Polaris Inc. Q2 FY2022 Earnings Call

Good day, and welcome to the Polaris 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 J.C. Weigelt, Vice President of Investor Relations. Please go ahead.

Thank you, Betsy, and good morning or afternoon, everyone. I am J.C. Weigelt, Vice President of Investor Relations at Polaris. Thank you for joining us for our 2022 second quarter earnings call. We will reference a slide presentation today, which is accessible on our website at ir.polaris.com. Joining me on the call today are Mike Speetzen, our Chief Executive Officer; and Bob Mack, our Chief Financial Officer. Both have prepared remarks summarizing the quarter and our expectations for 2022. 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 2021 10-K for additional details regarding these risks and uncertainties. All references to second quarter actual results and 2022 guidance are for continuing operations and are reported on an adjusted non-GAAP basis, unless otherwise noted. Please refer to our Reg G reconciliation schedules at the end of the presentation for the GAAP to non-GAAP adjustments. Please note that with the completed divestiture of TAP on July 1st, historical results of the business are now reported as discontinued operations starting with the second quarter of 2022. Financial figures and guidance referenced today incorporate this change unless otherwise noted. TAP was historically included in the Company’s aftermarket segment. However, because of the transaction, we eliminated the aftermarket segment and the resulting powersports aftermarket businesses were reclassified to the off-road and on-road segments. Please see the appendix in today’s earnings presentation for a historical reference of the reclassified segment data. Now, I will turn the call over to Mike Speetzen. Go ahead, Mike.

Thanks, J.C. Hello, everyone, and thank you for joining us today. I hope everyone is having a great summer and taking the opportunity to get outside. Our second quarter results are indicative of stable demand and a healthy consumer, offset by supply chain challenges, which continue to constrain inventory at the dealers. Sales of approximately $2.1 billion were up 8% relative to the second quarter of 2021. Our teams continue to perform exceptionally well in a difficult operating environment, and our results during the second quarter reflect our unwavering commitment to remain the global leader in powersports by executing for our dealers and customers. While we are closely watching a number of indicators to understand the resilience of the consumer in this environment, the data continues to show a healthy consumer and stable demand. That said, North American retail sales were down 23% versus 2021, largely driven by supply constraints. Specific to North America, ORV retail was up 13% sequentially. Although these results reflect modest share loss, we continue to see share driven by shipping timing versus fundamental competitive wins from new products. We did see share trends improve late in the quarter as availability improved and we expect this to continue into the second half of the year. Further, we’re seeing modest improvements in the supply chain, which should begin to help build inventory at the dealers as well as improve market share performance. While we are nowhere near being clear of supply chain headwinds, we are seeing logistics improve, supporting sequential margin improvement in Q2 and experiencing less volatility in some commodity costs. Pricing continued to be strong, offsetting increased year-over-year costs. It’s important to understand that the math of strong pricing offsetting costs produces minimal drop-through, resulting in pressure on margins. We expect this to continue to improve in the second half as we see better realization of our previously enacted price increases. All in all, adjusted EPS declined 7% versus last year to $2.42. We had a number of highlights during the quarter, so let me touch on a few. It was exciting to announce the nationwide rollout of our Adventures Select offering. Through the industry’s first monthly subscription program, members can now use monthly credits to rent the Polaris vehicle of their choice at Polaris Adventure locations nationwide. Members now have open access to get outside and explore their own cities or bucket list destinations across the country in a new way, exploring the outdoors off-roading, touring the city in an open-air slingshot, or even cruising the open waters by pontoon. Since launching Polaris Adventures Select early last year, 90% of our members are new to the powersports industry, again, reflecting our commitment to open the industry up to new riders and customers. In the spirit of innovation, which is the DNA of our company, we held our annual innovation awards to celebrate receiving a record-breaking 70 patents this past year. We are nearing the 2,000 patent mark since our inception, and we anticipate we will hit that milestone this year. We continually strive to push the industry with rider-driven innovation and the best customer experience. As the market leader in powersports, we believe innovation is key to growing the market. We have a strong track record of innovation and are excited for what we have in store later this year and into next year. During the quarter, we celebrated two important days aimed at celebrating our riders, the industry, and inviting new consumers to discover what powersports has to offer. The first was International Female Rider Day, in early May, where people in over 120 countries took to their motorcycles, off-road vehicles, snowmobiles, and boats in support of the female riding community. It was great to help celebrate this event and increase awareness with women, particularly because we have seen female ridership increase approximately 30% over the last two years. The second event was National Get Outdoors Day and what better day to celebrate than with a company that asks its customers and employees to think outside. Our products live outside, and we want people to think about getting out with our products to help them discover fun and unique ways to experience the outdoors. The final highlight I want to mention, which transitions us to the next slide, is the launch of our 2021 Geared for Good ESG report. We launched this initiative in 2019. One thing remains certain. Our products live in the environment, and we need to be good stewards of our land, water, and air. Our 2021 report consists of a tremendous amount of information and some success stories around our ESG strategy. We’ve done a lot of work to reduce energy use, water consumption, and our carbon footprint. In addition, we have a $5 million investment with the National Forest Foundation to help improve trails and protect our land for our future enjoyment. We also provide support in our local markets to help improve repair and create trails. Our Geared for Good ESG report lays out some of the initiatives we’ve related to our rider safety. With many new riders coming into the space, safety is paramount, and we aim to support our riders on how to ride safely and responsibly. In fact, August kicks off National Motorsports Safety Month, and we have plans to leverage the timeliness of the month to promote safe riding practices with all our riders. While we remain genuine and authentic with this strategy and we’ll continue to do the right thing for our stakeholders, it is always nice to see external parties recognize the work you’re doing. We have seen recent improvements in scores and accolades from a variety of publications. Our Geared for Goods strategy will continue to play a critical part in the direction of the company, and I’m proud to lead a culture that embraces this commitment. Shifting to consumer demand, we are continuously looking at a variety of indicators to understand true demand and the health of the consumer. While this is more art than science, in aggregate, we believe our data shows a resilient consumer and stable demand with the vast majority of these indicators positive during the quarter with some others reflecting moderating demand. Looking at North American ORV, retail was up 13% sequentially. This data point, in combination with the fact that we shipped approximately 10,000 more units sequentially, led to a modest decline in presolds as a percentage of retail. As our shipments have increased, we are also seeing dealers able to retail more units on the floor or in transit, which is another step in the right direction to get back to a more normal environment and one factor that will naturally lower presolds going forward. This phenomenon was more pronounced in lower-end models versus higher-end or more complex models, where component availability is still challenged. Shipment levels continue to dictate retail performance as our days to retail continues at an incredibly fast pace. During the second quarter, days to retail was in line with that of 2021, which was one-fifth of the time we saw in 2019. This means there’s a high correlation between what we ship and what is retailed, which has given us little opportunity to restock dealer inventory. Some other demand indicators and what they’re signaling include: short- and long-term repurchase rates remain elevated or within the historic range. Off-Road and On-Road presold order cancellations remained low. PG&A attachment rates remain near record levels, indicating that consumers are looking to upgrade their vehicles with high-margin accessories. Web traffic remains well above the 2019 levels in areas like website vehicle builds as well as inventory and dealer searches. And lastly, customers new to Polaris continue to dominate retail purchases. Broadly speaking, we believe our demand trends are stable and the consumer remains healthy, especially when compared to 2019 levels. Additionally, dealers continue to be positive around demand and more constructive around availability, which we appreciate but know we have more work to do to improve availability even further. While other factors such as rising interest rates, inflation, and higher gas prices are certainly a concern, our data continues to show a resilient customer. Remember that our average consumer is fairly affluent, consisting of a dual income household and has good credit. We’ll continue to evaluate these metrics and communicate with our dealers regarding demand, but as it stands today, we see consumers that continue to be interested in powersports. Filling the channel remains one of the biggest opportunities for us in the near to medium term. With robust demand extending over the last several years, inventory levels have not been able to keep pace due to supply chain challenges. Where we sit today, inventory is down approximately 70% from pre-pandemic levels in 2019. While demand has been strong since 2019, supply chain challenges have constrained the industry’s ability to deliver and as a result, Polaris has only grown at a 2% CAGR over the 2019 to 2022 period. So, despite strong demand, we and the industry have not seen outsized growth. So, what does this mean? From an inventory build opportunity, the chart on slide 8 shows our expected year-end inventory position versus where it theoretically would be using the 2019 days sales metric. We’ve talked before about a new optimal level of inventory given what we’ve learned over the last several years, what we’re hearing from dealers and how we’ve been able to operate in this constrained environment. We believe this new optimal level of inventory represents an approximately 2.5 times increase from current inventory levels, which we estimate could total almost $750 million. This opportunity is separate from demand trends and could represent a meaningful buffer for sales if demand wanes or it could also represent upside if demand remains elevated and the supply chain can support production to fill the channel. Switching gears to the supply chain. Challenges remain globally. However, there are signs of improvement from logistics to the number of component shortages negatively impacting our production and shipping execution. Today, we have approximately 25 suppliers with component shortages impacting over 100 units. This represents an improvement of over 50% sequentially, and suppliers with part shortages impacting over 1,000 units has fallen 35% sequentially. Despite those improvements, we are still dealing with shortages in key components that continue to limit production, such as chips, shocks, and wire harnesses, particularly for our higher-end vehicles. While some of this is a trend in the right direction, production remains hampered by challenges within the supply chain. We continue to expect modest improvements as we progress through the second half of the year. We’ve seen improvement in logistics relative to what we saw in the beginning of the year with very few delays at major points of entry. This has allowed us to reduce expedited costs, which had a small positive impact in the second quarter and is expected to be another positive factor in the second half of the year relative to last year. Reviewing our five-year strategy, we are now closer than ever to being a core powersports company. The sale of TAP earlier this month demonstrates our ability to execute on our stated goals and refocus the organization on being the global leader in powersports. For our continuing operations, the five-year financial goals we laid out at our Analyst Meeting earlier this year remain the same, with mid-single-digit sales growth, mid- to high-teens EBITDA and mid-20s ROIC and double-digit EPS growth. We view this focus on powersports and the financial metrics we laid out as a significant value creation opportunity for our shareholders, and our teams are committed to the strategy. Let me now turn it over to Bob, who will summarize our second quarter performance as well as our expectations for the remainder of the year.

Thanks, Mike, and good morning or afternoon to everyone on the call today. My comments will be around our second quarter performance and expectations for the remainder of the year. But first, I want to lay out our new reporting structure given the recent sale of TAP, which resulted in the financials from that business being moved to discontinued operations. We now have three segments: Off-Road, On-Road, and Marine. The mix of our previous aftermarket segment consisted of approximately 80% TAP and 20% powersports aftermarket including brands like Klim, 509, Pro Armor, and Kolpin. Results from these powersports aftermarket brands have been reallocated into the relevant segments, which include Off-Road and On-Road. We have provided historical comparisons of this new reporting structure in the appendix of our earnings presentation and on our website. Turning to the quarter, let us start by walking through sales and EBITDA for the quarter. Sales of $2.06 billion were up 8% relative to last year with strong mix and price offsetting lower unit shipments. In spite of foreign currency headwinds, international sales were up by 1%, driven by strength in EMEA and Latin America while Asia Pacific saw modest declines. Total PG&A revenue in the quarter was flat year-over-year with On-road PG&A up over 20%. Adjusted EBITDA margin was down 182 basis points to 12.4% with lower shipment volume and higher cost premiums being the largest headwinds. Positive price and operating cost containment helped partially offset some of these headwinds. Sequentially, adjusted EBITDA margin improved 315 basis points with positive contributions from price and modest improvement in the supply chain, which benefited our operational performance. Below operating profit, our tax rate was 21.7%. Interest expense ticked up as expected to $15 million, given higher rates and debt levels. There was no share repurchase activity in the second quarter as we remain prudent given current working capital levels and the portfolio actions we undertook in the quarter. Outstanding shares remained approximately $2 million lower versus last year given our repurchase activity late last year and in the first quarter. We remain committed to executing the share buyback levels included with our guidance, subject to market conditions. Turning to our segments. Let’s start with Off-Road. Sales of $1.5 billion were up 7% relative to last year. Whole goods were up 10% and PG&A was down 3%. Recall, we have accounted for the relevant powersports aftermarket sales in the segment. Adjusted gross margins were down 359 basis points. Supply chain disruptions continued to have a negative impact on performance. And although there was some sequential improvement, we are still seeing constraints in components such as chips and shocks. On the plus side, we did see positive pricing on new and presold orders during the quarter with cancellation rates remaining low. Looking at retail performance, we were down mid-20s in North America with better performance than side-by-sides versus ATVs. We believe the industry was down mid-teens, thus pointing to share loss for us in the quarter. Breaking out recreational ORV, we believe we held share in the first half of the year and lost share in the Utility segment, which includes RANGER and ATV. More of the loss came from ATV where shipments were negatively impacted by one key supplier. We continue to believe share shifts in this environment are the result of component availability and decisions around production priority, such as prioritizing less contented value products versus complex premium products and not the result of the launch of new products by competitors. Thus, we continue to expect quarterly share shifts to be lumpy this year. On a 12-month rolling average, we estimate ORV share was down approximately 2 points. Overall, while demand might be off the pandemic peak, we still see it above pre-pandemic levels, with particularly healthy demand for our premium, recreation, and utility products. We do expect our presold orders to decline in the second half as we begin to transition into a more normal operating environment coupled with an improving supply chain. This means we are closer to delivering products in a more predictable and timely fashion versus a negative signal on demand. It was encouraging to see sequential improvements within the supply chain, especially in logistics. And while challenges remain, we continue to be encouraged with our ability to execute in this difficult environment. We believe our business is poised for growth and share capture with an easing supply chain and look forward to continuing to deliver exceptional rider-driven innovation to our customers across the globe. Switching to On-Road now. Sales of $299 million were flat year-over-year, with whole goods down 5% and PG&A up 24%. Remember that our On-Road segment now includes Aixam and Goupil, thus, you see a strong mix of international revenue. Second quarter results from those two businesses were up mid-single digits. As noted last quarter, we have brought on additional suppliers at Indian Motorcycles and began to see the benefits of that towards the end of the quarter with more relief expected as the year progresses. Margin was down 71 basis points due to unfavorable foreign currency and higher input costs. While dealer inventory levels remain low, we continue to see strong demand as presolds remain near record levels. Indian motorcycle retail in the quarter was down in North America by approximately 40% and down almost 35% internationally. Looking at share on a 12-month rolling basis, we believe we lost approximately 2 points of share relative to the industry. With continued easing of the supply chain and additional suppliers up and running, we remain encouraged that our On-Road segment could have a robust second half, growing sales and expanding margins. Moving to our Marine segment. Sales of $273 million were up 38%. We continue to see component shortages resulting in field inventory down 50% relative to the same period in 2019. It seems the industry is beginning to return to a normal level of seasonality with demand slowing at this time of year, given summer is already in full swing. We continue to hear from dealers that foot traffic and new retail remains strong. North American retail was down mid-30s for pontoons, and we believe the industry was down mid-teens. On a 12-month rolling average view, we believe our share was down 3 points versus the industry as we focused on premium boats versus higher volume entry-level units. Margins were up 39 basis points due to positive mix and higher unit volume, somewhat offset by supply chain inefficiencies. Marine grew shipment volumes by 20% year-over-year. Summing up our second quarter performance by segment, it is clear that supply chain disruptions remain the main driver for our sales, share, and earnings performance this quarter. While we did see modest improvements in the supply chain, challenges remain. Our ability to execute and deliver in this environment remains our top focus as we progress through the remainder of the year. Moving to our financial position. We continue to expect 2022 will be a strong cash generation year with both operating cash flow and free cash flow well above 2021 levels. Our capital deployment priorities have not changed. We continue to focus on high-return organic investments, dividends, opportunistic share repurchases, and targeted acquisitions. Looking at cash, we believe there are a couple of main drivers to help improve our cash generation profile. The first is an improving supply chain that should allow us to ramp production to consume raw materials and complete and ship our current rework inventory to dealers. The second is the realization of selling these products at higher prices, which have already been implemented. We view our balance sheet and financial position as a competitive strength as it allows us to invest in our business for the long term while also providing the flexibility to deploy excess cash to generate strong returns for our shareholders. Turning to our updated full-year guidance expectations. I want to emphasize that this now reflects the removal of TAP in our current guidance as well as the base year of 2021. Sales are now expected to grow 13% to 16%, which is slightly above our prior guidance due to the removal of TAP. This reflects strong growth in the back half driven by price and an improving supply chain. We narrowed our sales expectation for On-Road to mid-teens from mid- to high-teens due to foreign currency and a weaker-than-expected second quarter driven by supply chain constraints. Adjusted EPS from continuing operations is still expected to grow 11% to 14%, although we did take the top end of guidance down by $0.10 to $10.30, which reflects the removal of TAP while holding the bottom end of guidance due to strong results this quarter. Therefore, the midpoint of our full-year guidance is $10.15, which is $0.05 lower than our original guidance. As Mike stated, we continue to be encouraged by what our demand indicators are showing us. There might be some mixed signals when comparing to peak levels over the last couple of years, but when stepping back and taking a longer view, we are still seeing elevated demand relative to pre-pandemic levels. We have confidence in these growth numbers given our expectations around stable demand and improving supply chain and depleted inventory at the dealers. This leads to stronger growth in the back half and operating leverage, driving double-digit adjusted EPS growth for the year. A couple of items on margins. First, we expect gross profit margins to decline 60 to 80 basis points. After adjusting for TAP, this is an improvement from our prior guidance, mainly due to supply chain costs getting better versus what we had originally forecasted. This is partially offset by an increase in planned strategic operating expense investments. We expect EBITDA margin to decline 20 to 30 basis points, which after adjusting for TAP is consistent with our prior guidance. I want to make note that with the exclusion of TAP, our base EBITDA margin improved by approximately 1 point relative to what it would be with TAP. As we look at the third quarter compared to the prior year quarter, we expect volumes and price to be positive contributors. These positives are expected to help offset higher supply chain costs, leading to modest gross profit margin expansion in the quarter. Some other items to note include a modestly higher net interest expense for the year. We are projecting a greater negative impact from foreign currency versus our last forecast due to recent movements in the dollar. Given the volatility in foreign currency, we thought it would be helpful to tell you we are assuming an average rate of $1.06 for the euro to U.S. dollar and $0.78 for the CAD to the U.S. dollar in the second half of the year. Every penny change in the euro has a second-half impact of approximately $1 million and every penny change in the Canadian dollar has a second-half impact of approximately $4 million. If forward exchange rates were to hold at these rates, there is a $25 million to $30 million headwind to operating profit for the year, which has been accounted for in our guidance. Overall, we have seen some recent improvements in the supply chain; however, there remains work to be done navigating current challenges. We still believe the health of the global supply chain is going to dictate performance. Our focus remains on execution, and we believe there are numerous opportunities to increase sales with current demand levels, a modest improvement in the supply chain, and replenish inventory at dealers. We believe we are set up to start seeing price overcome many of the inflation headwinds and look to expand margins in the back half of this year. Our teams are resilient, and we believe we are well-positioned in the back half of the year to deliver strong results. With that, I will now turn it back over to Mike for some final thoughts.

Thanks, Bob. While we’re closely watching a variety of demand indicators, demand remains healthy and stable across our business. We continue to see positive dealer sentiment and a variety of independent surveys; cancellation rates remain low, and customers continue to show interest in the industry. While the results continue to be highly correlated with the health of the supply chain, we are seeing improvements and expect the supply chain to continue to modestly recover in the second half of 2022. With this improvement, we expect retail sales to accelerate meaningfully in the back half of the year due to current demand levels, coupled with our presold order program and easing comps. On top of that, we continue to sit at the forefront of a meaningful restocking opportunity at the dealer. Taking all this into account gives me confidence in the trajectory of our business. We are more focused than ever on powersports and have a strategy to remain in the top spot while working to power the fashion, pioneer new possibilities for all those who play, work, and think outside. With that, I’ll turn it over to Betsy to open the line up for questions.

We will now begin the question-and-answer session. The first question today comes from James Hardiman with Citi. Please go ahead.

Good morning. Thank you for taking my call. It seems like the second quarter was solid and even better than expected. As we look ahead to the guidance for the second half, I'm interested in the key assumptions you have. What improvements do you need to see in the supply chain? Also, how much decline in consumer behavior can you tolerate to still meet your targets? It appears that the guidance is more influenced by the supply chain conditions than consumer issues, but could you elaborate on the key assumptions?

Thanks, James. As we've indicated, there's ongoing improvement in the supply chain, although we’re not expecting a significant enhancement. As mentioned in the last call, we noticed an improved flow in some areas that had previously hindered demand and our production capabilities, particularly regarding chips, shocks, and wire harnesses. This progress has continued into the second quarter, and we ended June very strong. Looking at the second half, there will be a unit ramp-up, but compared to 2020, it's just a small increase. Our average monthly sales for the latter half of the year are expected to be lower than what we achieved in June. We anticipate consumer demand to remain steady. However, if there were to be a decline, our current inventory deficit would allow us to accelerate channel replenishment more quickly than planned. As both Bob and I have stated, we don't foresee any factors that would drastically change this situation. We'll proceed with our existing plans and can adjust if consumer demand shifts significantly. Given our low dealer inventory levels, any pullback in demand would need to be substantial to impact the company meaningfully. Our teams have effectively navigated a challenging environment. While improvements are evident, they're still relative to our past experiences. The supply chain remains complex, and we face various challenges daily. Even though costs seem to have stabilized and we see some positive trends regarding logistics and expedited shipping, overall costs remain very high. This is why the price changes we've implemented over the past year or so have mainly covered these expenses. The good news is that in Q2, we were able to offset these costs for the first time in several quarters. We are confident in our ability to execute, although we need the supply chain to cooperate; however, we do not expect a major improvement.

Got it. Regarding costs and pricing, many dealers we've spoken to anticipated a price increase in July; however, it appears that didn't happen. I'm interested in your perspective on this. On one hand, it could suggest you're more confident in your cost structure and don’t need to focus as much on pricing. On the other hand, it could indicate growing concerns about price elasticity. Could you elaborate on your approach to pricing as we move forward?

Yes, James, it’s Bob. As we have mentioned previously, we have been careful with our price increases to avoid getting too far ahead and having to rely on promotions. We aim to adjust prices in accordance with cost trends, although this has led to a decline in our gross profit margins. Looking at July, we are considering pricing alongside our upcoming model year launches, which will occur at different times throughout Q3 and Q4 due to production circumstances. As we navigate this, we will keep an eye on costs and market conditions, making any necessary decisions at that time. However, we have not implemented a price increase since our last one in April.

It’s been a great call, very helpful slide. Thanks for that. Mike, I think you touched on this, but Walmart missed today, and yet your customer seems to be doing okay. I’m just wondering if you’re able to look at your demand by income cohort or something to understand if the dynamics are changing at that low end. And if not, like what are the signals that you look for to say, look, this slowdown, which has hit Walmart is finally catching up to us?

Yes. It’s a question that we’ve been spending a lot of time working through. And what I would say, Craig, is that we have seen demand moderate slightly, I would say, at the lower end of the category. Now, some of that is also being driven when you look at presolds by the fact that those are less complex vehicles. And with the supply chain starting to ease a bit, they’ve been easier to get out. The higher end of the spectrum from an income perspective certainly is playing out well for us. I mean, if you look at things like the Crew North Star RANGER, we are self-constraining the number of reservations we can take on that product. We know that our dealers have essentially a side book list of customers that are waiting for those vehicles in our other high-end vehicles like the Pro R and the Turbo R. And so, we know that the high end of the market continues to perform well. And I think as we step back and look at that, it’s not that the consumers at that level are not being impacted by higher fuel prices and groceries and everything that’s going on, mortgage rates starting to tick up. But their discretionary income levels are higher, and they tend to have more savings. And so, at this point, we really haven’t seen that impacting them, but we’re keeping a close eye on it. And if you think about over the past couple of years, we’ve been selling an awful lot at the premium category. So that demand level continues to hold relatively well. And we’re going to keep an eye on that lower end of the market and make sure that we adjust according if we need to.

And as a follow-up, is there any evidence that maybe consumers that would be regular buyers on a normal cadence, maybe they sat out last year because, look, you couldn’t find anything. But as production improves and those customers can get back into the market, are they showing any signs of improving their demand?

As we keep an eye on it, I mean, we’re obviously watching a lot of different things. I mean, one of the key metrics we watch is existing consumers buying products versus new. And, our new customers, as we mentioned, remain high, but they have come down slightly from what we saw the last couple of years where we saw 70% of our sales coming from new to the category. We’re now down kind of sitting in the mid-60s. So, one of two things. One, you’ve got a little bit of a slowdown in the new consumer, but more than likely, we’ve got existing customers who were just kind of waiting it out coming back into the fray. The good news is as we track things like repurchase rates, and we track them at short intervals, like 3 and 6 months, 1 year, 3 years, 5, 10, at least those near-term measures are holding up and are either in line, if not better, than some of our historical numbers have been. So, at this point, it looks good. As you know, the used market is still very constrained, and used pricing is holding up. So that obviously bodes well in terms of people still having interest to get into the category, maybe at some of the lower price categories.

I want to build on Craig’s earlier question. It’s encouraging to hear demand indicators are holding in, in light of everything going on with the consumer and appreciate the color on current purchasing and web traffic. If things were to change, where do you think you’d see it first? And would it be concentrated on one segment or more broadly, maybe toward the lower end or across the board?

I can respond to that in a few ways. We might start to notice it more at the lower end of the segment. While we have seen some moderation, I don’t want to signal alarm necessarily. This is primarily due to having more inventory in the channel. I believe we could begin to see effects in the PG&A area, with consumers possibly opting for fewer accessories or using their vehicles less, leading to a slowdown in parts needed for repairs. The impact may eventually reach the higher end of the category. However, it may not unfold exactly like that. That's why we are analyzing a wide range of metrics to monitor the situation closely. We won't overreact to any singular data point since we've experienced fluctuations before. Much of this volatility is driven by the supply chain and how components, parts, and vehicles move into the dealer network. We are observing this closely and have clear expectations about dealer inventory levels, and we monitor the channel daily. We're tracking demand patterns across North America and internationally, and we will adjust our approach as necessary. The positive news is that our dealer inventory levels are quite low, which provides us with a buffer should we begin to see some of these slowdown indicators emerge.

Anna, this is Bob. It's important to consider that during the pandemic, this industry faced significant challenges in growth. We did experience some increases in 2020 as we emerged from the initial closures, but we quickly depleted the inventory available in the dealer channel and warehouses. Following that, the industry struggled to meet production demands due to chip shortages and other factors. Typically, we would enter a slowdown with ample dealer inventory after high production and retail levels, but the current retail levels are not much different from those before the pandemic due to inventory availability, with shipment levels remaining similar. Craig raised an interesting point about whether potential customers walked away without making a purchase due to the lack of available units. I believe that has occurred to some extent. If we do see a slowdown, we will introduce more inventory to the channel, which should positively impact retail as people will have access to products.

Yes. I mean, Bob’s point is a great one. I mean, a lot of the questions we got early on in the pandemic were how much of a pull forward is this. I actually think it’s a bit of the opposite. I mean, when you look at the growth that I mentioned in my prepared remarks, from ‘19 to ‘22, where we’ve essentially grown about 2%. That’s at a lower rate from a CAGR standpoint than historical, which would suggest we’ve actually got pent-up demand, unfulfilled demand that has been waiting given all the supply chain constraints. So, I think if anything, that’s going to provide more of a tailwind than any perceived headwind from what was viewed as a pandemic bump that, as Bob pointed out, that pandemic bump kind of basically happened very quickly and it depleted dealer inventory. We think now we’ve got some of our tried and true customers now wanting to get back in, and that’s probably going to serve us well as we get through the next several quarters.

Great. Thanks for that. That’s really helpful. And I want to touch on the 2022 guidance and dig a bit into the volume ramp in the back half. I appreciate that supply chain has been a constraint here. Has that improved in line with expectations thus far into the quarter? And when should we expect Off-Road to inflect to positive volume growth?

So, I think as you think about Off-Road for the back half of the year, you’ll definitely see positive unit growth in the back half. The thing you got to keep in mind though is that in the back half of the year, the snow shipments come in. So, if you’re looking at the total segment, you have a lot of snow shipments in Q3, Q4 that historically aren’t in Q1, Q2. But, we will get into positive shipment growth in the back half of the year.

Just going back to a couple of comments putting together here. I think you mentioned you expected retail sales to accelerate in the back half. And then, you’re just talking about positive unit growth in the back half. So, does that acceleration mean we could actually have retail up year-over-year, or does that just mean less negative?

Less negative. We still think it will be down slightly. It’s anticipated to be up over where we were in 2019, but down ever so slightly versus ‘21.

I guess, first question, I wanted to clarify something that you guys mentioned earlier in response to another question regarding North America retail and the outlook for the second half. I think you said you expect second half retail to be down less than the first half and down modestly for the year, but I think you were down over 20% in the first half. So, maybe help us understand what you’re trying to do there.

Sorry, Joe. The comment was pertaining to the full year. So, we’ll be down modestly for the full year; we’ll be up in the second half, because if you think back to the second half of '21, right, the comps are a lot lower. Second half is when things really started to go more sideways from a supply chain standpoint. And so, as we get into the second half of this year, our shipping cadence is planned to improve and with it the retail cadence. And so, you’ll see growth in retail relative to '21 in the back half and relatively flattish for the full year is where we think it’s going to land.

Okay. Perfect. Thanks. And my follow-up to that is on market shares, obviously, it looks like you lost some share across the board here, mostly due to availability rather than consumer take some preferences. But, if I look at your Indian share down in a quarter where your biggest competitor shut down production for three weeks, maybe help me understand how we should interpret that and how you’re thinking about that business. Thanks.

Yes. Your comments are right. It’s why we clarify a lot of this is really availability. I would tell you that our share losses were not to them; ours and theirs were to the rest of the industry. So, you can imagine that’s over a number of different players. The other comment I’d make, and it’s probably more specific to ORV, but applies to a lot of the businesses, we are being very deliberate in what we ship in. Bob kind of touched on this a little bit. Our utility segment has shown share losses. But if you look within that segment, we have really focused on meeting consumers where they’re going, which is our 4 seat, the crew vehicles with North Star components; those are obviously more complicated, but that’s where the customer demand is. So, we’ve erred on the side of trying to make sure we’re hitting that demand versus producing maybe less complex smaller units. All of it counts the same when you think market share, but when you think about value to the company, future customers, there’s a big difference. And so, we’re being very deliberate about where we’re delivering for the customer. The good news is we saw the share movement move in our direction in June, which was encouraging, and we’re going to obviously keep the focus on keeping that to be a trend into the second half.

Bob, the walk on slide 12, I guess I’m not sure the exact price mix split. But if I just assume it’s pretty even and I look at the EBITDA flow-through, it would kind of suggest like $100 million to $150 million year-over-year higher cost to sort of get to that sort of level you’re showing on the flow-through. Is that ballpark correct? I just want to try to sort of mention the potential benefit you see as price starts to really more than cover costs in the back half.

I believe there isn't a significant difference between the first half and the second half of the year. When considering how prices have evolved over the year, we implemented a major price increase in April. This change began to reflect in Q2, and we expect to see full impact in Q3 and Q4, contributing to both margin improvement and revenue growth in the latter half of the year. Additionally, in Q2, we fulfilled several North Star orders that had been placed in 2021, which were important to deliver to customers who had been waiting for a long time. However, those units were not protected against price increases and were sold at the previous lower prices. Despite that, we anticipate margin improvement starting in Q3. In terms of costs, they were already on the rise in the second half of last year, so we expect a more stable cost environment year-over-year in Q3 and Q4.

Okay. Thank you. And Mike, sort of a big question here. I realize that. But I think investors are sort of looking at Polaris earnings pre-pandemic of north of $6, and now you’re doing over $10. And so, they’re looking for signals one way or the other as to why that would or wouldn’t revert. And so, to your comments on like the 2% growth, and that’s below historic, and there might be pent-up demand, obviously, revenue growth was well in excess of that because of price. So, how do you think about price in order to drive that historic volume? And I guess, why is that volume-price, a better sort of profit trade? And to make it even, I guess, an even bigger question, I guess, if you were to see consumer softness and sort of maybe price us to give to drive the same volume, do you think that lower commodities and maybe a losing of supply chain provides a little bit of a natural offset to the margin?

Yes, I have a few points to make. We have been adjusting prices, but in relation to our earnings, it has been somewhat of a negative situation; we haven't been able to keep pace with rising prices and costs. This situation plateaued in the second quarter where we managed to offset costs. As we move into the latter half of the year, we expect some incremental improvement, though it will still negatively impact margins, it should become less burdensome. From a price elasticity perspective, a significant portion of our price adjustments have been aimed at covering logistics and expedite costs. Some adjustments were made through freight adders that don't involve changes to the manufacturer's suggested retail price and are intended to be removed once logistics issues are resolved, which could serve as a potential lever. Our original intention with our price changes was deliberate; two years ago, we faced criticism for not being aggressive enough in covering costs to maintain margins. The strategy was intentional because as costs decrease, we plan to retain some of the price increases, which would be beneficial for pricing. We are closely monitoring this situation and understand price elasticity well. There’s notably more elasticity with high-featured products that incorporate more technology, which have been challenging to produce and meet demand for, yet consumers remain patient and are still interested in these vehicles. This will be a factor moving forward. We've noticed there hasn't been an overwhelming demand decrease; instead, growth over the past three years has been just over 2%. Feedback from customers indicates that many long-time Polaris customers have been holding back due to availability issues and focusing on accessorizing and maintaining their current vehicles. We believe they will eventually return to the market. With dealer inventories low, we can accommodate any potential demand fluctuations even if they last for a couple of quarters, putting us in a solid position. It's important to remember that our price increases have also come from selling larger, more feature-rich vehicles with advanced technology, which consumers are willing to pay for.

You’ve mentioned some expected tailwinds just from lower expedites. Is there any way to frame the benefit, either what you saw in 2Q or sort of what you’re expecting incrementally for the rest of the year versus the outlook last quarter?

Yes. I would say it's not a dramatic impact, Fred. They were improving in the last outlook, which aligned with our expectations. It's somewhat month-to-month. Expedites occur either because the supplier falls behind or due to delays at the port, necessitating air transport. Therefore, I don't anticipate a huge change in the second half of the year compared to Q2. I think, Fred, it's more of a positive signal since we've spent many earnings calls discussing the sequential increase in expedites. It's reassuring to see things at least stabilizing a bit, and hopefully on an upward trend.

I just wanted to stick with the financing line of questioning for a moment or two. I would love to talk a little bit about consumer affordability. Just with the step-up in ASPs over the last couple of years and now with base rates and probably risk in the credit market picking up. Can you talk to us about what monthly payments look like for the average consumer that comes in and picks up an On-Road and Off-Road vehicle, maybe compared to pre-COVID? And as you studied the consumer, how important is monthly payment to them? And where do you think the friction point might be in terms of demand destruction and along those lines as well, what sort of flexibility is there to work on maybe extending term of loans? And have you seen that in the marketplace at all?

Yes. So, I would say you take a step back and you think about sort of what’s happened with pricing over the last couple of years. So, you’re talking about products ranging from an ATV at sort of with an MSRP of $7,000, that’s up about 12% versus 2019. And then you get to the higher-end products, I mean, you’re 25% to 35% and those are up 20%. So, obviously, price has an impact. Consumers are sitting on, I think, it’s $2.3 trillion of excess cash. So, we’ve seen lower financing, a lot more cash buyers. So, as things change and rates go up, I think it will have an impact, but I think it will be relatively minimal. We’re not hearing that as a big part of the story right now. Credit has been heavily available if consumers want it and as is the opportunity for cash buyers. There’s not a lot of promo going on in the system right now, just because of the inventory situation. And then on the wholesale side, dealer credit lines, they’re nowhere near the tops of their credit lines just because of the low inventory, and dealer financials have never been better. So we’re not expecting any issues with restocking relative to credit.

That's really helpful. I wanted to ask about market share. We know there has been some loss, but I'm confident you will regain it. Can you discuss your current relationships with dealers and what makes you confident in your ability to recover? What is happening behind the scenes that can help us understand your thought process?

Yes. Bob and myself were out with Steve Menneto at a number of our dealers in four states. And dealer sentiment was very positive, especially considering the fact that deliveries are as constrained as they are, and that’s not just a Polaris issue. That’s an industry-specific. I will tell you that the feedback from dealers, they love the innovation that we’ve come out with. They’re seeing the enhancement and the quality of the vehicles. They’re incredibly appreciative of how we’re handling the approach to rework and the supply chain challenges that are sitting inside the network. And so, they’re giving us really good marks. Obviously, profitability is at an all-time high, just given how constrained inventories are, and there’s very little discounting going on in the marketplace. Really what they want is more product. And so, we have continued to enhance our communications. We’ve worked to try and take the burden off of the dealer to get caught in between the consumer and us. And so, we implemented late last year the ability for consumers to go in and check on availability and where their product is in the cycle. All those things are working in our favor. We don’t take it for granted. We know we’ve got to continue to improve the situation. But overall sentiment with dealers is very positive. And basically, what they told us when we were out is you give me more product, I’m going to be able to move it, because we’ve got a large list of consumers waiting to get stuff.

You mentioned increasing the marketing efforts somewhat, but selling and marketing expenses decreased by about 5% year-on-year, excluding TAP. Can you explain why that happened? Should we anticipate an increase in expenses in the second half of the year and possibly into next year? Yes.

Yes. It was mainly a comment about what we have planned for the second half. The last thing we want to do is create even more demand that we are struggling to meet right now. However, looking ahead, as the supply chain has improved and we expect it to continue getting better not just for the end of this year but also into 2023, when we discuss stimulating that upper funnel, we are not talking about boosting immediate demand. This is about broader advertising efforts aimed at increasing awareness of the category. We have been engaging in these activities, but we had to scale back due to the many challenges with the supply chain, recognizing that it would take us longer than just a quarter or two to navigate through those issues.

Okay, I understand. I also wanted to discuss the change in gross margin, specifically the pro forma gross margin compared to TAP, which is now down 60 to 80 from around 100 to 120. It seems TAP was a significant source of pressure, as mentioned on slide 21 where you indicate that gross margin expectations remain unchanged for some core segments. Could you explain this further? Why was TAP such a major drag? I know you're eliminating it, but why was it significantly worse than the core segments? Additionally, could you provide more insight into the expected improvement for the core businesses?

Yes. TAP was removed from the portfolio for several reasons. It wasn't central to our powersports focus, and the financial performance was extremely difficult and challenging. For those who have followed us, it has continued to get increasingly challenging. Regarding gross profit, several factors contributed to this. The tariffs imposed were a significant burden due to many components being sourced from Asia. Additionally, we noticed a decrease in demand, particularly in higher-margin segments. For instance, in Dealer Services International, where we equip new pickup trucks and jeeps for dealers, there was a lack of inventory, and dealers were unwilling to engage in this type of work since they were easily selling pickup trucks. Various factors created considerable challenges for the business. The positive aspect is that after this discussion, I don't anticipate us addressing this topic much further.

Yes. And I think as you look at the improvement in GP, so TAP obviously, that had a fairly minimal when you remove TAP from both, kind of the original guidance and the current guidance. The TAP removal actually had a fairly minimal impact. The improvement in guidance is really driven by operating improvement in the continuing business.

This concludes our question-and-answer session and also concludes the conference call. Thank you for attending today’s presentation. You may now disconnect.