Richard Edwards - Polaris Industries Inc. Scott W. Wine - Polaris Industries Inc. Michael T. Speetzen - Polaris Industries Inc..

James Hardiman - Wedbush Securities, Inc. Tim A. Conder - Wells Fargo Securities LLC Brandon Rollé - Longbow Research LLC David James Beckel - Sanford C. Bernstein & Co. LLC Robin M. Farley - UBS Securities LLC Craig R. Kennison - Robert W. Baird & Co., Inc. (Broker) Jaime Katz - Morningstar, Inc. (Research) Drew Lipke - Stephens, Inc.

Joseph Nicholas Altobello - Raymond James & Associates, Inc. Seth Woolf - Northcoast Research Partners LLC Joseph Spak - RBC Capital Markets LLC Gerrick Luke Johnson - BMO Capital Markets (United States) Jimmy Baker - B. Riley & Co. LLC Gregory Robert Badishkanian - Citigroup Global Markets, Inc. (Broker) Mark E. Smith - Feltl & Co..

Good morning. My name is Tiffany, and I'll be your conference operator today. At this time, I would like to welcome, everyone, to the Polaris Q3 2016 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Thank you.

Richard Edwards from Investor Relations, you may begin your conference..

Thank you, Tiffany, and good morning, and thank you for joining us for our 2016 third quarter earnings conference call. A slide presentation is accessible at our website at www.polaris.com/irhome (sic) [ir.polaris.com], which has additional information for this morning's call.

Today, you will be hearing prepared comments from Scott Wine, our Chairman and Chief Executive Officer, and Mike Speetzen, our Chief Financial Officer. Ken Pucel, our Executive Vice President of Operations, Engineering and Lean is also here to answer questions.

During the call today, we will be discussing certain topics, including product demand and shipments, sales and margin trends, income and profitability levels, and other matters including more specific guidance on our expectations for 2016 and 2017, 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 2015 10-K for a more detailed discussion of these risks and uncertainties. Now, I will turn it over to our CEO, Scott Wine.

Scott?.

Morning, and thank you for joining us. As we continue to deal with a broad-array of challenges and opportunities, it was both sad and inspiring to pay our final respects to Polaris' last remaining founder, David Johnson, this past weekend.

David epitomized our culture and our company and we will honor the virtues that defined him with our renewed commitment to innovation, perseverance and humility.

These attributes were instrumental to our third quarter performance as we launched an array of innovative model year 2017 vehicles, persevered through our recall challenges, and embraced the humility that comes with the major earnings revision.

Third quarter sales were down 19% to $1.18 billion as we prioritize recall execution and quality validation and delay the launch of many of our model year 2017 Off-Road Vehicles. Results were in line with our revised guidance but that does not make them any more acceptable.

We lost market share in a weak powersports industry and incurred approximately $65 million of recall and related legal costs. The resulting lower volume and higher expenses weighed heavily on our earnings per share of $0.50, down nearly 80% from the prior-year period.

Overall North American retail sales for the third quarter were down 9%, our worst performance since 2009. The Off-Road Vehicle industry declined modestly in the third quarter and [reworks] down slightly more as RZR retail dropped precipitously in the first two months, and ATVs continued their sluggish trends from the previous two quarters.

However, side-by-side retail improved in September as better product availability and aggressive promotions helps bend the trend line.

Specifically, the significant improvement in RZR during the final month of the quarter provides confidence that consumer preference for the brand remains strong and our vehicles are still the most preferred in the sport rack segment of the market.

Indian Motorcycles continue to prove that this combination of a legendary brand, great bikes and a strong and improving dealer network can grow in any market. While a heavyweight competitor recently commented on improved performance in September, it's worth noting that both Indian and Victory grew more than twice as fast in that period.

Victory's growth was aided by mid-sized Octane which is attracting new customers to the brand. Slingshot was down slightly in the quarter, primarily due to the tough first-year comparables from 2015. We anticipate Indian share gains and retail growth to continue in the fourth quarter, with retail sales expected to be up high teens to over 20%.

Despite the weak retail results, we made further progress on our dealer inventory goals, reducing our overall third quarter number by 10% with Off-Road Vehicle inventory down 16% year-over-year. The ORV inventory position is moving closer to our optimal levels, which will make our transition to RFM in 2017 less impactful.

Our Off-Road Vehicle results offsetting more than 50% increase in motorcycle inventories where five new models and a couple of dozen new dealers drove an increase over a prior year period that was artificially low due to our Spirit Lake paint issues. In many ways, it seems like Polaris has been consumed by recall news this year.

We have previously discussed our retrospective review process and anticipated additional recalls including Slingshot. This review is now complete. And while it revealed that the trend has not completely run its course, it is abating, and we are incorporating our improvements and learnings on an ongoing basis.

These recalls and the refined policies and procedures they engender reflect our commitment to identifying and addressing any defect that could put our vehicles or customers at risk. Technologically, organizationally and procedurally, we have made significant strides and we are undoubtedly building better vehicles and becoming a stronger company.

We are making good progress, but we are also continuing to elevate our quality expectations, and our financials reflect that. The previously announced RZR recalls have now passed the 50% penetration rate for both the RZR 900/RZR 1000 recall and the more recent Turbo recall.

Our dealer network has worked closely with our service teams to improve both the timeliness and effectiveness of these repairs. And our field repair teams are augmenting capacity in certain high-demand areas.

We continue to aggressively encourage our RZR customers to have the recalls performed and anticipate that we will have a significant majority completed by year-end. While we worked to repair vehicles, we are also enhancing our efforts to improve dealer and customer satisfaction.

With RZR share more than doubling all other competitors combined and RANGER commanding twice the market share and the largest competitor, we see customer loyalty as an asset worth investing in.

The foundation of our investment in customer and dealer satisfaction is building innovative products, and our model year 2017 vehicles have shown very encouraging early signs. With the launch of the new 80-horsepower RANGER 1000, we have clearly reestablished product leadership in the premium utility segment of side-by-side.

And by relaunching our RANGER 900 with an aggressive price point, we have made our 2017 side-by-side lineup stronger from top to bottom. Our Motorcycle business also continues to innovate and grow from the Indian Roadmaster, which is pure American luxury in motorcycle form, to the race-inspired Victory Octane.

These new vehicles extend our ride and handling advantage. With the initial rollout of our new ride command touch screen display system on Roadmaster 1000, they also have a technological edge.

The industry-leading system is a testament to the customer focus we bring to innovation, as we have utilized rider feedback throughout the development process to deliver an electronic suite that meets their most pressing needs and make every ride more memorable. We are focused on innovation and industry-leading performance across our portfolio.

We have added resources and rigor to our design processes to enhance safety and quality, and we'll continue to build on our model year 2017 improvements. TAP will provide another new platform to build upon, and we are excited to add Greg Adler and his Transamerican Parts team to our Polaris family.

The acquisition announcement has been well received and the regulatory filings and closing process are proceeding efficiently. We anticipate that the deal will close in the fourth quarter, possibly in November and provide more detail on the Aftermarket/PG&A segment at that time.

Steve Eastman is actively planning for the integration, continuing our careful and thorough efforts to ensure that neither the acquisition nor the integration process detract from our ability to execute and complete our recall activities. We will do both and do them well.

I will now turn it over to Mike Speetzen, our Chief Financial Officer for a review of our financial results and outlook..

ORV and Snowmobile sales are expected to be down high-single-digits to low-double-digits percent, given impacts related to the recall as well as a weak industry conditions. Motorcycle sales are anticipated to be up low-single-digits percent, which is lower than previously expected, given weak industry conditions.

And Global Adjacent Markets sales are expected to be up high-single-digits percent, slightly lower than previously expected, given weak Work and Transportation markets as well as timing of military programs. Now, let me provide more details around our segments.

ORV and Snowmobile segment sales were down 23% in Q3, driven primarily by the impact from delayed shipments of our model year 2017 vehicles as we revalidated those products for any potential safety or quality issues coupled with weak industry dynamics.

Sales were also impacted by higher promotional spending as we protected the brand and remained competitive against heightened industry promotional spending levels. For the full year 2016, our ORV and Snowmobile segment sales are expected to be down high-single digits to low-double digits percent.

Snowmobile sales expectations for the full year 2016 remained unchanged at down about 20% year-over-year.

Motorcycle sales declined 3% in Q3, primarily due to weak industry fundamentals coupled with Slingshot sales being down significantly quarter-over-quarter as we were shipping aggressively in the third quarter of 2015 to reduce a significant backlog for Slingshot deliveries in the first year of production.

Victory and Indian combined increased sales in the low-teens percent during the quarter, reflecting continued market share gains. Although we continue to gain share, weak industry fundamentals are driving a reduction to our full-year guidance for Motorcycles to be up low-single-digits percent.

Global Adjacent Market sales increased 6% in the third quarter, driven by the Taylor-Dunn acquisition completed in the first quarter of the year. Sales in our defense business and Work and Transportation businesses were lower quarter-over-quarter due to delayed military orders and weak rental and B2B sales.

We expect full-year 2016 sales growth for this segment to be up high-single-digit percent. International sales were down 8% in the third quarter, down 7% on a constant-currency basis. The decrease was driven primarily by lower ORV sales due to the recalls.

Parts, garments and accessory sales decreased 1% in the third quarter driven by lower sales in both ORV and Motorcycles due to weak industry trend, and delayed model year 2017 PG&A shipments, in line with the wholegood delay. Before I move to gross margins, I want to review our thinking around segment reporting for the TAP acquisition.

After the deal closes, we are planning to establish a fourth reporting segment called Aftermarket, which will include TAP, along with our current Aftermarket brands including KLIM, Kolpin, Pro Armor, Trail Tech, and 509. The fourth reporting segment will have annualized sales of approximately $850 million on a pro forma basis.

Polaris-engineered PG&A will continue to be included in each respective segment as before. Beginning in 2017, our guidance will be based on these four reporting segments, ORV and Snowmobiles, Motorcycles, Global Adjacent Markets, and the new Aftermarket segment.

As before, we will provide supplemental metrics for further insight to our business performance where needed. Historical data under the new reporting structure will also be made available once the new segment is finalized.

Moving on to gross margins; margins were down 655 basis points reflecting lower volume and additional warranty and customer loyalty costs taken during the quarter as we indicated previously.

The additional 490 basis points of warranty expense taken during the quarter includes the safety and service recall bulletins we've publicly announced, as well as expenses that are probable and estimable for quality issues being evaluated.

Additionally, gross margins were negatively impacted by higher promotional and customer appreciation costs to bolster confidence and credibility with our Off-Road Vehicle owners which is expected to be a multi-quarter activity.

As Scott indicated, we are spending what is required to get the recall repairs completed effectively, along with putting processes and systems in place to improve the quality and safety of our vehicles going forward.

Despite these headwinds, we continue to make strong progress in our VIP cost improvement initiatives, which help to offset a portion of these cost increases. For the full year 2016, gross margins are now expected to be down 380 basis points to 390 basis points compared to 2015.

This reflects the significant volume reduction on our very profitable Off-Road Vehicle business, approximately 200 basis points of impact from the added warranty-related costs we have incurred and approximately 100 basis points of negative foreign-exchange impact for the full year.

Operating expenses are now expected to increase approximately 300 basis points as a percentage of sales given product liability, acquisition costs, legal, and other recall-related costs incurred during the year.

Our expectations for the remaining P&L line items either remain unchanged or have only minor adjustments from our previously-issued guidance.

While we're not prepared to provide detailed guidance for 2017 at this point, we do think there are some key aspects around next year that are important as you began building your expectations for our performance.

From a sales perspective, we anticipate that the industry will remain challenged and we could see a third straight year of a flat-to-down industry. The oil and agriculture markets will likely remain challenged and competition will remain high. As a result, we anticipate promotional spend to continue at levels similar to the second half of 2016.

From a cost perspective, we anticipate that we will benefit from $120 million of non-recurring costs incurred in 2016 of which approximately 70% impacts gross margins. To clarify, this is the same $120 million I referenced earlier that includes one-time warranty, legal and acquisition-related costs incurred throughout 2016.

We will, however, spend more money in engineering resources and to continue quality and safety enhancements as well as ongoing innovation investments and expect that this will increase engineering costs mid-teens percent over 2016 levels. Lastly, we anticipate continued strong performance in our Lean evolution.

We expect continued gains in our VIP cost reduction efforts and anticipate a smooth RFM implementation in our side-by-side business during the course of the year. With that, I'll turn it back over to Scott for some final thoughts..

safety, quality, delivery and cost and, of course, execution. With that, I'll turn it over to Tiffany to open the line for questions..

Your first question comes from the line of James Hardiman with Wedbush Securities. Your line is open..

Hi. Good morning..

Hi, James..

Thanks for taking my call. I wanted to focus on what sounded like probably the most positive take-away from the quarter and that's the improvement in side-by-side in the month of September. Help us understand the factors that led to that increase. I would assume that the timing of some of the model year 2017 launches probably helped that.

How much of a factor did promotions play on a year-over-year basis? And any color that you could give us on retail trends in October would be really helpful.

I guess what I'm trying to figure out is, are side-by-side still growing and did September represent a turning point for you guys?.

Well, thanks, James. We're not going to provide color on October in the fourth quarter. I mean, we don't provide in-quarter guidance. I will tell you that we were not at all pleased with how July and August went for side-by-side in general, but RZR specifically. I mean, it was – we knew it was going to be difficult, and it was very difficult.

And Matt Homan and his team, they're really, really good and really, really competitive. And they took a lot of steps to look at what we can do to drive improvements in September. So, our promotions were better, more targeted and more impactful. Our model year 2017 vehicles had started to flow in and we released the – started to shift to Turbos.

I mean, the Turbos – the 16 Turbos were released for sale, which was very helpful at a price point that our customers like. So, it was the combination of those three things together that provided the churn that we hope for and certainly needed to get confidence that our brands were still strong..

James, I'd add to that the – obviously, you can do the math around the business plan. We're assuming a little bit of retail growth in our Off-Road Vehicle business in the fourth quarter. You got to remember, we're comparing back to the fourth quarter last year when things got pretty bad in that segment.

The second thing I'd point out is, Scott pointed to the Motorcycle performance in the quarter. And I think coming back to that is important. We are in an industry that was down high-single-digits. And our Motorcycle business, all inclusive, performed in the high-single -digits from a retail standpoint.

And as Scott pointed out, Victory and Indian together were in the high teens. So, that's continued market share growth and good performance in an industry that's a bit challenged right now..

Your next question comes from the line of Tim Conder with Wells Fargo Securities. Your line is open..

Thank you, and good morning, gentlemen. Slide 18 here, if we could, and thank you for the clarification on that. But as we – first of all, I guess, if you could give us some color on any quantification on the Lean and et cetera benefits.

And then, as we go forward and maybe think past 2017, should we start to see some of the incremental ongoing spending in 2017 here, whether it's R&D or continuation of some of the higher level marketing and customer engagement? Should we see that start to abate someone? And I guess the real root of the question is, how should we think about that normalize going forward?.

Yeah. I mean, I think, Tim, we're obviously not at a point where we're comfortable given out details. But I think your premise around normalizing is fair.

You're going to see our investment levels as we indicated here for Engineering come up to what we think is probably a more reasonable level, and then, I would anticipate that we would try and keep that somewhat consistent as a percent of sales.

I think the point around Lean, VIP improvements around costs is there is a significant amount of progress that Ken and his team have made over the past couple of years. It doesn't come through in the results, obviously, when we were pulling shipments down, double-digits in our most profitable businesses.

But I can tell you that they've saved off a fair amount of margin erosion with the activities that they have, and we anticipate that progress that they've made, the system that they've built, the capability and the processes will continue into 2017, and that's going to aid us in continuing to look for margin improvements as we start to get the business into more of a recovery mode..

Okay. And then, one follow-up here.

Any color at this point, you guys have given a little bit of 2017 color here on where FX stands at this point?.

Yeah. I mean, we've essentially guided with FX consistent where we're at. I mean, when you look at the last couple of years, I mean, two years ago we dealt with the $120 million of top-line headwind. It's abated significantly, about half of that, as we look at this year or less than half of that. It's anybody's guess.

I suspect if the rates hold where they are now, we might have just a tad bit of headwind, but it's certainly not going to be at the level of magnitude that we've seen. That's why we left it off the chart as we just don't think it's going to be a factor one way or the other..

Next question..

Your next question comes from the line of Brandon Rollé with Longbow Research. Your line is open..

Hi. This is Brandon Rollé on for David MacGregor. My question is surrounding looking towards 2017. Will we see any decrease in the number of players or the models that dealers intend to floor? And the second question would be on Indian, where within the price point lineup are you seeing the greatest strength? Thank you..

All right, with ORV, we are constantly evaluating our portfolio of products. Matt again, just credit to he and the team and how they're looking at the portfolio, I don't think it's fair to assume that there's going to be a dramatic decrease in the number of units, but I don't think that we're going to be adding a ton either.

Really as you think about ORV stocking a dealer, it's really important to think about the aggressive rollout of RFM next year, which means no matter how many units they have, we're going to be able to replenish them much faster and make the overall dealer inventory and availability of products for customers significantly better.

That's more important impact than any change that we'll make to the number of models available. On Indian, we're really seeing good demand across the price point.

Obviously, the launch of the Scout Sixty last year has made the portfolio, both the Scout and the Scout Sixty continue to do well, but the Roadmaster, especially with RIDE COMMAND has taken a lot of attention away at the top end of the market, and we feel really good about how – as we talked about with high teens to up more than 20%, or 20% retail in the fourth quarter, we expect Indian to continue to be strong..

Next question?.

Your next question comes from the line of David Beckel with Bernstein Research. Your line is open..

Hey there. Thanks for the question. You were mentioning that ORV sales or market shares began to firm up in your opinion or you expect it to shortly.

I was wondering, if you're to look over a two-year period, from 2015 to 2017, by the end of next year, where would you expect your ORV market share to be relative to where it was in fiscal 2015 before all the recall issues and the shipment disruptions? And I have a quick follow-up. Thanks..

Probably down slightly..

Down slightly. Okay. That's helpful.

And just with respect to Motorcycle guidance being reduced to low-single, how should we think about next year's growth? What are sort of the puts and takes with respect to fiscal 2017?.

Yeah. So, I want to clarify something because I know that there's probably a little bit of confusion when we talk about our Motorcycle revenue being down 3%. And then, obviously, if you squeeze out the math for the balance of the year that suggests that our Motorcycle revenue, company shipment revenue will be down 15% to 30% in the fourth quarter.

That does not indicate that we have a view that the retail has significantly softened. If you'll remember back, we had, obviously, a number of issues coming out of Spirit Lake last year and we ended up ramping up Motorcycle sales into the channel much later in the year. Our fourth quarter of last year was up 33% in terms of company shipments.

To put it in broad perspective, our retail last year for Motorcycles was up just over 60%. Our shipments were up well over 70%. So, we were clearly shipping ahead into the channel.

We're now at a point where we're on RFM, so our shipment to the business, to the retail channel and retail flow through as we get into 2017 is going to mirror more closely, so we're not going to have as many of these disconnects.

As Scott indicated, I mean in the third quarter where we saw a market that was challenged significantly down high-single-digits, we continue to turn in pretty significant retail strength.

Although we think the industry is going to be somewhat challenged, we do continue to see the opportunity for us to take share and continue to see strong retail growth..

Your next question comes from the line of Robin Farley with UBS. Your line is open..

Great. Just trying to think about your ORV shipments for next year with your comments that the industry, you think, will be flat to down, and you mentioned that you expect to have stable market share.

Does that mean – because we were thinking about some of the shipment decline this year being related to the fact that you were holding back some product as you were working through the recalls, but it sounds like based on these two pieces that we should not expect to see ORV shipments flat or up next year, that it sounds like your ORV shipments will be down for next year.

Just kind of triangulating those two things.

And maybe the only variable there is your dealer inventory goal by year-end maybe would make that not different, but I don't know if you can give any color on those factors?.

I think the important thing, Robin, is just where we feel about our share position, our ability to ship products. I mean, it was a difficult year in many respects this year, and we'll have a lot of that – not a lot, we'll have almost all of that pain behind us as far as the impact on shipments next year.

We do have to contend with the rollout of RFM, and we think the benefits of that far exceed anything that it hurts on a volume basis. But, as I said in my remarks, we've gotten a lot of that work done already as we head into next year.

So, really, it's going to be about what we can do in driving retail, and we will be quite aggressive with our plans and our promotions there. But I think, as Mike talked about in his remarks, think about flat is essentially the right way to think about it. We'll work from there, but that's kind of how we're planning for 2017 at this point..

Okay. Thanks. And I wonder if I could just ask one quick follow-up, which is....

That's allowed..

...on the recall front, if you're at this point do you think through anything that needs to be announced? I know Slingshot had like a safety notice which is that something that would be instead of a recall? So, at this point you – everything is announced that you expect..

The Slingshot is a recall, it's just through NHTSA, so it takes a little bit different form as you look at it. We are – in our industry there's always going to be recalls. And I will tell you that just because we've had a tremendous effort to get through as much as we can, we are going to have recalls going forward.

We anticipated the Slingshot, we knew it was coming, we just can't talk about – even if we're anticipating, we can't necessarily really talk about them. We can have them in our financials, we can plan for them and we try to be forthcoming when they're announced about whether there was new or includes...

So, we think there will be an abatement of the significant spike in recalls that we've had but by no means is it something that's going to go, dwindle down to nothing. The big ones are there. There's a couple – there's more work to be done.

The teams have done a really nice job as I said with this historical review and we know what's coming but certainly we are not done with recalls..

And, Robin, I would just draw you back to my prepared remarks where as I indicated at $120 million that we booked thus far that it includes what's been announced as well as anticipated costs, our estimable one, probable one, items that we're reviewing for quality issues..

Okay. Great. That's very helpful. Thank you..

Next question..

Your next question comes from the line of Craig Kennison with Baird. Your line is open..

Good morning. Thanks for taking my question.

Scott, on the recall changes, where are the top two or three operational changes you've made to give you more confidence in the product quality and safety?.

Yeah. I mean, it's not one thing, Craig. I'll tell you that the work that Ken and his team have done is extensive and it's ongoing.

But a couple of the key ones, promoting Joel Houlton to be our Safety and Quality VP, working directly for me and Ken, he's building an organization that gives us a pulse on what's going on, just the speed that we know and can react to any issues in the field, that field surveillance is just critical to ourselves.

We've upgraded our thermal engineering team, and I think we've got a much better grasp of how we design our vehicles, to have the right tolerances and quality.

And then, just the lessons that we've learned from these efforts have all been built back, not only into the products, but into our processes so that we have a tremendous amount of confidence now in our ability to take a step back and ensure that what we release as we've done with our model year 2017 products is the best that we possibly can from a safety and quality perspective..

And as a follow-up, what has the impact been on dealer profitability from the recall? And what can you do to kind of regain their confidence?.

Well, dealer profitability is one that it's much broader than just a recall and Tim and Matt and the whole teams were working through that. Obviously, it's a lot easier when our volume is growing like it was for so many years. And now we've got to revisit that how we managed that, and we're doing that.

Specifically, as it relates to the recall, we try to make sure that our dealers are fully reimbursed for any costs that they incur. Tim Larson and the team have done a really good job of working with them to make sure we've gone back and raised the reimbursement rate when we've needed to.

As I've said, we've augmented our field service teams to help some of the dealers that have the higher backlog. So, we are working with them. I think the general feedback as we've gone into the Turbo has been positive, as we reflected the learnings from the RZR 900 / RZR 1000.

So, obviously, it's not ideal because it's detracting our dealers away from selling, but it's important for our customers and important for our business, and we believe that overall – and some of our dealers actually do well with it. As they get customers in they can provide other services for them.

So, all in all, net-net, I think the teams have done a good job working through it, but we'll be thankful when our customers all have their vehicles repaired and we can move beyond this..

And Craig, what I would add to what Scott just indicated is one, look at the dealer inventory levels. I mean, we're trying to make sure we're taking the pressure off the dealers so that the interest costs that they pay, from a flooring standpoint, is minimized.

We also are picking up the interest costs when we've had recalls, so that they're not happen to bear that for a period of time. And then, one of the other things that we've done is we've deployed just about 100 of our employees out to help in concentrated areas.

The dealers are still getting compensated for that, but essentially they're getting extra hands and legs to help get the repairs done. And that's obviously been received very positively. So, it's kind of an all-out effort to make sure we're helping them execute and protect them financially..

Your next question comes from the line of Jaime Katz with Morningstar. Your line is open..

Morning, guys. So my first question is on....

Morning Jamie..

...Motorcycle gross margins.

I'm curious how you guys are thinking about the near-term and long-term outlook for gross margins in the Motorcycle segment? I think the improvement was a little bit lighter this quarter than the past few quarters, but I think as that business scales up, it still seems like there's a lot of room for upside over the longer-term..

Yeah, Jaime. Our Motorcycle margin was heavily impacted by the Slingshot safety and service bulletins. If you adjusted for the amount of money that we essentially provided for in the third quarter, you would have seen our gross margins improving north of 16%.

So, I think the line is that we've continued to see progress outside of this one-time issue that we're contending with, and we expect to continue to have our Motorcycle profitability increase. It's one of our long-term objectives, and the team's making good progress on it..

Okay.

And then I think that right around this time last year when we saw the oil and ag areas really start to pressure interest in the products for you guys, and so I'm curious how you guys are anticipating that to pan out in the fourth quarter, whether you think that it is still declining but at less of a cadence or less of a magnitude? Or do you sort of feel, generally, like we might see that sort of a leveling out over the next quarter and going forward?.

It's a tough one. I mean, as we indicated on the last call, the second quarter, the oil states were down north of 20%. They've improved slightly in Q3. They were still down kind of mid-teens. We're now getting up against the fourth quarter of last year when they were down 17%.

Given what we've seen, we don't have anything that tells those things are getting significantly better.

Certainly, our recall and the lack of shipments in these regions has clouded this visibility just a bit, but the intel that we're getting from our dealer network is that the oil recession and the lack of economic activity in these key states is still persistent. Ag has weakened even further, it was down kind of mid-single digits in the third quarter.

Given where crop prices are and just the general state of the farming community, we anticipate that's probably going to continue. That's really what led us to say the comments around 2017 is we really haven't seen anything that tells us that the trends in these areas are going to improve.

I suspect that they will probably worsen at a much slower rate, but they'll probably continue to be headwinds as we get into 2017..

Your next question comes from the line of Drew Lipke with Stephens, Inc. Your line is open..

Yeah. Good morning, guys. Thank you for taking the time..

Good morning..

Good morning..

The question I had was just on capital allocation and kind of tied to your 2017 initial thoughts. You called out the third straight year of a challenging ORV environment. Then we have the Transamerican acquisition where you're building out this new platform.

And so when you weigh your capital allocation plans for 2017, how should we think about growth CapEx compared to additional acquisitions for this Aftermarket portfolio? And then as a follow on to that, are there any other adjacent platform opportunities out there?.

Yeah. Maybe I'll talk a little bit more from a financial standpoint, and then Scott can weigh in on additional M&A opportunity. I think the way we're thinking about it is we're going to have our plate full next year with the TAP integration.

I think smaller acquisitions were they to come along, I don't think that's going to be difficult for us to handle. But we're obviously going to stay true to some of the parameters we'd put out.

We're not looking to buy fixer-uppers or anything that's going to require a manufacturing or engineering organizations to dedicate a significant amount of time just given the work we're doing on the quality and safety side. I think it's fair to assume that share repurchases still obviously on the table.

As we indicated with the TAP acquisition, even though we were deploying a fair amount of capital into that deal, we were also, as we just indicated, still looking to do about 1 million shares here on the fourth quarter which is a pretty substantial outlay.

And at the current trading prices, we view this is an attractive investment, and we'll obviously continue to keep the gas on from that standpoint. I think as it relates to capital expenditures, I do think the plant costs are going to come down. We spent the last couple of years investing a fair amount of money in Huntsville and Spirit Lake.

We do think that's going to abate a bit, but I do anticipate we're, obviously, going to have some incremental CapEx that goes towards growth investments, which is in line with the increase that we've seen in engineering, and we'll provide more color in commentary.

But, as Scott indicated in the past, the big plant building investments that we've made are probably not something that we're going to be looking at doing here in the next few years..

All right. Thank you..

Your next question comes from the line of Joe Altobello with Raymond James. Your line is open..

Thanks. Hey, guys. Good morning..

Good morning..

First question, I want to start on the fourth quarter and the guide, at least the implied guide for the Off-Road Vehicle segment in terms of positive retail? I'm curious what's going to drive that because it sounds like, Mike, in your comments earlier, you mentioned that you don't see much in the way of improvement in the oil and ag market.

So, I'm just curious why we should see that increase in retail in the fourth quarter..

Yeah. I think some of it is a sequential improvement, just given we were out of the market for a good two months on some of our key products. When you look at it on a unit basis, it's not a substantial uptick and you're comparing against the last year where we saw things worsen pretty dramatically.

And that's become somewhat of the new norm that we're dealing with within the current context. I do think the fact that we have some pretty impressive new products out on the market or coming out on the market shortly is going to be a big driver even in a market that's a bit challenged..

Okay. Okay. So, it sounds like you guys being out of market for a while will help a little bit from a demand standpoint..

Yeah..

So, switching gears a little bit to 2017, I know you guys aren't giving guidance today, but as we think about 2017, if you start-off with $3.50, call it, this year, or the midpoint of your guide, you get back a $1.20 next year and you add $0.25 or $0.30 from TAP, you're adding around a $5 number, so I'm curious, off of that $5 number, do you think that – the cost savings next year, you guys have planned, will offset or fully offset the increased promo in R&D or not necessarily?.

We are not going to get into a mass exercise on 2017 at this point. I will tell you..

Okay..

One of the things that we didn't highlight as much as we could or should have, is the significant progress that Ken Pucel and his team are making on this VIP program. I mean, the year-over-year savings increase in 2016 has been significant. It's just been consumed by a recall-related cost.

And as we roll into 2017, they're going to have additional projects and additional opportunities to drive more savings.

But to look at what's going to be actually hit the bottom line as we offset the additional engineering costs that Mike has referred to in the difficult environment, that's just not an exercise we're going to get in today, but it's certainly, it's fair to say that the work that Ken and the team have done this year with VIP and will do next year will be helpful for the business..

Your next question comes from the line of Seth Woolf with Northcoast Research. Your line is open..

Hey. Good morning, guys. Thanks for taking my question. Scott, I think in the slide deck you referenced that the RZR recalls was still – it's still disruptive to retail sales in 3Q. I was wondering if you could kind of maybe provide a little bit of context as to how disruptive it was especially relative to 2Q when you had the big recall going on..

I think – not I think. The word that I used to drop the RZR impact in Q3 was precipitously dropped. I mean the July and August decreases were hard to look at. And it really had two factors.

I mean one is that there was just not products available for sale, and we had a stop-ride/stop-sale on Turbo for almost the entire month of August and part of September. So, it was dramatic. I'm proud of how the team handled it and fought through and ultimately drove the recovery that we saw in September.

But it was a very, very significant impact for our business and our dealers..

Okay. Thanks. Something that. Thank you. And then Mike, it might be for you. Just a bit of clarification. I thought I heard you comment that the level of promotional activity that we've seen in the last couple of quarters, just the force of brand and compete in the current market, very choppy, you would expect this to be a multi-quarter phenomenon.

Did I hear that correctly?.

Yeah. Yeah. So, we stepped up the promotion level. If you look at our average selling prices that we have on each of the charts with the Off-Road Vehicle business, you can see our ASPs are down 8%. That gives you a pretty good context of the significant amount of promotional activity.

I think in light of what we've seen and what we anticipate will continue, we do think it's probably going to continue at least into the first half. And at that point, we would start to lap some of the activity we've done this year.

So, we just want to make sure people were thinking that through as they think about margins and overall revenue performance heading into next year..

Next question?.

Your next question comes from the line of Joe Spak with RBC Capital Markets. Your line is open..

Hi, Joe..

Good morning, everyone. Thanks for taking the question. The first one is on dealers. So, one of the things we've heard consistently over the past year is, in checks, is some complaining about the profitability of selling Polaris product versus some competitive product. And my guess is that the recalls probably haven't helped their attitude.

I just wanted to hear what your plans are to improve your standing, I guess, with some of the multi-line dealers?.

Joe, I think it's fair to say that we take our relationship with our dealers extremely seriously. You've heard – we talked about it earlier today that that's an area of focus for us. But let's be clear.

There are a number of our competitors that are accepting extremely low margins to buy their way into our dealerships and we are not going to compete at that level. I mean, as you know, for the longest time, Polaris made up for dealer profitability with our significant volume increase. And you tag on PG&A, it's a pretty good recipe.

That is not what we're going to be able to do going forward, so we're going to have to look to other elements forward. And I've got tremendous confidence in the way that Tim Larson, and Matt Homan and their teams are looking at how we do this.

But it relates, obviously, to improving our quality, so that they have less issues with our customers, making the PG&A stocking which we've already done less burdensome for them, and ultimately helping with the attachment rates going forward.

What we've done with dealer inventory? I mean, I'd put ourselves at this point against anyone in the industry.

And as we drive RFM next year and get to a much shorter lead times and ultimately a position where we can probably get to a made-to-order business model, that's going to be a tremendous benefactor to them on lower carrying costs as well as higher attachment rates as customers get the exact vehicle they want. So, it's a multi-pronged approach.

I don't think there's anything that's not on the table except a pocket shift from us to them to get lower profitability like our competitors..

Thanks. That's very helpful. And the second one and this is, I guess, a little bit of a difficult question to answer, I admit. But, on ORV, you guys are so big or such a meaningful part of the industry that one-year down, the numbers you talked about, the industry is going to be down.

But if you look at the industry ex-Polaris, it actually looks like maybe it was up mid-single digits.

I mean, do you view that as any bit of an encouraging sign based on what you're seeing out there from the consumer or do you believe that if you didn't have these issues with the recall, the industry still would have been down, the share landscape would have just looked a little bit different?.

When you say industry, are you talking ORV or are you talking side-by-side?.

Yeah. Sorry. Let's make it broader, ORV..

Yeah. If it's ORV, I doubt it was up much without..

Okay.

Then, on side-by-side?.

Yeah. Side-by-side, it was probably up slightly. And we always, always want a better market. When you are the leading share player, even when you're in a losing share temporarily, you still want a good market. And, obviously, that has not been the case for much of the year, and we're not projecting it to be a great market going forward.

So, we're positioning ourselves, as we talked about, to get back to a stabilization on share so that we don't contribute any longer to the down market aspects of it.

So, I will tell you that as we looked at the side-by-side market, really, there's only a couple of players that are doing well, and I don't know that it's necessarily the players that you think.

So, part of the reason we've confidence in Matt and the team going into the fourth quarter is how we've looked at the competitive landscape and where our new model year 2017 lineup puts us as well as product availability. So, it's a dynamic market for sure, but we want the industry to be good..

Your next question comes from the line of Gerrick Johnson with BMO Capital Markets. Your line is open..

Hey. Good morning. Motorcycle PG&A was down 10%.

Why would that be down if retail was up, and you've got a much bigger installed base year-over-year?.

Yeah. I mean, part of it is that's our PG&A shipments into the channel. So, we've obviously modified or as we've indicated in the past, our process for how we ship into our dealers. Again, this is aimed at helping them from an inventory standpoint, more frequent ordering, lower quantities. It's also somewhat driven by the mix shift that we've seen.

As Scott indicated, we're selling disproportionately more of the smaller bikes like Scout, Scout Sixty, and the Octane, and those typically carry less PG&A along with them. And those are going to be kind of the big overall drivers..

Okay. Got it. And kind of following up on Craig's question.

Short-term fix for these recalls has been to install a heat shield behind the rear fender there, but longer term, what's the root cause of this problem? What's the long-term fix? Is it a complete redesign of these vehicles? And then also in the case of the RZR 900s and RZR 1000s, why did these problems arise last year and into this year, and not three years or four years ago?.

Well, there's a whole bunch in there. When you talk about the heat shield, the heat shield is just one of the elements that we've corrected on the RZR. I mean, there's reflashes. There's a fairly complex list of corrective actions that we've taken.

Obviously, I can't stress and I'll use this public speaking opportunity to talk about the importance of heat shields in any of our consumers that have the vehicle to make sure that they're all on because they are an important part of our thermal safety of our vehicles.

But what we've done is gone through an extensive – I mean, extensive effort to understand any thermal risks on our RZRs and other vehicles. And part of the issue, the reason we didn't see it in 2013 and 2014 is that we didn't have the processes and tools to get the information from the field as quickly as we could and manage the information flow.

And ultimately, it took us a while to recognize the trends. And ultimately, these are very complex issues. I mean, we have had some of the best engineering experts in the industry, including the automotive industry to help us review these situations.

In some cases, it will take us many months to ultimately define the root cause and we went as aggressively as we could once we understood the risks, and it just took us a while to figure it out.

As I said in my remarks, we've embodied all of that knowledge now into both our processes and our products going forward and we feel extremely confident in our ability to manage the thing, the thermal risks of our vehicles going forward..

Your next question comes from the line of Jimmy Baker with B. Riley & Company. Your line is open..

Hi, good morning. Thanks for taking my questions..

Hi, Jimmy..

First, just big picture, interested in why you think the motorcycle industry has deteriorated so much more significantly than the ORV industry? Do you expect that gap to persist in 2017 in the context of a flat-to-down powersports industry? And then, I guess maybe within that, given the pressure from oil, gas and ag, can you just talk about the offsetting strengths that must be pretty meaningful to keep the ORV industry at these levels?.

Yeah. I think from a – maybe taking the motorcycle piece first, our expectations coming out of the last quarter was for the industry to be down low-single digits. The industry has weakened. I think you've heard that from one of our major competitors. We're now anticipating the industry probably would be down closer to mid-single digits.

Our performance is still significantly better than that just given the focus and attention and the progress we're making with Indian. It's tough for us to say. I think the oil and ag weight that we're seeing that's impacting our Off-Road Vehicle business is obviously impacting our Motorcycle business.

I mean, these are significant cash outlays, and a lot of the same states are driving as significant a reduction. And as we indicated in our prepared remarks, we don't anticipate that to get significantly better.

I think the play that we have that's proving to be very successful is with the introduction of Scout, Scout Sixty and Octane, we're attracting a slightly different demographic, and that's giving us some opportunity as the age demographic is starting to cause some of the declines in the motorcycle market.

That's giving us an opportunity to outperform, and we don't anticipate that changing as we move forward..

Okay. Understood. And then, just the – as a follow up, the change in ORV ASPs, can you just speak to the underlying drivers there? I assume promotions and like-for-like price degradation is a factor, but just wondering how much of that was mixed if RZR was particularly weak in July and August.

And any color about ASPs going forward in light of the ongoing promotional activity and so forth?.

Yeah. So, if you looked at us through the first half, ASPs were down about 3%. So, it gives you some context around a significant shift. I'd say the majority of it is directly related to what we're doing from a promotional standpoint as opposed to anything dramatic from a mix perspective.

And then I would just reference back to the comments we made that we think the promotional levels are going to remain consistent at the second half of 2016 as we head into 2017..

Your next question comes from the line of Greg Badishkanian with Citigroup. Your line is open..

Yeah. Great. Thanks. When you look at the major segments, ATVs, Side-By-Side, Motorcycles, Snowmobiles.

Just from a purely industry perspective, which segments would you expect to see a major difference in trend when you look at 2017 or you're expecting in 2017 versus what we saw in 2016?.

Is it going to snow or not? Actually, we do believe it's going to be a slightly better snow year and Chris and the team are on top of that from a product perspective.

But I think probably the side-by-side space is going to continue to be the best place in the market is that just becomes the preferred choice of so many people and that's where a lot of the innovation is being driven. And obviously, we're driving innovation and have a big market share and we want that to be the best growing part of the market..

Yeah..

All right..

Thank you..

Your next question comes from the line of Mark Smith with Feltl & Company. Your line is open..

First, Mark – I'm sorry, Mike. I think you talked a little about....

That's your name..

... the $850 million. That is. $850 million kind of pro forma number for the Aftermarket segment..

Yeah.

Can you just walk us a little bit through that number?.

Yeah. So, essentially, as we've indicated and we're obviously talking 2016, TAP adds just over $740 million worth of revenue. And our existing Aftermarket portfolio is right around $90 million – just over $90 million and that Aftermarket portfolio as we indicated is KLIM, Kolpin, 509, Trail Tech..

Okay.

And that's kind of full year number you say for 2016?.

Yeah. And we'll – as we provide our guidance, as I indicated, when we provide our guidance for next year, we'll obviously provide a historical context, so that you guys can update your models..

Okay. Perfect. And then, secondly, Scott, you just talked a little bit about the small business and maybe an outlook for better snow year.

Any reasons that we had kind of the delay in shipments here from Q3 into Q4? And any additional insight into the Snow business?.

Yeah. Mostly related to SnowCheck, Mark. We have year-over-year, sometimes we'll have more SnowCheck and we'll ship them early and sometimes we don't, and I think that was just strictly a timing issue there.

Obviously, we don't worry much about snow until November and actually late October and November, then it starts to matter, but until then, these small ships based on year-over-year SnowChecks don't worry us much..

There are no further questions in queue at this time. I'll turn the conference back over to our presenters..

Thanks, Tiffany, and thanks, everyone, for participating in this morning's call. We look forward to speaking with you again at the end of the year. Thanks again. Goodbye..

This concludes today's conference call. You may now disconnect..