Polaris Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Polaris designs and manufactures powersports vehicles and related parts, garments and accessories, and operates an aftermarket business. Results are seasonal and may not indicate full-year performance.
Financial performance
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Sales | $1,502.5 million | $1,364.9 million | $2,800.0 million | $2,518.7 million |
| Gross profit | $385.2 million | $350.4 million | $708.7 million | $592.9 million |
| Gross margin | 25.6% | 25.7% | 25.3% | 23.5% |
| Operating income | $122.5 million | $99.2 million | $205.7 million | $120.3 million |
| Net income | $92.5 million | $62.0 million | $148.3 million | $59.1 million |
| Diluted EPS | $1.43 | $0.97 | $2.28 | $0.92 |
| Operating cash flow | Not separately stated | Not separately stated | $165.1 million | $263.0 million |
- Q2 sales rose 10% and net income 49%; first-half sales rose 11% and net income 151%. First-half earnings comparisons also reflect prior-year charges and 2018 gains and tax effects.
- Q2 sales growth was led by ORV/Snowmobiles (+17%) and Global Adjacent Markets (+17%); Motorcycles fell 13% and Aftermarket increased 1%. First-half segment sales changed +16%, -5%, +20%, and +1%, respectively.
- Q2 gross margin edged down 4 basis points year over year, while first-half margin improved 177 basis points. Operating expenses were 18.9% of sales in Q2 and 19.5% for the first half, down from 19.8% and 20.3%.
Liquidity, debt and capital
- At June 30, cash and cash equivalents were $181.8 million; the cash-flow statement’s $210.0 million ending balance also includes $28.2 million of restricted cash. Current assets were $1.414 billion and current liabilities $1.115 billion.
- Total debt, capital leases and notes payable were $1.113 billion, including $1.073 billion classified as long-term. Debt to total capital was 56%; Polaris reported compliance with debt covenants and $359.6 million of revolving-facility availability.
- First-half operating cash flow fell $97.9 million to $165.1 million, primarily due to higher factory inventory associated with sales and model-year changeover. Capital spending was $104.6 million. Cash increased $48.3 million, including restricted cash.
- Polaris repurchased about 1.56 million shares for $192.4 million and paid $75.7 million in dividends in the first half. The quarterly dividend was $0.60 per share; a further $0.60 dividend was declared for payment in September.
Changes, outlook and notable items
- Management attributed growth mainly to sales volume, especially ORVs and Global Adjacent Markets. North American consumer ORV retail sales increased 6% in Q2; dealer ORV inventory was up high-single digits year over year. Management described the motorcycle market as weak.
- Commodity, freight and tariff pressures weighed on Q2 gross margin. Management expected higher commodity prices, freight costs and additional tariffs to continue through the rest of 2018 and adversely affect gross margins; currencies were expected to have a slightly favorable impact on net income. The filing provides no clear companywide full-year sales or EPS guidance.
- First-half inventory increased $141.3 million from year-end. The first-half effective tax rate was 20.5%, compared with 35.5% a year earlier, primarily reflecting U.S. tax reform and stock-based compensation tax benefits. Accounting for the Tax Cuts and Jobs Act remained incomplete, with completion expected during 2018.
- Polaris impaired its EPPL joint-venture investment following the decision to wind down operations: the first-half equity-in-loss line included $23.4 million of EPPL wind-down costs, including an $18.7 million impairment. A $13.5 million Brammo-related gain helped reduce first-half other expense.
- Victory Motorcycles wind-down activity had a net positive pretax impact of $0.4 million in Q2 and a negative $0.2 million for the first half. Management estimated approximately $5.0 million of total 2018 pretax wind-down impact, with substantially all costs expected by year-end.
- On July 2, 2018, after quarter-end, Polaris completed its $825 million acquisition of Boat Holdings, which had about $560 million of 2017 sales. $100 million of the consideration is payable in deferred annual installments over 12 years. Financing included an expanded credit facility and $350 million of 4.23% senior notes due 2028; pro forma acquisition disclosures were not yet available.
- Polaris paid a $27.25 million Consumer Product Safety Commission settlement in Q2 concerning two late-reporting claims. It accrued $49.2 million for pending product-liability claims and disclosed two early-stage U.S. putative class actions; potential losses for those cases were not estimable.
- Key risks include tariffs and retaliatory trade measures, raw-material and transportation costs, product recalls and warranty costs, litigation, foreign exchange, consumer demand, supply interruptions and acquisition integration. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Investor verification priorities
- Review Boat Holdings’ post-acquisition results, purchase accounting, integration costs and the resulting debt, interest expense and covenant headroom.
- Track whether tariffs, freight and commodity costs pressure margins further, and whether pricing or operational savings can offset them.
- Assess the cash conversion outlook, particularly inventory levels, capital spending and operating cash flow.
- Monitor product-liability litigation, warranty reserves and any further recall or regulatory costs.
- Confirm completion and final effects of the company’s accounting for U.S. tax reform.