Polaris Inc (PII) 2016 Q4 法說會逐字稿

Good morning. My name is Kim, and I will be your conference operator today. At this time, I would like to welcome everyone to the Polaris Q4 and full-year 2016 earnings conference call.

(Operator Instructions)

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

Thank you, Kim. And good morning, and thank you for joining us for our 2016 fourth-quarter and full-year earnings conference call. A slide presentation is accessible at our website at www.polaris.com/irhome, which has additional information for this morning's call.

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

During the call we will be discussing various topics, including our 2017 guidance, which should be considered forward looking for the purpose of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those projections in the forward-looking statements. You can refer to our 2015 10-K for a more detailed discussion of these risks and uncertainties.

A couple of items I want to point out before we begin: Throughout the presentation today, all references to 2016 actual results and 2017 guidance are reported on an adjusted non-GAAP basis, unless otherwise noted. Adjusted refers to GAAP results, minus the following: our TAP inventory step-up purchase accounting adjustments; TAP acquisition cost and integration expenses; and the impact associated with the Victory wind down in 2017.

In addition, beginning in 2017 we have established a new reporting segment called Aftermarket, which includes TAP, plus our five aftermarket brands -- 509, Klim, Kolpin, Pro Armor, and Trail Tech -- that were previously included in our ORV/Snowmobiles and Motorcycles reporting segments. 2016 sales and gross profit results have been reclassified to account for the fourth segment beginning in 2017 for comparison purposes.

We have provided a reconciliation of the adjusted non-GAAP to GAAP results, which is shown on this slide 5. With that, I will turn it over to our CEO, Scott Wine. Scott?

Thank you, Richard. Good morning, and thanks for joining us. 2016 was a difficult and challenging year for Polaris, but we undoubtedly became a better company, and will demonstrate that in 2017. While prospects have certainly improved for our Powersports customers to enjoy a better economic environment, Polaris is entering 2017 with a strong commitment to returning to profitable growth through consistent execution and aggressive innovation.

As anticipated, our fourth-quarter adjusted earnings were weak, down 31% from the prior-year period to $76.1 million. Sales were actually up 10%, aided by $109 million that came with the mid-quarter close of TAP.

Core sales were flat, as both ORV and Snow had slightly higher shipments compared to an easy prior-year comp, offset by Motorcycle shipments that were down 35%. Two factors drove this significant drop. Slingshot sales were severely constricted by the fourth-quarter recall, and both Victory and Indian faced artificially fourth-quarter shipment comps from the prior year that were related to the clearing of the paint-related backlog.

Although it belongs on another slide, I must point out here that Indian Motorcycle retail was up almost 20% in the fourth quarter. Full-year 2016 sales were down 4% at $4.5 billion, and adjusted net income dropped 50% to $226 million. In this environment, growth was elusive, but not absent. Parts, Garments and Accessories was up nearly 4%, largely driven by recall-related part sales.

Acquisitions also helped, with TAP and Taylor-Dunn together contributing approximately 3% sales growth. Overall Motorcycle sales were up 1%, as solid growth for Indian and Victory was offset by a nearly 10% decline in Slingshot.

Our international business was flat, as our teams in Mexico and Australia drove growth that offset a difficult European market and currency. Off-Road Vehicles were down over $300 million year over year, as on top of recall-related shipment reductions we also lost market share, had negative mix impact, battled unhelpful currencies, and reduced dealer inventory.

Mike will cover margins and earnings in appropriate detail, but I want to mention the less visible but very important progress the team made with VIP and inventory. Despite lower volumes, we generated more than $150 million of gross VIP savings, netting a 1.5% cost decrease that will yield real benefits as volume returns.

In another sign that our Lean initiatives are gaining traction, our team drove year-over-year decreases in both factory inventory and dealer inventory for the first time since 2009. Despite our earnings decline, we generated operating cash flow of $572 million, up 30% over 2015.

Fourth-quarter retail sales improved sequentially, but the 4% year-over-year decline trailed our expectations. Off-Road Vehicle market share remained under pressure, but progress and learnings throughout the quarter provided subtle indications that both retail and market share performance will improve in 2017.

Indian Motorcycles continued to outpace the industry, with retails up nearly 20% in the quarter and slightly higher than that for the year. Victory and Slingshot retail was down for the fourth quarter, lowering overall Motorcycle retail performance to down mid-single digits. Snow benefited from a strong December performance, recovering to almost flat for the quarter.

We maintained our focus on dealer inventory, ending the year down 8%, and putting us below our 2014 year-end level. We are well positioned to transition our side-by-side business to RFM in the second half of 2017, which will enable our dealers to carry more of the right vehicles, turn their overall inventory faster, and know with confidence that they will have, and when they will have, the right products to sell.

Motorcycle lead times continued to improve throughout the year. And with Spirit Lake now operating at a very high level of performance, we anticipate ongoing performance in 2017.

Our recent announcement to exit the Victory brand was undeniably the right strategic and financial decision. But that clarity did not lessen the blow felt by our many loyal and passionate customers. We share their pain at the same visceral level, but with cumulative losses exceeding $100 million and growing, we could not continue to invest in the brand. This poor financial performance does not detract from the awards for quality and industry-leading net promoter scores that Victory enjoyed up to the very end. And with better-than-industry retail growth in 2016, Victory went out with style and performance that defined its bikes.

I view the 18 years of blood, sweat, and tears we poured into Victory as the investment and education required to successfully bring the legendary Indian Motorcycle brand back to industry prominence. We will invest more in Indian to accelerate and expand our product introductions and innovations, and you will see the fruits of that investment over the next few years. We owe it to Victory and its die-hard fans to make our focus and investments pay off.

We aggressively addressed product quality throughout 2016, executing 13 safety bulletins that came at significant cost. But we have and will invest as necessary to make our vehicles safe for our customers.

In 2016 we conducted a thorough review of all model-year 2017 off-road vehicles, in addition to the extensive retroactive review that covered previous model years. We learned a great deal in the process, and are putting that knowledge to use as we continue to strengthen our global safety and quality function, and set aggressive corporate safety and quality improvement goals for 2017.

We're making solid progress on the two main RZR recalls, with approximately 70% of the 901,000 RZRs and over 80% of the RZR Turbo recalls completed. Safety and quality remains our top priority, but we know we still have much work to do. We will continue to closely monitor our vehicles' performance, and when we discover an issue that needs to be addressed, we will act swiftly to keep our customers safe.

Completing the Transamerican Auto Parts acquisition in November marked a momentous day for Polaris and TAP. Our complementary cultures and shared passion for off-roading certainly make this an attractive deal, but the long-term growth opportunities and synergies are even more alluring.

TAP's CEO, Greg Adler, and Steve Eastman have pulled together a top-notch integration team, and they have been hard at work to identify and deliver our $20 million cost synergy target. We did not allow gross synergies to justify the acquisition, but the teams are eagerly pursuing product, pricing, and accelerated retail expansion opportunities that offer strong returns and growth potential.

During times of distress or crisis, either or both of which arguably describe Polaris last year, it is imperative to have a longer-term vision and strategy to serve as a guide. We remain firmly committed to our goals of expanding our lead in Powersports, and becoming a more global, diverse, and profitable Lean enterprise, while our vision to fuel the passion of our global customers with innovative high-quality vehicles, products, and services remains worthy and relevant.

Though our strategy is intact after the significant financial retrenchment we experienced in 2016, we no longer expect to meet our 2020 financial target of 10% net income margin. The $8 billion revenue goal now requires a 15% compound annual growth rate. That is a significant stretch, but still possible. We will use our strategic planning process this year to evaluate our plans and likely outcomes, and we will update our longer-term financial targets in July. With that, I'll turn it over to our CFO, Mike Speetzen.

Thanks, Scott, and good morning, everyone. Before I get started, let me cover a couple of administrative items. As Richard indicated, beginning in 2017 we will be providing guidance for a fourth segment called Aftermarket, which includes all of our previously owned aftermarket brands, combined with our newest business, TAP.

Second, all of our guidance comments will be on an adjusted basis. Consistent with our Q4 results, we have removed the impacts of TAP purchase accounting for inventory step-up, and acquisition closing and integration costs. In addition, our guidance does not include any of the one-time costs associated with the Victory wind down.

Total Company sales for 2017 are expected to be up in the range of 10% to 13% from the full-year 2016. The 2017 sales growth includes the following assumptions. Foreign exchange is again expected to be a headwind in 2017 of approximately $30 million for the full year. We have reflected no whole-good sales for the Victory business in 2017, and have forecasted only a minimal amount of PG&A revenue, consistent with the ongoing support for the existing Victory fleet. We have forecasted a full-year sales from TAP of $775 million to $800 million, which represents a $665 million to $690 million increase from the sales recorded in 2016.

Lastly, organic sales for 2017 are anticipated to be in a range of down 1% to up 1%, which assumes the overall Powersports market is stable to down slightly, and dealer inventory levels remain approximately flat. You will note that we calculated the organic growth by adjusting the 2016 actual revenue to remove the Victory whole-good sales made in 2016, adjust for the negative effect of foreign exchange, and adjust for the TAP revenue recognized in 2016 to determine the organic growth baseline.

Adjusted earnings per share for 2017 are expected to be in a range of $4.25 to $4.50, up 22% to 29% compared to the full-year 2016 adjusted EPS of $3.48. Our 2017 earnings-per-share guidance assumes the following. Consistent with our guidance when we announced the acquisition, we have built in $0.25 to $0.30 per share for the full-year 2017 effect of TAP. This includes interest associated with the acquisition, as well as intangible amortization, but excludes the impact of one-time purchase accounting associated with the step-up of inventory, as well as one-time acquisition and integration costs.

Consistent with what we said in our third-quarter earnings call, we have built in $1.20 of non-recurring costs included in 2016 as a benefit in 2017. Partially offsetting this benefit is the mid-teens increase in our R&D expense, higher variable compensation costs, and $0.20 per share of foreign exchange headwind. Netting these headwinds against our non-recurring benefit yields $0.50 to $0.60 per share positive impact to EPS for 2017.

Lastly, we reflected the impact to earnings of our organic sales performance to be a range of a minus $0.08 per share to a positive $0.22 per share. We've included the benefit of VIP, as well as the drag from higher promotional costs associated with the current Powersports market dynamics, in these estimates.

It's important to note that our guidance assumes that our earnings growth is heavily weighted toward the second half of 2017, as the majority of the benefit from the elimination of the one-time costs incurred in the first and second quarters of 2016 is being offset by higher promotional spend, and increased research and development expense. While first-half sales are anticipated to increase given the addition of TAP, we anticipate that first-half EPS to be about flat to last year. Improved margins and earnings-per-share performance materializes in the second half of 2017, with improved sequential sales performance as we anniversary the delayed vehicle shipments, lap higher promotional spending, and realize a substantial benefit from the elimination of the one-time costs incurred in the second half of 2016.

Lastly, the currency rates for both the euro and the Canadian dollar, which have the largest currency impact to our financials, are assumed to be below average 2016 levels, which we anticipate will negatively impact our results. As a reference, a $0.01 change in the Canadian dollar represents approximately a $4 million impact to revenue and pre-tax income. For the euro, a $0.01 movement impacts revenue by $3 million and pre-tax income by $1.5 million. The rate assumed in our full-year guidance for the Canadian dollar is approximately $0.74 to CAD1. We have assumed $1.06 to EUR1.

On a segment reporting basis, sales expectations are as follows. ORV/Snowmobiles sales are expected to be down low-single digits, given a competitive industry and high promotional costs. Motorcycles sales are anticipated to be down low double-digit percent compared to reported 2016 segment motorcycle sales, given the Victory wind down. On a comparable basis, adjusting out the Victory whole-goods sales in 2016, sales of Indian and Slingshot are expected to be up low double-digits percent in 2017. Global Adjacent Market sales are expected to be up low single-digits percent on strong work and transportation sales. And the new Aftermarket segment sales are expected to be up significantly with the addition of TAP.

Now let me provide more details around each of our segments. ORV/Snowmobiles segment sales were down 9% in Q4, driven primarily by ongoing weak market trends in the Powersports market and continued competitive pressures. Sales were also impacted by higher promotional spending, as we protected the brand and remained competitive against heightened industry promotional spending levels. These competitive pressures and higher promotional spending levels are expected to continue in 2015 (sic). This, in addition to a market that is anticipated to be stable to down slightly, has us projecting Company sales to be down low-single digits.

Motorcycles sales decreased 35% in Q4, as motorcycle shipments were down compared to a strong production and shipment quarter in 2015, as we recovered from delivery issues experienced at our Spirit Lake, Iowa, facility. In addition, a planned final paint system upgrade at Spirit Lake required a shutdown of the production lines in Q4, which impacted production levels. Lastly, Slingshot sales were also lower, as the announced recall impacted sales and shipments in the fourth quarter. Our 2017 guidance for Motorcycles assumes that overall motorcycle market remains weak, but that both Indian and Slingshot outpace the market and gain (technical difficulties) market share.

Global Adjacent market sales increased 10% in the fourth quarter, driven by the Taylor-Dunn acquisition and higher sales in our defense business. In 2017, the Global Adjacent Market group is working to further leverage its current global portfolio and technologies to drive top-line growth in the low single-digits range.

In 2016, our Aftermarket brands were reported in their respective reporting segments of ORV/Snowmobiles and Motorcycles. TAP closed on November 10, 2016, therefore, we recorded $109 million of sales in the fourth quarter of 2016 in the segment named Other.

As we previously mentioned, beginning in 2017 we will be reporting a fourth segment called Aftermarket. For 2017 comparability purposes, we have provided 2016 sales on a reclassified basis, which includes TAP, along with the other aftermarket brands of Klim, Kolpin, Pro Armor, Trail Tech, and 509. Historical data under the new reporting structure and pro forma 2016 TAP sales will be available on our website.

Moving on to gross margins, on an adjusted basis, margins were down 165 and 370 basis points for the fourth-quarter and full-year 2016, respectively, reflecting higher promotion and incentive costs, higher warranty expense, and negative currency impacts for the quarter and full year. Despite these headwinds, we continue to make solid progress in our VIP cost improvement initiatives, adding approximately 150 basis points, which helped offset a portion of the previously mentioned headwinds.

For full-year 2017, we are expecting adjusted gross margins to improve from 2016 levels, increasing approximately 180 basis points, which is driven by a reduction in one-time warranty costs incurred in 2016, representing approximately 160 basis points favorable impact to gross margins in 2017. We anticipate a level of gross VIP savings similar to levels achieved in 2016. However, the reduction in one-time costs and VIP savings are partially offset by negative foreign exchange, increased promotions to protect our brand, and quality and safety feature adds.

On a segment reporting basis, 2017 gross margins are expected to perform as follows. ORV/Snow and Motorcycles are anticipated to improve. Global Adjacent Markets' gross margins are anticipated to be about flat, and Aftermarket gross margins up slightly compared to 2016.

Let me highlight a few additional expectations for 2017. Adjusted operating expenses are expected to increase in the mid-teens percent range on a dollar basis due to increased research and development expense, the addition of operating expenses from acquisitions, and higher variable compensation costs in 2017, somewhat offset by lower legal-related costs. Income from financial services is expected to decline about 10% in 2017, reflecting lower average dealer inventory levels.

Interest expense is expected to more than double, due to the increased debt related to funding the TAP acquisition. I would also add that we have factored in the impact of multiple rate increases in 2017 to our variable-rate debt.

The income tax rate is anticipated to be approximately 34.5% for the full-year 2017. And our operating cash flow performance is expected to be down significantly from 2016, driven by timing of cash outlays associated with the recall, and legal activity from 2016, as well as the one-time cash outlays from the Victory wind down in 2017.

Lastly, our share count is expected to be flat with 2016, as we intend to offset management equity issuance with ongoing share repurchases. Our share repurchase authorization stands at 7.5 million as of year-end 2016, providing ample flexibility to support additional repurchases should the opportunity present itself. With that, I'll now turn it back over to Scott for some final thoughts.

Thanks, Mike. After significant investments in people, processes, new business and new products, Polaris is better positioned to return to growth in 2017. Our culture was forged by a long history of challenges, failures, and great wins, and that spirit of innovation and competitiveness which defines us is fundamental to our success, now more than ever.

The prospects of lower taxes, a better regulatory environment, and a focus on factory and oil production are potential benefits of the new administration that can help our customers and our Business. The impact of that possible upside must be balanced with the risks of punitive tariffs and trade rules that could potentially make our costs much higher and our vehicles more expensive for our customers.

While the economic climate is volatile, we can say with confidence that Powersports customers should benefit from a very competitive industry that will introduce more new vehicles and offer consumer-friendly promotions. This competition is heightened in part by a Powersports industry that we expect to be flat or slightly down in 2017.

We're taking bold steps to improve service for our customers and dealers, and investing more than ever in research and development with a strong focus on developing the performance and technology needed to spur growth for our off-road vehicle business. That growth is contingent upon enhanced safety and quality.

As I noted previously, we believe we now have the people and processes in place to drive us to industry-leading performance. We will certainly face additional challenges along the way, but will respond faster, better, and more sustainably than ever before.

We are excited to have TAP as part of Polaris, and encouraged by the progress of the integration and prospects to accelerate aftermarket growth together. We share cultures and customers, and a bias towards growth, and believe the four-wheel parts business will be another great Polaris brand in our expanding portfolio.

Indian Motorcycles is a legendary brand, and its track record of solidly outpacing the industry continued in 2016. With confidence based on a growing line of great bikes, strong dealers and loyal customers, we are increasing our commitment to the Indian brand, as Victory rides into the sunset with industry-leading customer satisfaction that stem from wonderful designs, high performance and ironclad reliability.

We will be adding to our already impressive Indian lineup in the coming months and years, and will honor and embody the Victory legacy. Now that we are free to invest even more in the Indian brand, the pace and breadth of innovative new bikes will accelerate. And the resurgence of the Indian brand will continue to gain momentum.

One of the less visible but vitally important drivers underlying Indian's impressive market performance is our RFM system. And as we roll it out for off-road vehicles in 2017, we expect to deliver the same sort of competitive advantage there as well.

Bringing RFM to ORV is made possible by our new Huntsville facility, which has also become a beacon for our Lean journey, alongside the ongoing success of our VIP initiative. Ken Pucel and his team continue to advance this program, and their innovative ideas and value-creating concepts have spread to every level of Polaris. While the raw cost savings are notable in and of themselves, as we see volume begin to increase, the magnitude of these improvements will truly be revealed.

We enter 2017 with more vehicles, brands and businesses than ever before. And our focus on the fundamentals of safety, quality, delivery and cost will benefit every aspect of Polaris. I am proud of our team for their perseverance and passion, and look forward to working with them this year to make Polaris great again. With that, I'll turn it over to Kim to open the line for questions.

(Operator Instructions)

Your first question comes from the line of Greg Badishkanian with Citi. Your line is open.

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

Greg, we heard a lot of our dealers and customers talk about the benefit, but we did not see any of it happens. Floor traffic across the dealer network was light.

Both the oil and ag sectors that we watch very closely were no better in the fourth quarter than they were throughout the year. We did not see any actual benefit. It was just the prospects of a benefit that we heard from our customers and dealers.

Okay. Fourth-quarter, or the December versus before the elections, there was no difference? It was similar trend?

No difference.

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

That is a good question. Oil and ag for us continue to weaken. Fourth quarter was a little bit better than we had seen in Q2 and Q3, I think we were down, call it, the low teens for oil and ag -- or for oil, and then ag was down high single digits.

Our expectation as we go into next year is that we're not going to see a material improvement in those markets. We do feel like there's an opportunity for oil to stabilize given what we are hearing in terms of the rig count slowly improving and employment levels starting to improve. If that were to happen we would anticipate that being more of a second-half dynamic. But again, we are not banking on that in our guidance.

Okay, good. Thank you very much.

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

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

I think, Jaime, the way to think about it is we anticipate a margin being up from where they were in 2016. The warranty cost alone gives you the benefit. But as we mentioned, the promo cost is elevated in the first half relative to where we were in the first half of 2016.

As we get into the back half, two things happen. One, we start to lap the high promo costs. So that starts been a headwind.

And then we also start to see volumes improving slightly. So we should be able to see incremental leverage coming at that point. And then obviously the work that Ken's doing from a VIP standpoint also plays into that.

We're going to continue to fight foreign exchange, and our off-road vehicle business is heavily weighted toward Canada. And as we've got it forecasted right now, about half of our FX exposure is coming from Canada. That is fairly evenly spread throughout the year, so we don't anticipate that abating much time we get to the second half.

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

Yes, Jamie. Hiring Joel Houlton, who was a Polaris veteran, came from the aerospace industry, has a lot of wisdom and knowledge. And that has been very helpful for us as we have built out this safety and quality organization.

There were so many activities going on to improve safety and quality throughout 2016. And what we have done with Joel in that position now is to start to bring structure and rigor to how we execute that. One real benefit that we see, for an example, is our post sale surveillance where as incidents happen in the field how much faster we see them and then can react to them, and then ultimately build the lessons learned for those into our other activities.

Our thermal expertise has obviously improved as we've study what's happened in the field and how we design our vehicles. And just across the board we are taking every single step that we can to make our vehicles safer and higher quality for our customers. And I'm proud of the work we've done, but there's a lot more to do.

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

This is Drew Lipke with Stephens. Thanks for taking the time.

The first question I had, tied to your previous question there. Just with a higher quality of the competitive side-by-side offerings that we are seeing, and a lot of competitors having closed the gap in a lot of ways with RZR and Ranger. Would you say the promotional environment, and maybe the need for higher R&D spending is more transitory in nature, or as we look out more medium term, 2018 and beyond, is this something that you expect to remain? I guess, what are your expectations in ORV around incremental margins in light of this new environment?

I would say in the immediate environment, as we focus dramatically on ensuring that we get the quality and safety right, that we are going to have to rely a little more on promotions then we have previously. We do believe that is transitory.

Across all of our businesses there is a cycle of investment, and we happen to be right now in a heavy investment cycle for our side-by-side business. We're really encouraged about our nearer-term prospects for the Ranger business. With RZRs we have a little bit longer cycle, but we will continue to improve our quality.

Our performance is always industry-leading. To this day, I would put the performance of our RZR platform up against anybody in the industry. But we do have an opportunity to improve the quality reliability of our vehicles, and I think we will not wait for a model year change for that to happen; we will continue to make those investments.

The work that Matt Homan and his team are doing to reposition our off-road vehicle business for competitiveness using all of the attributes they have, whether it's R&D spend, promotion spend, advertising, dealer support, we are encouraged by that. But it's the significant R&D investments you refer to will be more transitory in nature for the next couple of years.

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

Okay. That's helpful, thanks. And then also just in Motorcycle, what were the costs associated with that paint line shutdown and the recall in the quarter? What was more one-time in nature there?

The recall costs, just to clarify it overall as a Company. We did incur some one-time legal and recall costs in the fourth quarter, but we also had some favorable pickups from a stock-base and compensation perspective. So effectively it netted to zero.

Really what you can see, Drew, is the 1.5% gross margin that we recorded in Motorcycles is a direct reflection. The cost, we captured most of the costs for the paint system in our capital budget for the year. It was really the fact that we didn't have Motorcycle volumes [blowing] through the factory, but yet continued to have ticking costs associated with the overhead.

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

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

Hi. Good morning. Just help me walk through the last few months. Obviously you were hoping for an improved, or better retail growth in ORVs in the fourth quarter. Ultimately where did that fall short?

Was that an industry thing? Was it a timing thing, maybe with the RZR Turbo? How should I think about the delta there between where you thought ORVs would be and where they ultimately ended up?

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

Got it. And then if we could rewind maybe to when you brought down the guidance in September. Some of that was recall, some of it was promotional.

Obviously the recall stuff we're adding back, but it seemed like a good chunk of that, I think half of it at the time, was identified as basically opportunity costs associated with the delayed model year 2017 shipments. It doesn't seem like we're assuming that we get any of that back in 2017.

I guess, how should I think about that? And obviously it's way early to start thinking about 2018, but is there any lost earnings power from 2016 that you might not get back in 2017 but might still be there for you to get back in 2018 and beyond?

I guess, James, I go back to when we brought guidance down, the one aspect that we are reflected in here and I think we've been pretty consistent, is the $120 million that is -- 70% of that's warranty, the balance is legal related and other costs. We are reflecting that.

Consistent with what we discussed at our last call, there are investments we're making, specifically around R&D to make sure from a competitive standpoint we maintain the number one position that we have today. I think when you look at the revenue bring-down that we had, and I would just point you to the fact that our retail was down for the year in off-road vehicles call it high single digits, and our inventory was done 11%, that is indicative of the fact that we brought our inventory down to levels that we felt would be supporting the RFM implementation as we came into 2017. And that's why you don't really see that coming back.

And when you couple that with a Powersports market that we feel is stable to slightly down, that puts a fair amount of pressure. So thinking about the revenue coming back is really not something to add back into the equation. I think that's probably where the difference comes.

I think as it goes to the leverage rebound in 2018, it gets back to some of the earlier comments. We're obviously going to continue to make investments in R&D, but as the volume comes back we're not going to be investing dollar for dollar, so you've got leverage there.

In addition to that, as Huntsville continues to ramp and we get more volume through there from an off-road vehicle standpoint, the efficiencies multiply. And then when you add in the work that Ken has done around VIP for the last couple of years, any volume that we get through from where we've been is going to create incremental leverage. I know it's early to think about 2018 but we are optimistic in terms of those factors playing in.

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

Good morning, everyone. The first question is, I just wanted to better understand some of the puts and takes on the bridge on slide 16. So you have in that one bucket VIP volume mix promo.

I thought I heard the gross VIP savings would be similar to 2016, which would be about $1.50. And I think you are estimating pretty flat organic growth. Is that big offset to that $1.50 all promotion, or is there also some negative or deleverage from the Victory wind down in that number?

There is no negative leverage, per se. The majority of what we have factored in is the impact of the promotional costs.

When we talk about VIP, we do talk about gross. One of the elements that we are contending with as we move into 2017, we didn't talk to specifically, but is we're seeing things like higher commodity prices coming through. All those things get offset against that VIP, as well as promo.

We are effectively counting on the upper end of that range getting about a 32% drop rate. At the other end of the range where we potentially could see volume decline, we are counting on a decremental margin of 14%, which speaks to the actions that we would commit to and undertake to make sure that we are pulling the appropriate level of costs out to minimize the impact to the bottom line from the revenue decline.

And just out of curiosity, why -- if there was shared overhead between, like on paint between the motorcycles and now the volume is lower, why is there no deleverage there?

There is deleverage, but in the grand scheme of things it's not material, given the walk that we have got here.

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

Thank you. Good morning, gentlemen. First of all on Victory, maybe a little bit of a following on a couple of the prior questions there.

You talked about a cumulative, Scott I you mentioned $100 million loss, or a little bit over that, and that was one of the main reasons to make the change you did. What was the lost in 2016? And I guess maybe the question has been danced around here, is how much of that loss do you anticipate flowing to the bottom line, the savings avoidance of that loss, versus the redeployment?

And then the second question is, granted the current tax policy, timing of implementation and so forth, it's a lot of uncertainty right now in that could you, for the RZR in the general sales that you have in the US, could those, what you need for the US. Could that be shifted from Monterey into Alabama and therefore that also gives you additional volume leverage in Alabama and gives you flexibility optionality versus maybe what happen with NAFTA or border adjustment or so forth?

Wow. (Laughter). Let's start with the latter question first, Tim.

We built Huntsville initially because we were tapped out at capacity across our plant network. So two years ago we would not have had the opportunity. With our volumes having declined and the improvements in productivity that Ken and his team have driven across our plant network, we could squeeze that in. But it would be inefficient and not a very wise move, and we will lobby against any such rules to the extent that we can, along with many other industries that would be negatively impacted.

But yes we could make that work. It would just not be good for our business or our customers.

Back to the Victory question. We are not going to talk about the specific losses, we never have. We don't do that by brand. And don't think of the $100 million as a fixed cost. We were just trying to indicate a magnitude of the loss, and as we said in our initial release, it continued over the most recent years.

As we looked forward there was a requirement to make the Victory bikes compliant and more competitive. To make another significant investment in that brand, and that caused us to take pause and evaluate, and when we did that we saw that a similar dollar investment in Indian would provide a significantly better return. And that's ultimately what drove that.

There is a benefit, certainly in 2017 we have included that in our guidance. So it's not something that's going to materially stand out and pop something. Mike, you want to add any color to that?

I guess what I would add to that, Tim, is we look at that over -- obviously we've disclosed the one-time cost that we anticipate having with the shut down. We anticipate we will recover that in, call it, in the next four to six years. It just give you a sense that it's a decent amount of money, but relative to the overall Company it's not going to move the needle.

Next question.

Next question comes from the line of Seth Woolf with Northcoast Research. Your line is open.

Good morning. Just a couple of quick questions. Could you, I think I missed it. You spoke to your expectations for market share in the ORV segment. I know you talked about the market itself, but usually provide a little more color, and I think you did but I missed it.

As we indicated, we are expecting the industry to be -- continue and potentially be increasingly competitive. We're expecting the industry to be somewhat flat. And (technical difficulties).

Ladies and gentlemen, this is the operator. Please stand by.

Seth, did you get any of that before we dropped off? Seth, you there?

His line probably closed.

Kim, are you there?

Yes, I am. Please go ahead.

Let's go to the next call.

Dave Beckel with Bernstein Research. Your line is open.

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

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

Got it. That's very helpful, thanks. And as a follow-up, I was just wondering, could you -- what's that, sorry?

It's very hurtful if they were to do something like that. Our position on this is that there is a lot of really smart people in the new administration. Congress understands economic issues very well.

We do not believe that they're going to take an action that could be that detrimental to the US economy. We are watching it closely, but confident that rational heads will prevail.

Got it. And this is a quick follow-up. Can you update us on how many Indian dealers there are currently in the US?

And a couple of months ago, or I guess a month ago, you updated us on your expectations for dealer growth over the next three to five years. How many dealers are you -- of that 1-1/2 times improvement, how much of that relates to US dealer growth?

We are right at about the 200 dealers. We have purposely gotten away from providing specific targets because we don't want to add dealers to create growth, we want to make sure our dealers are growing profitably as we are, and want to make sure that we're adding the right dealers at the right times.

We are right at that 200 mark right now and it's about halfway to where we think we will be, in the 350 to 400 range over time. What was the second part of the question?

It was the Indian dealers. I think you got it. Does that answer your question?

Next question, Kim.

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

The first has to do with dealer inventory. Clearly you made a lot of progress in 2016. But based on our checks, dealer ROI seems to be under pressure. You think inventory's at the right level today, and where would you expect it at the end of 2017?

We think the aggregate inventory level is essentially right. We think that there are opportunities to improve the inventory levels for some models, but that is -- we don't believe that is the main driver of dealer profitability at this point.

We believe that with our [efficiencies in] our line we will not take another step down in dealer inventory, but we will make sure that we have the right inventory at the right time to give our dealers more of a competitive advantage over time. There's a lot of things that we need to do. It's how we manage warranty, it's how we manage and deliver our promotion costs.

And ultimately it's getting back to providing volume growth. And I think if you'll look at the plans that Matt Homan on the business side and Tim Larson on the marketing and sales side have really done a good job of identifying those opportunities where we can help our dealers along with us get back to profitable growth. You'll see us take a lot of those steps in 2017.

Craig, we survey our dealers much like you guys do. And we are getting increasing feedback that is becoming more of a benefit. I'd just also point out that it does takes time for that to work through the system, given that we cover floor planning for a period of time.

For them to be able to feel that and see the consistent delivery is going to be important as we go through 2017. And as I indicated in my prepared remarks, we anticipate dealer inventory being flat this year.

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

Some of that comes from the way we steer our promotional programs. It also comes from the fact that we have brought Performance Finance online as we launched at the dealer show back in Nashville, and that partnership has taken off and done quite well.

We do anticipate that will improve, but I think the rates of improvement are going to diminish. We are -- overall financial services income, as I indicated, is going to be under pressure next year. The bulk of that is being driven by the dealer inventory position, but we do anticipate lapping more aggressive retail penetration then we had in 2016.

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

Great. I just wanted to clarify a couple of things. There were parts of the call where it was cutting out, so hopefully this wasn't something you addressed.

When you were talking about have under reviewed your longer-term targets, is that more due to you reviewing your organic growth targets or reviewing your M&A strategy or both? And then I also the question on your 2017 guidance, but maybe I'll let you take that one first.

Robin, really that was a realization that with a significant change in currencies and with the significant cost we've incurred with the 2016 recall activity, we did not see a clear path, based on the CAGR required which is close to 25%, to get to that 10% net income target. That is a very, very high bar for any manufacturing company. Previously when we were at 8% moving up we felt confident in our ability to get there but as we have taken this step back, that no longer appears to be something that we could reasonably feel any confidence that we could get to.

As I mentioned on the prepared remarks, our $8 billion revenue target, it's a goal that we have, but really it's the strategic objectives that are important to us, much more so than the dollars. We are very focused on being the best in Powersports plus driving our global business. But we will not be beholden to $8 billion just because it's out there.

We will absolutely not make bad investment decisions just to hit a target. But at 15% sales growth, that's a reasonable target that we could achieve if things turned around.

With that understanding, that income target is not likely possible and the revenue target is less likely, we're going to use 2017, our normal strategic planning process in conjunction with our Board of Directors, to evaluate what the new right targets for the Company are. And we will bring those out in July.

That's helpful, thanks. And then just on your 2017 EPS guidance, and I'm just trying to square it with your -- you mentioned that organic sales guidance is basically flattish in 2017. Because if we back out the $1.20 and the one-time recall costs and if we back out the accretion from the TAP deal the way you had quantified it previously, it's kind of suggesting organic earnings down 15% to 20%.

And so I guess I wanted to ask, I appreciate that you maybe being conservative with the guidance and all of that, but just trying to -- does that sound about right, that it [lower] the impact of the factors you mentioned, promotional costs and FX, that is getting kind of flat sales to earnings down 15% to 20% on a same-store basis?

And also kind of questioning your off-road shipment guidance down 9%, because you mentioned that your inventory levels at the end of the year were already where you want them to be in anticipation of RFM. And so since your anniversarying a period where you couldn't even ship your new model year for about two months, it seems like anticipating further shipment cuts when you've already adjusted for RFM, just trying to think about why you wouldn't see -- or why you would expect to see additional declines in shipments there?

Mike, I'm going to let you answer that one.

Robin, you referenced 9%. That was referencing back to 2016. Our guidance for ORV is down low single digits in 2017. I think that's reflective of the comments we made around the Powersports market, and as Scott indicated that we're going to continue to have the competitive dynamics coupled with higher promotional costs.

I'd steer you back to the slide 16 in the deck. We bucketed some things differently, but I think if you were to pull over things like R&D, the fact that we're investing up to $30 million more, higher compensation costs as the variable comp plans start to potentially kick back into place, the foreign exchange and the higher promo, that does certainly put pressure on the organic improvement that we are seeing in the business.

Next question.

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

Good morning. I had a question for you on Slingshot. It seems as though we're kind of looking at negative growth.

I appreciate the fourth quarter you're up against a rollout comp, but gauging from the guidance, it doesn't sound like you're terribly optimistic on Slingshot volumes. At this point, I guess I'm wondering if you're seeing anything in the order book patterns or the backlog or something to give you confidence in Slingshot. Where does the confidence come from in terms of your ability to create a profitable success with this product?

Slingshot has been a profitable business for us. We're encouraged by (technical difficulties) profitability for us and our dealers. The quality and recall issues we've had to deal with are unhelpful actually, but we are projecting growth in 2017. And now that Steve Menneto has just Slingshot and Indians to focus on, we are comfortable that we will bring out the right vehicles and products to get this business to be able to drive growth, long-term profitable growth for the Company.

I will tell you that I've always said that in this industry you really need to get to that 12,000 or 13,000 unit volume number before you have confidence that you've got a long-term growth business. Victory never got there. We have got the push Slingshot there. The biggest single issue or opportunity we have is that awareness for the vehicle and for the brand is still below 20% in the Powersports industry.

What you'll see throughout 2017 is a continued focus on improvement of quality and performance of the vehicles, but also a concerted effort to expand the awareness. For some of you that might've seen the National Race of Champions, pretty exciting race over the weekend where Slingshot was one of the premier events. Certainly lots of opportunities, but work to do.

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

Right. With respect to your comments on 12,000 to 13,000 volume, can you say where you are now with regards to that with respect to the target?

A good bit less.

Second question, just regards to the promotional environments. There's a lot going on out there.

Are you getting a sense that buyers are getting promo fatigue here and they're maybe slightly less responsive? And are you confident in your ability to enforce MSRPs?

On the MSRP, absolutely. We have a team that actively manages that. There is always going to be areas where issues occur, and we are quick to address those.

I think from an effectiveness standpoint it's probably a mixed bag. I would tell you that our team is quite adept at monitoring the programs and making adjustments. We actually did quite a bit of that in the fourth quarter.

We're not just going to spend money when we don't see a reaction coming from it. At the end of the day for us the key is going to be putting the best products out there and having the most technology, power, suspension travel. We'll continue to focus on that, and we think we have the ability to tailor our programs to be highly effective with consumers.

Next question.

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

Two quick ones, if I could. First one, more of a housekeeping. Just to clarify, the US 900cc and up motorcycle industry data, you cited it in your release this morning, about low single digit decline. That does not include Slingshot, just wanted to confirm that.

And then secondly in terms of ASP, it sounds like in off-road vehicle about flat in the fourth-quarter. Could you talk about some of the puts and takes for 2017 between list prices, mix, product mix, et cetera? Thanks.

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

Yes, sure. Just trying to tease out what ASPs are going to look like a 2017, given a lot of the puts and takes that you guys have with list prices and the mix impact with recalls obviously impacting 2016, up from a mix (multiple speakers)? Thanks.

For off-road vehicles, we ended the year down. Fourth quarter it was flat because we were lapping a lot of activity from last year. We anticipate ASPs will be under pressure as we head into next year. We have got higher promo levels, and probably some mix dynamics that play out there.

For Motorcycles we think ASPs will be up, and that really is driven because Slingshot improves. It was deeply impacted in the fourth quarter, just given what we had seen in terms of the recall impact.

Next question.

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

Good morning. Thanks for sneaking me in. I've just got a follow-up on the dealer inventory commentary. You highlighted that Polaris' North American dealer inventory is back below 2014 levels. I understand you might not have the data to quantify this, but in your view how much of that reduction in Polaris ORV inventory was floor-space share loss to competitors that had multi-lines versus an absolute reduction in all lines of inventory within your distribution?

Obviously being as competitive as we are, we watch that floor space very, very closely. We have not seen a material impact on floor space at any segment of the country, any segment of our dealers. Obviously there is a fairly aggressive effort from some of our competitors to get into our dealers, but typically we're not the one that's giving up floor space.

In fact, we are almost never the ones to give up floor space, nor are we the ones the dealerships are dropping product lines, which is happening -- are driving brands altogether. We're not seeing that.

Most of our -- and you think about it, we've decreased inventories while we broadened our product line. So it really has been an opportunity for us.

That is what we're trying to do with RFM. We have done it with ATVs, we've done it with motorcycles, we will do a side-by-sides. We're taking many steps to work with our dealers to make sure that we are making their floor space more productive for us. And ultimately we think that is what will make sure that we continue not to lose floor space.

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

Obviously there is a whole lot of different opportunities and challenges that we evaluated as we went through this. There was cannibalization across, we saw that for sure.

There was some characteristics of the Victory bikes, and trust me, I have received many correspondence from the loyal and passionate Victory riders. They were just great motorcycles.

I think at the time the benefits of that bike brought some people that would've bought an Indian over to Victory. And this is a large case where they just don't want other brand to purchase. We were the alternative. Certainly there was more cannibalization than we would've liked there, and we think it's an opportunity to get some of that back.

Next question.

You next question comes from the line of Mark Smith with Feltl and Company. Your line is open.

Looking at our capital structure and cash flow statement here, you've guided CapEx down, but also operating cash flow down pretty significantly. Excluding acquisitions and share buyback, can you guys be self-funding or will we see additional debt to fund the business this year?

At this point we don't anticipate additional debt. We think there's an opportunity as we get through the course of the year to both deleverage from an earnings standpoint, as well as have the opportunity if we want to redeploy cash.

At this point we don't see taking on additional debt. Could we go through and recharacterize some of our debt? We do have a disproportionate amount that's variable rate today, so it may take some of those actions. But I don't think you'll see the capital structure change dramatically.

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

We really haven't, but I think it's safe to assume low to mid-single digits for the core Polaris previous Aftermarket segment.

Next question.

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

You guys have covered a ton of ground. I was just going to follow up on something that Jimmy asked about dealership relations.

After the recalls, how are your dealer relations? It seems as though you're saying that you haven't lost any shelf space, or floor space I should say, you haven't seen any dealers drop off. How are they feeling about their Polaris business right now?

We still have work to do in that regard. Mike talked about the fact that we do regular surveys and the sentiment, the overall sentiment, is not where we want to be.

I will tell you that obviously we did way more recall activities than we wanted to. But we did, I think, actually improve sentiment somewhat with how we handle the recalls. Some of our dealers made a good bit of money, they brought in new customers back into their shops. And that, I think, we actually handled reasonably well.

During the process we also saw many other opportunities where we can improve the relationship and the service that we provide to our dealers. And that is going to be one of our big corporate priorities going into 2017. It's not a competitive advantage for us right now, our dealer relationships, and we're going to try to reverse that going into the year.

Thank you.

Final question?

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

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

We like the used market, as evidenced by our purchase of TAP. We have a very large growing business that Steve Eastman's got. We really like the growing piece of especially side-by-side, but overall aftermarket.

I will say it's not a one-size-fits-all, because in the recreational, the sports side-by-side segment, the secondary market is not very big. People ride them pretty hard. Lots of the transactions are happening from person to person rather than going back through a dealership.

Obviously with the recall activity, we may see a little bit more of a pick-up in used vehicles out there. But that is not -- nothing like the motorcycle industry where the used market pricing defines what happens in the category. We still see it's a net opportunity for us to sell aftermarket parts significantly greater than any negative impact we get from used taking away new buyers.

All right. Thank you.

Thank you.

I want to thank everyone for participating in the call this morning, and I apologize for the technical difficulties we had a little bit earlier. We look for to talking to you next quarter. Thanks, and goodbye.

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