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Edited Transcript of PII earnings conference call or presentation 23-Jul-19 2:00pm GMT

Q2 2019 Polaris Industries Inc Earnings Call

Medina Jul 25, 2019 (Thomson StreetEvents) -- Edited Transcript of Polaris Industries Inc earnings conference call or presentation Tuesday, July 23, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Michael T. Speetzen

Polaris Industries Inc. - Executive VP of Finance & CFO

* Richard Edwards

Polaris Industries Inc. - VP of IR

* Scott W. Wine

Polaris Industries Inc. - Chairman & CEO

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Conference Call Participants

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* Craig R. Kennison

Robert W. Baird & Co. Incorporated, Research Division - Director of Research Operations and Senior Research Analyst

* David J. Tamberrino

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Gerrick Luke Johnson

BMO Capital Markets Equity Research - Senior Toys and Leisure Analyst

* Gregory R Badishkanian

Citigroup Inc, Research Division - MD and Senior Analyst

* Jaime M. Katz

Morningstar Inc., Research Division - Equity Analyst

* James Lloyd Hardiman

Wedbush Securities Inc., Research Division - MD of Equity Research

* Joseph Nicholas Altobello

Raymond James & Associates, Inc., Research Division - MD & Senior Analyst

* Joseph Robert Spak

RBC Capital Markets, LLC, Research Division - Analyst

* Michael Arlington Swartz

SunTrust Robinson Humphrey, Inc., Research Division - Senior Analyst

* Robin Margaret Farley

UBS Investment Bank, Research Division - MD and Research Analyst

* Scott Lewis Stember

CL King & Associates, Inc., Research Division - Senior VP & Senior Research Analyst

* Timothy Andrew Conder

Wells Fargo Securities, LLC, Research Division - MD and Senior Leisure Analyst

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Presentation

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Operator [1]

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Good morning, and welcome to the Polaris Q2 2019 Earnings Call and Webcast. (Operator Instructions) Please note, this event is being recorded. I would now like to turn the conference over to Richard Edwards, Head of Investor Relations. Please go ahead.

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Richard Edwards, Polaris Industries Inc. - VP of IR [2]

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Thank you, Chad, and good morning, everyone. Thank you for joining us for our 2019 second quarter earnings call. A slide presentation is accessible at our website at www.ir.polaris.com, which has additional information for this morning's call.

Scott Wine, our Chairman and Chief Executive Officer; and Mike Speetzen, our Chief Financial Officer, have remarks summarized in the quarter and full year expectations, and they will take some questions.

During the call, we will be discussing various topics, 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 2018 10-K for additional details regarding these risks and uncertainties.

All references to the second quarter 2019 actual results and 2019 updated guidance are reported on an adjusted non-GAAP basis, unless otherwise noted. Please refer to our Regulation G reconciliation schedules at the end of this presentation for the GAAP to non-GAAP adjustments.

Now I'll turn it over to our Chairman and CEO, Scott Wine. Scott?

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Scott W. Wine, Polaris Industries Inc. - Chairman & CEO [3]

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Thanks, Richard. Good morning and thank you for joining us. Our significant research and development investments figure prominently in our major product launches. But we also do a lot that flies under the radar. An inspiring example of one of these less visible technology programs made news recently when it was revealed that a Polaris Defense MRZR on the deck of a Navy warship outfitted with Marine Corps air defense system brought down an Iranian drone to the Strait of Hormuz last week. We work hard to be good corporate stewards and demonstrate our purpose, but nothing beats playing a role in protecting American servicemen and women.

As a rule, I will not use a positive descriptor to refer to results that include both retail sales and earnings per share down year-over-year. But I must commend our team for delivering respectable second quarter performance in a very tough environment. Tariffs remain the single largest contributor to our lower earnings but the aggressive and innovative mitigation efforts we are implementing reduced their impact. Our manufacturing and supply chain execution is at the best it has ever been, which helps us overcome headwinds and the significant upside from our strategic sourcing project is still to come: the industry's competitive climate. And by that, I'm mostly referring to excessive promotions, is unhealthy and unhelpful, but it is a game we know well, and our growth in side-by-side testifies the effectiveness with which Chris Musso and his team managed the Off-Road Vehicle business in the quarter.

Parts, Garments & Accessories was very strong, highlighting the innovation and quality of our offerings. Our flat track racing success continues in 2019. And in Q2, we finally made the FTR1200 available to the masses. Initial demand is in line with device performance. Awesome.

Poor weather hampered motorcycle, ORV and especially boat retail, yet Bennington is still up year-to-date and gaining share in the second quarter. We continue to work diligently through resolution to our tariff issues, which I will address more thoroughly momentarily.

Second quarter North American retail sales were down 2%, lagging the overall Powersports industry, which was up modestly. Even with our strong brands and industry-leading products, we knew we were taking a calculated risk with our Q1 price increases, the biggest for Polaris and the industry in over a decade. Not unexpectedly, the largest impact on volume and market share was in our lower priced and lower margin youth and value ATV segments.

We chose to allocate more promotional dollars to our higher-margin RANGER/RZR lines where our product superiority is clearest and both performed better, growing low single digits.

The North American motorcycle industry remained weak in the quarter as evidenced by Indian gaining market share despite retail declining nearly 10%. Slingshot struggled in the quarter. But under new leadership, the team is making progress with the product, marketing and overall execution.

Boat retail was down slightly in Q2. But our most consequential brand, Bennington, grew and gained market share.

North American dealer inventory was up 1% at the end of the quarter, positioning us well for our model year '20 product introductions and our Factory Authorized Clearance sale. We have institutionalized Retail Flow Management across motorcycles and off-road vehicles and are managing the retail trends closely.

Disciplined inventory management has always been our strength at Bennington, and both inventory is also in good shape.

The May 9 announcement that increased 301 List 3 tariffs to 25% was a blow to Polaris not just in the increased cost, but also because it diminished the prospects for our near-term comprehensive U.S. China trade agreement. Fortunately, our team was prepared in their execution of aggressive countermeasures and mitigation efforts, along with the lifting of the 232 steel and aluminum tariffs allowed us to offset the 2019 impact of the 301 List 3 increase.

An excellent example of our mitigation efforts is the $30 million of machine parts that we will move from China to U.S. suppliers, including our WSI subsidiary. The risk of 301 List 4 going into effect remains, although the impact on Polaris would be limited as most of that final front would be direct-to-consumer goods.

We continue to spend considerable time, energy and effort in our pursuit of just relief for the unintended impact of tariffs on our U.S. plant and U.S. business units. We are making progress with the administration and Congress. And although we have no assurance that, that relief will be granted, we are continuing to press our very strong case for fair resolution.

We have aggressively leveraged our tools and talent to strengthen the performance in our Aftermarket business. So their second quarter progress was both expected and encouraging. Our Powersports aftermarket brand portfolio, which includes Klim, Kolpin, 509, Pro Armor and Trail Tech has consistently delivered strong growth for the past 18 months and was up over 10% in the quarter. Transamerican Auto Parts was flat in the period with a 95 stores strong 4WP retail channel, up 7%; and e-commerce, up 12%, demonstrating the effectiveness of improvements Craig Scanlon and the team were driving.

The smaller wholesale channel was down 12% as we actively managed the portfolio towards more strategic, higher-margin customers. TAP is well positioned for accelerating profitable growth in the second half and beyond.

Steve Eastman's transformation of our PG&A and Aftermarket business has been very impressive and very profitable. So it makes sense to invest more here to facilitate faster growth. We commenced operations earlier this month at our new state-of-the-art 500,000 square foot distribution center in Fernley, Nevada. It is our first distribution facility capable of supporting all of our businesses and brands and importantly, enables 1- to 2-day parcel shipments to the West Coast customers.

I will now turn it over to our Chief Financial Officer, Mike Speetzen, who will update you on our financial plans and resources.

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Michael T. Speetzen, Polaris Industries Inc. - Executive VP of Finance & CFO [4]

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Thanks, Scott. Good morning. For the second quarter, sales were up 18% on a GAAP and adjusted basis versus the prior year. Organic sales growth was 7%, foreign exchange was a 1-point drag and the Boats acquisition added $182 million of sales during the quarter.

Average selling prices were up 7% driven by price increases as well as favorable side-by-side mix. Second quarter earnings per share on a GAAP basis was $1.42. Adjusted earnings per share was $1.73, down 2% for the quarter, which slightly exceeded our previously issued guidance driven by a combination of tariff mitigation and timing and tariff costs. I'd note that earnings growth adjusted for tariffs, foreign exchange and interest rate increases would have been approximately 20% in the quarter, reflecting continued improvement in business fundamentals.

Foreign exchange had a negative impact in the quarter versus 2018 driven by a strong dollar primarily against the euro and the Canadian dollar; however, the impact was in line with our expectations.

For the remainder of the year, we're planning foreign exchange to continue to have a negative impact on pretax profit. The full year impact is estimated to be approximately $30 million or $0.37 per share. This assumes an average euro to USD rate of $1.12 and the CAD to USD at $0.74. If foreign exchange rates hold their current spot rates for the remainder of the year, there could be additional favorability that has not yet been included in our revised 2019 guidance. From a transactional perspective, we have hedged approximately 75% of our remaining 2019 exposure for Canada.

From a segment reporting perspective, ORV/Snowmobiles segment sales were up 6% in the second quarter primarily due to increased prices, PG&A growth, as well as from the benefit of stronger side-by-side mix. Snowmobiles were also up in the quarter, but Q2 is not meaningful given the seasonality for snow.

ORV wholegood sales increased 4% given the stronger side-by-side sales mix. Average selling prices were up 9% for ORV during the quarter driven by the price increases and positive product mix.

Sales unit volume was down during the quarter, in line with the retail volume decline. But as Scott indicated, we are strategically targeting categories where we can maximize profitability for business given the significant tariff headwind we're battling.

Our premium RANGERs, GENERALs and RZRs all grew sales volume during the quarter with declines in the less profitable segments of value, youth and trail.

Motorcycle sales increased 15% on a GAAP and 14% on an adjusted basis in the second quarter driven by strong shipments of Indian, which included the newly introduced FTR1200. ASP for the quarter was down 1% driven by foreign exchange given strong international growth and the mix of midsized and standard bikes versus heavyweight. Indian grew market share for the quarter as we began retailing highly anticipated FTR1200. International sales were up 41%, and PG&A sales were up 11% during the quarter driven primarily by the FTR1200 shipments.

As a point of reference, beginning this quarter, we are now adding the standard category of motorcycles to our midsized and heavyweight industry calculations when referencing the North American motorcycle industry to capture the retail sales and market share for FTR. I'd also remind you that the FTR1200 volume is also driven by non-North American retail, which is not reported on our retail sales figures but is included in our motorcycle sales guidance.

Global Adjacent Markets sales were up 7% during the quarter driven by all product categories. Average selling prices were flat during the quarter.

Aftermarket sales were up 1% compared to last year with TAP sales flat and our other aftermarket brands increasing 12% during the second quarter. Our Boat segment reported sales of $182 million for the quarter. On a pro forma basis, the Boat segment sales were down 2%. However, on a pro forma year-to-date basis, Boats are up 5%. The decline in the second quarter can be attributable to a combination of year-over-year shipment timing as we approach the closing of the Boat acquisition in July of 2018 and unusually wet weather patterns during this year's second quarter.

Our international sales were up 13% on a reported basis and up 19% when you remove the unfavorable impact from currency. The growth was driven by motorcycles and Global Adjacent Markets.

Parts, Garments and Accessories sales increased 10% during the quarter. All business segments were up for the quarter with growth coming primarily from accessory sales.

Given our first half performance and the outlook for the remainder of the year, we are revising our full year guidance as follows: We're narrowing our full year total company sales growth guidance and now expect sales to increase in the 12% to 13% range for the year. The North American Powersports industry is expected to remain positive in the low to mid-single digits percent range driven by growth in the side-by-side market while the motorcycle market is expected to remain weak.

We continue to expect Boat sales to contribute about 6% to the full year increase in sales versus 2018. We are narrowing our full year adjusted earnings per share for 2019. We're raising the lower end of our previously issued guidance by an additional $0.05 to $6.10 per diluted share given our first half results primarily from our Boat segment.

We're maintaining the upper end of the range at $6.30 per diluted share. The revised EPS range include the added cost related to the change in the 301 List 3 tariff rate from 10% to 25% on all components shipped after the effective date.

We're holding the upper end of the range despite this added cost given the positive tariff mitigation efforts the team has realized. The 301 List 3 tariff moving to 25% places an additional $30 million of cost pressure on 2019 earnings. And as Scott pointed out, we've been able to mitigate existing tariff exposure and we're recognizing the benefit from the 232 tariff removal to essentially offset this added cost. The $30 million of 301 List 3 at 25% annualizes out to $60 million to $70 million on a full year basis, or an incremental $30 million to $40 million impact as we head into 2020.

Excluding the tariff costs, along with the negative currency and higher interest cost, our underlying operating earnings performance is anticipated to improve 15% to 18% on a year-over-year basis reflecting the continued progress we're making in business fundamentals.

For the second half of 2019, our revenue is evenly split between Q3 and Q4. Mix however drives differences between the earnings within the quarters. Additionally, we have higher R&D costs in Q3 versus Q4 given supplier validation costs related to the supplier -- supply chain transformation project. This, coupled with the fact that our dealer show is expensed in Q3, drives approximately 55% of our second half expected EPS guidance to be realized in the fourth quarter.

Moving down the P&L. Our previously issued guidance ranges remained unchanged, as shown on this current slide. However, there are a couple of points I want to highlight. First, adjusted gross profit margins, while expected to be down on an absolute basis driven by tariffs and negative currency, are up 80 to 110 basis points prior to the effects of those items driven by higher volume, mix, price and productivity. We continued to see the competition promote aggressively in the second quarter open ORV and motorcycles. And while we are spending more around promotions than originally anticipated, we are being selective as to where we spend our promotional dollars, which is generating positive mix that offset the additional promotional costs.

Gross profit margin expectations by segment also remain unchanged. We have provided the gross profit margin details by segments in the appendix of this presentation.

Secondly. Adjusted operating expenses are expected to increase in the mid-teens percentage range in 2019, up 10 to 20 basis points as a percentage of sales, resulting from the addition of operating expenses from the Boat segment, the new multibrand distribution center in Fernley, Nevada, higher variable compensation costs, the costs associated with the 65th anniversary celebration and summer dealer meeting being held next week and lastly, the ongoing investment in research and development expenses.

Moving onto sales expectations by segment. ORV/Snowmobiles sales are now expected to be up mid- to high single digits. Our range has expanded from previous guidance with the mix of side-by-side products expected to be more favorable than previously anticipated as well as stronger international and PG&A sales. Motorcycle sales are now expected to be up low to mid-teens percent. We expanded the range from prior guidance given the weak market and a modest adjustment in the number of FTR1200 bikes expected to ship in 2019 as we cautiously ramp production to ensure we met high expectations around quality. Both Global Adjacent Markets and Aftermarket segment sales expectations remain unchanged at up mid-single digits percent.

International and PG&A sales, which are included in the respective segments, are both performing better than anticipated. Therefore, we now expect international sales to increase mid-single digits percent and PG&A sales to increase in the mid- to high-single-digits-percent range for the full year. And lastly, Boat sales expectations remain largely unchanged.

Operating cash flow finished at $203 million through the first half of 2019, up 23% over the same time last year driven by lower working capital requirements.

Cash flow is expected to improve approximately 20% to 30% for the full year compared to last year, unchanged from our previous expectations. Our bank leverage ratio, defined as total debt-to-EBITDA, stands at approximately 2.46x, well below our bank covenant requirements, and we will continue to focus on debt reductions for the remainder of 2019.

With that, I'll turn it back over to Scott for some final thoughts.

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Scott W. Wine, Polaris Industries Inc. - Chairman & CEO [5]

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Thanks, Mike. I'm encouraged by the way our Polaris team battled through the first half, driving quality and productivity improvements that will pay dividends in the months and years ahead. The Powersports industry has been resilient and growing year-to-date, and we are excited to launch our model year '20 product introductions to extend our reach. Over the weekend, we had a prelaunch event with our closest partners and social media influencers and received outstanding feedback, reinforcing our conviction that these new products will raise the bar in their respective segments.

Our innovations are not limited to vehicles, and we will continue to leverage technology to improve customer experience across the business.

As we begin our second year in the Boat business, we like the market share gains and growth at Bennington, and we use our boat dealer shows over the next few weeks to showcase plans for growth across all of our Marine brands.

International, Global Adjacent Markets and Parts, Garments and Accessories are all performing well, highlighting the disparity between North American unit volume and overall corporate revenue and demonstrating the positive impact of our diversification.

The motorcycle industry remains challenging, with promotions more than products putting pressure on our Indian business. With FTR1200 production accelerating in the second half and our portfolio continuing to expand, we like our opportunity to gain market share. Our strategic sourcing initiative continues to yield positive results. Wave I is moving the implementation with savings now projected to exceed our aggressive targets. Wave II kicked off in May, and we remain confident that this strategic sourcing project will be the largest productivity boost the company has ever executed. We are excited to welcome thousands of Polaris dealers from around the world to our 65th anniversary dealer show here next week. We plan to demonstrate clearly why we are so confident in our ability to lead the industry and drive profitable growth for many years to come.

With that, we'll open the line for questions. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question will come from Jaime Katz of Morningstar.

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Jaime M. Katz, Morningstar Inc., Research Division - Equity Analyst [2]

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I'm curious about aftermarket parts. It looks like for the second half of the year, you guys are anticipating sales that rise maybe at a high single-digit pace, which is faster than that segment has risen for you over the last few years since you've owned it. So is there something coming out in that segment that is giving you confidence that you can accomplish that run rate?

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Scott W. Wine, Polaris Industries Inc. - Chairman & CEO [3]

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Yes. Jaime, as I indicated in my remarks, we had really strong growth in our retail segment up 7%, our e-comm segment, up 12% in the quarter. And Craig Scanlon and the team have really put a lot of fundamental improvements in the business. So we feel good about that.

And then our Powersports portfolio, as I indicated, has also been continuing to grow strongly. So I think as we reduce some of the headwinds we've seen in our wholesale business, and they start to get their arms around that, we just feel better about the way that business executed in the second quarter, what we're expecting the kind of the trends as we move into the second half of the year.

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Jaime M. Katz, Morningstar Inc., Research Division - Equity Analyst [4]

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Okay. And then there wasn't too much discussion about dealer floor space. But I'm curious as you have -- if you guys have been able to capitalize maybe on incremental floor space as Arctic Cat has incrementally weakened over the last year or so, and whether or not dealers are more receptive to taking more of your product.

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Scott W. Wine, Polaris Industries Inc. - Chairman & CEO [5]

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Thanks, Jaime. Good question. But I tell you, with RFM, we have our profiles set with our dealers, it is working extremely well. We do see as we introduce new products as we're about to do, we tend to get more floor space to make sure that they can showcase and they increase their profiles a little bit. But I wouldn't say that there has been a tremendous increase because of the shift in that competitor.

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Operator [6]

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Next question comes from James Hardiman with Wedbush.

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James Lloyd Hardiman, Wedbush Securities Inc., Research Division - MD of Equity Research [7]

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So ORV retail was down a little bit in the second quarter. But the guidance for that segment was actually raised at a high end. Maybe walk us through how that works? What was incrementally more positive? You touched on a little bit of it, but maybe walk us through that bridge.

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Michael T. Speetzen, Polaris Industries Inc. - Executive VP of Finance & CFO [8]

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Yes. And James, as I pointed out, we actually pulled the shipments down, unit shipments down, in the second quarter pretty much in line with retail again, the testament to how RFM works and adjust on a real-time basis. Really what we're benefiting from is vindicated from a retail standpoint, side-by-side sales are growing, ATV is contracting, and that gives us a boost from an ASP standpoint. But you also have to consider there is international revenue. It wasn't much of a factor in Q2. But as we look out for the balance of the year, international growth will help ORV as will PG&A.

And so those really fed into the revision in terms of the mix expectations, the growth coming from PG&A, which obviously, the accessories that go with our side-by-sides are a big component of that.

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James Lloyd Hardiman, Wedbush Securities Inc., Research Division - MD of Equity Research [9]

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Got it. And then sort of a 2-part tariff question here. So the $30 million of 301 List 3, you've got some exemptions I think you pointed out. But I'm assuming that none of those exemptions were on the List 3 stuff since that window just opened up a few weeks ago. And so if you're successful with exemptions, is that -- is there still a potential for $30 million of upside as we work our way through that?

And then if at all possible, and I'm not going to ask you for guidance for 2020. But just how do I think about 2020 in terms of the incremental tariff pieces that we've gotten over the last few months? Obviously, for '19, there was $30 million, and you are able to offset that. Should I think about that being offset in 2020 as well? Or were there some timing effects that will still make the incremental piece for 2020, if everything stays where it is right now, go up?

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Scott W. Wine, Polaris Industries Inc. - Chairman & CEO [10]

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That's a long 2-part question. It's obviously -- it's a complex topic, but you actually summarized it accurately. There are no exemptions for List 3 301 yet. There might be, and really it's unlikely that we're going to get significant relief from exempts like part-by-part exemptions. That's why we're working so hard to get overall relief from these 301 List 3 tariffs.

As Mike indicated, we've really done a nice job of offsetting it with mitigation efforts this year. Ken and his team have worked every single angle to -- and then with the benefit of the 232 steel/aluminum's, we did not increase it. But Mike said in his prepared remarks that the increase is up -- the flow-through to next year would be an incremental $30 million to $40 million. I don't think we're going to provide tariff guidance beyond that.

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Michael T. Speetzen, Polaris Industries Inc. - Executive VP of Finance & CFO [11]

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Yes, you know James, the only piece that would be incremental to that is obviously we still had some of the 232 impact this year. And that obviously won't reoccur next year. And then we're doing a lot of work around the retaliatory tariffs. So my expectation is that if nothing else changes, meaning no tariffs are reduced, no tariffs are added, we'd be up a little bit as we head into 2020, which is going to come primarily from this incremental 301 List 3 at 25%, less some favorability that we'll get out of 232 and the retaliatory certain to be reduced as we ramp motorcycle production in Europe.

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Operator [12]

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Our next question comes from Scott Stember with CL King.

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Scott Lewis Stember, CL King & Associates, Inc., Research Division - Senior VP & Senior Research Analyst [13]

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Maybe talk about retail a little bit. ORV, in the release, you talked about, I guess, you explaining why the industry was up and there are some competing products in the market that weren't there before. Maybe just talk about the areas where you were going up against that? I'd imagine it was more in the value, in the youth side. But maybe just give still a little color on that?

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Scott W. Wine, Polaris Industries Inc. - Chairman & CEO [14]

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Yes. Really I think that the new products that we haven't been up against before is really Honda entering with the Talon more than anything else. But the most of our retail challenge is if you will, as we talked about in our prepared remarks, we're really in the value ATV, the youth products and somewhat in the trail RZR segment where we haven't refreshed the products in quite some time. And we chose with our price increases not to put as much promo on some of those lower-margin product lines, and we actually saw that hurt volume and market share. But we are -- we have a real product advantage with RANGER and RZR right now, and we chose to capitalize on that. And I think it allows us to manage the quarter reasonably well. I will tell you that we've got a very good plan as we roll both with new products and our Factory Authorized Clearance sale. And I expect us to continue to execute our retail and share play improving and better in the second half.

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Michael T. Speetzen, Polaris Industries Inc. - Executive VP of Finance & CFO [15]

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You know, Scott, and the way I would add to Scott's comments is keep the word discipline in mind when you think about how we are going at promotion. There are some competitors out there that aren't being disciplined. We're going to be smart about it. As I said in my prepared remarks, we're doing the work around each program to make sure that it's got the right financial profile, and we're protecting where we need to protect.

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Scott Lewis Stember, CL King & Associates, Inc., Research Division - Senior VP & Senior Research Analyst [16]

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Got it. And then last question about retail, I know there's been a lot made about weather. How much it impacted the quarter, whether it was April, May or June? Maybe just give us an indication of how it impacted your businesses maybe by line, boats, ORV to motorcycles and maybe just by month as well. Just let us know how much weather really impacted June in particular.

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Scott W. Wine, Polaris Industries Inc. - Chairman & CEO [17]

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That is not -- we don't have refined data on that. And if we did, we probably wouldn't share it. I will tell you that throughout April was better weather, but May and June, both were difficult. It's probably hardest on Boats, second hardest on motorcycles and then least hard on off-road vehicles, but it's certainly not helpful to any of our product lines when it's raining. And I think the Midwest really had its -- the most impact of wetness in the second quarter.

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Michael T. Speetzen, Polaris Industries Inc. - Executive VP of Finance & CFO [18]

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And we -- Scott, we did see -- I've seen a lot of the reports came out around Boats -- we did see a pickup at the end of June and in the early part of July when weather did improve. So we know that, that was definitely a factor.

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Operator [19]

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And it comes from David Tamberrino with Goldman Sachs.

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David J. Tamberrino, Goldman Sachs Group Inc., Research Division - Equity Analyst [20]

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I just wanted to add more into the mitigation actions that you've taken so far, I believe you called out about $20 million of benefit for this year. What have you done? What else are you looking to put in place? And how much of this incremental tariffs or are incremental $40 million year-over-year in the 2020 as where we currently stand do you think you could mitigate from some of your incremental actions from here?

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Scott W. Wine, Polaris Industries Inc. - Chairman & CEO [21]

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Obviously, the number we gave you is what we think we won't be able to mitigate. That's how we calculate impact. But I will tell you that, as Ken likes to say, we haven't had our next best good idea. And the work that they are doing whether it's changing country of origin, which has been quite helpful to us, as I indicated, moving of some of the machine part sourcing we've done from China traditionally to some of our U.S. suppliers, including our own WSI subsidiary. We've got bonded warehouses to make sure we're not paying tariffs when we shouldn't pay tariffs, really it is an unrelenting focus on reducing that impact. And I think Lucy and I spent a lot of time in Washington trying to get the relief we should, so we're not spending so much non-value added time trying to work around the tariffs and the impact on the company. But really proud of the way the team has been able to navigate the impact thus far.

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David J. Tamberrino, Goldman Sachs Group Inc., Research Division - Equity Analyst [22]

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Okay. And then just lastly, from an inventory perspective, end of the quarter up a little bit year-over-year. Do you feel as if there's any particular products where you have a little bit too much excess inventory at the dealers right now, and you need to pull back for 3Q? Or do you think you're in a good position ahead of your product launches?

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Michael T. Speetzen, Polaris Industries Inc. - Executive VP of Finance & CFO [23]

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We feel good.

Yes. We took the opportunity when we saw retail softening in Q1 to make sure that as we loaded up Q2, knowing that we have model year changeover, Factory Authorized Clearance, new products coming out that -- we were making sure we were disciplined. We put a comment on the chart that we're at 95% of our RFM profiles, that we're making sure that we have enough room. If things were to move from where we've got them projected right now.

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Operator [24]

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The next question comes from Robin Farley with UBS.

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Robin Margaret Farley, UBS Investment Bank, Research Division - MD and Research Analyst [25]

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Two questions. One is I know you commented about the tariffs' impact of $30 million to $40 million into 2020. I just wanted to clarify, was that after any offsets from the 232 that won't recur next year? And if not, can you just remind us the dollar amount of 232 that won't recur next year?

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Michael T. Speetzen, Polaris Industries Inc. - Executive VP of Finance & CFO [26]

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Yes. It's -- so Robin, the $30 million to $40 million is just purely the List 3 at 25%, so that's an annual value of $60 million to $70 million, but it's incremental $30 million to $40 million. The 232 tariff and the retaliatory going away, we did not quantify those. They're in the $10 million to $20 million range, to give you a rough order magnitude.

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Robin Margaret Farley, UBS Investment Bank, Research Division - MD and Research Analyst [27]

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Okay. Great. Now, that's helpful. And then also just on the increase in ORV shipment guidance. You mentioned a higher mix of side-by-side, so obviously the ASP would be higher in the mix. Was there also the increase in that shipment range or was it partly the ASP mix?

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Michael T. Speetzen, Polaris Industries Inc. - Executive VP of Finance & CFO [28]

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Yes, there was a little bit of an increase in the shipment because we are making that shift change. From an overall standpoint, from a unit, there wasn't anything material. But when you look at the value of those units that we've got going on from side-by-side standpoint, there's a big price ASP advantage. Unfortunately, a fair amount of that is getting eaten up by the incremental promotion that we've had to put in place. But again, we're making sure that we're evaluating each of those decisions independently.

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Robin Margaret Farley, UBS Investment Bank, Research Division - MD and Research Analyst [29]

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Okay. Great. And if I could just throw one last one there. I was just looking at European sales. And I think your comments were talking about the growth of international in the second half. Other than Powersports, or at least one other in Powersports comments on Europe being weaker than they expected, so I wonder if you can just give us your take on kind of European retail demand overall.

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Scott W. Wine, Polaris Industries Inc. - Chairman & CEO [30]

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Well, motorcycle industry in Europe is significantly better and stronger than it is here. So we feel encouraged by especially as we're launching the FTR, as we've always indicated that, that really is a bike targeted as much as Europe as anything. But with our second half product offerings, we believe that, that will be as attractive as in Europe as it is here. So we think the market is better than the overall European kind of Powersports market, and motorcycle market is better than the overall European economy, and we're encouraged by that.

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Michael T. Speetzen, Polaris Industries Inc. - Executive VP of Finance & CFO [31]

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And Robin, you saw that we raised our guidance for international from low to mid-single digits, and that's not just a motorcycle-driven movement.

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Operator [32]

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The next question comes from Greg Badishkanian with Citi.

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Gregory R Badishkanian, Citigroup Inc, Research Division - MD and Senior Analyst [33]

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Great. In terms of the wet spring, do you think that's lost sales, or would you expect to get some of that lost sales back?

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Scott W. Wine, Polaris Industries Inc. - Chairman & CEO [34]

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We think it varies by industry. With motorcycles and boats, it tends to be -- you're going to lose the vast majority of it. They lose the riding season or the boating season and are less likely to purchase. Off-road vehicles, we think it tends to have less of an impact. People have thought about those purchases a little bit longer, and we'll still continue to -- we've seen that recover a little bit better. But we think we lost some of it.

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Gregory R Badishkanian, Citigroup Inc, Research Division - MD and Senior Analyst [35]

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Okay. All right. And then just to clarify, in terms of the intense promotions in the value segment, that's been pretty consistent but still, it's still aggressive now that you said got to continue to July, right?

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Michael T. Speetzen, Polaris Industries Inc. - Executive VP of Finance & CFO [36]

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Yes. I'm not sure that we've really seen a notable change recently. They are down from what we saw at the beginning of the year. But that's been pretty consistent.

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Gregory R Badishkanian, Citigroup Inc, Research Division - MD and Senior Analyst [37]

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Okay. Just finally, the upcoming 65th year celebration, new product launches. The (inaudible)

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Richard Edwards, Polaris Industries Inc. - VP of IR [38]

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Yes. Greg, you're breaking up. We can't hear you. Maybe if you can get back in the queue -- go ahead.

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Gregory R Badishkanian, Citigroup Inc, Research Division - MD and Senior Analyst [39]

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Could you see -- I'm sorry, about that. Could you see a step-up in terms of the new products that are coming out in terms of innovation? Or would you expect that to be pretty similar, new products since the last year or 2? Or could we see a step-up this year when we come out to the show?

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Scott W. Wine, Polaris Industries Inc. - Chairman & CEO [40]

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As I've -- and we don't talk about what we're going to launch, but we are spending more money. So therefore, you'd naturally expect if we're going to get a good return that we'd get more and better products. And I think that's consistent with what you'll see.

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Operator [41]

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And that's from Joseph Spak with RBC.

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Joseph Robert Spak, RBC Capital Markets, LLC, Research Division - Analyst [42]

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Maybe just turning to Boats. I was wondering if you could talk a little bit about your inventory situation there given the weather and some of your comments you just mentioned about it being tougher to sort of pickup sales. And then is there an opportunity over time to do something more RFM-like with that business?

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Scott W. Wine, Polaris Industries Inc. - Chairman & CEO [43]

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Yes. We -- they are already -- the Vogel family just had a really good operating model. I'll just remind you when we bought the business, it had returns on invested capital of over 100%, so they really understand this idea of flow.

The weather impact, there's nothing you can do. You've got to ship in before the season. So I think boat inventory was up high single digits, but it's already depleted in July. I think we're feeling better about that. We did cut shipments in the second quarter. And retail has picked up in July. So we're feeling really good about where boat inventory is overall. So -- and as I said, we're having our dealer shows this week, in the next couple of weeks for the Boat brands, and I think they're going to be pleased with the innovation that the Polaris and boat teams have worked together to bring to the market.

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Joseph Robert Spak, RBC Capital Markets, LLC, Research Division - Analyst [44]

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And then just on motorcycles. Nice sales increase with the FTR, which looks great by the way. So, you had sales up like $25 million year-over-year, but the gross profit up only $2 million. And I know there's a lot of stuff going on with the tariffs and the promotions, et cetera, but was there also some element of start-up or launch cost with that FTR that sort of gets a little bit better as you move to the back half?

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Michael T. Speetzen, Polaris Industries Inc. - Executive VP of Finance & CFO [45]

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Yes. I mean there's always that aspect, Joe. But I will tell you that when I look at second quarter for motorcycles alone, there was 300 basis points of drag created from tariffs. Because what you have remember is motorcycles is dealing with 2 tariffs, they're dealing with all these inbound stuff that we have on 301, but they're also dealing with a very hefty retaliatory tariff. Now we've got the Scout production up and running, it's going incredibly well, we're working on getting FTR up and running. So we think we'll be in a good spot to be able to mitigate that next year if those tariffs are still in place. We'll still have a drag on heavyweight, it's much less. And it doesn't make sense for us to move production over there at this point. Or add production I should say.

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Operator [46]

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The next question comes from Gerrick Johnson with BMO Capital Markets.

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Gerrick Luke Johnson, BMO Capital Markets Equity Research - Senior Toys and Leisure Analyst [47]

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A couple of things on the balance sheet caught my eye. Your owned inventory up 22% and then warranty reserve up 25% year-over-year. So can you just talk about those 2 lines, please?

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Michael T. Speetzen, Polaris Industries Inc. - Executive VP of Finance & CFO [48]

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Yes. So from an inventory standpoint, the thing to keep in mind is number one, we added Boats, which adds over $50 million worth of inventory. We've also got, on order of magnitude, somewhere in the range of $30 million sitting in there that's a bump up versus last year from tariffs because, if you remember, we really didn't have a whole lot of tariff in the inventory at that point in time. And then really, we've got inventory buildup as we get ready for the new product launches. We'll be obviously, launching shortly after the 65th dealer show, and making sure that we're prepared for that.

And then from a warranty standpoint, there's a couple of things. The reserve is up. We actually last year had a couple of reserves that we reversed, kind of holdovers from the legacy recall issues that we had. As we got further into those, we were able to threw up those reserves. The other thing to keep in mind is we have about $8 million to $10 million worth of boats warranty that's been added year-over-year as we bring that business onboard. And then we did it in the third -- or the second quarter, we did have several small recalls and service bulletins that added a little bit of cost, nothing material or significant.

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Operator [49]

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Our next question comes from Michael Swartz with SunTrust.

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Michael Arlington Swartz, SunTrust Robinson Humphrey, Inc., Research Division - Senior Analyst [50]

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Just wanted to touch on the competitive environment again and maybe just as a point of clarification, was the competitive environment in the second quarter in off-road vehicle a little different than maybe what you would have expected going into the quarter?

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Scott W. Wine, Polaris Industries Inc. - Chairman & CEO [51]

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The competition wasn't heavier, the promotions were significantly more. I mean Mike used the word disciplined, and that is a word that I wish our competitors would start to think about. Because some -- and it's true not just in off-road vehicles, we saw it in motorcycles as well. I mean I think the most accurate term I can use for is ridiculous.

When you're putting literally thousands and thousands of dollars on vehicles that in this day it's not necessary, and we were quite surprised by it. And as I've said, we were -- we chose not to do anything at our -- where we already had lower margins in our value and youth products. So that's why we lost some volume and share there. But I think as we grow into -- we're going to be aggressive with Factory Authorized Clearance sale, we always are. And I think we're going to take the knowledge of what we learned in the second quarter and apply some of those learnings to how we execute promotion in the third quarter and through Factory Authorized Clearance. And then really it's an innovation game that wins, and I think we feel really good about the model year '20 product launches. But no, I would tell you that the competitive promo from people that should know better was disappointing.

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Michael Arlington Swartz, SunTrust Robinson Humphrey, Inc., Research Division - Senior Analyst [52]

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Okay. That's helpful. And then Scott, maybe just quickly on Slingshot, I know it's a smaller part of the business, but just given what you've seen in retail there, I mean maybe just discuss your level of commitment. Sounds like you're doing some things there to turn that around. But any color you can provide on maybe what you're doing and again longer-term commitment to that.

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Scott W. Wine, Polaris Industries Inc. - Chairman & CEO [53]

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My commitment to any business is if I see a future of profitable growth, pretty simple. Now Mike's got a whole bunch of other stuff that he's going to look at, but my simple lens is through that view of can we see a future and be confident of future profitable growth. So with that lens, we feel good about Slingshot both from the products that are in the portfolio but really, the execution that we're learning. We do have a number of dealers that do really well with Slingshot. The problem is it's just not enough of them. But we're learning from those dealers and then applying those learnings in other places, and we're seeing the results of that. Like I've said we've got new leadership in there, they're really digging in, and we do feel like we've got to -- and I've said all along, this is going to be a slog of a year for Slingshot. But as we move into 2020, we feel better about our ability to play in that segment. And so we're very committed to it until something changes and tells us that we don't see a future of profitable growth.

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Operator [54]

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The next question comes from Craig Kennison with Baird.

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Craig R. Kennison, Robert W. Baird & Co. Incorporated, Research Division - Director of Research Operations and Senior Research Analyst [55]

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Mike, you mentioned you're undershipping relative to the RFM profile. Why would that be?

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Michael T. Speetzen, Polaris Industries Inc. - Executive VP of Finance & CFO [56]

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Well, we're just trying to make sure that we leave enough room. It's tough to get a solid projection around what's going on with retail and what we saw coming out of the first quarter. We intentionally did that just knowing that we were coming up against Factory Authorized Clearance and the model year changeover to make sure that we had flexibility and put the dealers in a really good spot with all the new products coming out.

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Craig R. Kennison, Robert W. Baird & Co. Incorporated, Research Division - Director of Research Operations and Senior Research Analyst [57]

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And then with respect to Factory Choice, as we see it, that's a different kind of innovation, it differentiates Polaris in a different dimension, I guess. It also gives dealers a crack at maybe better margins. How are your current Factory Choice options performing? And how quickly can you roll that capability out to other products?

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Scott W. Wine, Polaris Industries Inc. - Chairman & CEO [58]

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It is performing exceptionally well. And it's -- I appreciate you're actually acknowledging that it's really an innovation in it and of itself. The work that our teams did or really a couple of years to put the capability within our supply chain in factories to bring that to market was quite impressive. The uptake has been exceptionally good, the execution has been impressive. I think we're rolling out to more categories as we go into the model year '20 product line. Motorcycles has already done a version of it, but I think the learnings that had really gone in the RANGER and start to apply that to other categories is quite exceptional. So that's -- it really, we were making as many as we can to fulfill demand there. But we're going to continue to expand that category, and we're seeing the uptake not only in how fast those retail but the profitability that you mentioned for dealers is another real benefit there.

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Operator [59]

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The next question is from Tim Conder with Wells Fargo Securities.

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Timothy Andrew Conder, Wells Fargo Securities, LLC, Research Division - MD and Senior Leisure Analyst [60]

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Congrats again to the team on the execution here in a difficult period. Just a couple of follow-ups here. On motorcycles, has the outlook, excluding FTR, has that changed here over the last 90 days?

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Michael T. Speetzen, Polaris Industries Inc. - Executive VP of Finance & CFO [61]

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Yes, it has. That's why we widened the range from low to mid-teens. We obviously -- as I mentioned in my prepared remarks, we pulled back a little bit on the shipments of FTR just given some of the focus around making sure we had the product absolutely positively right. But we have seen weakness in other areas and that's why we've expanded the range. Scott spoke to it earlier, we have seen some very aggressive promotional activity in the marketplace from our largest competitor. We're dealing with that as best as we can, but we're going to continue to be disciplined.

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Timothy Andrew Conder, Wells Fargo Securities, LLC, Research Division - MD and Senior Leisure Analyst [62]

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Okay. Okay. And then Mike, just to follow up again on -- to clarify the 232, in a couple of the earlier questions you said, I think it looked about a $10 million to $25 million range on the 232 that you had not factored in for 2020. Is that a gross number or is that just would be the incremental savings on 232 in 2020?

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Michael T. Speetzen, Polaris Industries Inc. - Executive VP of Finance & CFO [63]

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All right. So let me -- I'm going to make sure I try and do this as clear as I can because I have a feeling we'll be talking about this after we get off the call. So we've got the 301 List 3 going to 25%, that adds $30 million to $40 million in 2020. I think Robin had asked the question around 232 and the retaliatory. My response to that was those are $10 million to $20 million of favorability, meaning as we ramped up production in Poland, we obviously start to avoid some of those retaliatory tariffs. And with the 232 tariff being canceled this year, obviously as we roll into next year, the fact that we had cost in 2019 will not reoccur, and I'd commented that, that was $10 million to $20 million.

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Timothy Andrew Conder, Wells Fargo Securities, LLC, Research Division - MD and Senior Leisure Analyst [64]

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Okay. And that's collective, encompassing both of those 2 items?

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Michael T. Speetzen, Polaris Industries Inc. - Executive VP of Finance & CFO [65]

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Correct.

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Timothy Andrew Conder, Wells Fargo Securities, LLC, Research Division - MD and Senior Leisure Analyst [66]

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Collective?

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Michael T. Speetzen, Polaris Industries Inc. - Executive VP of Finance & CFO [67]

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Collective. Total.

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Operator [68]

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(Operator Instructions) The next question comes from Joe Altobello with Raymond James.

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Joseph Nicholas Altobello, Raymond James & Associates, Inc., Research Division - MD & Senior Analyst [69]

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First question, I just want to clarify, the $60 million to $70 million of annualized increase from 301 List 3. I think you guys had previously said that was $80 million? So that why did that come down by $10 million to $20 million?

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Michael T. Speetzen, Polaris Industries Inc. - Executive VP of Finance & CFO [70]

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Well, I mean I think some of it is just getting more refinement. I will say as unfortunate it is this is to say, we've become very good at working through what these tariffs mean. And Ken's team has spent a lot of time studying the materials that we have coming in direct from China as well as making sure that we understand the indirect, which has a lot more complexity to it because that's where we have suppliers in North America, for example, that are using parts from China and how does that flow through. So it was more of a refinement. It moved around $10 million to $20 million. But that's the key driver.

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Joseph Nicholas Altobello, Raymond James & Associates, Inc., Research Division - MD & Senior Analyst [71]

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Okay. That's helpful. And secondly, if and when there is a new NAFTA, that gets through Congress, is there a major impact for you guys from that?

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Scott W. Wine, Polaris Industries Inc. - Chairman & CEO [72]

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I'll give our trade and government affairs team a lot of credit. There won't be hardly any change, well, it's USMCA as what they call it. Now we don't expect material change in how that impacts Polaris, but only because we were able to work with the USTR to make sure that, that was managed properly. So no, feel reasonably good about that. Interestingly, we are trying to leverage both for USMCA to help us get tariff relief. So that could be a more helpful agreement than I had originally thought.

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Operator [73]

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Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Richard Edwards for any closing remarks.

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Richard Edwards, Polaris Industries Inc. - VP of IR [74]

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Thank you, and I want to thank everyone for participating this morning. We appreciate that. And for those of few that will be attending our Analyst/Investor meeting this coming Sunday, Monday, we have some exciting products to show and demonstrate, so we look forward to seeing you there. Again, thanks for participating this morning, and we'll talk to you next quarter. Goodbye.

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Operator [75]

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Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.