Polaris Inc. (PII) Earnings Call Transcript & Summary

Good afternoon, everybody. Thank you for joining us. I'm Joe Altobello, research analyst here at Raymond James, covering the leisure space, and we are very happy to have with us today Polaris Corporation. The company is a leader in the North American powersports industry, competes in a number of segments, including off-road vehicles, snowmobiles, motorcycles and most recently, boats. The past few years have clearly been challenging for Polaris, since it had to confront meaningful tariff headwinds, followed by a spike in demand at the start of COVID that put a strain on its supply chain and led to very lean dealer inventories that persist even today. Through it all, however, the company has been able to deliver healthy topline and bottom-line growth. And here to update us is CEO, Mike Speetzen; and CFO, Bob Mack; and also in attendance, VP of Investor Relations, J.C. Weigelt. I believe the plan is for Mike to have a few slides, and then we will jump into a fireside chat. So with that, here's Mike.

Okay. I'm going to correct, Joe, though. He said, we're the leader in North American powersports. We're the global leader in powersports. So we're going to make sure you get that corrected for your script. I thought I would start with our strategy slide. For those of you who are familiar with the story, you've seen this probably a few times. The reason I want to start here is because for those who aren't familiar with the story, it's really important to understand the context. Polaris had gone down a diversification path and had started moving into adjacent markets, is the term we use, that were not necessarily core to powersports. And the reality is, is that it diluted the company, it diluted our focus, our attention, our competitiveness in the areas that were core to us, and it diluted our financial performance. So when I stepped into the role and Bob stepped into the CFO role, over the last 2 years, we've embarked on a pretty aggressive retooling of the portfolio. And so we've divested 3 businesses, Transamerican, GEM and Taylor-Dunn, about $1 billion in revenue and loss-making businesses. So it's raised our EBITDA margins about 1 point. The portfolio is largely clean now, and we're really happy with the segments we have. I'll talk about that here in a second. And you can see that we've set some pretty ambitious financial goals. We already have strong returns in the portfolio. We're going to continue to amplify that, but we're going to raise the EBITDA margins and continue to deliver double-digit EPS growth. We've had a couple of years, despite all the challenges, of record financial performance so we feel like we've really put the company in the right spot. We're investing heavily in innovation and we -- Bob and I were at the spring dealer meeting that we kicked off just about 15 minutes from here last night. In addition to launching a bunch of new snowmobiles, we launched the replacement of our XP 1000 RZR, which is essentially the heart of the market for our RZR business with a new product. Dealer receptivity was really strong. After this conference Bob and I are going to head back over and spend some more time getting feedback on that, but just another sign of the continued drumbeat and innovation that you'll see from us. We put this one pager in here that gives you a good picture of this company at a glance. And I think the key is, look, we're the #1 player in powersports, we're not going to defend that position we're going to continue to grow it. The term that I've used with our internal team is, Polaris is done playing defense, we're back on offense. We are going to continue to act like the leader in the powersports industry. We're going to set the cadence for innovation, and we're going to force competition to have to figure out how to catch back up with us. And that isn't necessarily what we'd been doing over the past 5 or 6 years. Industry-leading innovation, we saw it last night. We saw the reaction to it. Quite frankly, you've seen it now for about 1.5 years. The introduction of the Pro R and the Turbo R RZR last year has jettisoned us up again from a market share standpoint. The motorcycle business with the introduction of the Chief and the Chief Sport. And our boat business or our marine business continues to gain momentum with new products coming into the market. So we're really excited about what we've got there, and we're continuing to focus on spending money in the right areas in R&D. We showed our dealers a chart last night that we've increased spending in R&D about 40%. And I would argue that we've gotten even more efficient because of the focus we have in the portfolio, and so that gives you a really good sense of how much energy we're dedicating to making sure that we continue to be on top from an innovation standpoint. This company is incredibly strong from a financial perspective. We've got a reasonable level of debt. Our balance sheet is in a great spot. Bob has done an excellent job of making sure that we're managing the cost in the business and holding people accountable. And so we feel like we've got this thing geared to really accelerate as we get out over the next few years. It's a global business. There was a reason I made the point in terms of Joe's introduction, we sell products in over 100 countries. We have factories in Poland, in Vietnam. We're one of the only powersports companies that has nondomestic manufacturing, and that really is aimed at satisfying demand in the European and Asian markets and really an important component of the company. Disciplined capital allocation, this is a change. We're being very focused. We're spending a lot of money inside the company on things that probably weren't viewed as glitzy. We spent money expanding our distribution footprint. We've added capacity across every 1 of our segments. We're investing in new equipment like paint systems. It doesn't get a lot of fanfare, but I'll tell you, it's really important not only for the quality of the product, but also the flexibility and the efficiency and the ability to produce at the rate we need to given the growth that we're seeing. And then the last is committed employees and dealers. Our employees own the company. If you look at our stock register, you'll see that employee stock ownership program is about a 5% owner of the company. Every single person in the company gets stock. It's really important. It's important for their retirement, but it's important because they own the company. And I'll tell you, they act that way all the way down to the shop floor, and that makes a huge difference. And then the dealer network. We've got 2,500 dealers here in North America, 4,000 globally. Bob and I were with a big subset of the dealers last night. I can tell you, the enthusiasm around the company has never been higher. The dealers appreciate the fact that we're back to being focused on powersports because they know they're not going to get some unpredictable curveball in the future, and they know that we're focused on making sure that we're better in every aspect of the business. This is just a quick picture of the segments. These are our 3 segments. You shouldn't expect to see us do anything outside of these segments. There's plenty of room for us to grow in each one of these, both organically and inorganically, and there's a lot of room in here to grow the market in terms of bringing new customers in. And so all 3 franchises are in a really strong financial position. Each one has different characteristics in terms of areas for improvement that we're focused on, and that's a big part of that journey to get EBITDA margins in the mid to high teens. This is really just why invest in Polaris. I think it speaks for itself in terms of we can demonstrate and have demonstrated stable growth in powersports. We've got a really strong competitive moat. Innovation, speaks for itself. We got a little bit behind over the past several years. We've innovated this entire category, and we're back to doing that. You look at what we've brought to the category, not only ride handling, but the suspension capability through DYNAMIX. RIDE COMMAND, RIDE COMMAND+, which brings connected technology. And the industry's first credible electric vehicle with the XP Kinetic, which launched last year and is going to be delivering here in the spring. Huge opportunity to improve the financial -- the already strong financial performance to improve even more, which creates a ton of leverage in the business. As I said, strong balance sheet and attractive ROIC and back to a very disciplined capital deployment strategy. Last thing I want to end on is Geared for Good, which is the way we approach ESG. And the reason I want to cover this is, obviously, it gets -- ESG gets a lot of press. It's to assure you that we are taking a very genuine and authentic approach. If you think about it, you might say, why not powersports, why are they spending time talking about this? Well, the environment is incredibly important. Our products are used in the environment. And so our team takes this mission very seriously, and we do it in a way that's very genuine. And that really hit me as I sat on an airplane looking at an advertisement on the plane or the airline talking about Net Zero. And I'm sitting there going, how do you do that with these massive jet engines? And I came from the aerospace industry and I know how that works. We're not going to put foolish goals out there. We're going to put credible goals out that are good for the environment, they're good for our business. And our employees rally behind this, they engage. There's a ton of work that we do with the forestry service. There's a ton of work that we do with local trails and all the areas where our products are used to make sure we're maintaining the environment. We take this very seriously, and we're going to make it a credible part of the business, where it improves environment and the business. And then the last thing I would end on here is 2 things: one, we were notified a couple of days ago that we were named in Newsweek's Most Responsible Companies again in 2023. We take a lot of pride in that accomplishment. And then our MSCI rating moved from a BB to BBB, which is really important because I think it reflects the amount of work and effort and the credible programs that we have inside the company. So with that, I tried to get through that as fast as I could, Joe. I think we're ready for any Q&A.

Thank you, Mike. That was great. It's probably not going to be a surprise, but I wanted to start on retail. If you look at industry retail, I think it was down high-single digits last year. Your retail was down mid-teens. Doesn't take a genius to figure out you lost a little bit of share. So what were some of the factors that you think attributed to those share losses?

Yes. I mean our issue really stemmed from supply chain. There wasn't really a lot of new innovation coming into the market. I think everybody was really struggling with the same thing. In 2021, we actually gained a bunch of share, and it really centered around the fact that we had product availability better than our competitors. Well, that changed, and it changed pretty severely in Q1 and Q2 of '22. As we improved our delivery cadence into Q3 and Q4, we saw that share loss come down quite a bit, and it was really concentrated in one area. It was really in our RANGER product line. We ended the year with RZR share up. Indian Motorcycle had share gains in the last 2 quarters of the year. Our issues with Indian earlier in the year centered around availability of black paint. Consumers are really looking for blacked out bikes versus chrome. We had some delivery issues stemming from availability of product coming out of China. Once that got corrected, we saw the share move pretty quickly back in the right direction for us. So for us, it was really around that utility segment. We made a fundamental decision that was different than at least one of our competitors. We had a very large order book of Northstar and our XP 1000 RANGERs. These are crew cab, fully cabbed, air conditioned, the highest-end vehicle that we make in that segment. And we focused our time and attention on producing the vehicles that our customers were waiting for and had been waiting for. One of our competitors pivoted and went into the 3-seat de-featured category that competes with our RANGER in that same category. And we're able to pick up share points, and that's just a move we weren't prepared to make. We were behind on delivering to our customers. And so we made the decision to dedicate our parts and our capacity to fulfilling that demand. And as we fulfill that demand, we've seen the share performance moving back in the right direction. And frankly, I think it's the right call because ultimately, customers who buy at that level are very sticky customers. Customers that buy less, de-featured vehicles, lower price point, they tend to move around because they're looking more for availability and buying something that day as opposed to getting exactly what they want. And so we were okay -- not okay, but we were okay with ceding a little bit of share to make sure we were taking care of our customers. And now we're in an environment where, at least here in the first quarter, the supply chain and the operating environment is felt more normal than it has in 3 years, and that is -- has been a welcome change. The reports that Bob and I get -- we used to have daily conversations with the thousands of units that were being put on hold and being moved into rework. We're literally not having conversations daily, we're now having a conversation once a week, and we're talking about 10, 20, 50 vehicles being impacted, not thousands of vehicles. So I feel really good about where the environment is at, and as we look into '23, we see a path to gaining that share back. We saw the momentum as we exited the year. We've got new products coming into the market, not only replacement products like the XP RZR that we just launched, but we have new category-defining vehicles that are not going to be replacing the existing vehicles. So that's about bringing new customers into the market because we're addressing a customer segment that doesn't have a vehicle addressing it today. So really excited about that opportunity, and we've got the plans in place to gain that share back.

On that point on innovation, you talked about that in the past, particularly in the second half. It sounds like your pipeline is pretty robust. Is that going to be across all of your 3 segments? Or is it focused on one segment, particularly like Off-Road, for example?

Well, I mean there's been a lot of innovation that's come out more recently in our Indian lineup and our Slingshot lineup. And that's not to say there isn't more, but there probably is a little bit of a pause before you see that. The marine business, Ben Duke took over the Marine business. He had been running the Godfrey and Hurricane brands within the Marine segment. He is doing a lot of work around refreshing the Bennington lineup. It was probably long overdue. So you should expect to hear some news there. But the big news really comes in the Off-Road vehicle segment, which, quite frankly, is where we probably had fallen the most behind. And I think you're going to see that we've put ourselves back in a clear leadership position when it comes to introducing new products.

So if we think about 2023 and the retail outlook, I think you talked about an industry that's flattish this year. Hopefully, you guys can do a little bit better than that. But if we think about the macro backdrop, it's probably gotten worse since '22, yet you're looking for an improvement in retail trends. So help us understand or get comfortable with sort of that outlook in an economy that seems to be slowing with rising interest rate.

It's funny because to us, it almost feels like it's better. And when I say that it's -- one, the supply chain disruption, that backdrop definitely is better, and it was pretty bad in '22. We had seen segments of the market weakening in Q3 and Q4. We've talked about it on a couple of the calls around the rec space. And I would say, it's kind of more of the mid-to-lower portion of the segment and that has kind of continued. What hasn't really changed is the upper end of the consumer funnel, whether it's marine, rec, utility or motorcycles, those customers still want what they want and availability is still somewhat constrained. And so whether it's someone spending $150,000, $200,000 on a Pontoon boat or $45,000 on Pro R Ultimate or buying a Chieftain Elite, they still want their equipment. And I think it's this dynamic of unemployment is still very low, people are still doing well. Yes, inflation is high. People are also being paid more. We've paid our hourly folks -- we've moved pay up twice now to compensate the hourly team at a far higher level than they had in the past. And even in the salaried workforce, we've gone through 2 years of 4% increases, which obviously doesn't keep pace with the headline inflation numbers, but when you're putting 4% against your income, not 8% against an expense line item, it does help offset a good portion of that. So we don't see anything playing out thus far in the first quarter different. And as we talked about, 60% of our off-road business is utility and the utility side is holding up. Farmers are doing well, multi-acre homeowners, the wealth creation that they have and the savings that they have and the functions that they use the vehicle for in terms of work, and then there's a portion of that business that serves the commercial market. So we're selling into job sites, we're selling into rental companies like United Rental and Sunbelt, and their backlog is pretty much set at this point, given the amount of infrastructure work that's going on as well as new semiconductor facilities and those types of things. So at this point, we don't see anything playing out any different than what we said, but it's 2 months and some days into the year.

This is probably a good question for Bob. But if you think about your pipeline fill, I think coming into '22, you guys estimated around $750 million. You're exiting '23 -- or exit '22 at about $150 million. And I think you're going to complete that pretty quickly, right, by spring, call it. So why shouldn't we think about that as sort of a $450 million headwind from a wholesale perspective heading into 2023?

Yes. I think it's a few things. So to your point, we exited 2022. We were a fair amount behind still on RANGER, and so we'll catch up. I don't know that we'll get it all done in Q1 because retails remain strong, right? It's a 2-part math problem, what do we ship, what do people buy. And retails remain strong on RANGER. So we're not going to maybe catch up as fast as we once thought. But also, we -- as Mike has pointed out, we lost a bunch of shares. So we're not trying to match 2022 as the benchmark. We want to get back and take the share in RANGER that we've historically had. So that provides -- we're confident we can do that. We saw it in Q4 when we shipped better. We had much better share. We're seeing that in Q1. So we're confident that as that continues, that provides some tailwind. And then really across the portfolio, we've got a fair amount of innovation. And so we launched the great new RZR last night. And while it's not a new category, it's replacing a product that's -- depending on which version it is, it's 7 to 10 years old. So that provides some momentum, both from dealer stocking and retail. And then in the back half of the year, we've got a lot of new innovation coming in off-road. So we feel like that's going to also give us tailwind because it's really kind of category-defining products. And then really you look at Indian, we launched Chief. We launched Challenger, which is our liquid-cooled heavyweight bike. We launched Pursuit, which is the big touring version of the Challenger. We launched Chief, and now we've launched multiple versions of Chief. And we did that all through the course of the pandemic, and we've never really been able to get the units out to take advantage of all that new innovation. So as we head into '23, we've got much more, much better motorcycle availability in the dealerships, and we're seeing upticks in retail, and we're not even into season. So we feel good about really being able to capitalize on some of that stuff as we go through '23, and we think that's going to drive the growth that we have in our forecast.

Got it. So if we think about -- it was a little over a year ago, I guess, we were in Las Vegas for your Investor Day, and you laid out some 5-year targets, mid-single-digit sales growth, mid- to high teens EBITDA margins, double-digit EPS growth. You certainly delivered on that in 2022. I think 15% growth on both the top and bottom lines. Your '23 guidance is a little bit below that to some degree, but I guess, as we sit here today, March 7, how do you feel about those '26 targets at year-end?

I feel really good. Bob worked the share repurchase pretty aggressively last year. So we got ourselves out ahead of that. And we're going to continue to buy the stock at the very depressed prices that we've got right now. It's the best buy out there in our opinion. But when I look at the most challenging part of the plan and probably, the area we have the most work to do to earn credibility back is around the margin improvement. And we've had this discussion a number of times in breakout sessions. It's not dependent on one thing, and that's what I think gives me a lot of confidence about our ability to execute. It's a combination of things like the portfolio, which we've already demonstrated and executed on in terms of getting the noncore dilutive portions of the business out. It's things like improving the profitability of the On-Road segment, specifically around Indian and Slingshot. We bought Indian in 2011. We didn't buy a business, we bought a brand. We had to essentially create a new company, and you don't do that without losing some money along the way. Well, this year, we're going to probably be, if not positive, at least breakeven from an EBITDA standpoint. And we probably should have done a better job of how we message that to the market when we bought that asset and start embarking on rebuilding every aspect of it, but it gives us the runway to continue to see that improvement. And it happens because we're getting more volumes through the business. We're increasing the amount of PG&A -- high-margin PG&A. There's a lot that we're doing around the designs of the bike to get cost out. We now have global manufacturing. We're producing bikes for Europe in Poland, and we're producing bikes for Asia in Vietnam. When you look at the amount of cost that came into the business over the past 3 years, over $700 million, some of that comes out pretty quick. When you get a container going from $30,000 to $2,500, that happens pretty naturally. Some of it, we have to work at. Inefficiencies we had in our factories because we were reworking 60% or 70% of our products, and you have more labor in the factory than you may need when you get to a more stable environment. So there's a lot of different levers that we've got to pull on, and the good thing is, the team is 100% aligned around it. The simplicity of the portfolio makes it very easy for Bob and I to keep the team focused as opposed to if we had a bunch of other stuff going on that dilutes our ability to stick to the basics and make sure that we're managing for the improvement. So I'm very confident about where we're headed.

And like last night, launching that RZR was a good example of what Mike's talking about. Typically, we would have launched a 2-passenger version and then maybe 6 months later, launched a 4-passenger version and then the accessories. And it would have rolled out kind of in increments over the course of a year. And last night, we launched 2 pass, 4 pass, 3 versions of each a sport, a premium and an ultimate. So 3 different kind of price-point packages and 200 new accessories. And so as we move forward, we're taking the time to get everything done right, design it from the beginning, which makes the designs a lot more efficient. I mean we have 2-pass and 4-pass vehicles that quite frankly, the designs were done by different teams because they were done at different times. And so we've changed our philosophy. We're a lot more focused on modularity, both on the component end, things like brake systems. If you were at our Investor Day, we talked about how there's areas where we have 11 brake systems and BRP might have 3. So I don't know that we'll get to 3, but we're still focused on performance, but we're going to be more efficient. And then also really platforming so that when we launch these products, it's not different generations and different vehicles, it's -- the product plan takes into account all the versions of that vehicle that you plan to launch, and they're designed in from the beginning. And so we think that's going to make us a lot more efficient, which helps us drive out cost.

So just to drive that point home. If I look at your guidance for 2026, I think you said mid- to high-teens EBITDA margins. I would interpret that as 16% plus, call it, round numbers. And the guide for this year is around 13%. So you got 300 basis points to go over 3 years. It sounds like a lot of that is self help and not dependent on any acceleration in market growth.

Yes. I mean we built a layered plan because nothing is going to play out exactly as you expect. So we have a layered plan that adds up to more than the target just like any good financial person would, and so we're working each one of those pieces. And don't undervalue FX. If you took out the impact of FX for '23, I mean we'd be more like 13.7% from an EBITDA perspective. I don't know when rates are going to kind of return more to normal and maybe they don't go exactly back to where they were in 2019, but there are a fair amount of out of bounds of kind of historical on the CAD and the euro, which are the 2 that impact us the most. So we'll see at some point some tailwind from FX turning around, which will help us on the margin side also.

Just staying on margins for a second. Promotional activities pretty much nonexistent for a couple of years, is coming back. I know some of your competitors have talked about margin pressures from promotional activity. It doesn't seem like you guys are looking for all that much. So maybe help us understand why we wouldn't see more headwind from increased promotional activity, at least on the gross margin side?

So there's a couple of things. I mean, one, there is the lapping of some of the price actions we had last year that carries forward. And what happens is, the increase that we have in promo kind of gets offset in there. The promo that we have in the market is really -- I'd say, there's kind of 3 buckets. One is -- and I think this got picked up on in some reporting over the past week. We put some promo out on the XP 1000. Well, we did that on purpose because we just announced a new vehicle and we knew that was coming. So we were trying to help dealers clear out some of the inventory they had, and frankly, the market had started slowing in Q3 and Q4 of last year. So that was a very targeted program. We do have some general promo out in the marketplace. We always have. Even during the pandemic, we had rebates in place for a lot of our military and our veterans, ag programs in places like Texas. And we've continued to amplify those programs. They're really important and key. And then the third area is around interest rates, and those are very targeted regionally and by segment because we know where the customer tends to buy on credit. We know where the customer is sensitive to the interest rates, and so we end up orchestrating things like interest rate buy downs. But when you take the carryover price, you take the negative of promo and then you take the fact that we're pushing cost out of the system relative to that $700 million that we've had, the net-net is a positive from a margin standpoint.

Okay. We got about 2 minutes left. So I've got 2 questions on capital allocation. You mentioned in your prepared remarks, you spent about $0.5 billion last year on share repurchases. What should we expect in 2023?

Yes. Our guide for '23 was that we would offset dilution from stock program. So I think roughly a net of between $100 million to $125 million, depending on how much there is in option exercises. That's kind of the minimum we're going to look to do. And then we're going to be balanced as we go through the year and see how the year plays out. We've got -- obviously, we can continue share buyback. We could pay down debt. Our debt levels are still pretty low. We're at about 1.6x. And so -- but that's an opportunity given the higher interest rates and then M&A to the extent that we see opportunities that meet our financial criteria. So stock buyback is going to continue to be important, but we went into the year with kind of a measured plan just given the uncertainty of the macro environment, and we'll see how the year develops.

And CapEx was about $300 million last year. The guide is $400 million this year. What's a good run rate number?

I think it's tough to say. I mean, as Mike talked about, we underinvested a bit in some of our facilities over the past several years. We also underinvested in IT. And so we're not going to go do a big ERP implementation, don't get nervous, but we are upgrading edge-based -- edge systems to make ourselves more efficient and to help us with some of the supply chain challenges and other things that we found during the pandemic. So I think we'll run at an elevated rate for at least a couple of years and then probably trend back down towards normal. So we don't have an exact target yet.

Well, we're just about out of time. So Mike, Bob, thank you. Thank you, everybody. Enjoy the rest of the conference.

Thanks, Joe.