's further development. With the scale afforded by this combination, Slingshot is poised to grow faster and more efficiently.

The off-road industry was weak in the second quarter as overall North American retail was below our expectation, with declining ATV sales and a side-by-side market that was essentially flat. Our retail was weaker than planned, down low double-digits for the quarter. While we are concerned about the industry, we are more focused on issues within our control, namely improving our retail performance by addressing two specific areas: quality and market share.

What made Polaris number one in off-road vehicle is outstanding product performance, powerful brand, and industry-leading net promoter scores. RAZR embodies all of these, but retail sales declined sharply after the recall was announced in April. The team implemented countermeasure plans in May that drove improved retail and share performance for the remainder of the quarter and we expect this momentum to carry into the second half.

While we are understandably frustrated with declining market share in both ATVs and side-by-sides in the quarter, we're comfortable that the share erosion is confined to a few specific products, and Matt and his team have a very strong competitive response, which we believe will turn the tide in the second half.

As I mentioned earlier, motorcycle retail continues to be a bright spot, even with the major competitors' aggressive investments in marketing and retail financing. Victory retail was up high teens for the quarter, driven by Octane in the mid-sized market and the Magnum X-1 bagger in the heavyweight sector. Indian retail was up over 20% for the quarter, powered by strong demand for both Chieftain and Roadmaster.

Our new Springfield and Chieftain Dark Horse models exceeded retail expectation and Scout continues to set the pace in the mid-sized segment. Slingshot's strong first-half growth in profitability should continue as we expand awareness and model offerings. Steve and his team are staying on the gas with exciting news that will continue to fuel motorcycle growth in the second half.

Fixing quality and safety is our top priority and getting that right will help drive better retail in the latter part of the year. We have made consistent and significant progress in our efforts to reduce dealer inventory, with second-quarter ORV inventory down 8% year-over-year. Motorcycle dealer inventory was up, keeping pace with demand, while also reflecting our limited ability to paint bikes during the same period last year.

We're not yet where we want to be nor where our dealers want us to be and we would not call this an ideal state, but we will continue to aggressively monitor retail and dealer inventory trends and work toward further improvement in the second half. With the ramp-up of Huntsville, we will begin to transition RANGER and RZR to retail flow management, or RFM, which provides shorter lead times and better overall inventory management for us and our dealers.

I will now turn it over to Mike Speetzen, our Chief Financial Officer, for a review of our financial results and outlook.

Thanks, Scott, and good morning, everyone. This morning, I will provide a brief update on each of our segments and review our updated guidance for the remainder of 2016. First, as Scott mentioned, during the quarter we booked additional costs related to warranty and other recall-related expenses totaling approximately $25 million.

We're working aggressively to offset these expenses with additional cost-down efforts, as well as benefits from favorable currencies. However, given these costs, as well as a weaker industry environment, we are revising the lower end of our EPS range to $6 and lowering the upper end of the EPS range to $6.30 for the full year 2016.

The range reflects EPS being down 7% to 11% compared to the full year 2015. On a constant currency basis, earnings per share would be down 2% to down 7%.

Our 2016 revised guidance assumes the following. The currency rate for the Canadian dollar is assumed at levels slightly lower than the current rate. Currencies are expected to negatively impact full-year pre-tax profit by approximately $30 million, which has improved from previous guidance.

Share count is expected to be down approximately 3% for the full year. Year-to-date we have repurchased 1.7 million shares and will continue to repurchase shares at these stock price levels. Dealer inventory is expected to be about flat at year-end, which implies shipments in aggregate will closely track against retail sales for the remainder of the year.

As a result, total sales are expected to be in the range of flat to down 2%. On a constant currency basis, this equates to total Company sales being down 1% to up 1% compared to 2015. Currency is anticipated to negatively impact full-year 2016 sales at the high end of the range by about $35 million or about 1%. We are assuming the second-half industry to be slightly better than the first-half, which represents improvement from Q2 levels.

On the segment reporting basis, sales expectations are revised as follows. ORV and snowmobile sales are expected to be down mid-single-digits versus previous guidance of sales down low to mid-single-digits. Motorcycle sales are anticipated to be up double-digits percent versus previous guidance of sales up high teens and global adjacent market sales are expected to be up mid-teens percent.

Now let me provide more details around our segments starting with ORV and snowmobiles. ORV and snowmobiles segment sales were down 6% in Q2, driven primarily by weak industry trends and the impact from product recalls during the quarter.

Sales were also negatively impacted by currency, as well as a higher promotional spend environment as we fought a tough competitive environment. For the full year 2016, our ORV and snowmobiles segment sales are expected to be down mid-single-digits percent, which implies second-half sales will be down in the low single-digit range.

Despite a weaker industry than anticipated, market share gains continued in our motorcycle segment. Sales increased 23% in Q2 as product availability improved considerably and demand for all three of our brands remained strong. Growth was also driven by increased PG&A-related sales. We are, however, lowering our full-year guidance for motorcycles to be up double-digit percent taking into account weaker industry trends.

Global adjacent market sales increased 14% in the second quarter, driven by market share gains in [XM] and the added sales from the Taylor-Dunn acquisition. In addition, our defense business was up over 30%, and our PG&A-related sales for the segment increased 21%. We expect full-year 2016 sales growth to be up mid-teens percent.

Parts, garments, and accessories sales increased 5% in the second quarter. Growth was driven by all segments of the business, primarily by part sales. International sales increased 5% in the second-quarter. Growth was strongest in Latin America and Europe, driven primarily by motorcycles, as demand for Indian and Victory accelerated throughout. [XM make] as market share-driven growth also grew sales in Europe.

Moving on to gross margins. Gross margin were down 325 basis points, reflecting additional warranty, as well as continued pressure from foreign exchange. I'd also point out that the warranty costs incurred in Q2 reflect ongoing quality and safety issues, including a higher assumed completion rate for the RAZR 900 and 1000 recalls and associated costs to attain that higher completion rate.

We are maintaining our full-year 2016 gross margin guidance to be down 70 to 120 basis points. This assumes foreign exchange will be an approximate 80-basis point headwind for the full year. On a constant currency basis, gross margins would be up 10 basis points to down 40 basis points. Our full-year gross margin guidance not only includes the additional warranty costs mentioned earlier, but also reflects stronger than originally anticipated savings from our cost-down VIP initiatives.

Operating expenses are now expected to increase up to 100 basis points as a percentage of sales given the product liability, acquisition, severance, legal, and other recall-related costs taken in the first half of the year. We continue to make the necessary trade-offs between preserving critical engineering investments and optimizing or eliminating unproductive processes to improve our results.

Despite the top-line pressure, we have approved additional engineering spend in the second half to ensure important growth opportunities are realized. The expectations for the remaining P&L items have not changed from our previously issued guidance.

Finally, given the one-time events that have occurred this year, as well as a weaker industry than expected, I'd like to make a few comments around our expectations for Q3. Given weaker industry trends and continued foreign exchange headwinds, we're expecting sales growth for our ORV and snowmobile segments in the third quarter to be down low double-digits over the prior year.

We expect motorcycle sales to continue to grow in Q3, but at a more modest rate than in the first half of the year. Overall, Company sales are anticipated to be down mid- to high single-digits versus prior year. Gross margins in the third quarter are expected to be similar to 28.5% reported in the third quarter of last year, which is a significant improvement from the first half of 2016.

The improved performance will be driven by lower foreign exchange headwind coupled with a stronger savings from our cost-down VIP initiatives versus Q3 of last year, as well as the first half of this year. Lastly, we anticipate Q3 operating expense dollars to be about flat to Q3 of last year.

While our first-half 2016 results have been disappointing, there are a few areas of performance worth noting. First, dealer inventory is in line with our expectations year-to-date, with ORV being down 8% and with RZR down double-digits.

Second, our cash flow performance has improved significantly from a year ago, increasing over 280%, driven by improved working capital management. Factory inventory is down from last year, which reflects the efforts underway to improve our internal discipline and management systems.

Lastly, as I mentioned earlier, we're realizing significant savings from our cost-down value improvement projects Ken and his team are aggressively pursuing. These reflect our commitment to drive improved quality, a lean Enterprise, and work to improve our cost structure. With that, I'll turn it back over to Scott for some final thoughts.

Thanks, Mike. Between what can be charitably termed a tumultuous run-up to the presidential election, the volatility surrounding Brexit, and generally elevated geopolitical risks, the global economy appears much closer to a recession than an uptick in growth. We expect the powersports market to reflect this, growing slowly in the second half, largely due to weaker comps in the oil-producing states in the latter part of the half.

The market will remain highly competitive, but the Polaris line-up will be much more difficult to beat. With paint offerings now plentiful and exciting new bikes shipping soon and Slingshot benefiting from access to better tools, support, and infrastructure, we expect our motorcycle market share gains to continue throughout the second half.

Off-road vehicle sales will improve and we will stem the tide of our share loss as our outstanding sales team continues to elevate customer engagement with new vehicles and embody our resolve to protect and grow market share. We will work to reduce dealer inventory, while developing and implementing better tools and technology to help our dealers drive profitable growth.

The ramp-up of off-road vehicle production in Huntsville is an important milestone. Partly because we are now out of the plant-building business for the next several years, but more so because our newest, leanest factory will provide improved quality and a template for process improvement across all of our manufacturing plants, while also providing the capacity and delivery we need to accelerate the roll-out of retail flow management for our side-by-side vehicles.

RFM is only one aspect of our lean journey, as we're combining upgrades to our supply chain with aggressive quality improvements, manufacturing excellence initiatives, and product development efficiencies. These efforts will reduce the number of safety and quality issues, while driving, in conjunction with our value improvement projects, meaningful cost reduction.

Coupling this with the strong cash flow we are generating from decreased working capital, we are well-positioned to fund further operational improvements, as well as an exciting list of growth projects. The results from some of these investments will be on display next week at our dealer show in Nashville, which will highlight how we are incorporating technological advances, including better performance and handling, into the newest product to join our industry-leading armada.

With that, I'll turn the line over to Michelle to open up the line for questions.

(Operator Instructions)

Scott Stember, CL King.

Good morning, guys.

Good morning.

Could you maybe talk about the recalls? You did indicate that you have gone through a process of identifying future items and I think there was a recall for -- on the RANGER side. Maybe just quantify the size of what you are looking for and whether you think that the majority of the recall charges and issues are behind you right now?

If you listened to my accounting speak during my prepared remarks, I did say that we had all of our probable and estimatable costs included in the guidance that we just issued, or the second-quarter results. I will tell you that the work that Ken and his team are doing to go through our products and ensure that there is not fire risk in our vehicles, it's a massive project. I don't think it's -- as I said in my remarks, there is still more work to do, but we don't foresee things that are drastically different from what's been included in our results in our forward-looking guidance.

Okay. Then on the R&D side, you pointed to some gaps. Maybe just talk about how you are addressing the R&D process. I don't know if this is all part of the answer that you just gave, but from an R&D spend going forward, will it be more on a case-by-case basis or is there a change in the process going forward?

This is Ken Pucel. We did an internal diagnostic on the root causes of the recalls and we traced them back to the quality system elements and the design control elements and we're putting systemic fixes in place to address those. We are also increasing our spend and our investment in safety and design capabilities in those areas. So you're going to see some systemic fixes that come across our engineering capabilities as a result of that.

One of the things that Mike alluded to is the significant increase in VIP savings. Obviously, we had a lot of cost and we offset some of those with the great work that Ken and his team are doing. Part of the savings that we get will go to fund these investments in safety, but I want to make sure we are clear.

There is no cost that we won't spend to correct these quality and safety issues. This is not about protecting our P&L. This is about getting these problems resolved and behind us as quickly as we possibly can. And Ken and the team have really done a nice job of getting their arms around this and putting a plan in place to drive much improvements going forward.

Okay. Multix. Can you please talk about how that's shaping up right now?

We had some product issues when we first launched it. We fixed those in the second quarter and we are very pleased with the new product that's going out. We are -- the sales are lagging our expectations early.

Obviously, we are building out the distribution network and now that we've got the transmission fixed, we feel like we will have a much better opportunity going forward. We had a board meeting last week and both us and Eicher and the entire team are encouraged by the opportunity in front of us, but certainly not excited about the results year-to-date.

Thanks, Scott. Next question.

Robin Farley, UBS.

Thanks. Just wanted to understand, looking at your full-year guidance for motorcycle, and the slightly lower growth rate, it seems to imply that second-half sales for motorcycles will just be up in the single-digit range? That's a step down from the levels in the first half, so I wonder if you could give us some color around that?

Predominantly what that reflects is ongoing industry weakness. We are going to outperform the industry and we are going to continue to gain market share.

But Robin, the other aspect to keep in mind is we have got year-over-year dynamics. We were short on motorcycle deliveries up until we got into third and fourth quarter when we had gotten the paint system back up and running at a level.

So we saw some pretty significant motorcycle sales increases. The fourth quarter was 30%-plus. There's a little bit of the lapping.

From a retail standpoint, we anticipate it continue to be strong in the second half, but our shipments will pace down a bit as we've already gotten the inventory up to levels that pretty much are meeting the profile expectations at each of the dealerships, which started back in the fourth quarter of last year.

Okay, great. That makes sense. Thank you.

As a follow-up, on off-road sales, it looks like the implication is off-road and snow combined in the second half would be down around 3% or so. Did you say in your initial comments -- I don't know if I heard this -- that you expect that to roughly track what you think retail sales would do as well or did I hear that wrong?

No, I used the word aggregate in there on purpose because overall the Company's retail deliveries track with what we're doing from a dealer inventory and a retail standpoint or shipment perspective. But there are differences between the two. Off-road vehicles will probably be a little bit stronger from a retail standpoint, just slightly.

Jaime Katz, Morningstar.

Good morning, guys. Thanks for taking my questions.

I'm curious about the gross margin. It looks like it's going to still be down around 70 basis points to 170 basis points for the year, and with the third quarter flat, it looks like the fourth quarter should have a pretty nice tick up in gross margins. So I'm curious where you guys see the most opportunity to take margin improvement in that final quarter and whether or not that has something to do with being more prepared for the ORV market conditions this year?

Jaime, there's two aspects and I'll let Mike provide the details of it. But the big one, obviously, we get into the fourth quarter is when we took the drastic reduction in RZR shipments into the channel to try to protect dealer inventory. That drove a massive mix change for us which wasn't helpful in the fourth quarter of last year. So one aspect is the comparables get much better.

The other important point is -- I cannot overstate the work and the results that we're getting from what Ken Pucel and his team are doing with our lean and VIP efforts. It really is a long, long list of projects that are delivering significant savings, and that builds momentum throughout the year. So naturally, by the time you get to the fourth quarter, you should get better results from that.

And then thirdly, I hope you're going to be able to make it down to Nashville next week because we believe that the plan that Matt Homan and his team have with products going into the second half is exciting and should be helpful to us both from a margin perspective and a share perspective. Mike, you want to add any color?

I would just add, when you look first half to second half, as well, obviously we are assuming that the warranty costs obviously abate and that helps. Then really that second half year-over-year volume increase is up about, call it, 1% to 2% versus we were down in the first half.

It's really important to think about the mix. We had very strong motorcycle mix in the first half, and although our margins are improving, they are still, call it, roughly 40% lower than what we have in off-road vehicles. As we get into the second half, as Scott indicated, as we lap that fourth quarter, you get a little bit more favorable mix dynamic with motorcycles being essentially down, given the fact that we charged the inventory channel last year and then the pullback we had last year in ORV being offset with some growth in the fourth quarter of this year.

Okay. Then it sounds like the throughput is starting to match better to demand. I'm curious with Huntsville coming online this quarter, how is this changed capacity utilization rates for you guys? Is there maybe some slack in the manufacturing process now -- I mean you guys were bumping up against capacity constraints in the past. So does this is give you a little bit more flexibility to be more nimble and meet demand a little bit better?

That's an insightful question because that's exactly what it gives us. We've been at about 107% capacity at peak during Q3 in the past. Bringing on Huntsville allows some slack in the system, it allows us to focus on the value streams and drive lean and eliminate costly overtime. So that's one of the enablers that Huntsville is giving us.

Gerrick Johnson, BMO Capital Markets.

Good morning. In your gross margin discussion, there is no mention of sales allowances. You were quite promotional in the quarter, so how much did additional programs impact margin in the quarter?

Promo was definitely up. As we look at the year, the impact from promotional activities in the, call it, 20- to 30-basis point range, it was a little heavier in the second quarter. But from a full-year standpoint, that gives you a sense of how much we are looking at.

Okay, and I just wanted to clarify what you were saying about the impact from recall. You said all the probable and estimatable costs were in 2Q results and guidance.

So how much are you building into for the future quarters? We have the $25 million in this quarter and, what, about $9 million in the first? Also if you could break those down between gross and operating? Thank you.

I'm not going to get into a lot of details behind the cost for obvious reason. But Scott's point around saying they are probable and estimatable is that we have included everything in what we've reported so far in terms of forward guidance. Other than any promotional activity that we are required to reserve for given the shipments we have made, that we think we'd have to do in terms of simulating demand, there would not be any additional cost that we would have built in, in the forward guidance.

Joe Spak, RBC Capital Markets.

Hi, good morning. First question is, with ORV retail down in the double-digits and shipments only down 6%, was that because you had to ship more RANGER in advance of the changeover to Huntsville? And if so, does that reverse in the third quarter?

There's a little bit of that, but you have to remember that there is international sales and PG&A sales, which were both, at least from a PG&A standpoint, were up in the quarter when you compare those two numbers. The 6% ORV snow is the total reported sales and the down low double-digit retail is just North America.

Okay. Then sticking on inventory, if you look at what you guys are saying in sales, it's actually bringing you somewhere back to let's say 2013, somewhere in the 2013, 2014 time frame. If you look at your inventory chart on slide 8, you are still well above that.

I recognize motorcycles are slowing, but then you also just talked about some slower demand there, as well. So could you just help us get comfortable with -- because you did say you are fairly comfortable with dealer inventory, so can you help us with that dynamic?

So you are asking, Joe, why is it still up over 2013 levels, if we're saying it is reasonable? Is that your question?

Yes. If your sales level is closer to -- on the ORV side, anyway, closer to 2013/2014 levels, why should it be so much higher, especially if motorcycles are slowing?

We've got obviously quite a few more dealers than we had and we've got a much larger spectrum of products. We obviously look at the DSO internally. We don't share that externally, and I said very clearly that we were not yet at optimal levels, but we were getting there and we feel like with the second half plans, we can.

The whole idea of RFM coming online is that we have lead times down so that we can continue to migrate this down. It's all part of our plan to have a competitive advantage with how we deliver and how we stock inventory in our channel.

Joe, we obviously don't get into a lot of the details, but the devil's in the details. Relative to if you peeled that number back, we're actually down on our off-road vehicle business, and up in motorcycles.

When you think about it, the compare point back to the end of, say, 2015, we were woefully short from a channel perspective with our motorcycle business. So we are making sure that getting into that peak selling season in Q1 and Q2, that we are going have the appropriate level of inventory. So we're making sure that we're dialing it back in the areas that are the most critical and the areas that have been the biggest pain points for most dealers.

David MacGregor, Longbow Research.

Good morning. I wonder if I could get you to talk a little about, within the ORV space and just bifurcating between utility and recreational. How are you thinking about competitive pressures these days and how you are prepared to respond to that?

We have prided ourselves for a long time on always having the best product in the industry. I do believe if you look at our off-road line-up, that fact holds true right now. But from a marketing perspective, when one of our larger competitors launches 1000cc utility vehicle and our largest is a 900, that's not a great competitive position to be in.

Even though our product is better hands down, it's not great from an advertising and marketing perspective, especially when there's a good brand on it. I'm extremely encouraged -- when we asked Matt to step back into this role with so much experience in the industry, the plan that he and the team have built for the second half, from both a product standpoint and the way we communicate and market these, I'm really, really encouraged by it.

If you get a chance to come down to Nashville next week, you will get a very first-hand effort at both the simplicity and the directness and the performance of what we are going to introduce. It's pretty encouraging.

On the RZR side, we are hands-down the industry leader there. And I don't think you are going to see us let off the gas at all while we continue to drive significant improvements in quality and safety.

Just as a follow up, with respect to the motorcycle business, you've got such a strong offering in the cruiser category. You've had Roadmaster and Touring, now you're rolling out Chieftain Dark Horse. From this point forward, should we expect to see a lot more in the way of new product introductions in the touring and that segment of the market? Or do you focus maybe a little further down market and focus more on the light cruiser where you've had pretty good success with, Scott?

We don't talk about the forward product plans. But what you have seen is that -- and I really applaud what Steve and the team have done, is they have gone after the opportunities to get volume and get share in where we had product weaknesses.

In some of the areas where we have not been as successful at gaining market share, you'll find this year that we will reinforce those areas and give ourselves a better chance to get more volume. I don't think motorcycles will disappoint anybody in the second half with what they have from a product perspective.

Michael Swartz, SunTrust.

Good morning, everyone.

Good morning.

Just looking at your guidance for the full year and the third quarter, you gave us some details, looking at the OpEx side of it, it would imply that there is a pretty big reduction in OpEx and particularly in the fourth quarter in reported dollars. Could you maybe walk us through and help us understand some of the levers there, some of the buckets and where you're getting a lot of those cost savings?

It would appear that there is a reduction and there is, but it's really driven by the fact that we've had some one-time costs in the first half. When you calibrate for those costs, essentially we're up, call it, 2% from first half to second half when you normalize for that. Again, we disclosed in the first-quarter call that we obviously had some legal-related costs and we have obviously -- we've got some more of that in the second quarter. I don't want to get into the details of that.

But that gives you some of the first half to second half dynamic. But I also think it's safe to assume that we are continuing to put pressure on any areas that aren't related to growth from a cost standpoint. So we are going to continue to modulate given the fact that our top line has fallen 4 or 5 points short of where we were expecting at the high end of our range. So we are going to continue to have pressure and focus there.

Then you always have comp-related accrual adjustments that are going to happen later in the year. And given our performance, it's safe to say that some of that is going to be at play, as well.

And we don't want to overlook the tremendous efforts that -- when we put Dave Longren into this Enterprise-wide cost effort, to lead this, what we call all-out-assault on cost, they are taking a pretty aggressive look at all of our areas of spend. Some of those -- we spend a lot of money in OpEx and they are finding opportunities. So if you add that to the work that Ken is doing with VIP, there's a significant opportunity for us to drive productivity, both in the second half and into the next several years.

Then Scott, you made the comment earlier in the call that you saw some select pockets of share erosion on specific product lines. How much of that is related to the warranty, the recall environment versus what you are seeing from competitors? Maybe you can just flesh that out for us a little bit?

I would say that most of the share loss was not related to the recall. It was very, very inconvenient, but I don't know that, specifically around RAZR, that people bought competitive products during that period of time. We got after it pretty quickly so we could have product in the dealerships. The bigger issue was on value ATVs and the utility side of the business and I'm encouraged and comfortable with the plan that Matt has, as I've said a couple of times.

Tim Conder, Wells Fargo Securities.

Thank you. Scott, I wanted to circle back on the recall, just to hopefully to put that thing to rest. The RZR response rate and the Consumer Product Safety Commission said on that they wanted a much higher response rate than they normally do and were targeting close to 80%. What is that response rate that you guys have had on that?

30% to date. We typically get about 50% in these efforts and we're tracking ahead of that right now. We're going to redouble our efforts with the dealer and Mike talked about the fact that we're going to target a higher rate. We really are stressing to our customers that there is potential for fire issues here and we want them to get these fixed.

But there are some of our customers that would just rather ride and they haven't had any issues and they don't want. So we're really trying to work through that and partner with the CPSC to improve our communications and go back out to our dealers and encourage all of the people that have these products to bring it in. We'll continue to drive this aggressively going forward.

Okay. And then on the ORV PG&A, what really drove that versus -- or the PG&A in general versus the softness you've seen on the ORV whole goods side?

Tim, in times like this when the industry is down, you've got folks who are riding the equipment longer, and if you look at where the growth in PG&A was, it was primarily around parts. So you've got folks that are extending the life of the vehicle so they are buying more replacement and service parts as a result of that and that's really where the growth comes from.

Jimmy Baker, B. Riley & Company.

Hi, good morning, guys.

Good morning.

When you look at what's happening in the ORV environment, a pretty significant deterioration from an industry perspective, and then you mentioned the industry has also put some pressure on your motorcycle guidance. If you zoom out and look over the next few years, what level of improvement in that external backdrop do you need to achieve your 2020 plan?

We've looked at our 2020 plan through a series of lens including a recession in the near-term. Obviously, we feel like -- we have underperformed. Obviously, we are saying and allocating a lot of the weakness into the industry, but we have underperformed from a quality and even a product line-up perspective.

You are going to see that we turn that around quite well going forward. We don't need a dramatic upturn in the industry. What we need is just not for the industry to continue to decrease. That would be patently unhelpful.

Sure. Then looking at your updated guidance for this year, it looks like despite the lower earnings outlook, you increased your buyback assumptions. Are you being opportunistic here during a more challenging period or are you shifting your philosophy as it pertains to capital allocation in favor of that buyback?

I don't know that we have really signaled that we are increasing the buyback. We certainly have gone at it much earlier and that's really where the implied EPS benefit is coming from. We've repurchased about 1.7 million shares at this point. We indicated that we would be going after about 2.9 million.

We have been opportunistic as I indicated in my prepared remarks. At these share price levels and knowing what we know about the prospects of the business, we view it as a very attractive investment and one of the best acquisitions out there. So we're going to continue to take the philosophy going forward.

But just to be clear, there has been no shift in our Corporate-wide capital allocation philosophy. We are going to invest in growth first, we're going to pay a healthy dividend, we're going to use acquisitions to help us drive strategic growth, and then we're going to use buybacks. We've been really consistent in that but that doesn't mean we also won't be opportunistic.

Craig Kennison.

Good morning. You've addressed a lot of questions on the powersports side, so maybe I'd like to ask about your global adjacent market business. Specifically on Taylor-Dunn, what have you learned so far and what is the product and distribution strategy we should think about?

We really like the Taylor-Dunn business, first of all. And actually from a performance out of the gate it's been one of our best acquisitions yet. Really off to a good start.

It's helpful also -- when Bob Mack joined, he got the corporate development role, but he also took on the adjacent markets. And with a lot of experience in this space, he is very helpful as we look at the ways to manage distribution.

We learned our lesson with some of our products. We can't just take everything and throw it through our powersports channel.

Taylor-Dunn has got a pretty good distribution network. They are located in areas where they are easily accessible to big factories and they do that quite well. And from a lean perspective, the factory is not very lean itself, but they have almost a made-to-order model that we really like.

We do see synergies with all of our work and transportation businesses because we've got Taylor-Dunn that sells a people mover, we've got GEM that has a people mover, we have got Goupil and Aixam Mega that have a people mover. So Bob's looking at all of these products and trying to optimize, both from a product standpoint and a distribution standpoint, how we serve customers globally with that effort. You will learn more about that next week in Nashville when we do our Management presentation.

And then to follow up on Jimmy's question, you'll still need to acquire a fair amount of revenue to hit the 2020 plan. What does that M&A environment look like today?

Bob gave me a hard time last call when I said we had a robust funnel. The outlook -- we're not -- what you implied, Craig, is that we're going to buy to get bigger and that's absolutely not what we will do. We will look for opportunities to put ourselves in businesses that we can help accelerate growth and profitability over time and we do see a lot of opportunities to do that. We've said, long-term, there is $1 billion or $2 billion worth of acquisitions and we have not shied away from that at all.

Mark Smith, Feltl and Company.

Hi, guys. Just wanted to follow-up on the global adjacent markets. Given your guidance here in the second half, is the strength really coming from Taylor-Dunn and military, or is there anything else to call out that's really driving that growth?

Obviously, Taylor-Dunn on a year-over-year basis is fully incremental, so that's helpful. Military, as I mentioned, really encouraged by the engagement we're having with our military customers, specifically DAGOR but also with the MRZR, where lots of opportunities there.

What our team has done in Europe with Aixam, that's essentially a duopoly. We continue to gain notable market share and are encouraged by the growth outlook in that business. It's fairly broad-based when you look at the various opportunities we have to drive growth.

And we launched a new GEM product last year and there's been good customer engagement there as well and we're looking to see if we can accelerate that, as well. It really is a good opportunity with our portfolio of products there to have a good opportunity for growth, really almost across the board.

Okay. Then a follow-up question here, and it might be a bit broad, but if you look at off-road vehicles some losing share here recently, how much of this do you really feel is due to near-term negative impact from recalls versus low prices from competitors? Or is there something else, just competitors being good? What do you really put it down to that you have lost some share?

It's more related to our product line-up than anything else. We put ourselves at a product disadvantage, and as I said, it's more in the value ATV segment and the utility segment, that was difficult to defend. It drove our promotion costs higher, as we tried to compete with not our best products.

Like I said, I'm really confident in the plan that Matt and the team have put together on how we address this. It is a very competitive industry, but as you have seen really over decades, we are not afraid to compete against really big, really good players. And we believe we've got the sales team, we've got the distribution, we've got the brand, and we'll have the product as well.

Joe Altobello, Raymond James.

Hey, guys. Good morning.

Just staying on the ORV market share trends you guys are baking into guidance for the back half, how quickly did you expect to go back to gaining share? Is it late this year or is it early next year?

We guided essentially flat in the second half. We said we're going to protect share and we get a little bit of help from a share perspective in the fourth quarter with the compare, not too tough. But we believe long-term this is still a market where we can gain market share.

It's not going to be a U-turn. We will turn it but it's going to take us a little while and it's a broad-based effort. I've given a lot of appropriate credit to the work that Matt and his team are doing. But Tim Larson and his sales team on the front-end are really driving very, very good tools to help our dealers compete and sell against the other brands and you are going to see that pay dividends in the second half and going into 2017, as well.

Okay, that's helpful. Just a follow-up on that in terms of trying to tease out the weather impact and the recall impact in the quarter, could you provide some color on RANGER versus RZR retail sales and how trends progressed throughout the quarter as the weather at better into June?

We said that the detail got less bad as we went throughout the quarter. Obviously, with the recall announcement in April, it was impactful because we didn't have products to sell in dealerships. And then we saw improvements as we quickly got after that.

Joe, the way I look at it is, one, it's difficult for us to separate the two, but RZR retail was obviously down significantly more than RANGER and that was pretty much anticipated, given the impact from the recall. As Scott said, April retail was really bad and things sequentially got better into May and June. Given the fact that we were in the middle of the recall at that point pretty heavily, that tells us that the weather impact early in the quarter was probably pretty heavy. And with the recall pulled out, we would've probably seen pretty significant improvements in the retail trend.

(Operator Instructions)

Tim Conder, Wells Fargo Securities.

Thank you. Wanted to shift to the financial services. In the back of the deck, you had some stats there, a little bit more in penetration and approval rates.

Any changes that you are seeing with your retail partners in underwriting standards? Any little bit looser standards, more local competition to go against Sheffield that maybe stepped in to take out maybe a just hair of that Capital One share that has exited? Sheffield took the majority of it, but any comment along those fronts, gentlemen?

If you look in the appendix, Tim, you can see that our penetration rate is up around 3 percentage points. That's really being driven in connection with some of the promotional programs that we have underway from a financing standpoint.

From a standards perspective, really nothing notably has shifted from what we have communicated previously. We have one retail partner that we have been working with to try and target deeper into the lower credit bands, but we're doing it in a very deliberate manner. We're really taking an in-depth look at the credit profile to understand if credit scores are low because they lack the credit history as opposed to having black marks in the credit history. Our loss rates, which are not materially different than where they have been in the past are reflective of the fact that we're continuing to have discipline in that arena.

Okay, great. Thanks, Mike.

Drew Lipke, Stephens.

Good morning, guys. Drew on here for Trey. Quick question from me.

Can you -- as we look at the GENERAL and the trends that you are seeing there, is that helping to mitigate at all the RZR sales that you are seeing? Then on the RANGER recall that was announced at the end in the quarter, I realize that was pretty limited. But what are your expectations for any impact we could see from that recall announcement?

We do not think that the GENERAL is offsetting RZR weakness. We tend to find more that's the utility customer coming down. But by and large the performance of GENERAL has done exceptionally well in the first half and we are encouraged by the opportunity for continued growth in the second half.

What was the second part of the question?

Just like with RZR, I don't know that it had too much of an impact on long-term trends. But we just really have a competitive issue with RANGER that we need to get addressed. Our product line-up is not exactly right. This is the fifth time I have said it, we're going to correct that.

Okay. And then last one for me, as we take a step back and look at the earnings weighting for the second half of the year, it seems very heavily weighted to the second half relative to the last several years for you guys. Can you give us some confidence around that?

We've looked at it pretty extensively. It is heavier although it's not too far out of the range. The thing to keep in mind is the distortion that we have had coming into -- out of the fourth quarter where we pulled earnings back pretty substantially given the shipments and then continued to see weakness and quite frankly inventory adjustments in the recall through the first half.

You have to really normalize for that. So when we normalize all those items and we look at first half to second half, the EPS split is literally almost completely in line with what we have seen historically, number one. Number two, don't underestimate the impact of the cost-down VIP work that Ken and his team are doing. It was substantial in the second quarter and it will continue to gain momentum.

Ken and the team have a very robust mechanism to track and we know the line-up of products that are either in the hopper. And we're waiting for that to turn through inventory or the projects that we're just at the cusp of closing down and making sure that they start to go into the financial statement. Those two things are really going to be the key drivers. Outside of that, the volume uplift and the normal margin rates that we would expect to get off of that is pretty much what we're counting on.

Scott Stember, CL King.

Just a follow-up question. In the first quarter, about $9 million of the $30 million was related to actual recall if I'm not mistaken. Could you maybe break out the $25 million in the second quarter, how much hit cost of goods sold versus how much hit operating expense?

Actually, in the first quarter, the recall costs were probably closer to $12 million. And then I would say as you get into the second quarter, you are talking about a number that's $15 million-plus.

Okay. That's all I have. Thank you.

Michelle, go ahead. Let's take this last question and then we will have to close it up today.

Seth Woolf, Northcoast Research.

Good morning, everybody. Thanks for taking my question. Just real quick, I didn't know, did you guys quantify the impact that the oil patch had on the overall industry, and if you did and I missed it, would you mind repeating it?

No, we did not talk about it. We saw a pretty significant weakness.

Typically we get asked a lot about ag and oil. Ag was down in the quarter low single-digits. Oil was down, call it, close to 20% and that's where we look at the specific states.

The thing I would caution about overreacting to that is that clearly the recall played a significant part in that impact to our shipments. It's safe to say that we don't believe any of the underlying characteristics from an oil standpoint have changed but certainly the recall had a pretty significant impact to the second quarter.

Okay, thank you. And then just real quick on the motorcycle business.

After you saw some of the dislocations at retail from the RZR recall, you gave the updated 2Q guidance more or less with how [it's] trending. At the time, you said that motorcycle growth was still strong so I'm curious is that -- did you see a deceleration or further deterioration in the end of June that made you rethink guidance as we sit here today?

We certainly, as we indicated -- the industry, the motorcycle industry was notably weaker. The industry itself was essentially flat in the first quarter and it was down mid-single-digits in the second quarter. So we certainly were feeling the weight of that.

The fact that we still grew 23% and we had retail up in the mid-teens is consistent with what we talked about, but it is safe to say that it was a little bit below our expectations and that's why we've pulled the full-year guidance down from the high teens to the mid- low double-digits.

As I mentioned in my remarks, though, the broad-based success in motorcycles, with both the Octane and Scout in the mid-sized segment and then across the board on Victory and Indian, it's a pretty good momentum going into the second half. We are encouraged by everything except the industry stats, motorcycles.

I want to thank everyone. That's all the time we have. Thank everyone for participating in this morning's call.

And those of you who are participating in our analyst even next week, we look forward to seeing you next Monday and Tuesday. Again, thank you and goodbye.

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