Polaris Inc. (NYSE:PII) Q3 2023 Earnings Call Transcript

Polaris Inc. (NYSE:PII) Q3 2023 Earnings Call Transcript October 24, 2023

Polaris Inc. beats earnings expectations. Reported EPS is $2.71, expectations were $2.69.

Operator: Good morning. And welcome to the Polaris Third Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. [Operator instructions] Please note this event is being recorded. I would now like to turn the conference over to J.C. Weigelt, Vice President, Investor Relations. Please go ahead.

J.C. Weigelt: Thank you, Gary, and good morning or afternoon, everyone. I am J.C. Weigelt, Vice President of Investor Relations at Polaris. Thank you for joining us for our 2023 third quarter earnings call. We will reference a slide presentation today, which is accessible on our website at ir.polaris.com. Joining me on the call today are Mike Speetzen, our Chief Executive Officer; and Bob Mack, our Chief Financial Officer. Both have prepared remarks summarizing the third quarter, our expectations for the remainder of the year and some initial thoughts on 2024. Then, we’ll take your questions. During the call, we will be discussing various topics, which should be considered forward-looking for the purpose of the Private Securities Litigation Reform Act of 1995.

Actual results could differ materially from those projections in the forward-looking statements. You can refer to our 2022 10-K for additional details regarding risks and uncertainties. All references to third quarter 2023 actual results and 2023 guidance are for our continuing operations and are reported on an adjusted non-GAAP basis, unless otherwise noted. Please refer to our Reg G reconciliation schedules at the end of the presentation for the GAAP to non-GAAP adjustments. Now, I will turn it over to Mike Speetzen. Go ahead, Mike.

Mike Speetzen: Thanks JC. Good morning, everyone. And thank you for joining us today. This morning we posted third quarter results that were slightly lower than our original expectations, driven by elevated manufacturing costs and an increasingly cautious consumer environment. which resulted in lower shipments. Despite these headwinds, we posted share gains across all of our segments for the quarter, and we had record PG&A results that were bolstered by the broadest portfolio and all Powersports. We also had an incredibly successful Off Road dealer meeting in July and marine dealer meetings in August, both with positive feedback from dealers regarding our new products. We are certainly operating in a dynamic environment where we have seen declining consumer confidence, given persistent inflation, coupled with even higher interest rates, and rising consumer debt.

We saw this impact retail more than we anticipated in the third quarter, and anticipate this to continue into the fourth quarter. Additionally, dealers are taking a more conservative position, given a slower retail environment, and rising flooring costs associated with higher interest rates. Despite all this, I remain confident in our ability to excel in this environment, as evidenced by our share gains in all three segments in the quarter, and a very positive reaction to our recently introduced new products. Our teams continue to closely monitor the environment, and we believe our revised guidance accounts for what we know today. Turning to our third quarter performance, sales declined 4%, driven by lower shipments relative to a year ago, as well as higher finance interest.

If you will recall, last year we had elevated shipping in the quarter to alleviate low dealer inventory levels, and to catch up on motorcycle shipments that have been constrained earlier in the year. North American retail was up 5% in the third quarter. The promotional environment picked up a little in Q3, but still remains lower than 2019. Additionally, we believe we are successfully targeting potential customers, with the right promotional offers to drive dealer traffic. While retail was generally lower than we had expected, we further strengthened our share position in each of our three segments. This included achieving the notable milestone in North America of being the number one motorcycle company in the mid-sized category. Margins were down due to continued headwind from foreign exchange, as well as increased pressure from floor plan promotional costs driven by higher interest rates and higher dealer inventories.

Shipping volumes were also lower as we lapped a strong shipping quarter last year. The mix was another contributing factor to lower margins as we saw a slower than expected ramp up in production of our premium Off Road products including our new Polaris XPEDITION and RANGER XD. I would note that our Marine team did a good job reacting to lower demand signals early in the quarter and made required cost adjustments to protect margins. On the manufacturing front we have two big themes occurring in our Off Road business. The first which is encouraging is that we had some of our strongest clean build days and weeks as we neared the end of the third quarter. These are days where vehicles came off the line ready to be shipped versus entering a rework process.

Our teams believe they can build on the success in the fourth quarter. While this is encouraging, the later than anticipated improvements did impact our ability to get many high-demand vehicles and dealers on time. The second theme is that we continue to build at a much higher cost than we should be. The supply chain has improved quite a bit but our ability to more cleanly and efficiently execute has not. There are several factors that impacting this. Over the last few years our plants have contended with the pandemic, labor shortages, park shortages, new production lines and facilities and in the third quarter the complexity of the startup of manufacturing of our new premium products. These rapid and drastic changes have brought on an inefficient cost structure and mode of operation.

As we appear to be entering a slower growth time in our industry there is no better time than now to address these inefficiencies. We’ve deployed key lean resources into the most troubled facilities and remain committed to a culture of continuous improvement. While this is disappointing it is very fixable and we will show the best of Polaris’ fighting spirit as we work aggressively to not just improve our performance but to make it better than it has ever been. Execution is key here. And I believe we have the right team, as well as the right strategy to remediate the situation. Considering these manufacturing inefficiencies and weaker than anticipated end markets, we’re narrowing our full year sales guidance to the lower end of our previously issued range and lowering our margin and adjusted EPS guidance.

Bob will provide more detail later in the call, but we plan to remain competitive and gain share in this dynamic environment while actively managing costs. Our goal is to continue to invest in the business, strengthen our operations, and emerge from this stronger than we entered. Now let me share some thoughts related to customer trends we’re seeing. We’re closely watching software retail trends that have extended into October. In Off Road, these trends are pointing to a cautious outlook in utility and continued weakness and recreation. We missed our third quarter retail expectations, which was the result of weaker than anticipated end markets coupled with the slower ramp up of new product shipments, and continue constraints on manufacturing our premium products.

Retail continued to be strong in new and premium products. Our dealers are telling us they have sufficient inventory of base and value models and would prefer to see higher volumes of our premium NorthStar products in more of our recently launched Polaris XPEDITION and RANGER XD, which is obviously a big focus for us in the fourth quarter. For On Road, Q3 retail was down low teens, given a slower market and difficult comps to last year when motorcycles were retailing much later given constrained availability early in the year. I would note that our heavyweight bikes are seeing more pressure than our mid-sized category. In Marine, softness continued and even somewhat accelerated. We’re now over 90% through the selling season, and dealers seem cautious given negative headlines covering the broader market as well as elevated interest rates.

Given the selling season has mostly wrapped up and the continued softness through the first three quarters of the year as well as sufficient dealer inventories, we have adjusted our Marine sales guidance downward. Pressures have mounted on our retail assumptions, but we still expect to grow retail in the fourth quarter, albeit at a slower rate than previously expected. Growth is expected to be driven by snowmobiles as well as our new products. We also have a favorable comparison in snow that should help contribute to retail growth in Q4 as we are on track this year to ship snow check units before the season begins versus much later shipments last year. As many of you saw firsthand at our dealer meeting in July, we launched two new categories in the Powersport space and could not be more excited about the opportunity ahead of us.

Polaris XPEDITION, which started shipping in Q3, has seen strong demand for our premium models, and we’re working hard to meet this elevated demand. In addition, feedback from early customers has been very positive. The RANGER XD is the first extreme duty side-by-side with industry-leading torque, payload, and towing capacity. Shipments are slate to begin in November, and dealers are telling us they have high interest and allocations to customers already established. Also important to remember the RZR XP launch from earlier this spring. This product has been well received by dealers and customers. Importantly, the RZR XP hits at the largest sub-segment of the recreational market. It’s a multi-terrain product that makes up approximately 35% of our RZR sales, and our share in the multi-terrain space is over 2x our nearest competitor over the last five years.

This is certainly a product we love having in the portfolio and should not be overlooked in our share gain strategy. In addition to our new vehicles, we also launched the next generation Lock & Ride with our all new Lock & Ride MAX cargo system. The new system adds an unmatched level of adaptability and provides customers with virtually limitless configurations to best match their needs for every journey, task, and activity. Lock & Ride MAX is yet another step in our industry leading parts, garments, and accessory strategy, where we’ve seen significant content increases across all product categories related to new accessory and attachment offerings. While they are not explicitly mentioned on the page, our On Road and Marine segments also had incredible new product launches that reflect our continued commitment to industry leading innovation.

It was an exciting new product year at Polaris, and we believe these new products can help us gain share in the fourth quarter and into 2024. We continue to be in a much healthier dealer inventory position relative to last year. Dealer inventory has improved, given better production and supply chain dynamics, coupled with softening demand in some markets. I would note that dealer inventory is still below 2019. As I mentioned earlier, we’re continuing to evaluate and adapt our mix, given current demand trends. We’re putting more emphasis on prioritizing RANGER XD, Polaris XPEDITION, and Ranger NorthStar lines during the fourth quarter, as this is where we see the greatest demand. We’re watching inventory levels closely and are ready to take appropriate steps necessary to manage inventory in Off Road and On Road.

Similar to how we’ve pulled back production in marine in the face of weakening demand and rising dealer inventory. Wrapping up my comments on the quarter, While the results are short of our expectations, we did gain and share and see strong demand for our new products. We’re excited to get these new products into the market so consumers can again experience what Polaris leads the industry in innovation. We still have work to do operationally to ensure we deliver more consistently and at a lower cost. As I said, I am confident in the team and their ability to execute. We’ll continue to watch retail trends and are prepared to adjust our business model accordingly. We’ll continue to invest in innovation and to improve our operations. The strategy we laid out last year and talked about at our Capital Markets Day in July remains unchanged and I expect our team to deliver on all aspects of the strategy, which we believe can generate attractive returns for our shareholders.

I’ll now turn it over to Bob who will summarize our third quarter performance and provide additional details for the remaining balance of 2023, including guidance and expectations. Bob?

Bob Mack: Thanks, Mike. And good morning or afternoon to everyone on the call today. Third quarter results were driven by lower shipping volumes and higher finance interest, impacting both sales and margins. Manufacturing costs remained elevated versus expectations heading into the quarter, which tempered much of the expansion opportunity. Promotions continue to be higher on a year-over-year basis given abnormally low levels last year during the third quarter. Adjusted EPS was down 17% for the quarter. Positive contribution from tax and share account was more than offset by the previously mentioned headwinds to margin, as well as higher net interest expense, which was up over 60% relative to last year, primarily due to higher rates.

As Mike mentioned, PG&A had a record quarter for revenue as we continue to benefit from the broadest portfolio in Powersports, as well as new innovation such as Lock & Ride MAX that is being very well received with our new products. In our Off Road business, revenue increased 6% driven by strong growth in utility, snow, and commercial. This was partially offset by a decline of approximately 20% in recreation. North American retail was up 5% in ORV with double-digit contributions from utility and crossover lines, which include general and the new Polaris XPEDITION. Industry data shows we took share across the ORV portfolio. Snow season is off to a good start, and what is encouraging is that we are well on track to deliver customer orders before the ‘23, ‘24 riding season begins, which was a key goal of ours this year.

Margins in the quarter were pressured by foreign exchange, finance interest and unfavorable mix. Another factor which Mike mentioned was elevated manufacturing costs that did not subside during the quarter. We do expect share gains going forward as we pick up production of our new products and allocate promotion dollars effectively to drive customer purchase patterns. It remains an exciting time in our Off Road segment as we continue to lead with innovation and enter new spaces within the Powersports market. Switching to On Road, our fifth straight quarter of motorcycle share gains was driven by our strong product portfolio and healthy inventory. During the quarter, our mid-sized portfolio earns the distinction of number one market share in North America.

This is another achievement in the rich history of Indian Motorcycles. Our mid-sized bike portfolio consists of the Scout, Scout Bobber, and Scout Rogue, all of which have an iconic style rooted in the 120-year history of Indian Motorcycles while offering modern performance and technology to our riders. North American Indian Motorcycle retail was down low teens driven by a challenging backdrop and increased competition. On Road revenue was down 19% due to lower ship volumes given industry softness combined with comparing against our third quarter last year, which saw a large catch-up on motorcycles with black painted parts given production issues earlier in 2022. On Road gross profit margin was up 335 basis points driven by favorable product mix, partially offset by promotions driving lower net price.

This marks the fifth straight quarter expanding margin over 250 basis points as the On Road team continues to deliver on its profitability plan. In Marine, the industry continued to be negatively impacted by slowing consumer demand. Industry data shows the pontoon market is down almost 10% year-to-date as customers continue to be deterred from purchasing by high interest rates. Despite these industry headwinds, our Marine portfolio did gain share in the quarter led by Hurricane in Bennington. Gros profit margin was down 338 basis points given top line pressures. However, our team continues to actively manage the variable components of their cost structure to protect profits. Most of the season is behind us in Marine and we are busy planning for 2024.

At the August dealer meeting, we launched some new value boats under the Bennington brand called the S and SV. We know dealers are closely watching inventory and we want to support their ability to have the right boat mix. We believe the S and SV Bennington boats attract a different customer relative to our legacy portfolio and we look forward to helping dealers broaden the options they offer to customers with more approachable pricing and features. Moving to our financial position, we continue to see our balance sheet as a competitive advantage. Cash generation continues to trend favorably and our net leverage ratio continues to be in a healthy spot at 1.7x. Our cash flow in the quarter was impacted by late quarter shipments in Off Road, as well as the delayed wire transfer from our Polaris Acceptance joint venture.

This pushed a normal month-end payment into early October. Absent these items, which provided strong cash inflows the first week of October, our leverage would have been approximately 15 basis points lower. We have repurchased 1 .4 million shares year-to -date and we are well ahead of our target to repurchase 10% of our outstanding shares before the end of 2026. We believe we are set up well for a variety of scenarios in the broader market with our balance sheet and cash generation capabilities in 2023. Now let’s move to guidance and our current expectations for 2023. Given what we saw in Q3 in our updated assumptions for Q4, we are slightly narrowing sales guidance towards the bottom of the previous range and bringing margin guidance down, which lowers our adjusted EPS guidance.

Regarding sales, we are lowering the top end of guidance and now expect sales to grow 3% to 5% this year. While we have lowered our Off Road sales expectation, which has a negative impact on mix, we still expect Off Road sales to grow in the high single digits. We are moving On Road to flat, given the softness we have recently seen in the industry and moving marine down as well given year-to-date trends. We do expect Off Road to have a sizable contribution from snow in Q4 as we remain on track to ship a significant amount of model year ‘24 Sleds in the quarter. Shipments of Polaris XPEDITION and anticipated shipments of RANGER XD are also expected to have a positive impact on sales and retail. Share gains are expected to continue for Off Road as well on the back of these shipments.

In line with prior expectations, net price will be a fourth quarter headwind, driven by the lapping of the benefit we have seen from the price increases in a stronger promotional environment. Finance interest will also continue to be a headwind. Margin guidance is being lowered given what we saw in Q3 in the trends we expect to continue into the fourth quarter. While we knew we had over 130 basis points of margin headwinds heading into the year associated with higher finance interest and FX, we had planned to overcome these macro headwinds with efficiencies on the operation side and improvement in warranty. While we have seen year-over-year benefit in these areas, they are not to the extent that we had planned. On the operation side, benefit from improved logistics costs have been somewhat offset by higher plant manufacturing costs that have not subsided.

While we see the typical startup inefficiencies associated with launching major new products as temporary, they remain a headwind for Q4. Production of the RANGER XD is late relative to our initial thinking, we now expect to start shipping the product in November. As Mike mentioned, going forward, we see significant opportunity to refocus on lean principles to improve the overall efficiencies of our plants. It is also worth noting the mixed benefit we are seeing in the first half of the year has gone the other direction with delays in new products and lower than previously guided Off Road sales. Operating expense dollars are expected to be sequentially flat in Q4, therefore the same factors that are impacting gross margin are also impacting EBITDA margin.

We will continue to contain costs where we can and certainly move fast in this area if we see our markets deteriorate further. Adjusted EPS is now expected to be in the range of $9.60 and $10 or 8% to 4% percent below 2022. We are not expecting any material changes in interest expense or share count, but we are expecting our tax rate to be closer to 20% as we close out the year. For the fourth quarter, a few things to note. We expect retail to be up year-over-year in Off Road, partially offset by On Road and marine, the main driver being snowmobile ship and retail. As noted earlier, margins are expected to be down year-over-year. We have significant other cost headwinds from higher finance interest, debt interest, and foreign exchange that we expect will persist.

In summary, there are some puts and takes in the third quarter, but our longer-term goals of driving leadership in the powersports space and delivering on our financial goals remain on track. We have work to do and the team remains focused on the task at hand. It was encouraging to see share gains in the quarter, which are expected to continue. It was also great to see another strong quarter from our On Road team. We believe our long-term strategy can generate strong shareholder value and our teams are working hard to make that happen. With that, I will turn it back over to Mike to provide some early thoughts on 2024 and summarize our call today. Go ahead, Mike.

Mike Speetzen: Thanks, Bob. The dynamic environment I spoke about earlier is not expected to abruptly end on January 1, and thus we need to be vigilant and agile in how we manage our business going forward. When I turn on the news, it does seem like a parade of horribles facing the consumer, with higher interest rates, persistent inflation, mounting credit card debt, student loan payments returning, and other significant domestic and global events. However, we are focused on adjusting and adapting to these external factors. We expect to manage production, shipments, and spending consistent with what we see an ongoing demand trends and will stay close to our dealers. We just got started with Polaris XPEDITION and RANGER XD is next.

Therefore, we expect those to be nice contributors to retail and share gains into next year. Innovation remains key to our strategy, and you should continue to expect innovative new products each year from our teams to help strengthen our leadership position in Powersports. Tackling the manufacturing inefficiencies is critical to our long-term strategy to expand EBITDA margin. Thus you should expect to hear more about this opportunity when we formally provide guidance in January. Part of this will help with lowering working capital through inventory management, which should result in positive cash generation. No matter what happens externally, cash remains king and we have a strong track record of investing that cash and earning high returns for our shareholders.

And I do not expect this pattern to change. I strongly believe our team with focus execution can deliver a strong year with share gains and margin expansion in 2024 by focusing on innovation, improving manufacturing efficiencies and implementing smart capital allocation decisions. Wrapping up, it was encouraging to see share gains across all three segments during the quarter and to see record results from PG&A as well as strong margin expansion in On Road. The feedback from dealers at our dealer meetings over the summer gave me renewed confidence that we were focused on the right areas to drive strong results. While we are tracking software retail trends, we believe that we have an attractive lineup of products to enable share gains with new products as well as premium products that remain in high demand.

Efficiencies within manufacturing are a huge opportunity for us. And while they will not be achieved overnight, we are focused on improving them through an enhanced lean environment. We remain confident in the strategy we laid out in 2022. And with all long term strategies, their objective is to see through good times as well as bad. With focus execution, I believe we can end the year strong and emerge stronger to continue marching towards our 2026 goals. We thank you for your continued support. And with that, I’ll turn it over to Gary to open up the line for questions.

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Q&A Session

Operator: [Operator Instructions] Our first question is from Joe Altobello with Raymond James.

Joe Altobello: Thanks, guys. Good morning. I guess first, Mike, for you, I wanted to dive in a little deeper into your initial thoughts on 2024, you did make the point that you expected –to be continued retail softness to extend into ‘24. But if we look at Q3, retail was up five, you expect retail growth in Q4 as well on an easy compare. So is the base case for ‘24 right now in terms of retail flat to up modestly or somewhere in that neighborhood?

Mike Speetzen : Yes, Joe, we’re still working through the first views of next year. Obviously, we saw a fair amount of change happen relatively quickly here in the third quarter. On our last call, we talked about July retail looking good. And then obviously August and September start moving in a very different direction. So we’re still working through that. I think the key point for us is that we anticipate that the pressures are going to continue. The Fed has clearly signaled that they’re not going to do much on rates here for the balance of the year. We anticipate there could be other action next year, but I anticipate interest rates are going to continue to remain headwind. And I think when you look at the broader macro, even though the talk of recession had come down, it’s kind of bounced up just a little bit.

And so we do think consumers are going to continue to have a cautious mindset given everything that’s going on in the environment. That said, we do feel good about the new products. We think that’s certainly going to be a tailwind as we get into next year. And given our poor performance from an efficiency and margin standpoint, even in what I’d call a flattish environment, we do anticipate that we can improve margins next year with the level of cost discipline that we’ve got brought back into the business. You’re starting in the fourth quarter and we’ll continue to gain momentum as we go into next year. Operating expenses for us have been well managed and we’ll continue to do that as we head into next year. And our guidepost is going to be dealer inventory.

We’re still below where we were in 2019, we’re going to continue to watch that, make sure it remains at the right levels and react accordingly. So tough to call what we think next year is going to be. We need to get a couple more months under our belt, see how things are headed for next year and then we’ll talk more in January.

Joe Altobello: Understood. Maybe just to kind of follow up on that. How does the software and your term retail outlook impact your ‘26 target? Does it make the past a little bit more back end loaded than you thought back in Nashville?

Mike Speetzen : I don’t think so. Clearly the biggest headwind that we’ve got is really around the margins. And I’d make a couple of comments. Number one, the thing to keep in mind and we don’t use this as an excuse, but between interest rates impacting our flooring costs as well as foreign exchange, we’re dealing with 120 basis points of headwind right out of the gate versus when we put the targets out originally. All that said, given the deterioration in productivity we’ve seen in our plants over the past year or so, we see a pretty ample opportunity. I actually look at it very positively because these are things well within our control and we can get after that. When you look at revenue and you look at the other measures, I feel very confident about that.

The margins we’ve got some work to do, I think you should expect to see progress on that into ‘24 and I think we’ll be on the right trajectory to get ourselves into that mid to high teens EBITDA level that we committed to.

Operator: The next question is from Craig Kennison with Baird.

Craig Kennison: Hey, good morning. Thanks for taking my question. I appreciate the candid call here. I wanted to ask first about the utility segment. That’s an area that has held up better in recent quarters, but it seems to have changed recently. Maybe shed some light on that.

Mike Speetzen : Yes, I’d say a couple of things, Craig. We have seen some softening in the commercial side. As we’ve talked about in the past, we’re a top provider of equipment into big rental companies and we have seen some pullback and hesitation as they’ve seen some of the commercial building projects either get delayed, pushed out or canceled. So we have seen some of those things. Then I would tell you that we’re seeing similar dynamics in that kind of the value to midline side of the market where consumers are a little bit more sensitive to interest rates. And that certainly has impacted not only the rec space, but now has crept in to the utility space. All that said, as we talked about in our prepared remarks, we continue to see a high level of interest in those premium products, things like NorthStar.

Obviously, the XD hasn’t hit dealer showrooms yet, but we know from talking to dealers, they’re anxious to get the product on the floor and they’ve already got a number of customer commitments. So we continue to feel good about that high end of the market. We just see a little bit of slowdown relative to expectations in the middle to lower end of the utility market.

Craig Kennison: Thank you. Then on slide 4, you mentioned that 70% of your customers are new customers. That seems like an unusually high number. Maybe you can just tell me what that has been recently and then what it might say about repurchase activity among your existing customers.

Mike Speetzen : Yes, I mean it’s still in the range that we’ve seen. I would say over the past two to four quarters, we’ve probably seen that number in the mid-60s. So I don’t know statistically that I would say that it has moved dramatically relative to what we’ve seen both historically as well over the last few years. We have seen some slowdown and repurchase rates, the near term repurchases rates, which isn’t surprising given the comments that we made around the health of the consumer and just some of the other dynamics. Consumer has an existing vehicle. They probably are more apt to put accessories on it or let that vehicle run for another year or so until they repurchase. So we don’t see anything in those numbers that has us overly concerned.

As we talked about in the prepared remarks around customer dynamics, the search, the configuration builds, all those types of things remain healthy, not just versus last year, but in many cases relative to 2019. So we know there’s still interest in the category. We think people are just hesitant to make the purchase right now relative to what we were expecting.

Operator: The next question is from Robin Farley with UBS.

Robin Farley: Thank you. Just if we could return to the long-term targets for a moment. I know you mentioned a bunch of the changes that you still expect to come over time with the manufacturing improvement. Could you circle back to kind of your top line expectations and what you kind of thought about with those 2026 targets and whether that’s impacted by starting to see utilities soften here or just how we should think about the top line part of the long term. Thanks.