Polaris Inc. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2016; filed October 27, 2016. Figures are unaudited. Comparisons are with the corresponding 2015 periods unless noted.
Business context and results
Polaris sells off-road vehicles (ORVs), snowmobiles, motorcycles, Global Adjacent Markets vehicles, and related parts, garments and accessories. Results are seasonal. Third-quarter sales fell mainly because Polaris delayed ORV shipments while addressing recall-related issues and validating model-year 2017 products.
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Sales | $1,185.1 million | $1,456.0 million | $3,298.8 million | $3,613.7 million |
| Gross profit | $260.8 million | $415.6 million | $792.9 million | $1,028.8 million |
| Gross margin | 22.0% | 28.5% | 24.0% | 28.5% |
| Operating income | $57.4 million | $242.7 million | $251.5 million | $557.0 million |
| Net income | $32.3 million | $155.2 million | $150.4 million | $344.7 million |
| Diluted EPS | $0.50 | $2.30 | $2.30 | $5.09 |
Cash flow, balance sheet and capital
- For the first nine months, operating cash flow was $426.2 million (versus $464.0 million); investing cash outflow was $187.8 million (versus $169.1 million); and financing cash outflow was $271.1 million (versus $196.0 million). Cash declined $32.7 million to $122.7 million.
- At September 30, current assets were $1,149.7 million and current liabilities $986.1 million. Total debt, capital leases and notes payable, net of debt issuance costs, were approximately $436.7 million, including $4.7 million current maturities. Debt to total capital was 32%, compared with 25% at September 30, 2015.
- Management reported $895.1 million of combined availability under the revolving and delayed-draw term facilities. Polaris had $104.3 million outstanding on its $600 million revolver and $100 million outstanding on the $500 million delayed-draw term facility; it reported compliance with debt covenants.
- Polaris repurchased approximately 1.8 million shares for $154.4 million and paid $105.7 million in dividends during the nine-month period. The quarterly dividend was $0.55 per share.
Material changes and drivers
- Q3 sales declined 19%; nine-month sales declined 9%. ORV/Snowmobiles sales fell 23% in Q3 and 14% year to date. Motorcycles declined 3% in Q3 but rose 13% year to date; Global Adjacent Markets rose 6% and 5%, respectively.
- Q3 gross margin contracted 655 basis points. Management cited higher warranty and promotional costs and unfavorable product mix, partly offset by lower commodity costs and product-cost reductions. Recall-related warranty expense reduced Q3 gross margin by approximately 490 basis points.
- Warranty expense additions were $87.7 million in Q3 and $155.2 million year to date, compared with $25.3 million and $53.9 million in 2015. The warranty reserve was $130.1 million at quarter-end versus $56.5 million at December 31, 2015.
- Operating expenses rose 16% in Q3 and 15% year to date, primarily reflecting higher legal and other recall-related costs. Q3 net income fell 79% and nine-month net income fell 56%.
Outlook, risks and unusual items
- No specific sales or earnings guidance is provided in the filing. Management said existing cash, operating cash flow and borrowing capacity should fund operations, investment, dividends, repurchases and the pending acquisition for the foreseeable future. It expected 2016 capital expenditures to be slightly higher than 2015.
- Management expected commodities to have a positive gross-margin impact for the remainder of 2016 versus the prior-year period, while foreign currencies were expected to have an overall negative impact on 2016 results.
- Polaris issued voluntary recalls for certain RZR 900 and 1000 vehicles and certain RZR XP Turbo vehicles after thermal-related incidents, including fires. The company said the initial Turbo repair solution could not be sufficiently validated, requiring a more complex and expensive repair and prolonging shipment delays. Recall, warranty, safety and reputational costs are material risks.
- At September 30, Polaris accrued $37.5 million for probable product-liability claims. A securities class action filed in September 2016 alleges misleading statements about RZR products and recalls; damages sought are unspecified, and Polaris said it intends to defend the case.
- Polaris agreed after quarter-end to acquire Transamerican Auto Parts for $665 million, subject to customary closing conditions and regulatory approval, with closing expected by year-end 2016. The target had approximately $740 million in trailing twelve-month sales through September; Polaris expected to fund the purchase with existing credit facilities.
- Polaris’ dealer-financing arrangements included a potential 2016 obligation to repurchase repossessed products capped at approximately $182.8 million. The filing states exposure is limited to the resale shortfall and reports no material losses under the arrangement to date.
Key facts for investors to verify
- Recall scope, repair progress, claim experience and whether warranty reserves adequately reflect expected costs.
- Whether delayed ORV shipments and lower retail demand recover, and the effect of dealer inventory levels on future shipments.
- Cash generation, borrowing availability, covenant headroom and leverage after any Transamerican Auto Parts acquisition financing.
- Acquisition closing, final consideration, integration costs and contribution to results; the filing provides no pro forma financial results.
- Developments in the securities class action and product-liability claims, and any resulting financial or reputational exposure.