Polaris Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; comparisons are with Q1 2017 unless noted. Polaris designs and manufactures off-road vehicles, snowmobiles, motorcycles, Global Adjacent Markets vehicles, and related parts and accessories, and sells aftermarket products. Results are seasonal and may not indicate full-year performance.
Key financial results
| Metric | Q1 2018 | Q1 2017 | Change / context |
|---|---|---|---|
| Sales | $1,297.5 million | $1,153.8 million | Up 12%; volume contributed 10 percentage points and currency 2 |
| Gross profit / margin | $323.5 million / 24.9% | $242.5 million / 21.0% | Gross profit up 33%; margin up 391 basis points |
| Operating income | $83.3 million | $21.1 million | Operating margin was approximately 6.4% versus 1.8% |
| Net income (loss) | $55.7 million | $(2.9) million | Turned profitable |
| Diluted EPS | $0.85 | $(0.05) | Turned positive |
| Operating cash flow | $(3.2) million | $47.0 million | Lower mainly due to planned inventory buildup |
| Capital expenditures | $55.6 million | $38.4 million | Primarily manufacturing capacity, capability, and tooling |
Gross profit benefited from lower warranty costs, lean savings, favorable foreign exchange, and comparison with prior-year Victory wind-down and TAP inventory step-up costs. These benefits were partly offset by unfavorable product mix, higher commodity costs, and freight. Q1 2018 gross profit included $5.8 million of restructuring, network realignment, and supply-chain transformation costs. Operating expenses rose 8% to $261.6 million, principally due to higher research and development spending.
Business and material period changes
- Sales grew across reporting segments: ORV/Snowmobiles +15% to $832.6 million; Motorcycles +9% to $131.6 million; Global Adjacent Markets +24% to $113.3 million; Aftermarket +1% to $220.0 million.
- North American consumer retail sales increased 3%; sales to North American customers rose 10%, while sales outside North America rose 27%, led by EMEA. ORV retail demand strengthened, but North American snowmobile retail sales fell about 10% for the season, which management attributed to inadequate snow in some regions.
- Motorcycle sales growth reflected Indian Motorcycle shipments; Slingshot sales declined. Aftermarket growth was constrained by soft light-duty truck industry sales.
- Income from financial services increased 5% to $21.4 million, associated with improved retail financing penetration and extended service contract income.
- Equity in loss of affiliates was $21.5 million, including a $18.7 million full impairment of the Eicher-Polaris Private Limited (EPPL) investment after the joint venture approved an operating shutdown. Other expense included a $13.5 million gain from Brammo distributions, contributing to the favorable comparison.
Liquidity, debt, and capital allocation
- Cash and cash equivalents were $166.4 million at March 31, 2018; cash, cash equivalents, and restricted cash totaled $191.3 million. The company reported $479.0 million of availability on its revolving facility.
- Total debt, capital leases, and notes payable were $1,029.5 million, up from $913.0 million at December 31, 2017; long-term amounts, net of current maturities, were $964.2 million. Debt-to-total-capital was 51%, compared with 58% at March 31, 2017. The company said it was in compliance with debt covenants.
- Q1 financing activities provided $75.2 million, including net borrowings of $116.1 million. The company paid $37.8 million in dividends and repurchased approximately 133,000 shares for $15.0 million.
- Management stated that cash, expected operating cash flow, and borrowing capacity should fund operations, product development, dividends, repurchases, and capital needs for the foreseeable future.
Outlook, risks, contingencies, and unusual items
- No full-year sales or earnings guidance is stated in the supplied filing text. Management expected commodity prices to reduce 2018 gross margins compared with 2017, and anticipated higher freight costs and additional tariffs during the remainder of 2018. Currency was expected to have a slightly favorable net-income impact.
- Management estimated 2018 pretax Victory Motorcycles wind-down costs of $5 million to $10 million, including promotional activity, with substantially all costs expected by year-end. Q1’s total pretax wind-down impact was reported as a negative $0.7 million, compared with a negative $57.6 million in Q1 2017.
- At March 31, the company had a $47.1 million accrual for probable pending product-liability claims. Four U.S. putative class actions were disclosed; the company said they were at an early stage and could not estimate likelihood or range of loss. A $27.25 million Consumer Product Safety Commission settlement agreed to on April 2, 2018, resolving two late-reporting claims, was accrued at March 31.
- Polaris had a potential 2018 product repurchase obligation of approximately $165.0 million under its dealer-financing arrangement, subject to an annual cap; management reported no material losses under the arrangement. Dealer receivables financed under the arrangement totaled $1,203.6 million.
- Other risks emphasized include commodity, labor and transportation cost inflation; tariffs and trade-policy uncertainty; foreign-exchange exposure; product recalls and warranty costs; weather and consumer demand; supply or manufacturing disruptions; and international-operation risks. The filing reported no material changes in market risk from the 2017 Form 10-K.
- The company had not completed its accounting for the Tax Cuts and Jobs Act and expected to finish during 2018; it reported no material measurement-period adjustments in Q1. Adoption of the new revenue-recognition standard had no material impact.
Important facts for investors to verify
- Whether inventory growth and seasonal working-capital needs translate into stronger operating cash flow in subsequent quarters.
- How tariffs, commodities, freight, and product mix affect gross margins against management’s stated 2018 expectations.
- Developments in product-liability claims, class actions, warranty reserves, and the CPSC settlement payment.
- Debt levels, revolving-facility availability, refinancing of the $25 million note due May 2018, and compliance with covenants.
- Costs and timing of the EPPL shutdown and Victory wind-down, and whether the anticipated remaining costs stay within management’s estimates.