Polaris Inc (PII) 2017 Q1 法說會逐字稿

Good day. My name is Jack, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Polaris First Quarter 2017 Earnings Conference Call. (Operator Instructions) Now I'd like to turn the call over to your host, Richard Edwards, Head of Investor Relations, you may begin your conference.

Thank you, Jack, and good morning, everyone, and thank you for joining us for our 2017 First 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; and Mike Speetzen, our Chief Financial Officer.

During the call today, we will be discussing various topics, including an updated 2017 guidance, which should be considered forward looking for the purposes of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those projections in the forward-looking statements. You can refer to our 2016 10-K for a more detailed discussion of those risks and uncertainties.

Throughout the presentation today, all references to first quarter 2017 actual results and 2017 guidance are reported on an adjusted non-GAAP basis unless otherwise noted. Adjusted refers to GAAP results excluding our TAP inventory step-up adjustments and integration expenses and the impact associated with the Victory wind-down. We have provided a reconciliation of the adjusted non-GAAP to GAAP results, which is shown here on Slide 3.

Now I'll turn it over to our CEO, Scott Wine. Scott?

Thanks, Richard. Good morning, and thank you for joining us. Back in January, one of our young leaders gave me a red Make Polaris Great Again hat, it still sits proudly on my desk. As our Polaris team knows, and many in Washington across America are belatedly figuring out, getting to great is long and hard work, but our customers, dealers and shareholders expect no less. We have the team, plans and work ethic to get there and we will review our progress along with our first quarter results this morning.

The first quarter in Powersports might as well be called March. It was an encouraging finish to the quarter with momentum and post respectable financial results to start the year. The industry is both weak and competitive, which is far from ideal, but we planned for it and executed well in this difficult environment. Importantly, off-road vehicle sales were modestly ahead of our expectations. And although I'm still not satisfied with our overall market share performance, it was encouraging to see ATV market share turn positive. Market share improved for our RANGER and general side-by-side, and RZR was down but in line with expectations. Despite high promotional spending throughout the industry, we are pleased with the overall improvement across our ORV business and are working to build on this throughout the year.

Indian Motorcycles continued to outperform the market, increasing retail sales 11% in the quarter and posting healthy share gains for both Chief and Scout. Sales were especially strong in the heavyweight segment, and the success of our Indian flat track racing team is generating favorable impressions for our smaller Scout bikes. We were encouraged that our Indian flourished during the first few months of the Victory wind-down, which pushed Victory retail up over 60% in the quarter. Slingshot was weak in Q1 as we continue to work through some of recall-related backlog and face tough comparables from the 2016 launch of the SLR model. We also focused more of our advertising for this strongly seasonal product towards the second quarter.

With Europe stabilizing, Australia improving and growth accelerating in Mexico, it was an encouraging start to the year for international business despite continued foreign exchange headwinds.

Aixam Mega remained a strong competitor to our adjacent market business, joined by solid performance from our government defense business, Goupil and Taylor-Dunn. We also had a healthy start for TAP and our core PG&A business performed well in Q1.

Adjusted gross margins were up slightly despite continued pressure from warranty costs, largely due to progress with our VIP initiatives. Our safety and quality organization is making good progress and will lead to better quality and warranty performance over time.

Huntsville's successful ramp-up provided the impetus to consolidate some of our smaller manufacturing facilities, which will drive improved factory capacity utilization and expanded margins.

Our VIP program will also continue to drive margin improvement. After generating over $100 million in gross cost savings last year, VIP is accelerating further, with over 1,500 projects in the pipeline and 25 of those exceed $1 million in opportunity. This mirrors the improvements in our product development pipeline as our focus on innovation paves the way for game-changing next-generation Polaris ORVs, motorcycles and other vehicles.

First quarter adjusted sales of $1.16 billion were up 18% from the prior year, with an incremental boost from Transamerican Auto Parts more than offsetting the revenue impact from the Victory wind-down. Organic sales, which adjusts for TAP and Victory, were up 2%, driven by improved performance from off-road vehicles and Global Adjacent Markets. Our Motorcycle business, adjusted for Victory, was down 10% as Indian's revenue gain could not compensate for the reduced Slingshot shipments. Adjusted earnings per share were up 6% to $0.75 per share, and Mike will provide additional details on our financial results in a few minutes.

First quarter retail sales were down 6% against the most difficult comparable we will see all year. Snowmobile and Slingshot retail were both down more than 10% in the quarter, and off-road vehicles were down approximately 5%, while retail sales for Indian Motorcycles were up over 10%. Though elevated promotions certainly supported ORV performance, we also saw our comprehensive sales and marketing campaign drive improved results in March.

While we backed the results out of our numbers, the strong 60% year-over-year growth in Victory was encouraging as we work down that remaining dealer inventory.

We continue to make progress with dealer inventory in the first quarter, and our overall 8% reduction for Polaris vehicles marks both our commitment to improving dealer profitability and our evolution towards the expansion of RFM later this year. Despite weak snowfall in the central region, we decreased Snowmobile dealer inventory, as expected, and ORV was down 9%, more than offsetting an increase in motorcycle inventory, which reflects new models, new dealers and strong demand for the Indian brand. We believe overall inventories are reasonably well positioned, but we'll continue to actively manage each product line to maximize retail growth and dealer satisfaction.

Ensuring the safety of our customers by building quality products is of paramount importance, and we continue to strengthen our capabilities to deliver the level of performance our stakeholders demand. We have the fundamentals in place and the global product and safety and quality team continues to improve our processes and our procedures. While our goal is to prevent safety and quality issues, we will issue a recall if we identify safety concern with vehicles in the field. The Model Year '17 Sportsman recall announced 2 weeks ago illustrates our ability to rapidly diagnose safety and quality issues. The Sportsman issues were caught quickly through data analysis within our post-sales surveillance process, and we were able to plan the recall to ensure minimal disruption to our customers. As a result, the cost and time required to repair these vehicles was not material. Our 2017 earnings guidance incorporates this recall, our larger Model Year '15 RANGER 900 recall announced earlier this month and all known potential warranty issues. We anticipate that our full year warranty accrual will be lower than 2016 but at a higher rate of sales given the changes in warranty coverage periods and mix of products sold. Adjustments to the warranty reserve will be made throughout the year if necessary as quantity and cost of actual claims becomes known.

We are devoting significant resources and focus to our safety goals and those efforts complement the pursuit of our other strategic objectives. They are certainly directly supportive of the work that Matt Homan, Steve Menneto and Chris Wolf are doing to drive innovation and customer-centric growth to be the best in Powersports PLUS. Mike Dougherty is working with every business unit and function across Polaris to attain our goal of global market leadership. And quality is paramount to the success in these new markets.

With Transamerican Auto Parts acquisition off to a strong start and continued progress with Taylor-Dunn, Aixam Mega, Goupil and other acquisitions, Bob Mack has our adjacent market strategy on the proper trajectory. We talk often about the outstanding VIP initiatives that Ken Pucel is driving across the business, but the strategic work that he is leading is impressive as well. As we announced yesterday, Ken and his team are taking a step to realign and optimize our plant network. We will be transferring Milford manufacturing to existing Polaris facilities, taking advantage of our new capabilities and capacity in Huntsville as well as in Roseau. We will also consolidate gym assembly with Taylor-Dunn to create an electric vehicle-focused factory.

Additionally, our TAP acquisition allows us to migrate Pro Armor's manufacturing operations from Riverside, California to an existing TAP facility in Chula Vista. We expect these moves to create a 400-basis point improvement in North American plant utilization when fully executed later this year.

All of these growth and productivity efforts are designed to yield strong financial performance, which we need and expect after a difficult 2 years. As I mentioned during last quarter's call, we will be revisiting and revising some of our financial goals when we meet with the Polaris board for our strategy session this summer. Due to the timing of that board meeting, it will be late in the third quarter before we have those finalized and ready to publish.

I will now turn the call over to our CFO, Mike Speetzen, for additional details on our financial performance and outlook.

Thanks, Scott, and good morning, everyone. As Scott indicated, our first quarter results finished slightly ahead of our internal expectations, driven primarily by stronger retail sales than anticipated. Although the first quarter was slightly ahead of our expectations, it is our smallest quarter. This, and the fact that the Powersports market continues to exhibit weakness, led us to maintain our guidance for the full year.

We continue to expect total sales, total company sales to be up in the range of 10% to 13%. Sales expectations by segment also remain unchanged from our original previously provided guidance.

Organic sales, which is defined as total revenue excluding TAP, Victory sales and the effects of foreign exchange remains in the range of minus 1% to plus 1%. We have not seen any significant change in the Powersports markets, and oil and gas as well as agricultural regions continue to underperform. Promotional spending remains elevated and consistent with rates experienced in the back half of 2016. We anticipate the promotional levels will remain elevated at these levels across the industry as we move into the peak spring selling season. Lastly, we anticipate dealer inventory levels to be roughly flat by year-end.

Adjusted earnings per share guidance remains in the range of $4.25 to $4.50, up 22% to 29% compared to the full year 2016 adjusted EPS of $3.48. As a reminder, there are several key points to consider when evaluating our EPS guidance. We anticipate realizing $1.20 of nonrecurring cost benefit as we lap higher warranty and legal-related costs from 2016. TAP is anticipated to be accretive to 2017 earnings by approximately $0.25 to $0.30, and we're driving to realize gross VIP savings of approximately 150 basis points. Partially offsetting these benefits is an anticipated mid-teens percent increase in R&D to support improved quality and accelerated product development, higher promotional costs reflective of the challenged Powersports market, higher variable compensation costs and continued foreign exchange headwinds. The cadence of our expected performance has not changed, with earnings growth heavily weighted to the second half of 2017. The majority of the benefit from the elimination of the one-time costs incurred in the first half of 2016 is expected to be negated by higher promotional spend and increased research and development expenses.

Our first half 2017 EPS expectations remain unchanged, with EPS being about flat to last year's first half EPS of $1.80 per diluted share.

Second half 2017 results are expected to be significantly improved versus 2016 as we anniversary the delayed vehicle shipments, lap higher promotional spending and realized the substantial benefits from the elimination of the one-time costs incurred in the second half of 2016.

Moving down the P&L. Our expectations again remain unchanged for the following: adjusted gross margins are expected to increase approximately 180 basis points. I'll provide additional comments on gross margins on the next slide; adjusted operating expenses are expected to increase in the mid-teens percent range on a dollar basis due to increased research and development expenses; the addition of operating expenses from acquisitions and higher variable compensation cost in 2017; 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 increased debt related to funding of the TAP acquisition; the income tax rate is anticipated to be approximately 34.5% for the full year 2017; and lastly, share count is expected to be about flat with 2016 as we intend to offset management equity issuances with ongoing share repurchases.

We repurchased 256,000 shares on the first quarter at a cost of $22 million, in line with our projections.

Our adjusted gross margin increased 17 basis points in the first quarter, reflecting significant gross VIP cost savings and positive product mix, which was mostly offset by higher promotional cost and slightly higher warranty costs. Our warranty costs were about $3 million higher in the first quarter of 2017 compared to 2016, partly to cover the recalls announced a couple of weeks ago as well as the provisioning for future potential recall issues, changes in warranty coverage periods and product mix. We do expect full year warranty expense to be below last year's level but at levels higher than we experienced historically.

Full year gross margin improvement versus 2016 of approximately 180 basis points remains unchanged. The expected improvement is driven by the following: ongoing gross VIP savings similar to levels achieved in 2016; a reduction in one-time warranty costs incurred in 2016, representing approximately 160 basis points. Partially offsetting these improvements are safety and quality feature adds, which increase product costs, increase promotional cost to protect our brand and foreign exchange headwinds.

On a segment basis, our adjusted gross margin guidance remains unchanged.

Now let me briefly provide more details around each of our segments.

ORV/Snowmobile segment sales were up 2% in Q1, driven primarily by improved ORV shipments of RANGER and general wholegoods and a 13% increase in PG&A-related sales. RZR wholegood sales were down year-over-year, as expected, but the trajectory of the decline is improving. Sales were also impacted by higher promotional spending as expected in the face of heightened competitive pressure.

Motorcycle adjusted sales decreased 32% in Q1. A significant portion of this decline is driven by the wind-down of Victory, which represented approximately $46 million of sales realized in 2016. Excluding this impact, the Motorcycle decline in Q1 was 10%.

The company sale of any motorcycles sales were up in the first quarter in support of higher retail sales. The company's sales of Slingshot were down significantly due to slower retail sales in the channel due in part to recent recalls, which restricted the availability of saleable products. Slingshot product availability has improved as we move into the spring selling season.

As a side note, some of you may have noticed that on our GAAP to non-GAAP sales reconciliation, we show adding back $5.1 million of sales. The sales add-back is due to the promotional cost accrued during the quarter related to the Victory wind-down, exceeding the sales of Victory wholegoods and accessories that were removed from Q1.

Global Adjacent Market sales increased 24% in the first quarter, driven primarily by the Taylor-Dunn acquisition in our government business.

Aftermarket sales, which include TAP, along with our other aftermarket brands of KLIM, Kolpin, Pro Armor, Trail Tech and 509 were up significantly, primarily due to the addition of just over $200 million of TAP sales in Q1. TAP results were in line with expectations and integration plans are on track. Lastly, I would point out that we have provided historical financials reflecting our new segment disclosure on our investor website.

Our operating cash flow performance was down 63% from Q1 2016 as expected, driven by timing of cash outlays associated with prior year promotional warranty accruals. Additionally, factory inventory was up sequentially in preparation for the peak spring retail selling season but improved versus last year when adjusted for acquisitions.

We anticipate full year cash flow from operations to be down significantly due to the timing of accrual payments and Victory wind-down costs.

Income from financial services was up 5% during the quarter, attributable to higher income generated from the sale of extended service contracts, which we brought in-house in mid-2016. As expected, our wholesale credit receivable balance was down 10%, given the lower North American dealer inventory levels in the first quarter. The retail credit environment remains stable, with approval rates of 59% for the first quarter in 2017. Our penetration rates were lower during the quarter at 31% versus 40% a year ago as we were offering significantly more aggressive financing programs in the first quarter of last year. Historically, our penetration rates run in the low 30% range. We continue to expect full year income from financial services to be lower given the expected lower Polaris Acceptance floor plan financing due to lower average dealer inventory levels.

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

Thanks, Mike. In most sports, it is important to start strong, and that is especially true after a couple of losing seasons. With that in mind, for Polaris, with a number of pressing issues demanding resolution, it was particularly necessary for us to show improvement out of the gates in 2017. We were far from perfect and certainly not yet delivering the results we are capable of. We are confident that we're making the right moves to unlock our latent potential. That must begin with the resurgence in our off-road vehicles. We have consistently made great strides in reducing inventory levels, not just at our dealers but throughout the system as we prepare for the launch of RFM later this year. As we work to simplify the order process and reduce lead times, we will improve our ability to respond to customer trends, enabling our dealers to reap the benefits of this powerful tool. They are already seeing the early advantages of our revamped sales and marketing organization, which is now coordinated through Matt's ORV management team. Over the next several quarters and years, they will be rolling out the next generation of trendsetting Polaris vehicles as the significant investments we're making in R&D, manufacturing and safety and quality come to fruition.

We will face less challenging comparables for the rest of the year, but the true measure of our ORV progress will be in the nimbler, customer-focused organization that deliver the optimal customer experience, both at and after the dealership.

Customers of a premium brand like Indian Motorcycles also expect the unique buying and riding experience and the momentum Indian has built proves that we are supplying exactly that. As we enter the spring selling season, we have strong product and marketing plans designed to accelerate Indian even further. Wider availability of the Ride Command-equipped bikes will spur retail growth, and with Victory owners sentiment toward Indian gradually rising, we see opportunities to get more of our faithful Polaris riders onto Indian Motorcycles.

We are expecting Slingshot to gain traction as well.

The fact that our customers' loyalty to Polaris has remained solid in the face of ongoing recall issues is a testament to the strength of our brands, but we need to reward that faith by building the highest quality, safest vehicles in the industry. Our revamped safety and quality organization and every employee across Polaris, for that matter, is passionate about achieving that goal and we expect to see their labors pay off as we progress throughout the year and years ahead.

Steve Eastman has led a significant and very successful transformation of our aftermarket group since he arrived 5 years ago. And with strong progress in both our core PG&A and TAP to start the year, we are confident that the future for these businesses remain bright. We will face more quality and safety issues in the future. The economy won't grow as fast as many of us expect or we would like. The risk of currency fluctuations is high and competition will remain elevated. We do not expect it to be easy, but we do expect to be better.

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

(Operator Instructions) Your first question comes from the line of James Hardiman with Wedbush Securities.

I was wondering if you could give us a little bit of commentary about how sales, particularly in the ORV segment, trended over the course of the quarter? You talked a couple of times about how it all comes down to March, but given the mid-single-digit decline, March weather being negative, I would've thought that March underperformed the rest of the quarter, but it seems like your commentary would suggest otherwise. Can you walk us through that?

James, we're not going to get in to a month-by-month retail comparison. But I will tell you that when I made the comment in the prepared remarks about March being the quarter and the fact that the quarter came out okay, yes, we felt like, and I mentioned it as well, that the work that Matt and his team and Craig Scanlon are doing with our integrated sales force, we had a good program in March. They executed well towards it and we had good momentum to exit the quarter. So we were encouraged by the work that they're doing.

Okay. And then on the margin front, there's a lot of different types of promotions in the channel right now. Can you just help us out with some of the accounting? I think some people were surprised to see gross margins on an adjusted basis better year-over-year, but then you had a big step-up in some of the SG&A, the operating expenses. Obviously, some of that was the TAP acquisition. But can you just walk us through, I guess, the gross margin impacts and the operating expense impact of some of the promotions that you're in right now?

Yes. So, James, this is Mike. The promotional costs, with the exception of an elevated level of advertising, is all being run as a contra sale. So it's all fully baked into the gross margin. And as I mentioned my prepared remarks, that offset quite a bit of a healthy VIP contribution that Ken and the team had. The operating expense increase that we've had year-over-year really came down to -- the addition of TAP drove, by far, the most significant portion of that. But our R&D expenses are also elevated. We've talked for the year to be up mid-teens. Q1 was slightly heavier than that. Some of that is the TAP acquisition. The balance is really the fact that we ramped up our engineering spend coming out of the end of last year for the quality and safety issues as well as just the work we're doing to really amp up the product development pipeline. There's a little bit of compensation expense that comes through when you think about how we deal with accruing for our annual profit share and anticipating a better payout in 2017 versus what we had in 2016, there's a little bit heavier impact in Q1. So those are really the large drivers.

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

I wonder if you could help us sort of get to what your retail expectation may be, if we just take your expectation that your year-end dealer inventory would be flat. Is that also -- I think that's an overall inventory expectation. Was that also flat for ORV at year-end? If so, what sort of range of retail would be implied by that. And your shipment guidance, and the reason I asked is obviously is just that the one of those measures is in units and one is in dollars and they have different bases, so I just want to make we are all thinking about that number correctly?

Well, we've said, Robin, and we're not backing off it, that we expect retail sales for off-road vehicles could be down slightly for the year. And we've also said that we expect dealer inventory to be flat to down slightly year-over-year. So we're not changing that right now, although we did have a good job -- the team did a nice job of bringing down dealer inventory overall in the first quarter, which gives us flexibility, which is what we want. We found, actually, in the quarter, there were a couple of times where we were short on the products that we wanted and we don't like that, but we'd rather have that than too much. And we're going to manage that throughout the year, but we're not changing our overall expectations for retail and dealer inventory. Somebody made the comment, I'm surprised, given how this industry works, that they were surprised that our retail shipments, our retail sales were up more -- I mean, our sales were up more than our retail was for the quarter. We had positive mix in the quarter, which was helpful, and we believe we'll see that could be helpful for most of the year. You want to add any color to that, Mike?

I think, Robin, as you think about that full year and as we essentially square out the business plan, the thing to keep in mind when you've got flat dealer inventory and we've got an industry expectation that's essentially flat to down, that could give us a little bit of a lift in sales, so when we talk about our guidance range being negative 1 to plus 1 from an organic standpoint, that plus 1 really comes from the fact that if you look back at what happened in 2016, our retail was down, as a company, about 5%, but we over-indexed from a shipment standpoint, and shipments were down well over 10%. So you get a bit of the year-over-year compares for those specific line items. And as we're continuing to pull dealer inventory down through the course of the year relative to where we were at quarter-by-quarter in '16, that also creates some of the dynamics that we have.

The next question comes from the line of David Beckel with Sanford Bernstein.

I had a question about the Victory wind-down, the effect on Indian sales. I know you mentioned that sales were very strong. I was wondering if the heavy discounting from the Victory product do you think cannibalize this quarters Indian bike sales at all or to any extent?

Yes, when Indian was up 11%, I'm not going to go out on a limb and say that something cannibalized sales. I think we held our own there. We were encouraged, obviously, helping the dealers work through that inventory shows that promotion levels with Victory's working, and I commented up, over 60% retail in the quarter. There was one of our competitors welcoming the Victory customers to come on over, and I think it's just really encouraging to see how well Indian did in that environment. What we do know is that over time, we're going to want those Victory customers to migrate over, and we know that's a tough putt. There's a lot of frustration there, and Steve and the team are working towards that. But right now, both Victory retail and Indian retail did well and certainly, I'm not going to suggest there was any cannibalization there at all.

Great, that's helpful. And another quick Indian question. I was curious about, have you guys looked strongly at or intensively on dealer productivity of your Indian stores and how that's trended in new markets versus established markets, over time? Just curious about what trends you're seeing there.

Yes, we look at basically every metric you can possibly imagine. How much we're going to share, I don't know. Like I said, we do know that after a dealer has been open a year, they tend to get, what I'll call, stability and start to be able to drive better market penetration. The first year is sometimes a little bit sketchy. But overall, we are very encouraged about the status of the network and the year-over-year performance of our dealers really across the dealership network.

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

I'm curious about the customers that are coming in and buying motorcycles. It sounds like you guys called out that the Chief and the Scout and then average selling prices were down, but there were some mix changes this quarter. So are there any sort of new insights to the consumer and how you're tapping into them across motorcycles? That would be helpful for us to understand.

Well, when you talk about mix, you're talking about shipments. And when you are talking about share, you're talking about retail. What we said is that the heavyweight, which is the Chief, and the Chief range of products, heavyweights bikes did better for us in the quarter than Scout, although Scout, the midsized bikes were strong as well. We're -- it's a very competitive motorcycle market out there. We've seen the promotion levels across the industry high. But Steve and the team are really doing a good job. The introduction of the new bikes, the new marketing campaigns, we're getting buyers coming over from other brands and not just Victory, and that's helpful to us.

And Jaime, on the mix side, the ASP was really driven by the fact that Slingshot was down as dramatically as it was. When you think about the impact versus the SLR shipments we had last year, which are very high-end expensive part of that product line.

Okay. And then I know you guys are working through sort of your long-term strategic objectives. But we're in 2017, and I assume you have sort of a feeling on what the magnitude of divergence from that $8 billion number might be. I mean, to get anywhere near there, I think you have to do a few transformational deals, and given what the industry looks like right now and I don't know that you want to change the leverage profile that much. So do you have any sort of early sort of thoughts on what the magnitude of that shortfall might be, if you're willing to share it?

Jaime, there's no chance we are going to share that. I will tell you, and I think I went over it on the first quarter call, the real challenge for us, if we reboot the sales rate that we believe we can with our innovative product design, the long putt is not the revenue number, and I think too many people got focused on the $8 billion in sales. Internally, we are much more focused on the profitability and the productivity, and that's where we think we have more of a challenge, and that's what we're working to be able to try to dial in, is how close or how much better can we improve this net income number throughout the time. And we will update that, like I said today, later in the third quarter.

Your next question comes from the line of Joseph Altobello with Raymond James.

First question on Victory. When do you guys expect that wind-down to be complete and all the existing inventory to be sold through?

Yes, I mean, our goal is to try and get through the majority of it this year. That said, there could be some lingering effects into next year. But as evidenced by the strong retail performance we had in Q1, Steve and the team are working hard with our dealers to create a win-win situation, and we're pretty confident we'll get the majority of it behind us this year. You could tell by the charges we took this quarter, we had line of sight to a considerable portion of those. That said, there will be more charges that occur during the year as we get more visibility into various issues around how well the promotional programs are working, legal costs and things like that.

Okay. That was my second question actually. So I guess one more on TAP. It sounds like the integration is going well. How comfortable are you with the cost synergy target of $20 million and how much of that is in 2017?

We're very comfortable with the number.

We said we would get to the $20 million by 2019, but trust that given the situation we're in, we're pushing the team to accelerate that profile.

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

Just one, if we'd just maybe go through math here, gentlemen. And I think, Scott, you may have touched on this earlier, but I just want to make sure we're clear on it. If the ORV retail was down mid-single digits and your shipments were down 1, so total shipments and units, you kind of look at that, they exceeded the retail by 3% to 5%, is that correct?

Yes. And I think, Tim, part of the problem is when we talk about our wholegoods being flat, our actual unit shipments were down low single digits. And when you look at the mid-single-digit decline in retail, some of the math works out that you've got to look back to what was going on in the first quarter of last year. If you remember, we were dealing, still dealing with the dealer inventory situation that we had. Last year we had slight retail increase in Q1, but we had taken our ORV shipments down pretty darn close to 10%.

And a lot of that was RZR shipments that we took down.

Right, and so we are benefiting a little bit from an ASP standpoint. As you can see on the chart that we provided, our ASPs are up, a lot of that has to do with mix of products coming through the channel. So it is a number of different factors that are playing out. Now what I would tell you is that our dealer inventory's sequentially. So from where we ended the end of last year to where we are now is up, but that's in support of the spring selling season and consistent with what the dealers are looking for from an order standpoint.

Okay. Okay, and then on Slide 8, gentlemen, just again to be clear here, the one bullet says ORV is down 9%, but then if you add the existing and the new, it says, they're down 10% and plus 3%, you get down 7%.

Yes, I mean, Tim, that's when you weight out the total ORV as a total portion of the dealer inventory move that we've got. So that's taking the 9%, and then weighting those 2 elements together.

Okay. And then -- okay. Then as you're saying, RFM should kick in here and that's going to obviously increase the velocity. But to bring down the absolute level of inventory, that's baked in to where your guidance was for year-end, correct?

We said that we've been able, both at the end of last year and in the first quarter, get our dealer inventory in a position that we've really taken that RFM impact out. But we will manage inventory of every single product line to what our dealers need to accelerate retail. But we've taken that step-down required for RFM already, and it gives us the flexibility to get that implementation exactly right for our dealers and our consumers.

Your next question comes from the line of Greg Badishkanian with Citigroup.

First, just wondering, the ORV seems like it slowed down in North America, down mid-single digits this quarter, it was flat in the fourth quarter. What dynamics were kind of working to impact the industry?

I was just going to say, Greg, one of the factors that I mentioned in my prepared remarks, oil and gas which we're getting tired of talking about because we felt that we were going to get long past this last year, we were down about 11% in oil and gas regions in Q1. Last year, Q1, we were down 8%. So that segment has gotten a little bit worse. We think the trajectory is still going to be favorable to where we were last year. Last year, we ended up down about 17%. Obviously, some of that was the recall playing in, but the region, clearly, was suffering. And then the ag markets were down here again here in the first quarter, about 5%. So we're still seeing a fair amount of headwind coming out of those 2 markets, which, as you know, those 2 make up roughly 25% of our off-road vehicle segment revenue.

Okay. And then just as a follow-up, you made a few references to innovation in the release and slides. And should we expect -- potentially, are you ready to make some bigger introductions this year at your dealer days now that the recalls are kind of behind you?

Well, I hope you didn't hear us say recalls are behind us because that's not what we intended to infer. In fact, there's an ongoing challenge and we're making the investments to make sure that they are ultimately behind us, but we're not declaring victory on that in 2017. We have made a significant investment, not only in our safety and quality organization, but also in, ultimately, I'll just call it, rebooting our innovation pipeline. And Matt and his team are doing a lot of that, Steve Menneto and his team, even Chris and what we're doing in Snowmobile. There's a lot of really good stuff going on in innovation and R&D. It's incorrect to assume that most of that hits in 2017. That's not the product lead times that we have. It's not like over the last couple of years, we weren't doing it, so there's a normal course of things coming through. But I wouldn't expect the increase in R&D that we've made over the last 6 months to be -- result in significantly greater innovation coming out this year, that's just our product lead times aren't that good.

Your next question comes from the line of Scott Stember with CL King & Associates.

Can we talk about the aftermarket side of the business. If you were to back out the $202 million from TAP, it looks like the rest of it was essentially flat. Can you maybe just talk about that and maybe just talk about what the organic growth rates for TAP running at in these days?

Yes, so Scott, another way to think about it is if you look at the financials that we provide on our website, you can get a view of Q1 on a, I'll call it, a pro forma basis because we can't technically call it a restated basis. Our aftermarket revenue was up 7%. You are right that the underlying legacy Polaris aftermarket was relatively flat. A little bit of that had to do with a less-than-stellar snow season. We also had one of our businesses that had some delays in large program orders with a major sports outfitter that really drove that. But if you look at the rest of the portfolio, which clearly has been driven by TAP, you are talking about high single-digit growth rates, which we're very encouraged by, and as we indicated in our prepared remarks, the business is performing as we expected.

And Transamerican organic growth is strong as well, not only with the opportunity to accelerate the retail points throughout the country, but just the performance of that business, amidst all of the integration activity, is quite strong.

Got it. And just last question. Can you maybe talk about the Eicher JV and maybe talk about what's going with the Multix product, we haven't heard about that in a little bit.

That has been an underwhelming launch for us, obviously, lots of difficulty penetrating that market. The regulatory environment is, at best, I'll have to call it volatile right now, so we're evaluating the right next steps there. But as you know, India is a tough market. We like the product, but understanding how to deal with a moving regulatory target is a challenge for us. Mike, you're on the board, do you want to elaborate?

Yes, so, Scott, I'm actually headed over with Mike Dougherty next week. We have a board meeting to actually talk through this very subject that Scott had mentioned. Regulatory framework is changing rapidly in India, so fast that many of the competitors are having a hard time even just keeping track. They essentially are going to leapfrog the European standards, which basically takes the Multix into a space that we may not be completely comfortable with, where there are certain safety requirements and emission standards that start to make that product very difficult to compete with. So we're going to sit down and talk about it. I mean, in the grand scheme of our balance sheet, it's a relatively small investment. And well, obviously, if decisions are made, we'll communicate that to you, folks, as we make them.

Your next question comes from the line of Scott Hamann with KeyBanc Capital Markets.

Just in terms of the promo activity, it seems like you've got a little bit more intense as we got through the end of the quarter and into April. Is that kind of consistent with your plans, your expectations? And then, do you still believe that in the back half of the year, that we'll see some of that promo activity ease a little bit?

Yes, I think the way to think about it, Scott, I mean, one, if you look at a press release, you can see in our financial statements that promo reserve is up, and that's pretty reflective of the level of activity that we had and that we anticipated in our guidance. We've talked a lot about promotion being a drag on the gross margin improvement initiatives that Ken and his team are driving. What we've also said is that the level we're at today is consistent with where we were exiting last year at. So as we get into Q3 and Q4, essentially, the promo levels start to level out. They stop being a headwind year-over-year. They're certainly not expected at this point to be a tailwind by any stretch. But we do think we get back to lapping the higher levels we experienced in 2016.

I'd tell you, the nuance in the elevated promotional levels, though, is that despite our best effort, we're not getting a significant competitive advantage with our higher promo. I mean, we're being matched by the, what I'll call, the toughest competitors in the industry and you're seeing pretty aggressive promotions across the level. So obviously, we had expectations that it would give us a boost, but really, we are -- we're not as far ahead or as we would have expected or would like to be based on our elevated promotion. The industry is just high right now. And that's true in motorcycles and off-road vehicles.

Okay. And then, I guess in terms of Slingshot, can you just give some additional color on kind of what the strategy is there? Do you still expect to grow in '17?

Slingshot is one of the more innovative product introductions that we've had. I will tell you that we had -- unfortunately, we didn't nail every aspect of quality of that vehicle and we've meant to work through that with a number of recalls. We're confident right now in the line-up. We've got some really nice innovation coming this year. We are really pushing the sales and promotions activities. As I've mentioned, we've kind of moved a little bit or more of that because of the seasonality of the second quarter. So really, a lot of what we expect out of that product and where we think it will go in '17 is going to be dependent on what happens in the second quarter. Steve and his team are, I think, they've got a good plan. And I would feel more comfortable giving you color on that at the end of the second quarter when we get into the full seasonality of it as opposed to guessing what's going to happen after just a couple of weeks in April.

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

So a couple of questions. One on Indian, one on ORV. On the Indian, how many dealers did you have in the quarter? And how did that compare with first quarter '16?

We have around 200 dealers actively selling, just under 200 actively selling. There was a question asked earlier around the profitability of the dealers. And given what we've seen in the industry, that's why we haven't been expanding the dealer count dramatically because we want to make sure that the existing dealer base is extremely healthy, and given the retail growth that we're seeing and the market share gains, we're confident that would continue.

So should we assume that dealer count is relatively flat year-over-year?

No.

No.

So what would that growth have been year-over-year?

We kind of -- early in the game, we thought it was important to give guidance on where dealer is -- dealer count was going to be. Now that Steve and the team, and there's most parts of the country and really North America, we're in reasonable drive time. So we're being thoughtful about how we add extra dealers and we don't want to artificially put a number out there that we feel obligated to hit. What we're really going to do is try to make sure that each MSA is properly represented and we're going to manage what that retail demand looks like. I will tell you that if retail acceleration continues, we'll add more and we're just going to play that by ear. But we're not going to get in -- we've said over time, it's going to be in the 300 to 400 range, and we'll get there when we get there.

Okay, that makes sense. Just on the ORVs, I guess given that you have such a major percentage of your ORV sales on multiline retail sales floors, do you see opportunity to increase the incentives to dealers and retail sales associates to promote your brand over that of a competitor?

It's pretty significant. I mean, obviously, it's, as we've said numerous times, it's a very competitive environment right now. Obviously, the best way for us to compete is when we have buy, and we've done that. It's had significantly the best vehicle out there. What Craig and Matt and the teams have done right now is come up with much better targeted retail acceleration and marketing campaigns, and we're encouraged by what they're doing. So we'll probably talk a little bit more, provide, a little more color at our summer sales meetings. But we're really encouraged by the work that they're doing and how they're using different tactics to accelerate retail.

Your next question comes from the line of Mike Swartz with SunTrust.

I just wanted to touch on some of the comments around the VIP cost savings. I know you've said you've generated about $100 million sales last -- or sorry, savings last year, and you're looking at a similar amount this year. How do we think about that on a net basis? And then, above and beyond, is any of the optimization of utilization rates across your facilities factored into that $100 million number for '17?

Yes, I mean, the way to think about it is, as we've indicated in some of our prepared statements and the Q&A is, Ken is driving considerable savings. It's things like logistics, it's procurement, it's the indirect buying that we do. But what that's doing is that's helping us fund some of the things in an environment today that we have to contend with. So we've talked about increasing our safety and quality organization. So we have hired and put in place a significant organization to make sure that we've got everything from post-sales surveillance to monitoring, manufacturing and supplier quality set up and established. We've talked about the promotional cost being a significant headwind. And when you look at the reserves that we've had here in the first quarter, you can tell that reserve is up about $30 million, and that gives you a sense of the magnitude that we're dealing with there. And then in my prepared remarks, I talked about quality and feature adds. Don't underestimate the cost of certain components that we've made decisions on that we're not able to price for that improve the product's safety and quality that we think are going to be fundamental for the go-forward plan for our business. So when we look at Q1, for example, a lot of what Ken did, basically, was offsetting all of those things that I just walked through. And that's pretty much the game plan we have as we go through the course of 2017. At the end of the day, the volume lift is really what's going to pull us out of having some of these headwinds. Factored into that is also some of the factory underutilization, so certainly, the move we just announced yesterday, which improves our factory utilization by 400 basis points, is going to go a long way to help that. We anticipate that will give us somewhere between a $5 million to $7 million benefit as we head into 2018.

That's very helpful. And then, Mike, just a follow-up, did you -- and I may have missed it, the $13 million in other income and expense, what was that related to?

That had to do with the electric powertrain investment that we had associated with the Victory motorcycle business that was impaired as a result of winding that business down.

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

Scott, could you add more color to what's involved in your post-sales surveillance process?

Yes, I'll turn it over to Ken Pucel who's here with us, and he's kind of led the effort to stand up that organization. So obviously, it's a very important -- it's not the only part of our safety and quality organization, but it's a critical factor which allows us to much more quickly capture what's going on with builded products.

Yes, so this is Ken. Really, what we've done there is we've continued to improve the way that we monitor the signals in the field. And that could be any signal from a media signal to a warranty part sales or safety claims. And then digest that and consolidate it down to trends and anything that we should be acting on. And then the decision-making around what to do and how to do it is part of that also. So it's a cascade of essentially looking at all of the activity and feedback you can get from your product performance and understand your quality performance.

Okay. And then Scott, a different question. In terms of dealer profitability, dealers seem to feel that profitability has deteriorated and that their return on investment is below other brands, which is not the norm at all for Polaris. Is there more you can do to drive better dealer ROI and win back those dealer commitments?

Yes, of course, Craig. I mean, obviously, we were so far ahead for several years when dealers were able to just have double-digit retail growth year after year after year. And that really drove what I'll call high level of profitability even though the price profitability per unit wasn't there. What we're finding is if you factor in the overall dollars that most of our multiline dealers make, they're still making the vast majority of their money from Polaris. And one of the things that we've got to do is, even though the comparison to a couple of years ago, it might be down, we've got to make sure that we are communicating very effectively what we're doing for their overall dealer profitability. That being said, there are certain specific steps that we can take to improve their cash flow and to improve their margin performance, and Matt and Craig have done a really nice job with that. There's still some work to do, but as I've said many times, this does not include a wholesale pocket shift of significant magnitude. There's multiple steps we have to take. We're taking those steps. But improving what I'll call dealer engagement and dealer profitability is one of our major strategic initiatives for the year.

Your next question comes from the line of Seth Woolf with Northcoast Research.

I just wanted to start off in ORVs. It seems like during the first quarter, there was some commentary at some conferences, cost and volatility with the stock, having to do with first quarter expectation. So I was wondering I know you don't like to get into the quarterly guidance game, but because we are looking at 2 very unusual quarters at retail, I think down double digits, can you maybe provide some color as to what exactly you guys are expecting to see from a retail standpoint this quarter?

I don't know what you're talking about.

Seth, when you mentioned 2 down double-digit quarters, can you elaborate on that?

Yes. So wasn't ORV retail down double digits in 2Q '16?

Yes.

'16.

So as you get it, it seems you've got down high single digits in [3Q]. I guess what I'm asking, because of all the volatility in the first quarter, I think it would be helpful if people kind of understood what your expectations were for 2Q because there's so many puts and takes?

Yes, Seth, I mean, we've talked that we're not going to get into providing, we really don't even talk about it in terms of the annual basis. But what I would remind you is last year in April is when we issued the first significant recall, the RZR 900 and 1000. And so that put us in a stop sale, stop ship that impacted April and into -- deep into the second quarter.

Okay. And then, I guess just kind of sticking with the VIP theme. A lot of the stuff that Ken has talked about, it sounds like we're talking about organic sales being flattish this year and yet you're going to take 150 basis points cost out of business. So as we get further out, do you need -- can you continue to -- with these projects you've discussed, can you continue to take more cost out of the business? Or do we need to see volume increase at some point to really take advantage of the VIP savings?

The work that Ken and his team are doing is extremely comprehensive, and it involves factory utilization, it includes material costs, it's labor productivity, it's product design. Mike walked through some of the headwinds we had with safety and quality, whatnot. But over the next, what I'll call, 5 years, absent volume growth, Ken and his team are still going to deliver significant VIP savings and productivity gains. If we factor in revenue gains, that's obviously a lot easier to get. But no, we are not contingent upon volume to get to our VIP savings.

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

First off, any movement in the defense business within Global Adjacent Markets? And has your view on that business changed with the new administration?

Obviously, we do better when there's activity. And certainly, there's a lot of activity in the Department of Defense right now. John also joined us about 6 months ago, and he has done a fantastic job, providing focus of that team. And we're encouraged about the opportunity there, not only from what's happening with the administration and a more engaged defense spending opportunity perhaps, but really what we have with our product portfolio and the opportunity to further penetrate not just Department of Defense but the overall government sales activities.

Was that a big mover in the -- I think it was 24% increase year-over-year?

It was helpful, certainly.

Yes. I mean, it's a small base, but essentially, we doubled the business. And a lot of it has just to do, Mark, with the timing of the program -- programs.

Okay. And then second one, similar vein, have you guys started to look at or started any shift in manufacturing out of Monterrey and into Huntsville or anywhere else just in potential anticipation of changes in taxes and regulatory?

No.

Your next question comes from the line of Gerrick Johnson with BMO Capital Markets.

Input costs like steel, aluminum, resins all look up, but I don't see inputs as either headwind or tailwind to your gross margin expectation. So what's your outlook on inputs? And how long do such increases take to flow through the P&L with hedging and inventory turns?

Yes, I mean, it's on there under because it's not a material component for us. I mean, we fortunately have a number of these components that we buy in an ultra-form, and so they are subject to supply agreements that we have. Where we do have raw purchases, we typically have agreements that mute the effect, meaning if we see upward or downward movements, we don't feel those right away, that they will be blunted to some extent. But that exposure for us is pretty small.

Okay. And my last question. Have you changed your outlook at all on the market and dynamics with Textron taking over Arctic Cat and making a renewed effort to basically blow out inventory at the dealer level?

No, we're -- obviously, we weren't surprised that there was transaction. Textron is a good company and a reasonably good buyer, so we're certainly not underestimating what they could do with that product in their portfolio. We do know from our dealer communications that they've been quite active and we'll be mindful of watching them as a better competitor going forward.

Your next question comes from the line of Joe Spak with RBC Capital Markets.

This is George on for Joe. We saw that you added a $10 million to $15 million manufacturing realignment cost to your 2017 adjustments. Could you provide just a little more color on that?

Yes, that has to do with the announcements we made yesterday, the Milford plant exit that Scott spoke to in his prepared remarks as well as moving some of the fabrication work that we do in California to our -- one of our existing TAP facilities. That is associated with the write-down of assets, the severance cost associated with any of the affected employee as well as any of the other onetime-related costs associated with those 2 manufacturing moves.

Okay, and then could you just remind us when we start to lap some of the easier comps for Slingshot?

Probably at the back half of 2017.

Yes, more of the fourth quarter than the third quarter, but...

Your final question comes from the line of Drew Lipke with Stephens.

One quick question. So you mentioned the oil and gas markets and ag markets were a greater headwind than you anticipated. And you called out RANGER and GENERAL retail is outperforming. I would have thought both ag and oil and gas markets would have a greater exposure to RANGER as compared to RZR. Can you kind of unpack the disparity there a little bit?

Yes, I think that GENERAL observation is true. But I think part of this is -- the GENERAL is a relatively new product introduction, and I think it's safe to assume that we are taking considerable share there. So even if the market isn't moving, we're doing well. And even with RANGER, we're battling back from some tough competitive entrants last year. So even though we've been dealing with a market that's down mid-single digits, we've been dealing with that for some time. And I think the move to introduce the 1000 RANGER late last year as well as the popularity and the acceptance that we're seeing with GENERAL, those 2 have enabled us to paddle back pretty significantly.

Okay. And then just on the Victory cost, I think kind of $20 million higher now for the year. Can you talk about the cadence for those one-time costs? I think previously, they're going to be more 2Q, 3Q weighted, it sounds like maybe get a little bit more in the first quarter. How should we think about that progression through the year?

Yes, so we've said 70 to 90. We've booked just under 60 in Q1. The balance is tough for us to predict because it's going to have to be event driven in order for us to be able to estimate it and assign a probability to it. So it's why -- it's why we did not put a guidance outlook on a GAAP basis because the costs are just too -- there's too much movement between the range to be able to identify what we think is reasonable, let alone trying to predict it by quarter.

All right, thanks. I want to thank everyone for your interest today in Polaris and we look forward to talking to you again next quarter. Again, thank you and goodbye.

This concludes today's conference call. All participants may now disconnect.