Polaris Inc. (NYSE:PII) Q4 2022 Earnings Call Transcript

Polaris Inc. (NYSE:PII) Q4 2022 Earnings Call Transcript January 31, 2023

Operator: Good day, and welcome to the Polaris Fourth Quarter and Fiscal Year 2022 Earnings Call and Webcast. . 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, Betsy, and good morning or afternoon, everyone. I’m J.C. Weigelt, Vice President of Investor Relations at Polaris. Thank you for joining us for our 2022 fourth quarter and full year 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 quarter and year as well as our initial expectations for 2023. 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 Securities Litigation Reform Act of 1995.

Actual results could differ materially from those projections in the forward-looking statements. You can refer to our 2021 10-K for additional details regarding risks and uncertainties. All references to fourth quarter and full year 2022 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 the call over to Mike Speetzen. Go ahead, Mike.

Michael Speetzen: Thanks, J.C. Good morning, everyone, and thank you for joining us today. We delivered another record year for both sales and earnings from continuing operations despite a difficult supply chain environment and lower retail versus our original expectations. We also improved our cash position in 2022 and executed over $500 million of share repurchases. I want to thank the entire Polaris team through your relentless effort in a challenging environment, we delivered record results once again proving this is the best team in powersports. During the year, we made progress on our 5-year strategy with a renewed focus on powersports. And while we intentionally delayed several product launches in 2022 as the team focused on navigating the supply chain challenges and delivering orders to dealers and customers, we didn’t stop investing in innovation.

With more than $365 million invested in R&D in 2022, we continue to make our mark on the industry within the wide open side-by-side category with RZR Pro R and Turbo R. And through the introduction of the industry’s first connected technology with RIDE COMMAND+. With a focus on extending our industry leadership, we divested TAP and redirected our resources, time and focus on our core powersports customer. A decision that has had a positive impact on our EBITDA margin and returns. While innovation is the foundation of everything we do, our #1 priority will always be the safety of our riders. We are making investments in product safety while standing behind our vehicles and acting if needed. This past year saw an increase in warranty expense and recalls driven largely by legacy designs or supplier issues.

Our investments in safety and quality over the years have supported what I believe to be one of the broadest post-market surveillance programs in the industry, which is enabling us to aggressively monitor for and identify issues. We recognize these recalls are frustrating for dealers and customers, but we are committed to correcting these identified issues. This approach to monitoring our products even after they leave our factory floors, combined with our ongoing investments in engineering testing, supplier quality and manufacturing processes, bolsters our focus on providing our customers with safe, high-quality vehicles. Last point I’ll make is that we benchmarked our recalls per 1,000 vehicles produced from 2016 through 2022 against automotive, On-Road motorcycles and powersports.

Polaris was in the top quartile in terms of the fewest number of vehicles impacted per 1,000 produced. We have and will continue to invest in and drive improved quality for safety of our riders. As we look at the fourth quarter specifically, sales grew 21% to $2.4 billion. Excluding marine, North American retail was down approximately 6% year-over-year with modest growth in Off-Road utility and Indian Motorcycle, offset by a slowing Off-Road recreational market. These trends are similar to what we saw in the third quarter and are expected to continue into 2023. While fourth quarter market share was down approximately 1.5 points year-over-year, it was our best market share performing quarter of the year, and we saw 2 consecutive quarters of sequential share growth in On-Road and ORV.

Pontoon retail declined overall with share loss concentrated in the low end of the market, and we gained share in the high end of the market. Both adjusted gross profit and EBITDA margins expanded nicely to drive year-over-year adjusted EPS. EPS growth of 57%, despite increased headwinds from warranty costs, interest expense and foreign exchange. I’m proud of our record performance, especially considering the environment and the unanticipated headwinds that the team worked relentlessly to overcome. Now let me talk about the demand environment. The demand story remains mixed. Polaris ORV Q4 retail was down 4% year-over-year and down 1% sequentially, mainly driven by softness in the REC space. Our ATV and RANGER products were up low to mid-single digits sequentially and year-over-year.

Remember, the utility space represents approximately 60% of our Off-Road business, including sales to commercial customers, which do not factor into our retail metrics. We continue to see and expect stable demand here as these customers use their vehicles for work applications on a ranch, farm, job site or multi care homes. I’d also add that weaker recreation of retail in Q4 was partially driven by many RZRs being on a recall-related stop sale in December. As anticipated, the backlog of free sales declined in the quarter as shipments improved. We continue to see sales growth in our premium models such as RZR Pro R, Turbo R and RANGER Northstar as they remain favorites with customers due to their competitive features and capabilities. A few other points on demand include PG&A attachment rates are at or near record levels, indicating that customers are upgrading their vehicles with higher-margin accessories.

We continue to see a steady mix of customers new to Polaris which is consistent with historical trends, while both short and long-term repurchase rates remain elevated or within the historic range. Interestingly, 5-year repurchase rates were at all-time highs and we’re seeing these customers return and upgrade their vehicles to RZR Pro R, RANGER Northstar and even vehicles with RIDE COMMAND+. And on financing, the metrics we’re seeing continue to point to a consumer in a healthy financial position. FICO scores and improved and approval rates are consistent with last year. Also, credit availability has not meaningfully changed. There continues to be strong consumer interest in the space, measured by online activity versus pre-pandemic metrics with Off-Road organic online searches, up approximately 30% versus 2019.

Indian Motorcycles also saw strong web traffic leading to a record number of leads. So by segment, let me wrap up our thoughts on demand. In Off-Road, there remains a delineation between utility and recreation. Demand indicators are stable in utility, while recreation is soft with more pronounced moderation as you move through models with less content. We expect these trends to continue for the foreseeable future. In On-Road, we had a strong Q4 with the second quarter in a row of market share gains for India motorcycle. With a strong product line up for 2023, we are optimistic that On-Road can continue seeing share gains in retail growth. The marine demand at premium levels continues to be healthy. Inventory is the healthiest it has been in a long time.

So we’re seeing customers shop around a bit longer. Boat Show season has kicked off and thus far, dealers are optimistic as we enter their busiest season the year. Turning to North American dealer inventory. We continue to move closer to a more normal operating environment with seasonality even more present within our business versus recent history. For ORV specifically, we look at data from 2016 through 2019 to get a sense of the average seasonality with North American dealer inventory and retail before the disruption that occurred over the past couple of years. The data shows we typically see our highest dealer inventory levels and lowest retail levels in Q1, which makes sense as customers typically come in looking for units before the spring and summer writing season.

We think this is an important context to know as we enter a more normal seasonal operating environment and to better understand the inventory build ahead of the heavier retail season in the summer. As for the current dealer inventory, we continue to make progress towards our new optimal level. In fact, most of our products are close to these optimal levels, except for our RANGER side-by-side portfolio especially the high-end Northstar additions, where we continue to see strong demand. Total company dealer inventory was up 116% from 2021 to 2022, but remains well below 2019 levels. We currently see the value of refilling dealer inventory at approximately $150 million, which is below the $400 million we discussed on the October call due to progress we made with its shipments in the fourth quarter.

We expect to reach this optimal level in inventory sometime in the first half of 2023. So today, given a return to more normal operating environment and traditional seasonality, our operations are focused on building inventory into the channel where needed to ensure a strong retail season allowing dealers to sell products and not worry about availability. In summary, our say-do ratio in 2022 was high, with revenue coming in at the high end of our guidance and EPS exceeding guidance by $0.10 despite headwinds and in the supply chain and increased pressure from interest rates and foreign exchange. I’ll now turn it over to Bob, who will summarize our fourth quarter and full year performance as well as 2023 guidance and expectations. Bob?

Robert Mack: Thanks, Mike, and good morning or afternoon to everyone on the call today. Q4 was another record quarter for us with contributions from volume, price and a mix up to higher priced vehicles. International sales grew 7% year-over-year, overcoming a 9 percentage point drag from currency. Adjusted EBITDA margin expanded 272 basis points, overcoming increased warranty, marketing and G&A expenses. Below operating profit, interest expense continued to tick up given higher rates. In Q4, we executed $400 million in 3-year floating to fixed swaps at an all-in rate of approximately 5%, starting in February 2023. This will allow us to maintain our fixed to floating debt ratio near our 50-50 target for 2023. Additionally, we were opportunistic share buybacks, repurchasing 1.2 million shares in the quarter.

Adjusted EPS from continuing operations was $3.46, up 57%, marking a new quarterly record for Polaris. For the full year, I want to call out a few things. First, we did what we said we would do and grew both sales and EPS by 15%. Price and favorable mix to higher content vehicles helped drive these results. We were also opportunistic with share repurchases by repurchasing over $500 million in shares. The year was not without its challenges, and I am incredibly proud of our team who delivered these results despite ongoing supply chain challenges, rising inflation and additional warranty costs. Turning to our segment results for Q4. Let’s start with Off-Road. Sales rose 19% relative to last year to $1.9 billion. Whole goods increased 22% and PG&A was up 8%.

Adjusted gross profit margins were up an impressive 503 basis points. Similar to Q3, sales growth and margin expansion were driven by price and mix, which more than offset higher warranty expenses commodity costs. Looking at retail performance, ORV was down about 4% in North America with declines in recreation, somewhat offset by growth in utility. Within Utility, there is better performance in RANGER versus ATVs. We believe the industry was down low single digits, thus pointing to modest share loss in the quarter. Some of our share loss was due to holds on recall products, and we would expect to gain back that share as we work through the recall and the sales hold lifts which should occur in the first quarter. Sequentially, we were able to gain share with higher shipments and healthier dealer inventory.

Photo by Roberto Nickson on Unsplash

Q4 also marked our highest quarterly ORV share performance in 2022. We continue to see positive trends in our utility segment as well as robust double-digit growth in our commercial, government and defense business. Snow was negatively impacted by rework associated with 2 recalls where fixes have now been communicated to dealers. With healthier inventory across our Off-Road portfolio as well as new innovations, we look to gain market share in 2023. Switching to On-Road now. Sales of $302 million were up 29% versus last year, with whole goods up 35%, while PG&A was flat. Remember that our On-Road segment includes the Aixam and Goupil businesses in France, along with our most global business, Indian motorcycles, thus, you see a strong mix of international revenue, which saw meaningful pressure from FX.

On-Road shipments in the quarter were the second highest of all year as we are settling into a more normal supply chain environment. This helped Indian motorcycle gain share for the second quarter in a row. Gross profit margin was up 358 basis points to 17.1% as the team continues to execute well on its path to profitability. Driving this expansion in the quarter was volume and mix towards heavyweight motorcycles and price. Moving to our Marine segment. Sales of $245 million were up 36%, driven by price and mix. Inventory is the healthiest it has been all year across all 3 brands. We still have some work to do in entry and high-end models but a healthier supply chain has given us a path to quickly make progress as we work hard to set up dealers for a successful boat show season.

North American pontoon retail was down low 30s as we continue to prioritize high-end boats. With recent improvements in dealer inventory, we expect to return to a more normal mix of entry, mid and high-end boats in 2023, which should lead to share gains. Gross profit margin was up 209 basis points based on mix and price, along with improving supply chain stability. Reviewing the full year segment data, actual results were in line with our expectations with a little outperformance in margin from the On-Road Group. The performance last year sets us up for a strong 2023, highlighted by expected share gains and an abundance of new innovative new products and technologies being launched. Moving to our financial position. We continue to benefit from a healthy balance sheet with our leverage ratio at 1.6% — 1.6x and a strong cash position.

Free cash flow was up over 800% year-over-year all of the growth coming in the second half of the year. The cash momentum is expected to continue with further growth anticipated in 2023. As a dividend aristocrat, we concluded our 27th straight year of increasing our dividend. We executed on our commitment to investing in our simplified portfolio with over $300 million spent on CapEx and 4% of sales spent on R&D in 2022. 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 us talk about our initial guidance for 2023. We expect sales to be flat to up 5% relative to 2022. Drivers for performance include the following in order of expected impact, favorable mix from new products, higher content vehicles and more PG&A.

It is important to note that the majority of our new products are expected to launch in the second half of the year and be priced above like products currently in our portfolio. Second is volume. We expect retail to modestly outperform the industry in Off-Road. Our commercial business is also expected to have a strong year, but those units do not count towards our retail share performance. On-Road is expected to have a strong year with a very competitive lineup of bikes. We believe Marine will be in a stronger competitive position with healthy inventory across its entire lineup as well as some new boats across all 3 brands. Price is expected to offset increased promotions with price being a stronger contributor in the first half of the year due to the carryover from 2022.

We view FX and finance interest as headwinds and to sales growth in the magnitude of over 160 basis points. These expectations contemplate flattish industry retail for the year. Therefore, any deviation in the industry could positively or negatively impact results. Another swing factor could be the timing of new products, which are expected to launch in the second half of the year. By segment, we expect Off-Road sales to be up low to mid-single digits and On-Road sales to grow low single digits, driven by retail and share gains. With new products and healthier dealer inventory, Marine is expected to be relatively flat to last year, with share gains from new products and healthier dealer inventory, offset somewhat by a weaker industry. For margins, we expect modest margin expansion at the adjusted gross profit and EBITDA line.

Drivers include volume and mix, along with reduced cost premiums associated with inflation and a healthier supply chain. Some headwinds to acknowledge include increased financing interest and FX. We are currently forecasting an FX headwind of approximately 60 basis points to EBITDA, mainly due to recent movements in the Canadian dollar. We are also carefully watching the euro. Adjusted EPS from continuing operations is expected to be down 3% to up 3% with most of the drop-through for margin expansion being consumed by higher interest rate expense. In fact, combining the headwind from FX and a higher interest rate expense in 2023, we estimate the impact to be a drag of approximately $1.50 to adjusted EPS, helping offset some of this headwind as a benefit in our share count given the work we did to repurchase shares in 2022.

A few other items to note before I turn it back over to Mike. Operating expenses are expected to tick up as a percentage of sales with the bulk of that being attributed to sales and marketing. This increase is driven by a return to more normal advertising levels and in-person dealer events. We encourage you to model shares flat to Q4, so roughly $58.5 million. Financial services income is expected to be up 40% with higher interest rates and increased dealer inventory, driving more income from receivables. Operating and free cash flow are expected to be up significantly versus 2022 as investment in working capital is not expected to be a drag. Lastly, we are planning a meaningful investment in back shop capacity in Mexico to bring outsourced fabrication and injection molding activities back to historical levels.

That activity, along with capacity expansion investment at several other facilities is going to drive CapEx higher year-over-year. Mike will touch on this briefly, but we are excited about the opportunity to invest in growth while also taking more control of our supply chain. Our capital deployment priorities in 2023 are as follows: we intend to continue to invest in the business, and our intention is to have our 28th straight year of increasing our dividend. After that, we look at balancing share repurchases and debt pay down with likely a bit of both this year. At a minimum, we look to offset dilution from our stock-based compensation program. If you recall, part of our 5-year strategy is to reduce our base share count by at least 10%. And with the repurchase activity concluded last year, I can say we are ahead of our initial plans.

Therefore, we expect to be opportunistic with share repurchases while also balancing debt pay down and making these decisions based off what we think is the best for the company given return metrics and what we deem as a healthy financial position. Lastly, as we think about the first quarter, there are some moving parts worth mentioning. We do expect retail ex Marine to be flat to modestly up year-over-year. Remember, promotions are netted out of revenue, and with those increasing, there will be a headwind to both revenue and gross profit margin. And then we expect year-over-year pressure from foreign exchange and interest expense. Some items working in our favor are price and an expected reduction in cost premiums. On EPS, we have looked back at pre-pandemic years regarding the cadence of earnings, and we expect 2023 to have a more normal cadence of earnings with 16% to 17% of our full year EPS being realized in the first quarter when we typically see a seasonally soft retail quarter.

Overall, we believe we are set up for a strong year, including share gains across our segments, margin expansion and strong cash generation. Although headwinds exist, our team is focused on delivering these results as we continue to march towards our 5-year targets. With that, I will now turn it back to Mike for some additional thoughts on 2023.

Michael Speetzen: Thanks, Bob. We made a lot of progress on our long-term strategy in 2022 and are well aligned on what needs to get done this year to meet our 5-year goals. Starting with the strategy we laid out at Investor Day last February, nothing has changed. This team is focused on executing the strategy. We consistently review progress to our strategic objectives as a team as well as with our Board. We believe the 6 pillars of our strategy will drive growth, improve margins and drive strong financial returns for investors. Rider driven innovation and best customer experience will be on full display in 2023 and as we have a very exciting year for new product introductions across all segments. Consistent with the success we saw in 2022 with the RZR Pro R and Turbo R, I think you will be impressed with our Off-Road launches in 2023.

Polaris Off Road will not only raise the bar for our industry, but will redefine product categories. Both dealers and customers should be excited to see and experience what’s to come. Indian motorcycle has much — had much to be proud of in 2022 with the launch of the new FTR Sport and Indian Challenger Elite. And 2023 is set up to be an even better year with new bikes and accessories consistent with the innovation riders have come to expect from America’s first motorcycle company. And our Marine business is gearing up to ship new products across all 3 brands from Godfrey Mighty G to the Hurricane Sundeck 2600 and plus more to be announced in 2023. Boat show season is upon us, and I saw firsthand the level of excitement and energy around these already released products.

Our strategy isn’t just about innovation. Last year, we invested significant money back into the company to ensure we have agile and efficient operations as well as capacity to support the innovation. In 2022, we expanded our PG&A distribution center in Ohio — added capacity at our Monterrey, Mexico facility to support new Off-Road products coming out in 2023, and added capacity in Elkhart, Indiana for our marine business to support the growth in our large boat cat segment. As we look forward, we see a need for additional capacity in our Off-Road business to support planned growth. Starting in 2023, we’re investing in vertical integration as well as capacity expansion in a new location in Monterrey, Mexico. The investments in construction are scheduled to start this year with the benefits being realized in early 2024, certainly an important step to support our 5-year strategy and align with our agile and efficient operations pillar.

Lastly, we’re well on our way and on trajectory to achieve our 5-year financial objectives. 2022 saw us drive growth, expand margins, improve returns and execute on our capital deployment plans. While 2023 is bound to have some challenges, I expect another solid year of progress against our objectives. Let me wrap up. We did what we said we would do in 2022. We expect demand signals to be mixed in 2023 as they have been for the past couple of quarters. We’re closely watching a number of demand indicators and our plan is to remain agile in managing our manufacturing and shipment plans so that we can swiftly respond to positive or negative trends. We expect overall powersports retail to be relatively flat this year, plus or minus a point or 2 as we settle into a more normal operating environment.

For Polaris, it’s expected to be an exciting year for product launches and new services as we accelerate rider-driven innovation and the best customer experience. There are meaningful headwinds to our financial results given recent foreign exchange moves and higher interest rates. We have done our best to help you model them given the information we know today, but realize both of these have been volatile as of late. This environment requires us to remain agile to changing conditions, and we are well poised to do just that. As I have said before and it remains true today, we know that winning in a competitive environment requires our entire organization to be focused on delivering. With the best team in power sports, I’m confident we will deliver on our commitment of being the global leader in powersports.

We’re excited for 2023 and what it offers us, our dealers, our customers and our shareholders. We believe the decisions and investments we are making today will not only set Polaris up to deliver a strong year, but also generate strong growth and returns over the long term. With that, I’ll turn it over to Betsy to open the line up for questions.

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Q&A Session

Operator: . The first question today comes from Craig Kennison with Baird.

Craig Kennison: I wanted to ask about the flattish retail forecast that is embedded in your guidance. To me, that suggests you hold or maybe gain a little share in an economy that does not enter a recession. I’m just curious if you considered scenarios with a deeper economic downturn or pressure on your market share and what those downside scenarios might look like?

Michael Speetzen: Okay. Thanks, Craig, and I appreciate the question. Yes, we’ve modeled a number of different scenarios and the result on operations. I think the element to keep in mind is it’s not predicated on a substantially better economy. If you think about the areas where we lost share in 2022 is predominantly concentrated around the RANGER product line, the utility space. And when we look at the inventory levels for that business, they are still well below even the optimal levels, and those optimal levels are well below where we were in 2019. And given that we see that market holding up, it’s an opportunity for us as delivery improves to get back in and pull that share back. And we essentially have seen that playing out over the last 2 quarters.

So we know when we’ve got the availability that we’re going to pull the share back. And we’re happy with the performance we had in REC last year, the Pro R, Turbo R put us in a share gain position, which is great given some of the challenges we’ve had over the past. And really, it came down to availability within our RANGER product line. And we’ve seen that steadily improving, and we anticipate that will continue through 2023. So being able to get caught up on both the dealer inventory as well as just the continued solid demand that we have in that category is important. The other element is we do have new products coming out that serve new segments. And I think that’s really important to think through because there will be a little bit of cannibalization that comes from these products, but we do think that they’re going to appeal to a different subset of the industry, and we think that’s going to put us into a really good spot.

The last thing I would point to is, we’ve managed this business through some pretty volatile and uncertain environments just in the past several years. And the team has got a really strong track record of being able to react and move the business in the right direction. And we know what our guideposts are relative to dealer inventory. We’re going to let that plus the demand data that’s coming in from the dealers really be a guidepost for us. The other point I’d make is dealer inventory obviously was up strong versus last year, ’22 versus ’21. But the thing to consider and similar to the dynamic we saw in the third quarter, a lot of that inventory went into the channel very late in the quarter. We were still dealing with some manufacturing disruption from suppliers as well as even some of the recalls and when you think about that dealer inventory number one, a lot of that is clearing out in January as we were able to get into the hands of dealers and they’re getting through the setup and delivering the customer demand.

But also, we’re clearing recall holds over the course of January and February. And we know that those vehicles are in demand because we’ve had consumers at least put initial deposits on them that has shown up in the presold numbers. So we’re watching January closely right now, retail is outpacing anything we would be shipping into the channel. So we feel good about the dealer inventory levels.