Polaris Industries Inc. Loses Ground Due to Recall Costs, Industry Headwinds

Image source: Polaris Industries.

Polaris Industries Inc. (PII +1.41%) reported third-quarter 2016 results Tuesday morning, and shares are down around 3.9% as of this writing.

To be fair, the motorcycle and off-road vehicle (ORV) company did warn investors when it revised its full-year guidance downward last month, noting it's still weathering the aftermath of significant recalls of its RZR Turbo product line, while separately continuing to face pressure in its core ORV market. Let's take a closer look at what Polaris achieved in its latest quarter.

Polaris Industries results: The raw numbers

Data source: Polaris Industries.

What happened with Polaris this quarter?

• These results were in line with Polaris' expectations as of last month's full-year guidance revision.
• International revenue fell 7% on a constant currency basis (including parts, garments, and accessories), to $141 million.
• North American retail sales declined 9% year over year, primarily driven by a high-single-digit percent decline in Polaris ORV unit retail sales. 
• Gross profit declined 655 basis points year over year, to 22%, due primarily to $65 million in expenses this quarter from increased warranty, legal, and other costs from last quarter's disruptive RZR recall. 
• Off-road vehicle and snowmobile revenue declined 23% year over year, to $923.4 million.
• Within that, ORV revenue fell 25%, to $619 million, due to Polaris' decision to delay model-year 2017 shipments to "revalidate its new model line-up and protect dealer inventory levels."
• By contrast, the ORV industry overall was down in the low-single-digit percent range.
• Snowmobile sales declined 35% year over year, primarily due to a shift in the timing of manufacturing and shipping of snowmobiles as compared to 2015.
• Motorcycle segment revenue declined 3% year over year, to $183.2 million, albeit primarily due to changes in shipment timing in Polaris' Slingshot line.
• North American consumer retail demand for Polaris motorcycles increased in the the high-single-digit percent range, including low-teens percent growth from Indian Motorcycle and Victory combined. The broader motorcycle industry suffered a mid-single-digit percent decline. Overall motorcycle industry retail sales for 900 cc models and above declined in the high-single-digit percent range.
• Product availability for all brands continued to be "adequate," as the Spirit Lake, Iowa, plant and new Slingshot production line in Huntsville, Alabama, are producing at levels in line with retail demand.
• ORV dealer inventory declined 16% year over year, while total inventory decreased 10%.
• Global adjacent markets (including government/military and work and transportation vehicles) grew 6% year over year, to $78.5 million.
• Parts, garments, and accessories sales (which are now included in each of the segments above) fell 1% year over year, to $224.4 million.
• Operating expenses climbed 16% year over year, to $226.6 million, representing 18.8% of total revenue. That figure was driven by a 51.1% increase in general and administrative expenses, to just under $89.8 million, from product liability and recall-related legal costs, as well as a 7% increase in research and development costs, to $47.6 million, for product revalidation and continuing innovation. Selling and marketing expenses declined 1.6% year over year, to $89.8 million.
• Cash from operations for the first nine months of the year was $426.2 million, down from $464 million over the same period in 2015.
• Debt, including capital lease obligations and notes payable, was $436.7 million at quarter's end, good for a debt-to-total-capital ratio of 32% (up from 25% this time last year).
• Cash and equivalents as of Sept. 30, 2016, were $122.7 million, down from $225.3 million a year earlier.
• Polaris repurchased and retired 111,000 shares of common stock for $10.5 million, leaving 8.6 million shares remaining under the company's current repurchase authorization.
• The company announced an agreement to acquire Transamerican Auto Parts (TAM) for an aggregate consideration of $665 million, expanding Polaris' reach in the off-road aftermarket accessories category.

What management had to say

Polaris CEO Scott Wine stated:

Our third-quarter results, while discouraging, were in line with our revised guidance and reflect our ongoing execution of the RZR recalls and significant quality and safety improvement initiatives. During the past three months, we have accelerated our efforts to get our loyal owners back to riding safely, and are now over 50 percent complete with the RZR 900/1000 recalls and slightly below 50 percent on the more recent RZR Turbo recall notice. In addition to these recall challenges, we continued to face a weak overall Powersports industry, but were encouraged by continued retail strength for Indian and our overall motorcycle business, and the return to growth for side-by-sides in September.

Looking forward

Polaris also further narrowed its guidance for the full-year 2016, calling for earnings per diluted share in the range of $3.40 to $3.60 (compared to 2016 EPS guidance for $3.30 to $3.80 provided last month), with revenue still expected to decline in the mid- to high-single-digit percent range.

This guidance assumes a high-single- to low-double-digit percent increase in ORV/snowmobile sales, low-single-digit percent growth in motorcycle sales, and high-single-digit percent growth in global adjacent market sales. But note it also excludes any contributions from Transamerican Auto Parts, the acquisition of which Polaris expects to complete by the end of the year, after which TAM should be accretive to adjusted earnings in 2017. 

Though there were some bright spots -- including motorcycle demand and the promise of Polaris' new acquisition -- this was a painful quarter indeed as the company weathered its RZR recall and a persistently difficult core market for power sports. But with shares down nearly 30% over the past year, including a 19% decline as of this writing over the past three months alone, it's no wonder today's decline wasn't more pronounced.