Polaris Inc. — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017; balance sheet compared with December 31, 2016. Polaris designs and manufactures powersports vehicles, parts and accessories. Results are seasonal and affected by production and shipping timing. The November 2016 acquisition of Transamerican Auto Parts (TAP) materially affects year-over-year comparability.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Sales | $1,478.7 million | $1,185.1 million | $3,997.4 million | $3,298.8 million |
| Gross profit / margin | $364.0 million / 24.6% | $260.8 million / 22.0% | $956.8 million / 23.9% | $792.9 million / 24.0% |
| Operating income | $116.9 million | $57.4 million | $237.2 million | $251.5 million |
| Net income | $81.9 million | $32.3 million | $141.0 million | $150.4 million |
| Diluted EPS | $1.28 | $0.50 | $2.21 | $2.30 |
- Q3 sales rose 25%, driven by TAP, stronger ORV shipments, and a 1% favorable currency impact. Management attributed 16 percentage points of growth to acquisitions, 6 to volume, 2 to mix and price, and 1 to currency. Q3 net income rose 153%.
- Nine-month sales increased 21%; acquisitions contributed 19 percentage points and volume 2 points. Nine-month net income declined 6%, and diluted EPS fell 4%.
- Q3 gross margin improved 261 basis points, reflecting lower warranty costs, volume, cost savings and mix, partly offset by promotions. Nine-month gross margin was down 10 basis points. Nine-month operating income was pressured by higher expenses and unusual costs.
- Segment trends: Q3 ORV/Snowmobiles sales increased 12%; Motorcycles declined 14%; Global Adjacent Markets increased 17%; and Aftermarket rose sharply with TAP included. TAP contributed $190.6 million of Q3 sales and $601.7 million year to date. Motorcycle gross profit weakened substantially amid Victory wind-down costs and lower Slingshot volume.
Cash flow, liquidity and capital
- Nine-month operating cash flow was $494.5 million, versus $426.2 million. Capital expenditures were $126.6 million. Investing activities used $88.9 million; financing activities used $410.2 million. Cash increased $4.9 million to $132.3 million.
- At September 30, cash was $132.3 million and revolving-credit availability was $599.6 million. Management said cash, operating cash flow and borrowing capacity should fund operations, product development, dividends, repurchases and capital needs for the foreseeable future.
- Total debt, capital leases and notes payable, net of issuance costs, were $920.0 million, compared with $1,141.9 million at year-end 2016. This included $690.0 million outstanding on the term loan and no revolving-facility borrowings. The debt-to-total-capital ratio was 51%, compared with 32% at September 30, 2016. Polaris reported compliance with debt covenants.
- Polaris repaid $226.7 million net under debt arrangements during the first nine months, repurchased about 1.0 million shares for $88.9 million, and paid $108.9 million in dividends. The quarterly dividend was $0.58 per share; the board declared the same amount for payment in December.
- Dealer receivables financed through Polaris Acceptance and its securitization facility totaled $1.157 billion, down 7% from September 2016. Polaris’s potential 2017 repurchase obligation for repossessed products under the arrangement was approximately $184.0 million; the filing reports no material losses under it.
Outlook, commentary and notable items
- No specific sales or earnings guidance is provided in the filing. Management estimated the 2017 pretax impact of winding down Victory Motorcycles at $80–$90 million, including promotional activity, with substantially all related costs expected to be recognized by year-end. The reported nine-month impact was $77.2 million, including $59.1 million of wind-down charges and $18.1 million of promotional impacts.
- Management expected commodities to have a slightly negative gross-margin impact for the remainder of 2017 versus the prior-year period. Its currency outlook indicated mostly neutral effects for the remainder of the year, with a slightly negative effect from the Japanese yen. These are forward-looking estimates.
- Q3 gross profit included $7.6 million of Victory wind-down costs and $6.2 million of manufacturing-network realignment costs. Nine-month gross profit also included $13.0 million of TAP inventory step-up adjustments. The cash-flow statement included $25.4 million of impairment charges.
- Warranty expense additions were $103.9 million for the first nine months, down from $155.2 million a year earlier; the prior-year period included substantial RZR recall-related accruals. The September 30 warranty reserve was $112.1 million.
- Polaris accrued $40.6 million for probable product-liability claims. A securities class-action complaint was dismissed with prejudice on October 13, 2017, after quarter-end. A shareholder derivative lawsuit based on substantially similar events remained pending; claimed damages were unspecified.
- Other principal risks identified include product recalls and warranty costs, litigation, consumer demand and economic conditions, raw-material and transportation costs, foreign exchange, supply and manufacturing disruptions, acquisition integration, dealer relationships, financing-market conditions, debt compliance and information-technology disruptions. Management reported no material change in market risks from its 2016 Form 10-K.
Investor verification points
- Separate organic growth and underlying profitability from TAP-related growth and integration costs; assess the acquired business’s contribution to margins and cash generation.
- Track remaining Victory wind-down and promotional costs against the $80–$90 million estimate, and confirm when substantially all costs are recognized.
- Monitor inventory, working capital and dealer inventory: factory inventory cash use increased, while North American Polaris dealer ORV inventory was down 12% year over year.
- Review debt leverage, interest expense, refinancing of the $25 million senior notes due May 2018, and ongoing covenant compliance.
- Follow the derivative lawsuit, product-liability reserve adequacy, warranty and recall developments, and exposure under the Polaris Acceptance repurchase arrangement.
- Confirm actual results against management’s commodity, currency and liquidity expectations; these statements are forward-looking and subject to the disclosed risks.