Polaris Inc (PII) 2017 Q2 法說會逐字稿

Good morning. My name is Krista, and I will be your conference operator today. At this time, I would like to welcome everyone to the Polaris Q2 2017 Earnings Call. (Operator Instructions) I would now like to turn the call over to Mr. Richard Edwards, Head of Investor Relations. You may begin.

Thank you, Krista, and good morning, and thank you for joining us for our Second Quarter 2017 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, we will be discussing various topics including 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 these risks and uncertainties.

Throughout the presentation today, all references to second 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 and some manufacturing realignment costs. We have provided a reconciliation of the adjusted non-GAAP to GAAP results which is shown here on Slide 3 and in the appendix.

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

Good morning, and thank you for joining us. Recently, I had a conversation with one of our better dealers and was pleased to hear him acknowledge that we were listening to and addressing some of his concerns. Before I could stop smiling, he constantly asserted that he expected us to get back to ignoring him just as soon as we started winning again. His cynical view was difficult to hear but also quite valuable. While we work to enhance quality, accelerate innovation, drive productivity and improve profitability, we can never stop listening to and delivering value for our dealers and customers.

We continue to invest heavily to support our safety and quality initiatives. Progress in these areas often reveals additional issues and this is manifesting itself in further recalls and higher-than-anticipated warranty costs, which we are aggressively working to abate over time as we apply lessons learned to our current processes. Fortunately, with higher VIP savings and overall execution improvements, we are largely able to offset these and other headwinds.

We were pleased with our side-by-side business returning to retail growth for the first time in 6 quarters but disappointed that we did not keep pace with the industry. Our overall ORV retail numbers were pulled down as ATV retail sales and market share declined in a highly promotional ATV industry.

Indian Motorcycles continue to drive growth in a weak heavyweight motorcycle market. Retail sales were up 17% as we accelerated share gains and positioned the business well for the second half, with our model year '18 bikes coming out next week.

Slingshot sales were low and promotional costs were high, which is never a good combination. We have action plans and product news to help turn Slingshot around in the second half, but we must engage with more urgency in returning Slingshot to growth.

The Victory wind-down is on plan, and we are continuing to persuade loyal Victory customers to take advantage of remaining Victory inventory and/or try out our new Indian bikes.

Mike Dougherty's International business had a strong second quarter, up 12%, as Australia posted a record quarter, and Europe and Mexico continued to outperform.

Equally welcome was the performance of our Parts, Garments and Accessories business, up 4% in the quarter.

TAP sales were solid 6% growth on a pro forma basis and both the integration and synergy plans are ahead of schedule.

Second quarter overall retail sales were down 3%. While I will never be comfortable with negative retail numbers, the makeup of our performance was reasonably good. The highlight was certainly Indian Motorcycles broad-based growth, which is important during the height of the riding season. However, Slingshot retail weakness more than offset Indian's strength, bringing overall motorcycle retail down modestly for the quarter.

RZR retail sales turned positive, admittedly against an easier prior year comparable, but it was encouraging to see demand improved sequentially as well.

RANGER retail was flat for the quarter amid strong competition and heavy promotions. The promotional environment for ATVs also remained high and we did not match some of the clearance sales that continued in the quarter, leading to lost market share and retail sales down high single digits. We believe our product news and retail plans and of course easier comparables will combine to improve results in the second half.

Dealer inventory was down 6% in the second quarter, putting us in solid position for the introduction of our model year '18 vehicles and facilitating a smooth transition to RFM.

ORV inventory also dropped 6% led by a double-digit decline in RZR units. And Slingshot inventory was also down, as necessitated by lower retail. We continue to project year-end dealer inventory to be approximately flat to last year.

A hallmark of Polaris vehicles is our industry-leading ride and handling. As our powertrain capability continues to improve, the combination of power and performance and, of course, some darn good riders is boosting our success at the racetrack. In our first year of flat track racing, Indian is dominating the field, winning 9 out of 10 AFT races and recording an astonishing 23 out of 30 podium finishes. Not to be outdone, RZR has won over 75% of the races it entered this season, reinforcing that we have the highest-performing vehicles regardless of the venue.

Transamerican Auto Parts had another good quarter as their deep array of innovative products, strong brands and omnichannel reach contributed 6% sales growth. Integration is proceeding slightly ahead of schedule and we have opened 4 new 4-wall parts stores this year, including our first store here in Minneapolis earlier this month. Synergy savings also funded a new R&D center in Southern California, which will enable Greg Adler and his team to further penetrate the off-road vehicle market.

With that, I'll turn it over to our CFO, Mike Speetzen.

Thanks, Scott, and good morning. Our second quarter finished slightly ahead of expectations for both sales and earnings per share despite a highly competitive industry. Second quarter sales were $1.36 billion, up 21% on a GAAP basis and 20% on an adjusted basis from the prior year. This included $209 million of incremental sales from Transamerican Auto Parts, which more than offset the revenue impact from the Victory wind-down of approximately $54 million of sales reported in Q2 of 2016.

Organic sales, which adjusts for TAP, Victory and foreign exchange, were up 7% including strong PG&A and international growth as well as improvement in company average selling prices driven primarily by off-road vehicles.

Second quarter earnings per share on a GAAP basis was $0.97. Adjusted earnings per share was $1.16 when adjusted for the Victory wind-down, TAP integration and inventory step-up cost as well as the manufacturing network realignment cost booked in the quarter. The increase was driven primarily by improved gross margins, which were somewhat offset by higher operating expenses due to increased research and development cost to accelerate new product introductions, higher selling and marketing and legal-related costs.

We anticipate a modest improvement in the global powersports market. This coupled with 2 quarters of improved execution has us raising our overall sales guidance range as well as raising the lower end of our earnings guidance range for the year.

We now expect total company sales to be up in the range of 12% to 14%. We're increasing our ORV/Snowmobile guidance to approximately flat year-over-year given the stronger year-to-date performance in side-by-sides, international and PG&A related shipments. We're lowering our motorcycle guidance to down high-teens percent on a GAAP basis, which equates to up mid-single digits when prior year Victory sales are excluded from 2016 for comparability.

The motorcycle revision is due to weaker-than-expected Slingshot sales year-to-date.

And finally, we're increasing or Global Adjacent Markets guidance to up mid-single digits percent.

Total company organic sales, which is defined as total revenue excluding TAP, Victory sales and the effects of foreign exchange, is expected to be in the range of flat to plus 2% for the full year, which is improved from our previous guidance of down 1% to up 1%.

Promotional spending is expected to continue at current levels, but we begin to lap similar levels of spending incurred in the second half of 2016.

Lastly, we continue to expect dealer inventory to be roughly flat by year-end on a year-over-year basis.

Adjusted earnings per share guidance is now expected to be in the range of $4.35 to $4.50, up 25% to 29% compared to the full year 2016 adjusted EPS of $3.48. While we have increased revenue guidance, we are holding the upper end of our EPS range as volume gains are anticipated to be offset by higher than originally anticipated warranty and legal-related costs.

Our first half 2017 EPS finished at $1.91, slightly ahead of our $1.80 estimate provided during our last call. Given our current full year revised guidance, the second half EPS equates to a range of $2.44 to $2.59 per diluted share, which is a significant improvement over the second half of 2016. I'd also add that the cadence for EPS in the second half of 2017 is more heavily weighted towards the fourth quarter, with approximately 45% of our EPS occurring in Q3.

I'll cover our gross margin guidance in a moment, so let me cover some additional revisions.

Adjusted operating expenses are now expected to increase in the 60 to 70 basis points range as a percentage of sales versus last year, driven by higher R&D expenses, increased variable compensation and legal-related costs.

The income tax rate is anticipated to be approximately 34% for the full year 2017 due to the benefit from the adoption of a new employee share-based accounting standard.

And lastly, share count is expected to be down 1% to 2% versus previously issued guidance of about flat with 2016 as we were more aggressive in share repurchases in the first half of 2017 than originally anticipated. Our full year repurchase target has not changed at approximately 1 million shares, but we'll get more benefit from the lower share count given the timing of repurchases.

We repurchased 758,000 shares in the first half of 2017 at a total cost of $66 million, and we have approximately 6.7 million shares remaining under the board's current authorization. You can find the specific guidance for these and other P&L items in the appendix of the presentation.

Lastly, Polaris is currently working with the appropriate agencies to review proposed corrective actions and release timing for a handful of pending recalls. These have been contemplated in today's revised guidance.

Gross margins on a GAAP basis improved 51 basis points to 25.7% in the second quarter, which includes $8.9 million of Victory wind-down cost and $4.3 million of manufacturing realignment and network optimization costs. As we indicated last quarter, we are transferring Milford manufacturing to existing Polaris facilities, taking advantage of our new capabilities and capacity in Huntsville as well as Roseau. We're also consolidating gym assembly with Taylor-Dunn and Pro Armor fabrication into TAP to leverage TAP's capabilities.

Our adjusted gross margin increased 160 basis points to 26.8%, reflecting significant gross VIP cost savings and positive product mix, somewhat offset by higher promotional costs.

Year-to-date, our warranty expense are approximately $6 million below the same period in 2016. The warranty expense in the second half of 2017 is expected to be lower in absolute dollars and as a percent of sales in the same period last year.

We continue to expect adjusted gross margin improvement in the 180 basis point range for the full year 2017 versus last year driven by the following: ongoing gross VIP savings similar to levels achieved in 2016; a reduction in warranty cost incurred as compared to 2016; partially offset by additional quality features adds which increased product costs, increased promotional costs to protect our brand and foreign exchange headwinds, although to a lesser extent.

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

Now let me provide a few brief highlights for each of our segments.

ORV/Snowmobile segment sales were up 6% in Q2 driven primarily by improved ORV shipments or side-by-sides worldwide and a 5% increase in PG&A related sales. Despite sales being negatively impacted as expected by higher promotional spending, we were able to recognize higher average selling prices on improved mix. Full year sales for the segment are expected to be about flat.

Motorcycle adjusted sales decreased 16% in Q2. Excluding the Victory sales of $54 million reported in Q2 2016, motorcycle sales were up 10%. The company's sales of Indian Motorcycles were up significantly in the second quarter, driven by new products with the introduction of the new Chieftain Limited, Elite and new Jack Daniels Chieftain edition.

Slingshot sales were down in Q2, partially due to tough comparables in the prior year as we shipped additional Slingshot models into the channel in anticipation of the move of production from Iowa to Huntsville. We're not pleased with our performance in Slingshot and are working to increase the awareness of the product, dealer engagement and improve the quality of the vehicle. We are excited about the model year '18 product line-up which will be on display at next week's dealer show.

Motorcycle segment sales are anticipated to be up mid-single digits for the full year as compared to 2016 when Victory sales are excluded.

Global Adjacent Market sales increased 7% in the second quarter. The growth was primarily driven by our excellent quadricycle business and Goupil light-utility business. We anticipate Global Adjacent Markets segment sales to be up mid-single digits for the full year.

Aftermarket sales, which includes TAP, along with our other Aftermarket brands, were up significantly primarily due to the addition of $209 million of TAP sales in Q2. TAP results were in line with expectations and integration plans are progressing well. We added 4 new 4Wheel Parts retail stores including the first store in the Twin Cities metro area that will open this weekend. Pro forma, organic revenue for the Aftermarket business was up approximately 7% in Q2.

Our operating cash flow performance was down 24% from the first half of 2016 as expected, and we anticipate full year cash flow from operations to be down significantly driven by timing of cash outlay associated with prior year promotional and warranty accrual as well as Victory wind-down and manufacturing realignment costs.

Net debt at the end of Q2 finished just under $1 billion at $938 million for the first time since the acquisition of TAP was completed.

Income from financial services was down 1% during the quarter as expected, given our wholesale credit receivable balance was down as a result of lower North American dealer inventories in the second quarter.

The retail credit environment remains stable with approval rates of 62% for the second quarter of 2017, up 2 percentage points from Q2 last year. And our penetration rates were flat with last year at 30%. Retail income was down in Q2 primarily due to lower retail volume. We continue to expect full year income for financial services to be about 10% lower year-over-year.

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

Thanks, Mike. As we enter the second half of the year, we are cautiously optimistic about our end markets. Ag remains weak while oil states are improving but not yet positive, and we still see no signs of the elusive Trump bump. Nevertheless, the global powersports industry outlook is improving for the first time in several years. The highly competitive market is good for consumers and drives us to make better products and deliver improved services, which we are assiduously doing.

The work that Matt Homan and his team are doing to reposition our Off-Road Vehicle business for growth is impressive and extensive. Their multiyear product plans are innovative and inspiring, and while our model year '18 introductions are very exciting, they are just the tip of the iceberg. Our marketing plans and sales teams are set to drive better traffic and profitability for our dealers. We are not yet where we want to be competitively but the overall business is improving.

Steve Menneto has transformed our Motorcycle business since we launched Indian in 2013, and our success with the Indian brand is encouraging but not yet sufficient. With the launch of the exciting new Scout Bobber last week, we've launched 6 new bikes in 2017 and we'll introduce more in the next few days.

From digital marketing to industry-leading electronic displays, we are adding technology to the styling and performance synonymous with America's oldest motorcycle to entice a broad range of customers into the Indian family.

Understandably, the external focus from the press and financial community primarily concentrates on our significant recall-related activities impact on our cost and market share. Internally, we have emphasized the safety of our vehicles and developing repairs in support of our dealers. We have also applied everything we have learned toward driving in improvements in our products and procedures to make Polaris better. Ultimately, this experience will result in a future of higher quality and improved safety, which is good for Polaris and our customers. Better quality, shorter lead times, lower cost are all part of the extensive productivity play that Ken Pucel is driving across his expansive global engineering and operations organization. Momentum and savings continue to accelerate as we seek to become an extremely lean and efficient growth company.

I look forward to seeing many of you at our dealer show and Analyst Meeting in Las Vegas next week. It will provide great opportunity to see firsthand the innovation, dealers and Polaris team members that combine to make us the global leader in powersports.

With that, I'll turn it over to Krista to open the line for questions.

(Operator Instructions) Your first question comes from the line of Robin Farley from UBS.

Two questions. One is just on what is your impression of what industry ATV sales are doing? I'm just wondering how much of the decline there is share loss versus just the ATV industry challenge -- being challenged. And then also your target is to have inventory flat year-over-year by the end of the year, I think, you said. I guess, what does that say about your expectation for sales going into next year if you were kind of expecting shipments to be flat this year and seeing retail sales decline and then you want to have your inventory position kind of flat which you had for this year, is that just being conservative and not expecting any growth in the market next year or so?

Robin, the overall -- we don't have to guess, we see exactly what the overall ATV industry is, and it's down and we were down slightly more. So we did lose a little bit of share but that -- the ATV segment was very highly promotional-driven by 1 main competitor that is trying to flush a bunch of inventory out that had, what I'll call, somewhat ridiculous promotional activity on ATVs, and we can't compete with that, we didn't try to, but we will certainly be better positioned going into the second half. As far as the end of the year dealer inventory position, you have to remember, we have really good product news coming out that we'll ship. A lot of it doesn't really start going until the fourth quarter, so it will be a good bit of channel fill and then there is profile establishment as we transition to RFM. And as we balance all of that out, we still believe that flat by the end of the year is the right position for us to be with overall dealer inventory.

Yes, I don't know Robin that I'd read anything into 2018 at this point, I think with RFM go-live, we're RFM live on ATVs and Motorcycles and with that going live on side-by-sides, we're going start to be able to ship more closely aligned with retail. So we just think that, that inventory level by year end is going to give us that same flexibility. So we'll have more of a perspective on '18 as we come into the third quarter call.

No. That's helpful. Maybe just one clarification, if I could. I think when you transitioned the ATV business onto that system that if I recall you were able to lower dealer inventory by about 10%. So now if you are doing that with the side-by-side business, I don't know if that's the equivalent of expecting then a sales increase maybe in that sort of flat to up single-digit range for next year even with that flat inventory. Is that -- I don't know if you can comment on that.

Yes, what I would say, Robin, is we've already taken side-by-side down, we're down 6% in the second quarter overall dealer inventory. I will tell you that the side-by-side is down significantly more than that. So we are already at a point where we're trying to ship at the same cadence as retail. It puts a lot of strain on the manufacturing environment until we go completely live with RFM. But we have essentially already put our inventory at the right level, essentially give or take.

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

First of all, just a little clarification, Mike, on the FX guidance, that's still a negative as you had listed in your presentation, but given the U.S. dollar strengthening, is that gotten a little less negative for the balance of the year? Just a little more color on that. And then on the ORVs, Scott, you've got -- you mentioned a competitor doing some crazy blowouts in that. And then obviously you guys have easy comps, you got very easy comps here in Q3 at retail. If you kind of parse through that, how are you seeing the core underlying demand, you mentioned oil still weak, but maybe ag's getting a hair bit better. Just a little color on that? And my follow-up would be the acquisitions. How big could you go if a large opportunity arose?

So Tim, let me hit that foreign exchange. We did see a little bit of the benefit in the first half, but year-over-year FX was still just under a percentage point of drag on the top line. And from a bottom line standpoint, we've been out aggressively hedging. So where we've seen gains from a FX perspective, we may not have that same reaction from the hedges that we put in place. We took a conservative view for the balance of the year, just given what we've seen happening with foreign exchange. And if -- certainly if rates hold where they are today, we would see a small amount of upside but nothing that would be material in the grand scheme of the earnings of the company.

Yes. And as far as the overall market, the powersports outlook, as I said, it's the first time in, I don't know, several years that we have commented that we feel better about the industry and we do. The overall, as I said in my prepared remarks, the oil segment actually got a little bit better but remained negative. And it's the comps were I think down 20 last year.

(inaudible)

So oil got better but still not quite positive.

Ag actually got worse. And obviously, we think, over time, that will get better. But overall, those negatives were outweighed by a little bit better sentiment across the rest of the network. So we felt reasonably good about that and are optimistic with our product news and better execution going into the second half that we'll be okay. As related to our capacity for M&A, obviously, I will tell you it's significantly higher than our appetite. We -- even with the TAP acquisition, we maintain a strong balance sheet, we generate a lot of cash, we are in good shape.

So how large would you all feel comfortable going if opportunity was there?

Well, I mean, Tim, we're sitting just under 2 turns of EBITDA. Obviously, comfortable load for the company on an ongoing basis would be probably sitting around 2.5x. But as you know when you're in doing M&A in the initial years, you are going to potentially balloon up. So could the company hit around 3x EBITDA and be able to quickly delever within a year to 18 months, I think we would be comfortable with that, assuming that we didn't see any markers in the economy that had us concerned.

Your next question comes from Greg Badishkanian from Citigroup.

Just 2 questions and follow-up to Tim's question. Would you be interested in something in the motorcycle industry? Or is it other segments if you were to make any type of acquisition?

We don't have an acquisition strategy. We have a corporate strategy, I think you guys are well aware of. We strive to be the best in Powersports PLUS. We like the global market leadership aspect of our strategy and the Adjacent Markets have been really good to us so far from an M&A standpoint. So we'll fit it into those 3 categories, obviously, there's some great motorcycle companies out there. We really are happy with what's going on with Indian right now and we believe that's a great horse to ride.

Okay. And -- so just staying on the motorcycle theme. What's been your ability to recapture, let's say, Victory, potential Victory riders and diverting those towards the Indian brand? Have you had any change in terms of your view of maybe what percentage of those consumers will -- potential future consumers will end up buying an Indian instead of another bike?

Yes, there was a lot of raw emotion when we first made the announcement, and I think over time, we're seeing people start to realize that -- and especially with the new Indian bikes that are coming out, that we make a great bike there. We targeted about 1/3 that would make the transition. So far early on, that seems to be about right. By far, the most Victory customers are buying new Victories. I mean, they're the best one helping us flush out this inventory, which is going, going quite well. But we still believe that we'll be able to get 1/3 of those over, over time. And maybe -- maybe more. I think it's well over 100,000 Victory customers out there and they've had a great experience with those bikes as evidenced by the Net Promoter Scores. So if they get exposure to Indian, perhaps we'll get more than that. But right now, we still feel like that 30% number is about right.

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

Scott, you mentioned a few times this morning about the improvement in the outlook for global powersports. I'm not sure if we've gotten a lot of insight into why that is. Is it U.S.? Is it international or both? Do you think some of the heightened promotional activities enticing new buyers? Is it new product? Because if you look at the 2-year stack basis, your industry is still flat to down and the compares get a little bit tougher in the second half. So I'm just trying to get a little more detail as to what's driving that improved outlook for the industry?

Yes. Well, we've seen, as I said in my remarks, Australia had a record month, Mexico was still very good, Europe's been better for us. So the international market has been quite strong. Obviously, a lot of that's driven by our Indian success in different parts of the world as well. But here the core market in North America is really driven by several factors. One is I think the comps are a little bit easier. The new products that are coming in are quite good. As I said, we think nothing like capitalism and great products to make everybody better, and I think consumers are starting to see the benefit of that. And overall, I think there are pockets, not by any ways an overall market trend, but there are pockets of improved outlooks in some parts of the country.

And we've seen, Joe, some of it come through. Scott mentioned earlier the oil regions, while they were still down, they're only down about 1%. And if you look back to where we were last year, we were down 22%. And it's certainly encouraging that industrial production has been on a little bit of a roll here, that it's improving. And when you think about our customer base, those stats play in our favor. So we use the word slightly because we want to make sure we moderate it, but at least it looks like things are more positive than they were negative a couple of quarters ago.

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

This is Brandon Rolle on for David McGregor. You had talked about the ATV industry growth, could you parse out what the side-by-side industry growth was there? And also, if possible, break out what you saw looking at utility versus rec?

Yes, we don't typically get into that level of detail. I think, as our chart indicated, the Off-Road Vehicle segment, overall, was up mid-single digits. We are encouraged with what we saw in our side-by-side Business. We saw more strength in the recreational than we did the utility side as a company, so that will give you some insight into where we think the growth came from.

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

Can you start off by elaborating a little bit more on Slingshot? I'm curious maybe what hasn't been resonating with the dealers or what has failed to gain traction as well as in the past? And then maybe how you guys have been thinking about what annualized like normal demand in that category would be, which I'm assuming is lower than maybe what you originally thought when you launched the product?

Yes, Jaime, the -- let's look back. I mean, we've sold, I don't know, 25,000, 30,000 of these vehicles to date, so it's been a well-received product. The early excitement was good. We don't feel like that we know that we did not yet all of the performance and quality attributes right on this vehicle. And we have been working really the last 2 years to address those. We feel very good that the model year '18 product is going to be a step-function improvement. But overall, with the recalls that we had to deal with, some of the quality concern, it just didn't deliver what it should for our dealers and our customers from that perspective. On a positive side, we've now got well over 30 states as an auto cycle, so you don't need a motorcycle endorsement to drive it. We understand the target customer significantly better, and we're doing a lot of work with a high degree of urgency to make sure we get back to a normalized demand. Now we're still tracking to a what a stable demand looks like, below that 13,000 magical number that we believe is necessary to be long-term sustainable growth in powersports. But we've got a lot of work to do, but we still feel like that with the efforts we're making, we have a good opportunity to grow a new segment of that market.

Okay. And then in the motorcycle category, it looks like for gross margins should be up for the year, they'll have to tick up pretty significantly in the second half, if I've done the math right. So can you talk a little bit about puts and takes and what is -- what might help boost that higher?

Yes, I think the key driver there, Jaime, is going to be the fact that we are lapping pretty significant recall costs last year that we had with Slingshot. I think if you look back, we recorded a gross margin of 1% in the fourth quarter. So it's a matter of lapping that. But I don't want to understate the benefits that Ken's team are driving around efficiency and lean and that's enabling us to offset partially some of the absorption issues we have from having taken Victory out of the factory. So there's a lot of great work going on, but we are definitely benefiting from the lack of recall cost that we had last year.

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

Scott, you mentioned the dealer engagement as a corporate priority, and that seems like the right priority to us as well. But in hindsight, what do you think went wrong? And what are you doing specifically to drive better engagement?

Well, I mean, what went wrong was our growth slowed down. I mean, as you recall, we have not -- we didn't have a downshift in how we interacted with our dealers from, say, 2013, where we were ranked #1 consistently in almost every dealer survey, you did them, so you know. What happened from '13 to now is that our growth has slowed down significantly and we've thrown a lot of recall-related cost and pressure on our dealers. And so they're -- they have a heightened sense of awareness of what they should expect from OEM. And I will tell you that when the volume was flowing really good for them and for us, I think it was a -- it wasn't the right thing to do, but we both accepted the fact that we weren't as good as a partner as we could or should be. What Tim Larson and Matt Homan and the teams are doing now is saying, where can we be a significantly better partner that helps us and helps our dealers serve our customers better. And that -- there's a lot of work. It's one of our corporate-wide priorities this year. There is detailed action plans. And if you're going to be in Vegas next week, I think you'll see that we're on the path to improvement there. And we've got a ways to go, but we feel good about the directions that we're heading.

And then as a follow-up. Dealers do seem frustrated lately with just the consistency and communication around delivery times. Is that something that Huntsville or other investments in RFM can improve?

No, that's part of the RFM plan. Obviously, the primary purpose of RFM is to get lead times shorter and delivery times more accurate. But there's also an element that we're putting in to drive much significantly improved communication and awareness of delivery time. I will tell you that part of the frustration of dealers around delivery is our purposeful effort to take ORV inventory down 6% in the quarter. As we get ready for model year '18 shipments and ready to transition for RFM, we purposefully tried to keep inventory in a position where we could manage it better than we thought their orders could. So obviously, that gets better with RFM and we're excited about what that means for us and our dealers in the second half.

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

Two questions. I guess, the first one is I know you sort of talked about you don't want to really get into utility versus recreational. But if you look at some of the data you provided, RZR shifted to more normal rate, but then RZR dealer inventory was still down double digits, and overall, side-by-side retail is up low single digits, so I guess implicit in that, is that RANGER's having a tougher time, is that true? And can you just talk a little bit about RZR versus RANGER?

Yes. Well, remember the comps for RANGER were significantly easier than the comps for RZR last year in Q2. So I think the improved relative performance is really a year-over-year comparison. I hope you're going to make it to the Vegas next week. One of the things that Matt Homan will do is make a very clear, let's not call it a reconciliation, but essentially -- he'll describe the market and what's important and where things are. And if you make time to attend the reveal, I think you'll have a good education and awareness of how these markets play together.

Okay. I will look forward to that. And then second just following up, I guess, on Craig's question on the dealer. One of the things we've picked up as well is in terms of some discontent is it feels like increasingly some of the dealers feel the level of competition between dealers has been too high, and I know again your remarks you talked about engagement. There seems to be a little bit of an investor narrative that you're overdealered. I guess, I just wanted to give you the opportunity to comment or respond to that?

Do you want to call it investor narrative or a short thesis?

Investor narrative.

Yes, let's go with that. I will tell you that I think the preeminent dealer network in North America is Honda. It's really extensive, it's really good, they've got a little bit more than we do. We feel really good about our overall dealer network for off-road vehicles. There's tactical work to be done as we manage that. We want more better dealers and less bad dealers, of course. But we've got a very good plan to deal with that. But I think, in aggregate, the narrative that there's too many to serve our customers when you have a broad array of products like we have is simply incorrect. That said, the competition between dealers, it doesn't matter if you have 700 or 1,700, if you have undisciplined dealers, when you don't follow Matt pricing, you are going to have some of that. So one of the efforts that Matt and his team are driving right now is to make sure that we drive better consistency and performance to protect our brand and protect the pricing at the dealers. And obviously there's a lot of legal ramifications as you try to deal with that. We're following our efforts very closely. But obviously, we are comfortable with our dealer network, we like our dealer network and, obviously, there's opportunities to improve it and we're taking those steps.

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

Maybe a little bit of follow-up, I apologize if this is a bit repetitive, but I just want to crystallize sort of the ORV market share dynamics. It seems by the math that we can do that side-by-side lost share, maybe significant share in the quarter. It seems like things were set up for you gain share just given what was going on a year ago. I guess, a, did you lose share in side-by-side? And b, why would that be the case given what we're comping against?

All right, so the answer is no and no. No, we did not lose significant share. And no, we didn't expect to gain share given where we are from a product news standpoint. Now as we get into the second half, we have a model year '18 products and all the news that we'll announce next week, we feel better about our ability to compete. But we expected and did lose market share in off-road vehicles in the second quarter. It was in our -- embedded in our guidance.

But just so I'm clear, you lost the share but not significant share in side-by-sides? Is that how to think about it?

I would say.

Okay. And then my follow-up. So you talked about 2Q -- really to your last point, 2Q sales and earnings were ahead of your own internal expectations. Can you flesh out where exactly, because ORV retail number, down low single digits, certainly the improvement wasn't as much as the easing comparison there. But you did raise your guidance for that segment on a wholesale basis. So was it maybe ASPs, which has certainly been a pleasant surprise I think for us in the first half? Was it more sort of how you're thinking about the back half as opposed to 2Q? What beat your expectations at least on the ORV side in 2Q? And sort of what led to the raised guidance for the full year?

Yes, I think, James, overall, it's that we performed better in off-road vehicles. And obviously you can read into that, that it was more predominantly around the side-by-side business. So that drives a more favorable ASP environment. That said, we did hold to the overall gross margin improvement, 180 basis points, so you would -- one would think that we would see additional volume leverage. That is being offset, as we indicated in my prepared remarks, by slightly elevated warranty versus our expectations. We still anticipate being down substantially from where we were last year, but we have had a few additional recalls this year that we had to build in. And we also suggested that we are up a bit in our operating expenses, which is also offsetting that. Some of it's legal-related, some of it is that we've pushed a little bit more into the engineering pipeline given some of the product development plans that we want to ramp up here in the second half.

Your next question comes from the line of David Beckel from Bernstein Research.

I noticed that one slide in particular was missing this quarter, the strategic objective slide. Can you -- will you be providing an update on your goals next week by chance? And is there anything you can share kind of today in terms of what we might be able to expect next week on that front?

Yes. No. The absence of the strategic objectives was nothing more than us deciding we'd like to spend more time on Q&A than talk to a slide that you've all seen before. As we said, we will be -- because of the dramatic downshift in our overall market and the elevated recall expenses we've had in the last year or so, we did say we're going to revisit, simply because of the CAGR, the financial objectives of our long-term strategic plan. Part of our meeting in Vegas next week is a board strategy session. We will use that board strategy session, which happened after the Analyst Meeting, to talk about what the 5-year outlook for Polaris looks like. We obviously feel very, very good about it. There is a lot of great activities. It'll probably be sometime late third quarter, maybe into the third quarter earnings call where we actually take what we work we do with the board and digest that into what we think are reasonable financial targets to share with the financial community.

Got it. That's helpful. And a motorcycle question. I'm wondering given -- I know Indian is doing extremely well, but given the sort of difficult backdrop upon which it operates, are you finding it harder to find motorcycle dealers willing to add an Indian brand? Just curious what your current dealer pipeline is looking like now relative to maybe a year or 2 years ago?

Pipeline looks great. Yes, there's a lot more people that want to add Indian, and then we are willing to let have Indian. That said, our -- and I think we've said it previously, our focus right now is driving profitability within our Indian dealerships. And the way we do that is drive more volume in those dealerships. And obviously, we are doing that with higher growth. But we have to be judicious in where and how often we add dealers, so we're being careful with that. And we think by being careful, the quality of the dealers we're adding is exceptionally high. So obviously there is a long way to go in building out the overall dealer network. We're going to do that carefully and methodically, but there's no lack of demand for people wanting the product.

Your next question comes from the line of Drew Lipke from Stephens.

I just -- I want to go back to ORV. So -- and just so I'm clear. Your guide implies wholegood ORV down slightly in the back half of the year after just being up roughly 3% in the first half. You've got an easier comp in the back half of the year relative to the first half. You talked about dealer inventory being flat. You mentioned side-by-side shipments being roughly in line. Historically, second half ORV sales are greater than first half. You're talking about kind of improving trends and your ability to compete with the model year '18 rollout. I'm just -- I'm trying to reconcile kind of the down slightly on ORV wholegood with all that commentary. Is there anything you'd point to that I'm really missing here?

Yes, no, I think you got it right in terms of the shipment, equal in retail. And essentially we are calling for things to be flat to slightly down. What you have to remember is it's about the 2 different quarters. We will certainly see a substantial uptick in the third quarter. I would expect to see very positive organics because if you remember, in the third quarter of last year coming out of the dealer show, within about a month we had stopped shipping to go through the revalidation of our model year '17 product pipeline. And so we were down substantially. That said, while we didn't fully recover the year in the fourth quarter, we did have a plus 4 from a shipment standpoint. So when you combine those 2 together and you take into account that we had very strong PG&A in the back half of last year, some of which was attributable to the parts that we were shipping in, the kits that we were shipping into the channel to support the recall, those are going to be your 2 reconciling items. Now we're obviously going to be pushing as hard as we can, but essentially aligning with what we think is going to happen in retail, that's consistent with our outlook in the back half.

Okay. And then just my follow-up. I'm curious just on the cost structure, thinking maybe a little bit longer term in terms of what's more onetime in nature versus maybe what's more recurring as we think '17 and then think '18, '19 and thereafter. With the Victory wind-down costs that are onetime, the gross profit about I think $70 million, you got the TAP which is $15 million. You've got elevated warranty costs and now maybe a little bit higher on the recall, and I don't know if you actually quantified that incremental recall costs this year. And then maybe what's more recurring being higher purchase materials, labor cost, increased safety needs, maybe continued promotional environment and then the offset on VIP. Can you kind of bridge all that for us thinking maybe longer-term cost structure (inaudible) process?

Yes. You sped a lot of -- I think you spoke faster than I did during the prepared remarks. Well, so here's how I think about it. I mean, as I mentioned, our warranty costs are going to be down substantially this year versus where we were last year. The additional warranty that we have this year related to the recalls is relative to our expectations. So as you think about '18, we would expect to see our warranty costs continue to come down. I wouldn't suggest that by '18 we get down to where we were pre the recall activity, I think it's going to take us a little bit of time. And the work that Ken and his team are doing to improve the product quality, those things are going to take time to root and improve out in the warranty rates. What I would point to though is if you look at Q2 and you look at the fact that we've got 160 basis points worth of margin improvement in an environment where our promo is eating up a couple of hundred basis points, it just speaks to the power of the VIP initiative. And when you think about that coupled with getting more volume through our factories, which admittedly are underutilized from a capacity standpoint, we're going to be more than able to offset the quality and feature adds that we will continue to have, and some of that's already built into the numbers this year, as we indicated on our gross profit slide. So we feel very good about the cost setup for the business. We do need some volume to move that through the system, but we think with the activities that we've got underway relative to the safety and quality of the product as well as addressing our manufacturing footprint, as we talked about earlier, and also improving the portfolio performance of the business with the exit of Victory, we feel very good about the profit setup moving out of 2017.

Your next question comes from the line of Seth Woolf.

Seth from Northcoast. Just wanted to start on the ORV market. ATVs, the entire industry seems to be down, it's underperforming side-by-side significantly. We've heard that with some of the promotional intensity you're seeing in side-by-side, it's caused consumers to just look at the value proposition and you're seeing an acceleration in cannibalization to side-by-side. Wondering if you think there is any merit to that or what's going on. And then what are the implications for margins longer term? Is it still going to be accretive even if it's coming from side-by-sides that are heavily promoted? And then secondly, Mike, I think you said -- you said something about warranty getting close to pre recall level, so just wanted to confirm you think you can get back there. And if so, how long is it going to take?

The overall ATV market is -- we believe, obviously, it's been long-term trend of cannibalization. I mean I think everybody knows there was 1 million units in '04, '05, time frame and it's come down. We believe it's about where it's going to be. There'll be times like this where it's weak and then it'll get a little bit better. There is a lack of product news in ATVs, not just with Polaris but across the news, across the segment. And as you know, innovation really drives dealer traffic and activity in the market. So most of the innovation is happening in side-by-sides, most of the promotional activity is in Side-by-sides, and I think that's what's driving the near-term shift. But we do believe that the overall ATV market is going to be about flat to where it is right now over time.

Yes. The only thing I would add to what Scott said, Seth, is ag was down 7% in the second quarter versus being down about 1% last year, so that certainly doesn't help when you think about the consumer base that we sell into. As it relates to warranty, yes, we're obviously, we are striving given all the investments that we've made that we want to at least get back to where we were, if not better. But what I would caution you is that it's going to take us a bit of time. So we're talking more over our strategic planning period than we are here in the next couple of years.

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

Can you talk about your experience in the rec/ut segment, you've heard about recreation and utility, but not rec/ut with the General both in the quarter and overall, being that it's a relatively new category from you that you are now comping against?

Yes, General's been an exceptionally good product for us. We felt like it was an open segment of our offerings. And we felt like we designed a good product, we're continuing to improve and refine it over time. So that's been reasonably good. Obviously, we think there is a lot of opportunity for us to continue to grow that. It's a -- the segment itself just offers a lot of opportunities for innovation. So we're comfortable with what we've got there, but we still think there's a lot of opportunities to do better.

Great. So more white space opportunities, I guess, in both models. And how about distribution on the General?

Distribution is pretty good. Obviously, as we would move to RFM in a more disciplined way, it's our opportunity to keep the inventory levels go and then flow. And really part of RFM is just giving the dealers more of exactly what they want, and we think that general offers a very good opportunity for us to demonstrate how that process will work.

Okay, thanks. That's all the time we have. We appreciate everyone participating in this morning's call. And for those of you going to Vegas next week, we've got some good things to show and tell next week, so we look forward to seeing you there. Thanks, again and goodbye.

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