Polaris Inc. Q4 FY2020 Earnings Call

Good morning and welcome to the Polaris Fourth Quarter and Full Year 2020 Earnings Call and Webcast. All participants will be in a listen-only mode. Operator instructions were provided. Please note, this event is being recorded. I would now like to turn the conference over to Richard Edwards, Vice President of Investor Relations. Please go ahead, sir.

Thank you, Chuck and good morning, everyone. Thank you for joining us for our 2020 fourth quarter and full year earnings call. A slide presentation is accessible at our website at ir.polaris.com, which has additional information for this morning's call. Mike Speetzen, our Interim Chief Executive Officer and Bob Mack, our Interim Chief Financial Officer, have remarks summarizing the quarter and the full year and our expectations for 2021, 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 fourth quarter and full year 2020 actual results and 2021 guidance are reported on an adjusted non-GAAP basis unless otherwise noted. Please refer to our Reg D reconciliation schedules at the end of this presentation for the GAAP to non-GAAP adjustments. Now, I will turn it over to our Interim CEO, Mike Speetzen. Mike?

Thanks, Richard. Good morning and thank you for joining us. I am pleased to be speaking with you today as Polaris' Interim CEO. Before we review the results for the fourth quarter and the full year 2020, let me say a few words about my current role. I first want to thank Scott Wine on behalf of the Board of Directors and the entire Polaris team for his leadership over the past 12-plus years. Through his tenure, he instilled a sense of enthusiasm and a commitment to excellence across the organization and has put our company in an enviable position to drive growth and profitability going forward. And I'm thrilled to build on that momentum. Our Board of Directors continues to work diligently through the process. In the meantime, I appreciate the Board's confidence in Bob Mack our Interim CFO and myself. Our performance in 2020 underscores the outstanding talent and dedication of our team, which will allow us to continue to win going forward. I'm excited and energized to lead the best team in Powersports to another successful year. To say that 2020 was an exceptionally unusual year would be an understatement. The company started the year with very aggressive goals, both financial and operational, and the first couple of months were trending on plan. Then the pandemic drove an abrupt shutdown of international commerce in March, sending shockwaves through the global economy. In response, we quickly implemented our recession playbook and worked to ensure the liquidity of the company. The agility and dedication of our team was on full display as we navigated incredibly uncertain times. We temporarily closed factories, cut non-essential expenses and shuttered underperforming assets. Within a matter of weeks, our retail sales turned positive and have only accelerated from there. I want to again thank the Polaris team for how they stepped up and leaned in to support our dealers and customers and protect this great company during such a challenging time. While we didn't experience sales growth in every business this past year, the momentum coming out of the fourth quarter was positive. Our fourth quarter sales increased 24% and adjusted EPS was up an astonishing 83%. Strong retail and corresponding revenue growth drove full year sales of 4% topping $7 billion. And we leveraged this growth to adjusted earnings of 22% for the full year. Market share gains continued for our Motorcycle business. And I'm proud to report that our ORV business gained share in the fourth quarter as our production velocity improved and we leveraged the competitive advantage of our scale in our retail flow management system. While the data for Boats is preliminary with a limited number of states reporting, the initial read is encouraging as well. Our manufacturing output improved substantially during the quarter, but constraints from various suppliers persisted, which impacted our ability to meet delivery plans. Improvements will continue into the third quarter of this year, and it will likely take us most of the year to improve dealer inventory levels. And finally, PG&A, aftermarket, global adjacent markets and international all posted strong year-over-year growth in the fourth quarter, despite ongoing challenges with supply and COVID-related economic shutdowns. Fourth quarter North American retail sales were up 20%, continuing the unprecedented levels of growth as consumers continue to turn to Powersports as a socially distanced outdoor activity. With improved product availability, our ORV business gained market share in the fourth quarter, as the industry grew in the high 20% range. In Slingshot, fourth quarter retail remains strong, finishing up nearly 40% and market share up four percentage points. Boat retail was also strong for all brands during the quarter and year, tracking essentially in line with the industry for the year, which was up high teens percent. Snowmobile sales were strong as well, with retail up in the mid 20% range season to date through December ahead of overall industry growth trends. We're confident that the growing interest in Powersports along with our expansive product lineup and innovative products will continue to drive strong performance into 2021 and beyond. Our retail flow management system provided us a competitive advantage as we were able to outperform the industry in terms of delivering much needed inventory to the dealers. Despite this performance, dealer inventory remained at historically low levels, as demand continued at unprecedented rates. North American dealer inventory was down 58% year-over-year, with all segments trending below ideal levels. While inventory remains at decade low levels, we improved on our delivery metrics sequentially as we ramped production and moved product around the channel to minimize customer wait times. Maximizing retail sales and filling order backlog remains front and center in this unique pandemic environment, while concurrently working to ease dealer inventory pressures as quickly as feasible. Supplier constraints remain the bottleneck, and we are working all available options to ease the supply chain strain as quickly as possible. As we project out dealer inventory levels for 2021, we have a couple of dynamics occurring that are meaningful. First, given improved delivery processes enabled by our refined retail flow management system, we believe that our dealers can successfully operate below their historical inventory profile levels. Secondly, as supply chain constraints abate, dealer inventory levels should improve through the year, but we still believe 2021 will finish below optimal levels targeted under this refined retail flow management system. During the early days of the lockdowns, it quickly became apparent that many people were seeking ways for their families to enjoy the outdoors, which positioned us quite well. As you can see, we added a considerable number of new customers. This new diverse customer base through growth across our Powersports portfolio is increasingly inviting their friends and families to the sport. An important fact for you to consider is that historically approximately 65% of our customer growth has come from new customers. Last year, new customers accounted for just over 70% of our growth, representing roughly a 30% increase versus 2019. Our existing customers grew at a mid-single-digit rate versus 2019, reflecting the strength of our installed base. Our Polaris Adventures business is further evidence of this increased attraction of first-time customers, with Adventures completing over 270,000 rides in 2020, a 95% increase over 2019. These are customers that have the potential to become Polaris owners in the coming years. As we've said in the past, Polaris is not unique in realizing the new customer growth, but we are taking active steps to engage and cultivate these important additions to the Polaris family. We recently introduced Polaris Adventures Select, the first ever monthly subscription service for the Powersports industry. This is yet another example of how Polaris leads in innovative approaches to attracting new customers to the business. Polaris Adventures Select is a membership program that offers access to the Polaris family of vehicles, including ORVs, Indian Motorcycles and Slingshots through a monthly fee. Members can tailor their program either by picking up a vehicle themselves, having it delivered directly to their home or booking an experience at one of our Polaris Adventures outfitters. The rollout of this unique service is currently being piloted in the greater Phoenix, Arizona market. First, I want to thank our manufacturing, supply chain and logistics teams around the world. They executed at levels never seen before and did so in an environment fraught with risks and challenges. Their effort and dedication made all the difference in Q4. Unprecedented demand has put considerable pressure on our plants. You will recall that during the peak of the pandemic, we had to bring most of our plants down for a period of time. And while our plants have been at full production for some time now, we have work to do to meet both the ongoing retail demand and replenish depleted dealer inventory. We've been ramping factory output to the extent our supply chain will allow. However, as we indicated earlier, some of our suppliers are not yet capable of meeting the rapid demand spikes. Based on our retail demand expectations for 2021 and anticipated supply chain improvement plans, we are likely to be running our plants above ideal capacity levels throughout most of 2021. Given the anticipated continued strong retail demand for our products and the robustness of our future product plans, we will continue to look at all options for meeting demand and customer expectations. We continue to make strategic investments in manufacturing, sourcing, distribution, digital and customer engagement, but we remain a product company at heart. In 2020, we introduced over 120 new products across our portfolio and over 900 new accessories in our PG&A and aftermarket segment. With the investments we've made in research and development over the past several years, our innovation vitality index, which is defined as the percentage of sales from products introduced within the past three years, was a healthy 90% in 2020. The cadence of new product introductions will continue to accelerate in 2021, including vehicles and technology that will make owning and using our vehicles more fun, easier to use and more intuitive than ever. Just last week, we introduced two new Ranger vehicles, the Ranger Big Game and Waterfowl Editions, three new Razor trail models and a new Sportsman ATV, and we trust that this is just the beginning of a full year of new product news in all categories, including a new Indian Motorcycle that celebrates the 100-year anniversary of the original Indian Chief by launching a brand new Chief on February 9th with shipments beginning this spring. I'm not going to steal Bob's thunder, but rest assured we have the company poised for another record financial year, and I'm very optimistic about our future. My role is to ensure that our strategic, operational and financial priorities are clearly understood across the organization. First and foremost, maintaining the health and safety of our employees is our top priority. Second, delivering on our financial targets, both near term and the five-year strategic goals is critical. Third, bringing dealer inventory back in line with targeted retail flow management profiles as quickly as possible. And finally, executing on our strategic initiatives, including quality, supply chain transformation, digital, and electrification. I can assure you that our entire executive leadership team has the experience and dedication and are fully committed to executing on these priorities. I'll now turn it over to Bob Mack, who will summarize our fourth quarter and full year 2020 results and our expectations for 2021.

Thanks Mike and good morning, everyone. I'm excited to be joining Mike and leading the company and I look forward to working with all of you. I also want to reiterate Mike's comments earlier that this was an unprecedented year on a number of fronts. The team remained focused and drove record performance in 2020. The ongoing robust demand for our products has generated strong sales and earnings results. Our fourth quarter sales were up 24% on a GAAP and adjusted basis versus the prior year, with all segments growing sales and most growing double-digit percent. Volume growth was the main driver with average selling price up only about 3% during the quarter. Fourth quarter earnings per share on a GAAP basis was $3.15. Adjusted earnings per share was $3.34, up 83% from last year's fourth quarter, benefiting from a combination of increased volume, positive mix, lower promotional and flooring costs, partially offset by inefficiencies from freight and rework at the factories brought on by the supply chain challenges. Additionally, our fourth quarter operating expense leverage improved compared to last year's fourth quarter due to both continued prudent spending along with $12 million of stock compensation reversal benefit related to the CEO departure. For the full year 2020, sales were up 4% on a GAAP and adjusted basis versus the prior year. All segments, except ORV, were down for the full year 2020 due to the impact of COVID-19 in Q1 and Q2 when the country, our business were impacted by the related economic shock and our factories, dealers and 4WP stores were closed for several weeks. Full year earnings per share on a GAAP basis was $1.99. Adjusted earnings per share was $7.74, well ahead of our expectations. As Mike indicated, the unprecedented growth in retail sales from new customers coming into the market and existing customer repurchases exceeded our optimistic assumptions as we moved through the year. Similar to the fourth quarter, the full year EPS benefited from a combination of increased volume, positive mix, lower promotional and flooring costs and operating expense containment, partly offset by inefficiencies from freight and rework at the factories, driven by the supply chain challenges. Adjusted gross profit margins increased 95 basis points for the fourth quarter, driven by favorable product mix, higher average selling prices due to lower promotions and flooring costs, which was somewhat offset by logistics and plant inefficiencies. You can find more detail on gross profit margin performance for 2020 in the supplemental section of this presentation. Turning to our segment performance. All segments grew sales in the fourth quarter, driven by a combination of continued strong retail demand, new product introductions in the second half of the year and the significant order backlog at dealers. Reported fourth quarter segment sales were as follows: ORV and Snowmobile sales were up 29%. Motorcycle sales increased 23%. Global adjacent market sales were up 18%. Aftermarket sales were up 8% and our Boats segment sales increased a strong 20% on a GAAP and adjusted basis in Q4. Average selling prices were up for all segments for the fourth quarter, except for Motorcycles and Boats, which were both lower due to the mix of products sold in the quarter. On a full year basis, with the exception of ORV, all segments' sales were down on a year-over-year basis due to the pandemic dynamics I described earlier. International and PG&A sales, which were also strong, are embedded within each respective segment. International sales increased 24% in the fourth quarter, which includes approximately five percentage points of benefit from foreign currency rates. All regions grew sales double-digit percent for the quarter, as vehicle supply improved. Full year International sales were up 1%, with Latin America and Asia-Pacific realizing sales growth. EMEA sales declined for the year due to vehicle supply constraints and sporadic COVID-related shutdowns in various countries throughout the year. Our parts, garments and accessories sales increased 31% during the quarter and 19% for the full year. Turning now to 2021 guidance. With the strong momentum coming out of 2020, we are anticipating a record year for 2021. Our guidance for the full year 2021 is as follows: Total company adjusted sales are expected to be up in the range of 13% to 16% versus 2020. The 2021 sales growth includes the following assumptions. The overall North American Powersports market and Polaris retail sales are expected to decline from 2020, given the strong new customer growth we and the industry enjoyed most of last year. We anticipate the industry will be down high single digits for the year, with share gain trends continuing for Polaris into 2021. The pontoon industry is also expected to decline slightly on a year-over-year basis, with our pontoon business expected to return to share gains for the full year. While we expect full year 2021 retail to be down from the incredibly strong 2020 market versus 2019 levels, 2021 retail will still be up 15%, which I think gives you a good perspective on how strong our end markets remain. We anticipate average selling prices will be slightly positive in 2021, but less than 2020 as we mix more to the mid-size and value-oriented vehicles and boats, and expect promotional spending to increase from 2020 levels as the overall Powersports market begins to normalize in the back half of the year. Adjusted earnings per share for 2021 is expected to be in the range of $8.45 to $8.75 compared to the full year 2020 adjusted EPS of $7.74, an increase of 9% to 13%. However, our performance is better than our guidance suggests beginning with gross profit margins. We anticipate that gross profit margins will be up slightly on a year-over-year basis, driven by a number of pluses and minuses. On the plus side, our manufacturing plants are expected to have a smaller backlog of vehicles needing rework as supplier constraints begin to abate likely beginning in Q3. On the pricing side, beginning with the ORV product introductions announced two weeks ago, we are pricing for added features designed into our vehicles. In addition, savings from our supply chain initiative now in its third year are accelerating as we move into phase three of the program. On the negative side, tariffs are expected to be a larger detractor in 2021 at the rates in place today. Our tariff costs ended 2020 at approximately $60 million, which is net of one-time exemptions and refunds received last year. If nothing changes under the Biden administration, our total tariff costs are expected to increase by approximately $40 million, which factors in both volume increases and the lack of the exemptions and refunds received in 2020. The bulk of these tariffs are from the China 301 list one through four with a modest amount of retaliatory tariffs included. Also, as I mentioned earlier, we anticipate the promotional environment to start to normalize as we go through 2021, which will be a gross profit margin headwind. In total, if you were to exclude the impact of tariffs and supply chain disruptions, our gross profit margin rate would be approximately 200 basis points higher. We will continue to focus on mitigating these items as the year develops and the new administration begins to address trade policies. Adjusted operating expenses are expected to be about flat as a percentage of revenue with 2020. Remember, during the height of the pandemic last year, we canceled or postponed all non-essential expenditures and undertook employee-related cost actions to reduce expenses and conserve cash. Given the significantly improved company performance expected in 2021, we have added back select operating expenses in certain strategic projects to remain competitive and continue to innovate in our respective market segments. The reinstatement of the previously postponed expenses and projects equates to about half of the mid-teens dollar increase in operating expenses in 2021. Income from financial services is expected to be down, given lower retail assumptions impacting our retail financing income, partially offset by an increase in wholesale financing income as dealer inventory levels increase throughout the year. Retail financing availability remains at acceptable levels. Interest expense is expected to decline about 20% in 2021 from lower debt levels as we modulate between debt reduction and share repurchase throughout the year. I will talk more about our 2021 capital allocation priorities shortly. The income tax rate is expected to be in the range of 23.5% to 24% for the full year 2021 as our rate reverts back to a more normalized level. Share count is expected to be up 1% in 2021, which is a combination of expected dilution from compensation plans offset somewhat by the reinstitution of share repurchases given our strong liquidity position. After first focusing on organic investment and returns to our investors via the dividend, our capital allocation plan pivots to our share buyback program, as we view our own stock as an attractive investment. Lastly, the currency rates for both the Euro and Canadian dollar, which have the largest currency impact to our financials, are assumed to be above 2020 average levels, which we anticipate will have a positive impact on results. We expect currency will be a tailwind to pretax profits of approximately $10 million. We have planned 2021 assuming the average Euro/U.S. dollar rate at $1.18 and the Canadian/U.S. dollar rate at $0.76. While currency rates have recently been trading above these, we are seeing a somewhat offsetting impact with the commodity markets. Given the unique events of 2020, the quarterly sales and earnings cadence was far from normal given the pandemic impact. Let me give you some clarity on how we see this year playing out, given those nuances. In a normal year, our first half/second half results are split approximately 40% and 60%, respectively. In 2020, that split was 20% for the first half and 80% for the second, given the pandemic impact on demand and production. For 2021, we are anticipating the first half/second half split to revert back to a more normal cadence of approximately 40%, 60% split. Looking a bit deeper into the first half of 2021, I'd also add that we anticipate the cadence for EPS between Q1 and Q2 to also be more in the normal cadence range with Q1 EPS in the 40% range and Q2 about 60% of the first half of 2021 expectations. Sales in the first half are expected to be about evenly split between the first and second quarter on a percentage change basis. We expect sales increases in the second half will be weighted more towards the third quarter. Now moving onto our sales guidance by segment. We expect all segments to grow sales in 2021, as we drive to meet the ongoing strong demand and replenish dealer inventory levels. The expectations by segment are shown on the current slide. On a gross margin segment reporting basis, we expect all segments' gross profit margins to be flat or slightly improve over 2020 on a comparable basis. See the supplemental section of this presentation for additional details around our gross profit margin expectations. Operating cash flow finished 2020 at $1.019 billion, a 55% increase over 2019 and a new milestone for Polaris of exceeding $1 billion in operating cash flow in a given year. We anticipate 2021 operating cash flow will be down from 2020 as we rebuild finished goods inventory to more acceptable levels. Let me summarize our capital deployment priorities and expectations for 2021. Capital expenditures are expected to increase from 2020 levels to approximately $250 million, which includes tooling required to support new product introductions, the supply chain transformation program and various strategic initiatives. Dividends remain a key priority for the company, with our 25-year track record of consistently increasing dividends to shareholders. And we expect to continue that trend for a 26th year. Our debt to total capital ratio of 56% is down from the 2020 ratio of 60% as anticipated. Our focus in 2020 was on cash preservation and debt reduction for obvious reasons. But in 2021, given our cash position and the outlook for the year, we will pivot to a combination of debt reduction and share repurchases given market conditions. Our long-term goal is to keep the share count at least flat, but we were out of the market in 2020 for the previously noted reasons. For the full year 2021, we are currently planning to spend approximately $250 million on share repurchases to help offset the dilutive impact of the stock compensation plans. We will adjust our thinking as market conditions dictate. With that, I will now turn it back over to Mike for some final thoughts.

Thanks Bob. 2020 is now behind us, but the impact of the pandemic is far from over. We expect the overall economic outlook will be tenuous as the country resets from the events of 2020—COVID-19, social unrest, contentious elections, new leadership in Washington, D.C., and the list goes on. However, the company has never been positioned better with innovative products, leading technologies, state-of-the-art plants and the best team in Powersports to lead us through 2021. While we anticipate the North American retail demand profile to moderate from the 25% growth realized in 2020, we expect a continued healthy retail environment driven by new customers and the demand from our core Powersports consumers. Also, as we've demonstrated this year and throughout our history, we have plans in place to rapidly respond to changing demand signals. For 2021 our path is clear. Continue to keep our employees safe, work relentlessly to improve supply chain to meet demand and replenish dealer inventory, and continue to focus on our strategic priorities: delivering high quality vehicles, leveraging our strategic sourcing initiative, amplifying our digital offerings and preparing for the foreseeable shift to more electrified vehicles. With that, I'll turn it over to Chuck to open the line for questions.

Thank you. We will now begin the question-and-answer session. Operator instructions were provided. And our first question will come from Robin Farley with UBS. Please go ahead.

Great. Thanks. Obviously, great results and guidance. Just looking at the guidance for 2021 and you addressed some of this in how 2020 was kind of an unusual split, it looks like, if my math is right, that your implied guidance is actually an acceleration in the second half growth rate versus the first half growth rate. If you compare it to 2019, like a normalized year, that there's an acceleration actually in the second half. And I guess, I still though would like to think about upside. So, the question is, how much potential is there, if supply constraints were able to be fixed sooner, if you could sort of think about what range potentially could be in terms of upside there. And then also, even though your guidance already implies this acceleration in the second half, how much of the $40 million of incremental tariff is actually falling in the second half, right? In other words, I'm wondering if your underlying guidance, if it weren't for tariffs, we'd love to kind of be able to see what the acceleration implied in your guidance is if it weren't for the tariffs. So, is the $40 million all a second half, or is that spread out? It looks like a lot of it may be in the second half. Thanks.

Well, Robin, let me address the question around the acceleration. Certainly, from a production standpoint, we're doing everything we can to accelerate. You can see from the chart around capacity utilization, things are getting better as we go. Part of that is we're relieving a fair amount of the supply constraints, starting with parts in Q2 and then really our vehicles in Q3. That's when we anticipate we're leaving the bulk of the supply chain constraints, and then we'll be off and running. As you can see on the chart, we actually fall below the utilization. As Bob indicated in his prepared remarks, we've got an expectation that retail's down for the year. I can tell you that for January retail is running stronger than we expected. To the extent that retail holds up at a higher level, we can obviously pivot later in the year to be in a position to produce. The other thing I'd point out—as I mentioned in my prepared remarks—even though our dealers are more capable now, given our enhancements to RFM to operate at lower dealer inventory levels and say they were in 2019 or 2018, we still anticipate being short of where they need to be by the end of the year. So there's still going to be channel fill that will have to happen as we get into 2022 predicated on the forecast we have for retail. Certainly, if things end up playing out better from a retail standpoint, we've got a little bit of flexibility in the back half to work through that and enhance delivery. We're going to continue to keep an eye on that. We planned relatively conservatively in terms of that back half from a retail expectation standpoint, just given how strong retail performance was starting in Q2. There's a lot of unknowns in terms of how long COVID shutdowns and sputtering starts go on for. We'll keep an eye on that. What I would say is from a supply chain management standpoint, the team has done an excellent job. In the fourth quarter, we were able to gain share while facing many of these same constraints. And while we weren't able to get as much inventory into the channel as dealers would have liked, relative to our competitors we did a much better job.

Sure. So, Robin, to think about tariffs, the bulk of the tariff impact will happen in the first half of the year, because that's when we received a lot of the refunds and exemptions from last year. So that moderates in the second half, and that's offset somewhat by promo and flooring, which kind of are the opposite. In the first half, promo and flooring are a bit of a tailwind given the strong retail environment. Then we see the Powersports markets returning more to normal in the second half. So then promo becomes a headwind as you look versus 2020.

Okay. Great. Thanks very much.

Our next question will come from James Hardiman with Wedbush Securities. Please, go ahead.

Hey, good morning. Sounds like the CEO stuff isn't that hard? Hi, Mike. Great quarter here.

Thanks.

So, as I think about this guide, and I know you guys don't really give quarterly retail guidance. But just maybe order of magnitude—if I think about this high single digit Powersports industry decline for the year—can you help get us on the same page in terms of what that looks like over the course of the year? Obviously, in the second quarter, you're going to be comping this monster 60% ORV number. I would assume that the assumption is that we're down, I don't know, 30%, 40%, 50% in the second quarter. But maybe just corral us so that we're on the same page and we don't have any massive surprises as we work our way through the year from a retail perspective.

Yeah. James, I think you're thinking about it the right way. If you look at the slide where we show the quarterly profile, retail was down 8% in Q1 and up 57% in Q2 last year. I think Q2 is probably going to be the most exaggerated year-over-year comp and likely down significantly versus last year. With the assumption that we're down high single digits for the year and comping strong 2020 levels, you're likely to see declines in parts of the mid-year, and then things will start to level out from there. Q1 could be up this year and Q2 down given the comps, and then level out into H2.

Got it. And then, I wanted to circle back to the capacity utilization slide, which seems to be conveying an awful lot of information. I'm just making sure I'm looking at it right. It sort of looks like the first half—eyeballing—looks like capacity is up a lot more than 30%. Maybe I shouldn't be translating that into sales. But then, regarding the fourth quarter production being down year-over-year and sequentially, why would that be the case given you still don't expect inventories in the channel to be back to where you'd like them to be by the end of the year? Even in this base case scenario, it almost seems like you would want to improve inventories once you get into the off-season next year.

I think you hit on it, James. We're trying to play this carefully, because we'll keep a watchful eye as retail continues to play out. When you look at the first half of the chart, the additional capacity is needed to meet spikes in demand. We're doing everything we can, and we're only as good as our suppliers. We still continue to have a number of suppliers behind schedule. The port situation frankly is getting worse by the day, not better. We know that we're going to be fighting that. There's also an overall backdrop of higher absenteeism rates that hit into the 20% range at times, which makes it incredibly difficult from a factory management perspective. The team is doing everything we can. If retail ends up playing out a little better than we're expecting, you can certainly expect to see better performance in later quarters. For now we've got time to think through that. We also want to be mindful of getting enough inventory into the dealer channel while not outpacing retail and putting dealers into a tough spot come 2022.

Our next question will come from Brett Andress with KeyBanc Capital Markets. Please go ahead.

Hey. Good morning. Congrats on the interim roles. Following up on James's question, under the plan or the guidance that you laid out, where do you think dealer inventories would be at the end of 2021? Just to kind of frame up the 2022 channel fill. And then any more color on what level January retail is running at so far this month.

Yeah. Dealer inventory will be up versus where we finished 2020. We're probably going to be 20% to 30% shy of the dealer inventory levels that we would like to have in the channel. Obviously that has a lot of variables: the cadence of retail and our production cadence. So that number should be taken with caution. We'll continue to monitor and drive to improve performance. For January, it's substantially better than we were expecting, but January is always the smallest month for us. Dealer foot traffic has not been as low as typical, likely due to the pandemic environment and the stay-at-home orders and the pivot to wanting to be outside. So, we do think that interest will remain high into the foreseeable future given the slower vaccine rollout and the current state of the economy.

Got it. Okay. And then just one quick one here. How were you thinking about the new product launches? In 2020, obviously a unique year, 2021 probably going to be just as unique. Do you plan to stick to the usual July launches for ORV, or has all this caused you to maybe rethink when and how you put new products into the market?

I think we've demonstrated that getting information out when it's ready probably works better than trying to wait for a single July launch. We recently launched new Ranger models and refreshed Trail Razor lineups, which look great. We have a lot coming and we're excited about it. You'll see a cadence of product announcements across the year rather than just one big drop.

Thank you.

Our next question will come from Scott Stember with C.L. King. Please go ahead.

Good morning and congrats on a great quarter guys. Mike, maybe to frame things out a little bit more from a demand standpoint versus your capacity: If somebody was to walk into an ORV dealer right now one of yours to buy a Razor or a hot selling Razor, what's the lead time to actually get it right now? We talked about being able to get it in a reasonable amount of time within the season. How will that improve as the year progresses with your capacity plans?

I'll answer the second part first. It's going to improve substantially. Steve Menneto and his team have done an outstanding job of working that issue. We've become much better at identifying inventory in different pockets and moving it between dealers to ensure dealers can make the sale. We've also increased our pre-sold vehicles coming out of the factory roughly six-fold from historical levels. That enables the dealer to capture the sale and give the customer visibility on when the product will arrive. I didn't give a single generic lead-time number because it varies, but it's longer than we'd like. The team's managing it very well and, as evidenced by the fourth quarter, we were in a better position than many competitors despite constraints.

My last question: aftermarket TAP still seems about flattish. I know you've been discontinuing some lower-margin sales. Is that still going on? How should we look at TAP for 2021?

TAP was more severely impacted than our Powersports business in the first half, and we've seen steady improvement in the back half of the year. Exiting some unprofitable parts of the business largely finished and that impacted 2020 revenue. On the retail side, whether e-commerce or Four Wheeler products stores, we actually saw single-digit growth in the back half and we're encouraged that those levels of performance will continue into 2021. Craig and the team have restructured that business and we feel it's poised for better performance in 2021.

That's all I have. Thanks, guys.

Our next question will come from Joe Altobello with Raymond James. Please go ahead.

Thanks. Hey, guys. Good morning. First question: can you discuss some of the efforts you are making with your suppliers to ease these constraints given most of the bottleneck is outside your direct control?

We've tried to take control where we can. We've had supplier teams on site or participating virtually to help manage facilities. We've provided financial support where suppliers needed investments to keep up capacity. We're prioritizing containers and working with logistics providers to ensure prioritization. Thankfully, we were 35% to 40% through our supply chain initiative before the pandemic, which improved our familiarity with logistics partners and suppliers. From manufacturing, we're producing vehicles that may be missing one or two components, then reworking them carefully later. We are finding every avenue to keep cadence and tempo up; the team is executing at a very high level.

And just to follow-up on that, how are you feeling versus competitors? Are you able to leverage scale to get in front of the line?

The fourth quarter is a good comparison point. Our scale, supply chain competency, logistics and strong dealer network helped us perform better than many competitors under the same constraints. Earlier in the year, share dynamics were affected by differing dealer inventory positions, but in the fourth quarter we performed strongly and gained share.

Our next question will come from Greg Badishkanian with Wolfe Research. Please go ahead.

Mike, could I follow up on the market share comment. You are guiding to gain share for the year. Is product driving share in retail, or is it really what's on the dealer lot that's selling? If it's the latter, could we see volatility on the market share side quarter to quarter? Or do you think we'll see consistent market share gains?

For the next quarter or two there will certainly be a component of availability. But with our product innovation and announcements, we expect demand driven by product to be strong and customers will be willing to wait. Relative to the competitive set, we are in a strong position and will prioritize getting production into the channel. It's tough to give quarter-by-quarter market share, but we are targeting continued share gains in Motorcycles and Off-Road vehicles and are focused on playing offense.

Makes sense. Could you touch quickly on the agricultural market outlook for 2021? Crop prices are stronger. How exposed are you and what tailwinds might you see this year?

Our ag mix is around 11% of revenue. We see big opportunity. Texas is one of our largest opportunities and specifically around Ranger. Customers are using these vehicles both for work and recreation. Product introductions like the Big Game and Waterfowl Editions target that market specifically. We are confident the innovation in that business will perform well this year.

The next question will come from Craig Kennison with Baird. Please go ahead.

Hey, good morning and thanks. First question on RFM: are you setting RFM parameters in the same way you did pre-pandemic, or do you think you might be able to run with lower structural inventory to protect dealer profitability and make the dealer network stronger?

We have recognized there are ways to be better at how we deliver. We are targeting inventory levels below where we were in 2019, supported by improved supply chain agility, better demand identification and increased pre-sold vehicles. The work Steve Menneto and the team have done gives us much better linkage between demand forecasting and the dealer feedback. All these pieces allow us to operate with leaner inventory. That said, for 2021 we still may not get to desired levels unless supplier issues abate faster and depend on retail.

Thanks. A follow-up on inflation: given excess liquidity and overall economy, how is your business set up to handle inflation?

We've planned for what we can see. Bob noted conservative FX assumptions, and commodity offsets are happening. From a pricing standpoint, we've built in more promotional costs in the back half recognizing inventory improvement will increase competitive pressure. From a wage and labor standpoint, we have processes to capture those costs. Tariffs are the largest question mark year-over-year. We're working all angles with the new administration and advocating where appropriate, but any change is unlikely to be immediate.

The next question will come from Gerrick Johnson with BMO Capital Markets. Please go ahead.

Hey, good morning. I just want to touch on the tariff question more closely. What is your ability or probability to get those exemptions back, or is that unlikely?

Our general counsel would say there is no current process to reinstate exemptions, so probability is very low to none at this point. We're continuing to advocate and present our case to the administration. They have shown a willingness to listen and are aware of negative impacts tariffs have had on U.S. employment, so we're hopeful they will consider other approaches over time.

Gerrick, we've also done a lot of work to mitigate tariffs through sourcing changes and will continue those efforts in 2021.

Okay. And then on supplier constraints, is it more oriented towards a specific line or a specific facility?

It's more oriented toward Off-Road vehicles, given the number of parts and diversity of the supply base. Boats has a more local supply chain and is less impacted by outside-the-U.S. activities. Geographically, impacts relate to COVID dynamics and absenteeism affecting facilities, but overall supply issues are common across the network.

Okay. One more: Motorcycle confidence. Inventory is only down 2% in the channel yet you're guiding to grow high-20s. Why are you so confident?

We have strong innovation and product momentum. Slingshot's automated manual transmission is doing very well. We have new product coming, including a major Indian Motorcycle release, and continued success with the Challenger and Scout lineups. The competitive setup also favors us with some competitors reducing models and increasing prices on entry bikes. We believe the business is well positioned for strong growth.

Okay. Next question.

Our next question will come from Joseph Spak with RBC Capital Markets. Please go ahead.

Thanks Mike. On capacity: you talked about new customers added. Assuming you retain a good portion of those over the years, can you meet future demand with current capacity?

We evaluate capacity continuously. Our installed base and new customer growth do create demand into 2022 and beyond. Ken's team continually reviews the network to optimize capacity. Given current demand projections, we don't expect demand to slow in 2022 and we'll continue to assess and potentially invest. We should have better clarity by mid-year.

Second, and this is sensitive: do you want to be CEO if the Board decides that way? Is your hat in the ring?

The Board has an important decision to make. I love the company and the role and would be thrilled to have that opportunity. Ultimately the Board will make the decision that is right for the company at this time.

Our next question will come from David MacGregor with Longbow Research. Please go ahead.

Good morning, everyone and congratulations on a really strong quarter. I wanted to talk about gross margins. In the appendix you present segment margins and Motorcycles stands out. Can you discuss what's realistically achievable in the next one to two years and the drivers behind it?

Motorcycles is a business we've been building for several years, focusing on margin improvement. We expect improvements in 2021. Long-term, we see Motorcycle margins getting closer to company average, nearer the 20% range, but that depends on product rollout cadence and volume growth.

Is it more a function of product growth or product mix? What's the path to those 20% numbers?

It's a mix of both. Volume provides leverage through factories and suppliers. Mix matters as heavyweight models like Challenger have higher margins, while mid-size grows faster and creates some headwind. Both volume and mix improvements are needed.

I'd add that we've worked to reduce PG&A relative to peers, and that will help margins. There's also design-to-value initiatives on product, factory scale benefits and ongoing aftermarket growth. It's a combined effort across product, operations, and accessories.

Second question on Polaris Adventures: how significant is this for future revenue and profitability? Is it a standalone profit center or an acquisition channel into your existing product offering?

It is both. Adventures actually made money this past year. The priority is to expand the opportunity: we have over 160 locations and growing, bringing customers in who may not own products now but will consider ownership in the future. Adventures Select provides membership access and exposure to products; it can convert customers who may later buy a vehicle. It's both a revenue business and a customer acquisition channel.

Our next question will come from Jamie Katz with Morningstar. Please go ahead.

Hi. Another way to ask: what do you think the total addressable market is for Adventures Select as you scale across the U.S.? How many consumers would you try to reach?

The TAM is substantial. With subscription and rental models, we're competing for travel and tourism dollars as well as Powersports dollars. That broadens the addressable market to tens of billions of dollars. These customers are likely to spend $100 to a few hundred dollars a month for access to vehicles, and many will convert to ownership over time.

Okay. Can you talk a little about working capital? Payables went up significantly at year-end. Will working capital demands remain similar or increase?

We had a very good year from a working capital standpoint. Payables were heavier at year-end primarily due to a switch in mix from lower finished goods to higher raw materials as we look to rebuild. Working capital will go up in 2021 as we refill finished goods inventory and build through the course of the year.

Our next question will come from Billy Kovanis with Morgan Stanley. Please go ahead.

Thanks and congrats. Looking ahead, can you give a view on levers to grow revenues organically in a steady-state period post-COVID such as 2022 when inventory is normalized? You mentioned international expansion, customer expansion, new technologies—can you summarize?

Key levers are: (1) new customers that bring family and friends into the sport and move into repurchase/upgrade cycles; (2) continued innovation and product introductions across categories and price points; (3) aftermarket, PG&A and accessory growth, which drive additional revenue from our installed base; and (4) targeted international growth where parts of Europe and other regions have room to grow. Combining these provides a strong organic growth pathway.

Our next question will come from Mark Smith with Lake Street Capital Markets. Please go ahead.

Hi. Electrification strategy was called out as a big emphasis in 2021. Do you have the organization in place and how should we look at goalposts for this business?

We have built internal talent and leadership in electrification. Mike Donoughe leads the effort and has strong background in electrified and advanced powertrains. We partnered with Zero for powertrain technology, which helps with cost-effective solutions. We're investing around $20 million this year in electrification initiatives and plan to launch a new product at the end of the year. The team is in place and we're putting capital behind the strategy.

Last question.

The next question will come from Shawn Collins with Citi. Please go ahead.

Thanks. Mike, Bob, Richard. Quick question on supply chain constraints: are you experiencing any particular issues with sourcing semiconductor chips? If you can comment on this.

We track components daily and have a prioritized list. We are managing chip availability among many other components. It's part of the overall constraints list, and teams are working to knock items off the list proactively. I wouldn't isolate semiconductors separately here; it's one of many inputs being managed.

Gotcha. Thanks. Second question: we're in winter—Snowmobile vertical, Q4 industry up roughly 15%, you were up roughly 22%. Can you offer color around your outperformance and the industry generally around Snow?

We've invested in Snow over recent years and new products have met great reception. SnowCheck was up substantially versus last year and the team's done a strong job getting sleds into customers' hands despite supply constraints. Snow is time-sensitive and our product lineup and execution have driven good performance. We have additional product news coming at our dealer event in March and later in the year.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Richard Edwards for any closing remarks. Please go ahead.

Yeah. Thanks, Chuck. I just want to thank everyone for participating in the call this morning. We certainly appreciate it. We look forward to talking to you again next quarter. Have a good day. Thank you. Goodbye.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.