Polaris Inc. Q2 FY2020 Earnings Call

Good morning and welcome to the Polaris Second Quarter 2020 Earnings Conference Call and Webcast. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Richard Edwards, Head of Investor Relations. Please go ahead.

Thank you, Andrea. And good morning, everyone. Thank you for joining us for our 2020 second quarter earnings call. A slide presentation is accessible at our website at ir.polaris.com, which has additional information for this morning’s call. Scott Wine, our Chairman and Chief Executive Officer; and Mike Speetzen, our Chief Financial Officer, have remarks summarizing the quarter, and then we’ll take some questions. During the call, we will be discussing various topics which should be considered forward-looking for the purposes of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those projections in the forward-looking statements. You can refer to our 2019 10-K for additional details regarding these risks and uncertainties. All references to the second quarter 2020 actual results are reported on an adjusted non-GAAP basis, unless otherwise noted. Please refer to our Reg G reconciliation schedules at the end of this presentation for the GAAP to non-GAAP adjustments. Now, I’ll turn it over to our CEO, Scott Wine. Scott?

Thank you, Richard. Good morning. And thank you for joining us. Last quarter, I spoke about how thankful I was for the Polaris team’s hard work and how confident I was they had positioned us to navigate and win throughout the pandemic. With the surge in demand for off-road vehicles, motorcycles and more recently pontoon boats, the team is demonstrating impressive agility and resourcefulness as they support our dealers and deliver innovative products and solutions to our customers. We will talk about outperforming expectations this morning, but admittedly, the outlook we provided in April was off by a country mile. The economic lockdown of our dealers and suppliers, along with concern for the global economy amidst the pandemic, led us to model negative retail sales for the second quarter and the year. Reality has been much different, as many more people sought out the family enjoyment, excitement and utility of our vehicles, and when coupled with more free time and fewer alternative ways to spend money, this provided a near-perfect backdrop for our powersports dealers. Our priorities remain consistent since the onset of COVID-19. First, implementing protocols and guidelines to keep our employees safe, and working across our global supply chain and factory network to ensure the viability of Polaris, winning for our dealers and customers, and ultimately doing good for our shareholders. Even though I’m known as a tough grader, the team earned extremely high marks in each of these fundamental considerations. The combination of record off-road vehicle retail, COVID-19 related temporary plant shutdowns, and our erroneous forecast for lower demand, brought dealer inventory down below target levels, but our factories are performing well, as they ramp up to meet demand and refill the channel. Liquidity is not a concern currently, but the cash war room exercises that Mike Speetzen and his team have greatly enhanced our cash outlook and management ability. While non-cash, we did take a $379 million impairment charge for our aftermarket business, which reflects the greater impact TAP has faced from COVID-19 and tariffs. This is accelerating our strategy to focus predominantly on TAP’s retail channels, which I will cover shortly. Second quarter North American retail sales were up 57%, behind broad-based demand across our dealer network. A key fact underlying this top-line number is that nearly 75% of our off-road vehicle and motorcycle buyers in Q2 were new to Polaris. While we love our current customers, we know that new customers are more likely to invite their friends to powersports, spend on apparel and accessories, and buy another Polaris vehicle. The solid demand for four-seat or crew side-by-side vehicles reinforces the family dynamic behind this surge, while our PG&A business experienced its largest-ever quarterly sales, confirming our large and growing installed base still has a strong desire to accessorize their vehicles. Both Indian and Slingshot performed well in the quarter, with the new Challenger and Slingshot AutoDrive leading notable market share gains. Boats did not turn positive until June, but the subsequent recovery was quite robust. Despite our impressive retail performance in off-road vehicles, our market share did decline in the quarter. This is never an acceptable outcome, and I am extremely confident that Steve Menneto and his team are driving the necessary actions and improvements to re-establish market share gains in the quarters ahead. I do not want to make any excuses, but this simple fact helps put things into perspective. In the months of May and June, the growth of our side-by-side business outpaced any of our competitors' total sales over the same period. Dealer inventory declined precipitously in off-road vehicles and slightly in motorcycles for a net decrease of 47%. We did bring our plant network down for approximately 10 days, including Monterrey, which was down considerably longer. But our significant US footprint was an asset that enabled us to respond quickly once we came back online. With factories rapidly ramping to full production, we expect to make progress towards replenishing dealer inventory throughout the second half, although year-end levels are likely to be down substantially. As noted, our growth is largely being driven by new customers who are increasingly gender, ethnic and age diverse. Changing market dynamics are certainly contributing to this shift, but the customer engagement and demographic outreach efforts that Pam Kermisch and her team are leading give me confidence that we can sustain it. Expanding the market is uniquely beneficial to the market share leader, and we will continue to invest in initiatives to keep this trend going. The aftermarket impairment charge we took primarily related to TAP did not cause us to change strategies, but it did accelerate the work Craig Scanlon and his team are doing to transition to a much more retail-focused business model. While we still see benefits in the integrated multi-channel approach we’ve been operating, we recognize it does not require TAP’s entire existing wholesale business, which has been a consistent drag on profitability. Our distinct 4WP advantage is in business-to-consumer retail, with both our national brick-and-mortar footprint and our significant online presence performing well. With a more retail-focused business, we expect to drive consistent growth and better leverage our investments and our exclusive TAP brand offerings. California store closures and tariffs remain near-term headwinds, but the path to improving profitability is clear. I will now turn it over to our Chief Financial Officer, Mike Speetzen, who will update you on our financial results and plans.

Thanks, Scott. Good morning. You’ll recall during our first-quarter call, my comments were centered around maintaining a healthy liquidity profile, given the economic uncertainty as a result of the pandemic. As Scott indicated, given the tremendous rebound in retail sales during the quarter and the extremely hard work of the Polaris team, I’m pleased to report that our second quarter results significantly outperformed our previous expectations. Our liquidity profile has returned to normal levels, and our full-year earnings expectations have rebounded to near pre-COVID levels. I’ll provide additional detail on our view for the remainder of the year. But first, some comments on our second quarter results. For the second quarter, sales were down 15% versus the prior year. All segments reported lower sales driven by our plants temporarily suspending production for up to 1.5 months due to the COVID pandemic. Despite many of our plants producing at or above pre-COVID-19 levels, by the end of the quarter, we were not able to offset the lost production during the shutdown period. Second quarter earnings per share on a GAAP basis was a loss of $235 million or $3.82 per diluted share, which included a non-cash pre-tax goodwill and intangible impairment charge of $379 million. Last year’s second quarter income was $88 million or $1.42 per diluted share. Adjusted earnings per share was $1.30, down from the prior year’s second quarter adjusted earnings of $1.73 per share, but up significantly from previous expectations given strong retail sales, enabling greater shipments. This, coupled with strong cost management, drove the overperformance in the quarter. The $370 million non-cash impairment charge is related to our aftermarket segment, primarily Transamerican Auto Parts. Given the deterioration in expected short and mid-term economic performance of TAP due to COVID-19, the company re-evaluated the goodwill and intangibles in the aftermarket reporting unit and concluded that the fair value of the reporting unit and certain TAP trade names were less than their respective carrying values, resulting in non-cash goodwill and intangible impairment charges. As Scott indicated, we believe in the fundamental long-term attractiveness of the TAP business as we continue to take corrective actions to navigate the current economic environment and strengthen the business for the long-term. Adjusted gross margins were down 190 basis points year-over-year, primarily due to COVID-related under absorption at our factories from the COVID-19 driven temporary production suspension. We also incurred costs to ensure the health and safety of our employees at all facilities. We did recognize a modest level of favorability in tariffs in the quarter given the lower volumes and continued progress on exemptions, as well as refunds of prior tariffs paid. Operating expenses, excluding the impairment charge, which we’ve separately categorized, were down 15% in the quarter as we canceled or postponed all non-essential expenditures and undertook employee-related cost actions as a result of the pandemic driven economic uncertainty. Turning to our segment performance. All segments experienced lower sales during the quarter as expected, given the reduced shipments as the pandemic began to take hold early in the quarter. Moving now to our balance sheet and liquidity profile for the quarter. Operating cash flow was $310 million for the six months ended June 30, up 53% from the same period last year and up significantly from Q1, driven by lower working capital requirements. Since our Q1 call, our cash position has improved significantly. We initiated the cash war room approach in Q2 that enabled the company to more effectively and efficiently manage cash flow, which not only benefited Q2 but through process enhancements will benefit the ongoing performance of the company. As a result of this effort and improving business conditions, cash on hand at quarter end was $544 million, and our total debt levels finished the quarter at $1.9 billion, down sequentially from Q1 by approximately $236 million or 11%. We currently have approximately $650 million available under our revolving credit line, as well as within our loan, and we’re also within our loan requirements. Combined with our cash, we ended the quarter with approximately $1.2 billion of liquidity. Given our current liquidity and near-term outlook, we do not anticipate any liquidity issues for the foreseeable future. Financial Services income, which is primarily comprised of wholesale finance income and retail credit income, was strong during the quarter, up 28%, driven by the strength of retail credit income given the strong retail demand. Dealer wholesale finance income was down 48% during the quarter due to dealer inventory levels being at historically low levels, as Scott explained earlier. Moving to full-year expectations. You will recall that we withdrew our full-year sales and earnings guidance back in March given the onset of the COVID-19 pandemic and the immediate negative impact to retail. Since that time, our visibility has improved somewhat. While we don’t expect the demand trends seen in Q2 to continue at those rates, we are reinitiating guidance given depleted dealer inventory levels coupled with modest ongoing power sports demand. Total company sales are expected to be in the range of $6.65 to $6.75 billion, which is flat to down 2% for the full year. While we don’t anticipate reaching our pre-COVID sales guidance range, it is encouraging that we are projecting to nearly reach our pre-COVID earnings expectations on lower sales for 2020. We expect total company earnings per share to be in the range of $6.40 to $6.60 per diluted share, which is near the low end of our initial guidance of $6.80 to $7.05 per share that was provided back in January before the pandemic crisis. Given our full-year sales and earnings guidance, second-half sales are expected to increase in the mid to high single digits percent, again driven by low dealer inventory levels and modest ongoing power sports demand. The second-half adjusted EPS equates to a range of $4.85 to $5.06 per diluted share or a 38% to 44% increase year-over-year. For the second half of 2020, we expect our revenue to be approximately evenly split between Q3 and Q4. However, given the mix of products produced and the timing of new product introductions, second half earnings are more heavily weighted to the fourth quarter by about 60%. Though our visibility has improved, I won’t be giving as much detail as we typically do for guidance today, as there are still many uncertainties around how this pandemic will play out for the remainder of the year. However, I will give you some top-level comments around a few key areas, beginning with gross margins. We now expect our gross margins to be about flat compared to last year. Despite being down 230 basis points in the first half of the year, the significant second half improvement is driven by improved absorption at our factories, along with lower than expected tariff costs. During the first half of 2020, we applied for almost $20 million of refunds from past tariff payments and expect to apply for just under $10 million of additional refunds on exclusions already received in the second half. We’ve received the cash for the bulk of these applied for refunds at this point. Our full-year guidance also assumes that we don’t receive extensions for our current tariff exemptions, which are set to expire next month. Operating expenses are expected to be down slightly as a percent of sales and in total dollars year-over-year, given the cost actions taken in Q2 and continued cost discipline into the second half. Considering the recovery in our business, we have approved several strategic programs and marketing outlays. We will continue to manage our cost with discipline, mindful of the economic uncertainty. Financial services income is expected to be flat to last year with higher retail income, offset by lower wholesale proceeds from Polaris acceptance. And finally, foreign exchange while slightly improved from our initial 2020 guidance is anticipated to be slightly negative to pre-tax profit. Moving on to sales expectations by segment. Again, I will give only directional expectations given the challenges in predicting with precision how the economy will perform. The strength of our second half recovery is primarily driven by the ORV/Snow, Boats, and PG&A businesses. We anticipate continued weakness in adjacent markets given the dependence on government, university, commercial and rental sales. With that, I’ll turn it back over to Scott for some final thoughts.

Thanks, Mike. Our outlook is much improved from a quarter ago, and I certainly expect our forecast accuracy to at least be directionally correct this time, as consumer and dealer demand has remained strong through July. We have invested significantly in tools, protective gear and social distancing in our plants and offices to guard our employees from the risk of COVID-19 exposure and are redoubling our efforts as community spread increases. Dealer health is also a priority, and for the next few months, that means accelerating shipments. The advantages of RFM are paying dividends, as we can shift production and redirect deliveries faster than our competition. With our fantastic team, impressive vehicles and accessories, and engaging creative and rigorous sales execution, I like our chances to drive growth and market share gains in the second half. Aside from a few minor delays of our model year 21 product launches, they are on schedule and will emphasize that innovation is alive and thriving at Polaris. As we proved in the first six months of the year, this Polaris team is ready to deal with whatever comes our way. Powersports appears strong, but the overall economic and global outlook is less clear amidst the persistent threat of COVID-19, so we will be prepared to navigate references if they arise. While the risks are real and I’m not prone to optimism, I can fairly say that we are entering the second half of 2020 with the best setup for the industry and Polaris that I have seen in my dozen years at the helm. With that, I’ll turn it over to Andrea to open the line for questions.

We will now begin the question-and-answer session.

We are ready, Andrea.

Our first question comes from James Hardiman of Wedbush Securities. Please go ahead.

Hi, good morning. I just wanted to make sure I understood the commentary on July, since you put it out there. Obviously, May and June were unprecedented in terms of ORV strength. It sounds like based on the prepared remarks and the press release that that ultimately continued in July, is that accurate?

It’s still far above our expectations.

Okay. That’s helpful. And then maybe any more incremental color you could give us on that 75% of your sales, which came from new customers, that sounded like maybe the most bullish part of all of this? And maybe help us think about as you know, investors are going to look at this and say, wow, this is unbelievable, how are we going to comp against this next year, right? And so maybe any color you can give us on the sustainability of this unprecedented strength, maybe starting with that new customer piece?

It’s helpful to refer back to slide seven, where we highlight some of the demographic increases we've observed. Our core customers are currently very engaged, and we’re experiencing solid growth among our loyal Polaris customers. With more time on their hands and extra money due to the lack of Little League Baseball, soccer games, and trips to Disney, many new people are discovering the sport and finding vehicles that suit their families or themselves. While our core customers are fantastic, they can be a bit insular with their established riding groups and routines. However, as we attract these new customers, they are more inclined to invite their friends for rides and eventually consider purchasing a second Polaris vehicle. We appreciate this trend, which is partly driven by demographic shifts but primarily stems from the dedicated efforts of Pam Kermisch and her team to encourage this growth. You are correct that the comparison for next year will be challenging.

Got it. Thanks for the color.

Our next question comes from Scott Stember of C.L. King. Please go ahead.

Good morning, guys. And thanks for taking my questions.

Good morning.

Can you maybe talk about the inventory situation? I know that, obviously, this is unforeseen demand that’s bringing things down to depleted levels. But when will you guys get to a point where you feel that you have 100% of what you need at these levels? Or is there a risk that at some point you could start facing some serious shortages, particularly on the side-by-side side?

We are currently experiencing some shortages. I want to commend Steve Menneto and the team for effectively managing product movements to meet retail needs. The prolonged impact on Monterrey significantly strained razor production. While we have bounced back in Mexico more quickly than expected, it presented some challenges. Currently, our plants are operating at full capacity, and we are making progress. However, as I mentioned to James, the demand in July still puts us in a position where we are trying to catch up and restock, and we aren't making much headway at the moment. This situation is affecting retail, but it’s not to a degree that is overly detrimental.

All right. And lastly, just digging into this new customer that you talked about. Maybe just talk about the age profile and also the creditworthiness of these new people?

Mike, I’ll speak to the age. I mean what we’ve seen is in the 26 to 45, which is kind of how we classify the millennials, if you will, they were up 100% for us in the quarter compared to the 53% that we reported overall. So that age group certainly did well for us.

And Scott, I would say from a creditworthiness standpoint, we continue to see very strong performance. As we’ve talked in the past, we used a number of third-party independent financing partners. And so that creates a check and balance. And what we’ve seen from the new demographic, the new customers coming in is they match the profile of the existing customers in terms of the income strength, the creditworthiness. So that’s actually been a bright spot as we look at continued growth.

Got it. Thank you.

Our next question comes from Greg Badishkanian of Wolfe Research. Please go ahead.

Great. Thanks. In terms of market share, the industry-wide as well as Polaris ORV rose, I think in the low 60s, according to the slide for North America. And I’m just wondering your prediction of market share. And then just as a follow-up, given the scarcity of product at the dealer level, what’s the promotional environment looking like now? And would you expect that to be abnormally low?

To start with the latter question, it is remarkably low. We’re seeing good discipline amongst the OEMs, but really amongst the dealers. I mean, they recognize that they don’t need to sell something that the next person will pay full price for. So we’re really seeing good discipline. And we really like the fact that our dealers are seeing a profitability boost through this. It’s helpful for us, and you’ll see it in our reserves coming down, but it’s also just helpful for the dealers’ profitability as well. What was the other part of the question?

Market share.

Yes. What we’re observing is that those with products are currently gaining, particularly Japanese competitors, who captured market share this quarter. We are aware of this and don’t appreciate it, but we know how to respond. I am genuinely pleased with the efforts that Steve Menneto and his team are making in sales execution. Our dealer sentiment surveys showed the highest results we’ve recorded since we began these surveys. There are noticeable improvements in that area. However, it was indeed a strong quarter for the Japanese, impacting us and some of our other competitors.

Makes sense. Thank you.

Our next question comes from Joe Altobello of Raymond James. Please go ahead.

Thanks. Hey guys. Good morning. So, I wanted to go back to slide 14 for a second. You point out your expectations for the powersports market to be up low single digits. It seems like that implies a pretty sharp slowdown in the second half. Does that mean that you feel like Q2 included a fair amount of pull-forward? Or am I misinterpreting that?

Yes, Joe, I don’t know if I’d say pull-forward. I think the fact that we’ve had so many new customers come into the business; that clearly has created a surge in demand. As I pointed out in my prepared remarks, we anticipate continued growth in the second half, just not at the same pace and cadence that we experienced in Q2. And certainly, we’re making the investments to try and make that not the case. But at this point, we felt it was prudent to plan for those levels. And given where our dealer inventory level is, we’ve obviously got the plants running full board to make sure we’ve replenished that into the second half.

That’s helpful, Mike. And then maybe secondly on tariffs, you gave us a little bit of color earlier, but just wanted to clarify what the difference in tariff cost this year versus last year on a full year basis? I assume you don’t get the extension beyond August.

Yeah. So, let me just give you a couple of data points. We’re obviously still working through as we look into next year, what that means. And we’re obviously still working to try and get exemptions extended. But as I look at the numbers for this year, we ended up roughly being close to $30 million lower than what we were expecting. And a big portion of that, as I indicated in my prepared remarks was the refunds that we’ve received. If you go back to our original guidance, I had mentioned we were around $10 million of refunds that we thought we would have this year, and that number is getting closer to $30 million. And obviously, that won’t repeat into next year. And then as I mentioned in my prepared remarks, the exemptions are not assumed to extend for the balance of this year and that’s worth about $12 million. So, that can give you a sense of what we’re looking at, assuming nothing changes as we head into 2021. But we’re obviously still working the mitigation efforts as hard as we can. We have moved some products out of China, and we’ll continue to look for opportunities, and we’re also continuing to work through USTR and the administration.

Got it. Great. Thank you, guys.

Our next question comes from Tim Conder of Wells Fargo. Please go ahead.

Thank you. And gentlemen, first of all, congrats to you and the whole team, great execution and when the goalpost continued to move throughout the whole quarter. Several of the questions have been answered. But Scott, going to slide six, again, you said you’re continuing to chase demand. It appears more on the ORV kind of there where current demand on motorcycles. But obviously, the other part of that equation is the channel replenishment to adequate levels. When do you think that latter part, getting the channel back to adequate levels at this point would be reasonable to expect?

I think we’ll get motorcycles there by the beginning of the fourth quarter, because the demand does fall off for motorcycle seasonality. Certainly, feels like we’re going to be chasing for really the remainder of the year with off-road vehicles. Because as Mike said, we’ve been relatively conservative with our expectations for retail in the second half. But if it exceeds that, which it has so far in July, it could put us in a deficit situation where optimal dealer inventory is for most of 2020.

Okay. And then I may have the follow-on here. Any potential looking to repay liquidity? And then on tax law changes, so whoever wants to take this one. I know, Scott, this is probably not in your optimistic bucket and probably your pessimistic bucket. But proposed changes by some of the candidates out there on the individual and the corporate, how do you anticipate that at this point, the potential impact that could have on 2021 demand?

I’m not going to speculate on what will happen in the political landscape in the coming months. A key reason for our cautious guidance is that we’re uncertain about how the election rhetoric will affect demand. Therefore, we are being a bit careful. It's clear that a shift in the administration could negatively impact tax policies for both corporations and many of our customers. We are aware of this and will be monitoring it, but there’s nothing we can do except hope for a different outcome.

And from a liquidity standpoint, obviously, we’re doing tremendously better than we had expected and anticipate that will continue through the year. We guided that our operating cash flow will be up mid-teens. And I think we’re going to be in a position, we have $100 million in notes that come due in December, that will be easily dispensed. The biggest issue that I’m working through with my team right now is the $300 million of term loan that we took out. There are restrictions, as have been publicly disclosed around share repurchase and some other things. And I think I’d like to try and get off of our shoulders as best we can. But we’ll continue to look at that. We want to make sure that our forecast is settled out and things are working towards what we’ve guided, if not better, and we’ll continue to manage that. But our goal is to continue to delever the business, and we did that in Q2 and we’ll do that for the rest of the year.

Okay. Great. Very helpful. Thank you, gentlemen.

Our next question comes from Brett Andress of KeyBanc Capital Markets. Please go ahead.

Hi, good morning. So just following up on promotions, what do you plan to do about the fact that we authorized clearances fall, given the inventory situation? And then normally, this time of the year, we started to hear new products. You mentioned some delays, but is the timing of those releases still sometime here in 2020?

Yes. No, as I said, we’ve been - the team has really done a nice job. And when I say the team, it’s certainly our engineering group, which many of them have been working remotely, have really done a nice job working with our supply chain team and our factories teams to keep our production launches on schedule. I don’t think anything has moved out of the year. Now we may choose for commercial reasons to not launch something depending on how late it goes in the season. But no, certainly, everything is on track to be in the year if we want it to be within the year. The FAC, as you can imagine without any inventory, excess inventory, we won’t be running our traditional FAC playbook. I will tell you, though, the team has really come up with a great plan with, again, as I talked about the strong demand for accessories, the record PG&A quarter that we had, we are going to have an event where we promote our aftermarket accessories and give people the opportunity to accessorize their vehicles through this - the fall thing. But right now with demand where it is, it would be foolish to spend money on an FAC.

Got it. And if I could just follow-up a bit more on inventory, likely to be down substantially by year-end. But is there a new normal channel inventory you want to end up at when things start to normalize? I guess what I’m getting at is, will dealer turns possibly be structurally higher coming out of this going forward?

One of the investments we’ve made and Ken Pucel and his team really led it is to get RFM throughout the entire portfolio. And so we’ve been working with our dealers prior to the pandemic, and actually, in the early days of the pandemic, they wanted less inventory, so we were helping them to lower their profiles. We are certainly looking at how much inventory finished goods inventory we need and how much inventory we need in the channel. And that’s an individual profile with each individual dealer that we will continue to evaluate. But I don’t know that it’s a huge step down, but it’s likely to be slightly less.

Thank you.

Our next question comes from Jamie Katz of Morningstar. Please go ahead.

Hi. Good morning, guys. Nice quarter. So I’m curious about gross margin gains ahead. And I surmise that the greatest gains that we’re going to see in the second half as we get back to flattish gross margins for the year would be in ORVs and boats. But is there any other catalysts we should really be thinking about that will help that metric improve?

Yeah, Jamie, it’s going to primarily be driven by just the surge in volume. When you look at - from first half to second half, our volume is going to be up well over $800 million and we’re driving a 40% plus drop rate. And just given the mix of business, I think it’s important to point out, and we’ve talked in the past, our ATB portion of ORV does carry less in lower margins than side-by-side and we’ve experienced strong growth there as well. So that will dampen that just a little bit. And there’s a little bit of favorability from some of the tariff refunds that will come into the second half, but really, we’re actually going to start to face headwinds as we get into the latter part of Q3 and into Q4, given the exemptions will expire and we’ll be bleeding off the lower value inventory. So I mean, that’s really the gist of it. Our supply chain transformation program is continuing in earnest. I can tell you that the team has not taken any of the pressure off of that. The savings, as we’ve talked in the past, are ramping as we get into the second half. So that’s certainly providing a little bit of tailwind. And – but it’s really attributable to the volume increase.

Okay. That’s helpful. And then with the write-down on TAP, I think you’ve probably updated your prognosis for both sales potential and maybe profit potential for that segment. Is there any insight you guys might be willing to offer on that as you revalue that TAP business?

Yes. So the - two things. One, we re-evaluated TAP and Boats. You’ll be able to read it in the Q that comes out today. The TAP business was far more significantly impacted. It performs better than automotive, but it follows more of those trends, which have been quite deep and that really triggered what we had to do on that business. The boats business has been impacted but it’s held up well, and Jake and the team continue to run that business incredibly well. And while it did lower the headroom between the market and book value, we still obviously are in a good spot there. And assuming we don’t have any further economic issues, we’re pretty confident with what we can do with that business going forward. Scott went through it in the prepared remarks with TAP. The retail side of that business is doing very well, especially with being slightly handicapped by some of the store closures and things that we’ve been dealing with, but the pickup in store and just the overall retail performance, DIY really has propelled that business nicely.

Okay. Thank you.

Our next question comes from Gerrick Johnson of BMO Capital Markets. Please go ahead.

Thank you. Good morning.

Good morning.

So on your first-quarter call – hi, guys. On the first-quarter call, you commented that COVID hotspots were not necessarily in gray off-road riding areas. That seems to have flipped. You don’t have hotspots from the South and West Interior. Has that affected retail at all? Is that a concern? Or was that something that in retrospect really wasn’t an issue in the first quarter?

No. I think riding and off-road vehicles is one of the safest activities to avoid COVID-19. Most people wear gloves and helmets and are outdoors, which is as good as it gets. What I meant when I mentioned that hotspots aren't where we sell is that those areas weren't our markets during the pandemic, and they still aren't. For example, while San Francisco and New York City are great markets for some products, they aren't for snowmobiles and off-road vehicles. Chicago is a good market for motorcycles, but other cities are not. In a strange way, I believe the pandemic has limited people's opportunities to engage in other activities, drawing them into powersports. We have observed this trend continue, and despite media reports of increases in certain states, there has been no negative impact on our retail.

Okay. Great. Thank you.

Our next question comes from Robin Farley of UBS. Please go ahead.

Great. Thanks. You’ve commented on it a little bit, but I just want to clarify two things on your retail expectations for the year, you’re seeing up low single digits for the market. And then I know you said Polaris a little bit ahead of that. But given that the industry was up 50% to 60% in Q2, how do you get to low single digits for the year without declines in the second half? In other words, I don’t know if you’re just sort of kind of making a conservative statement about the full year, just trying to square the math of that? Thanks.

We have retail that appears to be flat in the second half. We expect Q2 or Q3 to remain positive, although not as strong as Q2. However, we forecast that Q4 will likely see declines. We're being cautious based on what we saw in July, but we're aware of the volatility in the environment. The situation with COVID and election uncertainties could introduce significant fluctuations and uncertainty. That's our current outlook. If conditions improve beyond our expectations, we're prepared to respond, thanks to the excellent work done in our factories.

That's great. Also, you expect that it will take most of the rest of the year to replenish dealer inventory, at least in the RV segment. How should we consider the situation if retail sales exceed the somewhat flat outlook you've mentioned for the second half? Do capacity constraints limit your retail performance? In other words, what will ultimately cap supply growth, particularly given the depleted inventories? Can we discuss what the supply constraints might look like for retail in the second half?

I want to acknowledge the great work that Steve Menneto, our logistics team, and everyone else is doing to manage the movement of products. Despite the current inventory levels being significantly lower, we are experiencing very strong retail performance through July. We’re nearly 50% down from the end of the first quarter, yet retail remains robust. This doesn’t mean there’s no inventory available, but it does limit our potential growth. If demand continues as it is, we may find ourselves needing to keep up longer than expected. I'm pleased with the progress in our supply chain and factory operations. Ultimately, it depends on retail, but we don’t foresee a significant negative impact; we’re just discussing a decrease in the very positive retail outlook. I don't see that as a bad thing.

So you could grow retail double-digits in the third quarter. And again, not at the level you saw in Q2, but you’re not capacity constrained to that degree, it sounds like, right? You could still do some level of double-digit retail in Q2.

Our dealers are not going to run out of inventory.

Okay. Thank you.

Our next question comes from David MacGregor of Longbow Research. Please go ahead.

Hi. Good morning. It’s Colton West on for David. Thanks for taking my question. I guess to start off, how has COVID-19 impacted the way Polaris conducts business online in the long term? And are you looking at more direct-to-consumer channel utilization?

Yeah, last time we talked about the launch of click deliver ride, which has been really helpful, and we’re seeing more of our customers engage online with Transamerican Auto Parts, for example, they’ve got a great online presence that is really doing well. And our own accessories and aftermarket business, we’re increasingly creating opportunities for consumers to buy from us and pick up at the dealership. So we are doing more to move people in that direction. Really, it’s enhancing the website to make it easier for people to do the shopping there and then ultimately coordinate with that delivery to the consumer. So a lot is happening in that environment. We just launched the industry’s first customer portal. We saw the press release perhaps yesterday with ride ready and the ability to have dealers come to your house and repair your products. So we are certainly preparing to lead the way for a more digital future, but it’s transpiring now. Certainly with Adventures, we are gaining just tremendous momentum there as more people take advantage of the opportunity to find a place to ride and go do it for a weekend. Ultimately, that’s going to be helpful to long-term purchases. So, yeah, the team has really embraced it, but not a tremendous shift from the first quarter now.

Okay. Thank you. And then, can you provide some color on Challenger and how the progress is going there? I believe on the first quarter call, you guys commented that Challenger was taking share and Indian retail up mid-teens percent in the second quarter would suggest that you guys are continuing to do so? And what does the owner profile look like for Challenger specifically?

Challenger is performing exceptionally well, and we are pleased with our heavyweight segment due to its higher profitability. However, the mid-sized bikes, including Scout, Bobber, and FTR, have seen impressive growth. Notably, our first liquid-cooled bike has resonated with riders who previously enjoyed Victory models, offering them more space on the bike. Compared to competitors, our bikes are simply superior. We are optimistic about the demand from both consumers and dealers, which should continue to be strong for the foreseeable future.

All right. Thank you very much.

Our next question comes from Craig Kennison of Baird. Please go ahead.

Hey. Thanks for taking my question and great call, really helpful discussion here. My question was on Indian. The largest competitor there is conceding market share to focus on scarcity value. And that would seem to leave a nice price umbrella for Indian. And really open the door for further share gains. Does that change your view at all on the potential for Indian volumes and profitability going forward?

What we’ve seen - I mean, a year ago, you might recall, there was some lunacy over there as they were embracing promotions and discounts at a rate we hadn’t seen ever from them. So I think pulling back from that and having a more rational approach makes a lot of sense. The industry needs better pricing power. Our dealers need a bit of that. And to see some discipline there is welcome news. Ultimately, it’s a good brand. They’ve got a good dealer network, and we don’t expect to have this gift that they’ve given us continue. But certainly, with lower unit volume in their dealerships and higher prices, and really, we’ve just got a great lineup of bikes. I’d tell you what Mike Dougherty and his team are doing to make sure that we’re getting the bikes where they need to be. But really, the line-up is good and getting better. And then we’re encouraged by it.

Thanks.

Our next question comes from Brandon Rolle of Northcoast. Please go ahead.

Good morning. I just had a couple of questions. First, on parts and accessories availability, I think everyone understands ORV inventories challenged, but could you shed a little light on parts and accessories availability, especially ahead of a factory authorized clearance, while you’ll be running a special event for parts and accessories? And then, two, just also, could you talk about the new families that are coming in, are they replacing a vacation? Or do you really think these families are staying in the industry for the long haul? Thank you.

Yeah. Steve Eastman has done a miraculous job with our business since he’s been here. And really, the team’s managing inventory reasonably well. We were a little heavy with PG&A inventory, both in our dealerships and within our own warehouses. So this has helped clean that up a good bit. And they’ve done, again, just like the whole goods. They’ve done a nice job managing the supply chain. So we’re not seeing many stock-outs. And when we do, they’re days, not weeks or months. So that’s been very helpful. And really, FAC is really designed around some of those accessories that are slower moving, but really beneficial to consumers. And I think, Steve and Steve Eastman have worked together to come up with a good plan there that I think should work well for our dealers.

Yeah. I think the question around the new families and how permanent. I think when you’re making a commitment to the price tag of the vehicles we have, I think it’s safe to assume that this is going to become part of what they do, and they’re going to realize that it becomes a great family activity. As Scott said in his remarks, the number of 4C vehicles or crew vehicles that we’re selling is highly indicative of this being more of a family activity. And while it may not fully displace people taking vacations, I think that it brings a new aspect of being outdoors, and enjoying that with not only their family, but with friends. And we think that, that’s something that can continue into the future. It’s something that we’ve been focused on. It was a big part of the re-branding of the company that we did. And so we think it is sustainable. Obviously, the growth rates will be tough to mimic, but we do think that we’re bringing these folks in permanently into the family.

Great. Thank you.

Our next question comes from Mark Smith of Lake Street. Please go ahead.

Hi, guys. Can you talk about with new customers coming into the space, primarily as we look at off-road vehicles? Just a little bit about your mix, did you see more let’s call them entry type vehicles, maybe some older 900s and 1,000s versus XPs and Pro XPs or perhaps how ATVs trended during the quarter?

Certainly, you hit the nail on the head. We definitely observed that trend. Part of it was related to availability, but priority-wise, we noticed customers gravitating towards crew vehicles, which is where their interests lie. Following that, ATVs performed very strongly this quarter. I believe new families, as Mike mentioned, are not looking to invest in a premium vehicle; they just want something to take on the trails and spend time with family. Overall, the primary factor influencing our sales mix right now is availability. However, new customers are eager to explore and engage with options beyond the premium market.

Okay. And follow-up to that, does that give you perhaps opportunity for upgrade as we look maybe next summer, and then also with that just, anything you can talk about on stimulus and how you think that impacted sales, and as you look at maybe another round coming out to any potential positive impacts from that?

I don’t think next year, all of these new customers coming in, they’re not likely to upgrade a year from now. I mean, I think some will. We love those people that do, but I don’t think we should count on that. What is more likely though is again as I said, the likelihood of them inviting their friends and so they have someone else to ride with, and having those people ultimately buy vehicles is much more likely than that individual upgrading the vehicle.

I think from a stimulus standpoint, we’ve actually spent a lot of time with our partner retail financing banks, as well as external advisers. And the U.S. savings rate went up. We saw consumers actually prepaying loans. There was some taking advantage of deferral of loan payments and things like that, but those seem to be returning to normal levels. It doesn’t look like people were using that as just the way to get to a new vehicle. As I mentioned earlier, the creditworthiness of these folks coming in, they typically have dual income families. They weren’t necessarily heavily impacted by the unemployment activity that happened coming out of Q1 and into and we think that they saw this as a way to use money that they had allocated for other things; vacations, cruise, you name it. So, at this point, we don’t foresee that the stimulus necessarily had a gigantic impact. If there were more stimulus that were to come in the system, I think it just gives people that much more confidence and could create more stimulus for demand going forward.

Excellent. Thank you.

Our next question comes from Joe Spak of RBC Capital Markets. Please go ahead.

Thank you very much. Scott, I've missed sports for many reasons, but one is certainly that you’re running short on anecdotes to compare the business to. Moving to a broader question, stepping away from the immediate positive trends, this is more of a strategic inquiry. In the past, you've mentioned electrification, and I know you have some products related to that, but it's still quite costly. If you examine the listed prices from some new competitors taking pre-orders for vehicles that may not even be available until 2021, it demonstrates that point. I wonder if there’s a lesson in that for you since costs will eventually decrease. You understand the ORV customer better than anyone, so have you considered a model where you release a vehicle design, take pre-orders, evaluate the actual demand, and strive to maintain your leadership in what could evolve into a significant market segment over time? Also, could you remind us whether you plan to handle the powertrain for those alternative vehicles in-house or if you would consider partnering?

Yes, that's a good question, Joe. I'm looking forward to Navy's noted aim playing on Labor Day weekend to help get back into the sports analogy, but we'll see what happens since things have been a bit challenging lately. When we made the leadership change last year, we appointed Chris Musso to lead our electrification efforts. Although we haven't been making public announcements, the team has made significant progress in understanding the opportunities and how we might approach that market. My perspective on electric vehicles has evolved. My main concern has always been about the balance between range, cost, and performance, and right now, we believe that balance is starting to improve, which could lead us to offer powersports consumers a product that is not only comparable but potentially superior to our current internal combustion engine models. We see the potential and expect to be among the leaders in this space. We are not planning to engage in the type of pre-orders for vehicles that don’t yet exist, despite the high valuations that have been discussed, but certainly, you can expect to see more from us regarding electrification in the near future.

Thank you.

Okay. With that, that’s all the questions we have. We want to thank everyone for participating this morning, and we look forward to talking to you again next quarter. Thanks again and goodbye.

The conference has now concluded. Thank you for attending today’s presentation. And you may now disconnect.