Polaris Inc. (PII) Earnings Call Transcript & Summary

All right. Good morning, everyone. Thank you for joining us for day 3 of the conference and our next presentation from Polaris. The company is the leader in the North American powersports industry, competing in a number of segments, including off-road vehicles, snowmobiles, motorcycles and boats as well as aftermarket, parts and accessories. The past few years have clearly been challenging for Polaris as it had confronted not only heightened tariff headwinds, but also higher raw materials costs and logistics costs as well as supply chain constraints that have impacted production and led to extremely lean dealer inventories. The good news, however, is that demand for powersports broadly and Polaris products, in particular, remains very healthy. The company's innovation pipeline continues to be very robust. Here to update us is the CEO, Mike Speetzen; and CFO, Bob Mack. Also in attendance is the soon-to-be-retired Director of Investor Relations, Mr. Richard Edwards; and his successor J.C. Weigelt. And with that, I will hand things off to Mike.

All right. Well, thanks, and I appreciate everybody attending this morning. Yes, this is the Richard Edwards farewell tour. It's about the 50th stop we've had, and there's still another dinner tonight. So we thank Richard for all his hard work and effort, and we're going to be in great hands with J.C. I just have a few slides that I want to go through just in the event that someone in the room isn't really aware of the company. We are the global leader in powersports. We started in 1954. We actually started as a snowmobile company, snowmobiles now is probably the smallest part of our business; off-road vehicles; marine business. Pretty strong aftermarket portfolio and on-road business that includes motorcycles, Indian Motorcycles and Slingshot. We have 20 global manufacturing facilities, which is really important when you think about the ability for us to meet the demand that we've got in front of us as well as have a global footprint. So we're the only powersports player that has a factory over in Europe in Opole, Poland. And we produce not only off-road vehicles, but also motorcycles out of that facility. And we're going to be looking at additional expansion as we move forward. We just announced last week that we've added capacity at one of our distribution centers. And during our Investor Day last week, we talked about the fact that we're having discussions with our Board about adding more manufacturing capacity given what we see in front of us from a volume standpoint. We operate through a 2-step distribution model, about 4,000 dealers. About half of those are in North America, the other half are international. You can see 400,000 units, I'm going to talk a little bit about that size and scale advantage that we have. And then the last thing I'd say is we operate in 120 countries. We are a very global business. We just eclipsed $1 billion globally in revenue. And it is a surgical process. There is not another market that looks anything like, say, the U.S. or Canada. The international markets are very particular in terms of what products work. And so Mike Dougherty and his team have done a spectacular job of making sure that we went in. We're surgical about getting into those markets, we're either #1 or #2. And we're profitable in all those markets. So we're pretty proud of that accomplishment. One of the things we talked about at Investor Day was our competitive moat. And it's important for you to understand this for a couple of reasons. One, when you look at the size of our business, we're over 2x the closest competitor and really have to add up a lot of our competitors to even get to our size and scale. Now there's an advantage to that, obviously, with scale and being able to leverage and the brand recognition. But there's also complexity. When you think about the supply chain issues that Joe mentioned in the opening and what we've been dealing with essentially since the later stages of 2020, that creates a pretty huge advantage -- or a huge barrier for us to break through. You think about the complexity of our supply chain and the issues that are facing the entire industry, it's a feat that the team has been able to manage through that and put us in a position to gain share this past year. If you think about the complexity and if we stumble, our stumble could be almost the size of a competitor and so there's opportunities in there for share movement if we're not executing. The team has done a great job. The supply chain complexities have continued. In some instances, they've actually gotten a little bit worse as we've gone from Q4 to Q1. The ports are still jammed on the West Coast. We're still dealing with the semiconductor headwinds. We're still dealing with a lot of the challenges around just basic logistics and managing each of our suppliers. And so that really folds into that size component. But when you look at the competitive moat we have, you look at our On-road business, #1 position -- our Off-road business, I'm sorry. Our On-road business is #2. We're significantly larger than the next player. Then our Marine business is #1 and substantially larger than the next player. And the lifeblood of this company has really been the innovation that has led to incredible products. You think about the distribution that we have. We've got the top dealers across not just North America, but internationally. Our brands define the category. When people talk about going off-roading, they actually refer to it as RZR-ing even if they aren't necessarily using one of our vehicles. And then as I mentioned, the footprint and the scale, both from a manufacturing standpoint but also distribution, gives us the ability to reach deep and that's why we're able to be so successful internationally. So very large competitive moat for us. We don't take that for granted. We have really good competitors in our category. We respect them, and it keeps us on our toes. But we're in a really good spot as the #1 player. When we took over -- Bob and I took over in January of last year, one of the things we did with our Board is we said, look, we've got to relook the strategy. And this is what we launched last week at our Investor Day. And it really is about refocusing the business. We had gone down a path of diversifying the business and really focusing on revenue growth, and in some ways, got a little bit distracted from the core. And so when we stood back and said, hey, what makes this company so great, it's really the core, powersports. And so the strategy is pretty simple: global leader in powersports. And really underneath that, we've got 6 strategic pillars. At the Investor Day last week, we actually focused on really 2, which is best customer experience and rider-driven innovation. And that's not because they're more important, but it was really important for us to convey to investors that, number one, we see a huge opportunity for growth in the business. We've grown our new customers the last several years 70%. And we've been growing new customers prior to that, but a lot of the acceleration we've seen isn't necessarily because of what happened with COVID. That certainly did play a part. But it's all about how we've been positioning the product. It's about how we're marketing and it's about new business models, things like Polaris Adventures, where we're able to bring people in who would not normally ride our product and it gives them the opportunity to experience what it's like and then we end up converting a low single-digit percent into buying our vehicles. And so we're really trying to broaden the aperture. Our direct core market is about $55 billion. And then when you look at the addressable market, that expands pretty considerably, about $140 billion to $160 billion. So there's a lot of opportunity for us to grow within that core. And then using things like Polaris Adventures, we've really expanded the aperture to bring in people from other industries that don't even have a correlation to powersports, things like tourism and we funneled those customers into our category. Rider-driven innovation really is about how do we take those core capabilities that we have, the things we're excellent at, ride handling, the suspension, the ride command unit on the powertrain, and then marry that with emerging technologies, things like connected vehicle and electrification and using the customer lens to define where we want to go. If you attended our Investor Day, whether as virtual or in person, one of the things you would have seen is we showed an array of electric vehicles that we've produced. We obviously launched the RANGER XP Kinetic late last year. We had that there, and folks that were in attendance were able to drive it. But we also had on display an electrified RZR , electrified ATV, electrified Youth ATV and electrified snowmobile. Now that doesn't mean we're going to go into all those segments. The point that we were making is we've been working on the capability. But we're going to be very purposeful about what categories we go into and it's going to be defined by the customer, what the customer is looking for. And that's why we went into the RANGER, that utility category. If you think about the benefits of electrification, the torque, the power, the quietness, smooth vehicle in terms of just the ability to modulate the speed, those are all really important if you have somebody who's working on a winery, a ranch or going hunting. And so that really became our target demographic based on the feedback we had. And we were right. We sold out within 2 hours the initial allotment, and we have a list growing of other customers who are interested once we open up ordering beyond that. So that's an example of how we're listening to what customers are looking for, marrying our existing capabilities and then looking beyond that for new capabilities that are really going to enhance that customer experience. Inspirational brands. Simple is we showed our Board 3 slides that had pictures of customers out enjoying their family, their friends, the outdoors because of our products. And it's really about that enthusiasm. People are just so excited to share, whether it's posting on Instagram, bringing their friends along for a ride, it's really how do you create that inspiration behind the brand and make it something that people are excited about and want to share. Agile and efficient operations. This is really about how do we continue to drive productivity. We've done a lot of great work. Unfortunately, between tariffs and what's going on here lately with logistics and commodity costs, it's been overshadowed. But I can tell you that we continue to make progress internally. If you look at our operating expenses, they're at record low levels. And that's not because we're cutting spending. In fact, we're refocusing spending into the core of the business and we're eliminating spending into areas that are in the periphery. For example, we divested GEM and Taylor-Dunn late last year. We had been spending money on things like autonomy, which really when you think about core powersports, there isn't a lot of relevance. And so we've cut those things off that aren't really helping us continue to stay in that #1 market share position. Best team, best culture. Really, this is about how do we recruit the best, develop the best and retain the best and really drive that riding culture. That's something that we probably moved away from over the past several years, and we've really tried to reemphasize what other business do you have where you can enjoy the product as an employee and experience firsthand what the customer goes through. And so we're really pushing our organization to make sure that people are getting out and riding and then sharing what they're seeing on our vehicles and attributes associated with that. And then the last piece is geared for good. And I put this up here because we get a lot of questions around, hey, with ESG, you're a powersports company, how does that play? The reality is it's really important to us. Our products live in the environment. We need land and water to use everything that we have. And so why wouldn't we want to be good stewards of that? When we embarked on this several years ago, we knew that we had to do it in a way that was genuine and authentic because it had to be meaningful to our employees and had to mean something to our customers. We've gotten serious about improving our scores. We've done a lot of work around reducing energy, water consumption, our carbon footprint. And those are all great things because it saves the company money. So we're improving the environment and we're doing good things internally from a company perspective. We have a $5 million involvement with the forestry foundation over 5 years. That really shows you the dedication we have to improving trails. We also do a lot of work in local markets where we have facilities and employees that can go out and help improve trails, repair trails, create trails. So it's a really important aspect. And then safety is a key component. Rider safety is paramount. We've done a lot over the last year to put videos and instructions out for customers. A lot of new customers coming in, making sure that they know how to use the product, training our dealers on how to help them. And then also safety of our employees. Obviously, with COVID as a backdrop, we had to make sure we were keeping people from getting ill at work, and we've done a great job with that. But it's also managing the complexity of the manufacturing environment, making sure that people go home in the same condition that they came in. And really, we could pat ourselves on the back, but getting the external recognition really just helps validate that we are working on the right things. And you've got some of the things up on the chart. The one that I take a lot of pride in is being named again to Newsweek's Most Responsible Companies because I think as a powersports company, people wouldn't intuitively think that we would necessarily show up on that list. And I think it just speaks to the fact that we can keep the environment and the social issues upfront and making progress in a meaningful way and something that's very relevant to the company. So with that, I'm going to turn it over to the Q&A, and we can get to it.

Thanks for that, Mike. Want to start off with demand, not surprisingly. I mentioned earlier that COVID has been -- during COVID, we've seen a sizable surge in demand for powersports broadly, although sometimes it's not easily seen in retail sales numbers. So maybe, I guess, number one, update us on what you're seeing from a demand standpoint. Or have things slowed down at all? And why isn't retail the best indicator of that demand?

Yes. I mean it's a little bit more of the same of what we were seeing last year where the supply chain issues are really -- it's not unique to us. The entire industry is facing this. It has put us in a position that we cannot meet the demand that we have in the marketplace. So the retail numbers, there's a pent-up level of demand. One of the things that we've shared on our earnings calls is the presold or now the reservations that we have from customers. And when you think about the fact that 75% to 85% of the retail in a given month is presold, that gives you a pretty good indicator of if those units were sitting with the dealer, they would be moving a lot faster. What I would tell you is we talked about this in our one-on-one yesterday, the supply chain really hasn't improved in the first quarter. We talked on our earnings call back in January that we viewed kind of the first half was going to look a lot like the second half of last year. And in some instances, the supply chain has gotten even more challenging in the first quarter, and certainly, the events in the Ukraine are going to potentially test that as we go forward. We haven't seen anything here in the near term, but we're going to keep a close eye on that in terms of commodity prices. Our exposure in Russia is very small. We did stop shipping in units and accessories and aftermarket into that region. But we're largely through the season, which is largely related to snow, and it's not a big part of our business. Bob, anything you'd add to that?

No. I think to Mike's point, the supply chain stuff bounces around. When we got into the year, we thought we would see kind of gradual improvement from Q1 sort of through Q4 and I think that is what will happen. It's just obviously with the current situation, probably a little more volatility than we had hoped in Q1. And so Q1 is looking a lot like Q4. But we're hoping the back half of the year starts to look more like Q1, Q2 2021 which, while challenging, we're a little better than there right now.

And I guess what I'd add is as those supply chain disruptions start to come down, we've got ample capacity here in the near term. So it's not a manufacturing concern. We are at capacity now, but it's 100% driven by the supply chain constraints that we have. But as those start to abate, we've got ample capacity to handle it. And we got this question a couple of times. You shouldn't think about the supply chain getting better overnight. I think this is -- it onset over a period of time. It's going to take time for it to improve.

What part of the supply chain has gotten worse? Is it logistics? Is it materials? Is it all of the above?

It's been interesting because, call it, 6 months ago, we were still dealing -- even 3 months ago, we were dealing with labor issues at suppliers because they were having COVID outbreaks and so they would have to shut the facilities down. Those elements have improved, but now we see issues where they've got labor shortages because they can't get workers. And so that certainly is continuing to be an issue. The situation in the ports, actually we watch it pretty carefully. And the optics behind, especially in California, it looks a lot better because now they require the ships to sit 100 miles off the coast because it was -- there were some environmental issues with them dragging anchors and things like that. But I also think it was just -- there were a lot of them off the coast. And so it looks like it's improved. But the reality is we track those ships in the containers. It's -- in some instances, it's actually gotten a little bit worse. And then, for us, there's always those supplier-specific things. For example, we had a semiconductor company that had a sub-tier supplier shutdown because of weather-related issues for a number of days. And it's just -- we're still continuing, and everything is so fragile that any one of those things that in normal times we'd be able to work through, but they're stacking up on top of an already taxed supply chain.

So demand is still healthy. Supply chain is still an issue. Are you guys worried that we've perhaps pulled forward some demand or we're due for a slowdown from a demand standpoint as COVID restrictions ease??

I don't because -- we've talked about this. I mean in a lot of the areas where we sell product, I think people ease their own COVID restrictions back in even 2020, but definitely '21. And I think the reality is, as restrictions ease and people get more comfortable flying and going on vacations, that doesn't mean that they certainly go, oh, hey, now I can take a trip to Europe or Disneyland. I can sell my side by side. I mean the reality is, is that they do both. And that's exactly what we've seen. The new customers that have come in, we capture repurchase rates. Obviously, over the last couple of years, they're still early in their ownership. But the repurchase rates we've seen from those customers, meaning they come in within 3, 6, 12 months to buy another vehicle, mirror what we've seen before that. And we also do a lot of work surveying and talking with our customers. I know some of our competitors do the same thing. And their propensity to stay in the sport is actually stronger than what we've seen in our historical demographic. So there's really nothing there that tells us that we've seen some abnormal surge. I do think -- and I do think the work we're doing to open the aperture from a new customer standpoint is going to continue to funnel more people in. One of the things we've talked about is our Polaris Adventures business is funneled in low single digits conversion. So we've had people that go on an adventure and they turn around and want to buy a RZR. We've gotten that with absolutely zero effort, and that's been intentional. When we first set the business up, we didn't want it to come off as we were trying to funnel people into the purchase funnel right away. And then when COVID hit and we ran into supply chain issues, we obviously didn't have the capacity to funnel more people in. So that remains a great opportunity for us to continue to cultivate customers because one of the best ways for us to bring somebody into the sport is to get them into a vehicle. Anybody who was at our Investor Day last week, as you were, knows that. Once you get in the vehicle, the propensity to potentially buy raises pretty high because it's an exciting, unique experience.

So you mentioned the high level of presold, and obviously, inventory has been an issue. We do our regular dealer surveys, and dealers across the board complain about the lack of vehicles. What they don't say normally is that their margins are through the roof. So as we think about the channel inventory levels, do you think we eventually perhaps go back to pre-COVID levels or somewhere in between where we were then and where we are now?

No. I think the reality is if you look at -- we've gotten the question about what was presold before all this happened. And our presolds were kind of mid-single digits, which means the majority of the retail that was happening in a given month was coming from inventory sitting on a dealer's lot. That equation has literally flipped the other way. So you've got 85%, 90% of the monthly retail is coming from vehicles that are already sold and a very small portion from a vehicle that lands on a dealer's lot somebody comes in and looks at it. The reality is neither one of those is probably great. You want to go somewhere in between. And that's the piece we're working through, having the right mix. You're always going to want to have inventory on a dealer's lot because you're going to have people come in and are looking to get something immediately. The problem is, and this was not just unique to us, it's an industry issue, is when you have too much inventory there, you start to drive consumer behaviors that are bad for the OEM and it's bad for the dealer. The dealers are making an awful lot of money right now, and I think they're seeing that there's an opportunity here that you're going to have customers who want a vehicle immediately and they're maybe not looking to put a lot of accessories on it, that's great. You need to have those. But giving people the ability to customize and order the vehicle they want, first of all, you're meeting the customer where they want to be. Second of all, it's really good for a dealer because they're getting all the accessories on the vehicle. And the one thing we know we can do is deliver those vehicles relatively quickly in a normalized supply chain environment. So that's really going to be the focus for us is how do we -- we've got improved dealer inventory from where it is. It's not going to go back to where it was pre-COVID, and we're still going to have things like the Polaris reservations and even the presold on some of the lower-end units as an opportunity for customers to really get the vehicle that they want. And we think that's going to be good for the industry, for the dealer and obviously good for us.

So you mentioned at your Analyst Day and a big focus of that day, I think, was margins. Your EBITDA margins stayed around 12%, down from where they were a few years ago. And obviously, tariffs are part of that, supply chain is a part of that. So I guess first question on margins. Maybe explain to the audience where the big pressure points have been from a margin standpoint?

Sure. So at our Investor Day, we talked about how do we get back to kind of our historic 18-ish percent levels. And really, it comes down to a few key things. The current supply chain challenges, and it's a mix of supply chain cost and then price. We have added price to effectively offset the actual cost we're seeing and that's been a little bit delayed, so the price lags some of the costs. But as we get out of Q2, we'll sort of be fully -- we'll have full realization of our price. We had a lot of presolds, as Mike talked about, so takes a little bit of time to get the price on all the kind of stuff that's shipping in the quarter. So as we exit the supply chain challenges, our focus is going to be on managing out the costs that can go away. And a lot of it is transitory. Commodities are really high, steel, aluminum, resins, a little bit of copper. Those are the things that really impact us. Steel is already starting to normalize. It's bouncing around a little bit now with the Ukraine crisis. But that was already starting to trend in a good direction. We expect the others to start going that way, too, again, present challenges excluded. And the rest of it is logistics. And it's really 2 pieces in logistics. It's freight, actual freight cost. So a container to Asia 2 years ago before -- prepandemic was $3,000 -- container from Asia. Now it's $30,000. And is it going to stay that way? No, probably not. It's also not probably going to go back to $3,000. It will probably settle at something a little bit higher than $3,000. But over time, that should moderate back. And then we're also spending a huge amount of money air freighting parts over the top of the stuff that's stuck in the ports, and that's at premium rates. So that should really go away almost 100% because we didn't use to spend very much on that other than emergency situations. So we'll continue to manage down that cost, and that's why we've been prudent with our price increases. We didn't want to be -- some of the industries, RVs in particular, really got aggressive with price and now they've had to back off of a lot of that. And we think we've been pretty prudent with our price increases as has the rest of the industry. And we think we'll be able to hang on to some of that price. So part of it is getting that mix right, and that will play out over the next year or so as the supply chain hopefully starts to normalize. Secondarily, it's our portfolio. We have pieces of our portfolio we need to work on. Indian motorcycles isn't profitable. It's a business we bought the brand Indian. We didn't really buy a business. So we're building a large motorcycle business with great characteristics, but we've got to get the profitability right and we're at a point right now where that's the team's focus. And then the Transamerican business also has been challenged. So that team has got a big focus on profitability as well. We'll do a little bit of work on tariffs. We can't predict what's going to happen with tariffs. We're not assuming tariffs are going to go away. I think in the current political environment, that's going to be kind of tough. But we're doing everything we can to minimize our exposure to tariffs. And then it's just good discipline around how we develop products. We've been pretty aggressive with our product development over the last several years. And now we're kind of focusing more on platforming and modular design so that we can reuse things more frequently and get more commonality of parts. We have a big parts -- a big sourcing initiative we call Sunburst and that dovetails really well with what we're trying to do on the design side because we can reduce the number of -- we can increase the number of common parts, we can reduce the number of suppliers and that gives us a lot of benefits. So we feel pretty good. It's a self-help path, in our view. It's not really tied to getting huge volume increases. And it's a big focus for Mike and I and the rest of the team.

And last question in a couple of minutes we have left. Capital allocation, you spent a lot of time on that at the Analyst Day. Maybe explain to the audience where the priorities are today? And maybe more importantly, how they differ from where you've been in the past?

Sure. So historically -- and we haven't really changed this, it's more the focus has changed. Our first priority was organic investments, and we have increased the level of organic investment. So if you look at our CapEx and tooling, it had averaged around $200 million kind of the 5 years prior to '21, and now it's over $300 million. So we are increasing that investment. But to Mike's point about the portfolio early in the discussion, it's also much more focused. There were things that we were spending money on, GEM, Taylor-Dunn as a good example, where we were investing in those businesses even though they really weren't core to the company and those were taking investments really from our core platforms like ORV, motorcycles and boats. So not only are we investing, we're more focused with that investment. We're going to continue our dividend. We're a dividend aristocrat, so we'll continue small increases to the dividend. And then we'll toggle between share buyback and M&A. But right now, given the current market environment, obviously more focused on share buyback. And as you see us look at M&A in the future, you'll see a more focused M&A strategy and also a more financially disciplined M&A strategy. We did some things where we bought EBITDA dollars, but not great EBITDA rate. And as we go forward, we're really going to be focused on anything we buy, it's got to fit the financial profile that we're trying to get the company to and it's got to get there pretty quickly. If it's not there, we've got to have a clear path. So you'll see, I think, more discipline on the M&A side.

I think we're just about out of time. So let me thank Mike and Bob and everybody for joining us today. Enjoy the rest of the conference.

Thanks.