BRP Inc

TSX:DOO

Earnings Call Transcript 2022-Q2

[Operator]

Good morning, ladies and gentlemen. Welcome to the BRP Inc.'s Fiscal Year 2022 Second Quarter Results Conference Call. [Operator Instructions] I would now like to turn the meeting over to Mr. Philippe Deschenes. Please go ahead, Mr. Deschenes.

[Philippe Deschenes, Manager of Treasury & Investor Relations]

Thanks, Natalia. Good morning, and welcome to BRP's conference call for the second quarter of fiscal year '22. Joining me this morning are Jose Boisjoli, President and Chief Executive Officer; and Sebastien Martel, Chief Financial Officer. Before we move to the prepared remarks, I would like to remind everyone that certain forward-looking statements will be made during the call and that future results could differ from those implied in these statements. The forward-looking information is based on certain assumptions and is subject to risks and uncertainties, and I invite you to consult BRP's MD&A for a complete list of these. Also during the call, reference will be made to supporting slides, and you can find the presentation on our website at brp.com under the Investor Relations section. So with that, I'll turn the call over to Jose.

[Jose Boisjoli, President, CEO & Chairman]

Thank you, Philippe. Good morning, everyone, and thank you for joining us. I am pleased to report that we concluded the first half of the year on a very strong note, delivering record financial results again this quarter, driven by continued momentum across all our product lines. Our team once again demonstrated incredible resiliency and successful management through a challenging supply chain and logistic environment while limiting the negative impact on our dealers and customers. This resulted in dealer -- in the delivery of more units than planned. I would like to thank our supplier for the relentless effort and for going above and beyond to deliver in a very difficult environment. Given these exceptional results, our continued positive outlook for the business and factoring in the successful completion of our substantial issuer bid, we are increasing our normalized EPS guidance for the year to a range of $8.25 to $9.75 per share. It now represents a growth of 53% to 81% compared to last year. You will notice that we widened our guidance range to account for the current environment and ongoing supply chain challenges. Sebastien will provide further details on this in a moment. Let's take a look at key financial highlights for the second quarter on Slide 4. Revenue were up 54% to $1.9 billion, Normalized EBITDA increased 94% to $415 million, and normalized earnings per share were up 1.5x to $2.89. This robust performance was primarily driven by higher volume across all our product lines, lower-than-expected sales program due to the continued strong retail demand, coupled with very low network inventory. Turning to Slide 5 for a look at our retail performance for the quarter. Our North American powersports retail sales were better than expected but were down 19% for the quarter as we were lapping a record quarter last year with retail up 40%. Compared to the second quarter of fiscal year '20, which was pre-COVID, our North American retail was up 14% despite operating with significantly less inventory in the network. This is a clear indication of continued solid demand. In fact, our fiscal year '22 Q2 retail is the highest ever recorded with the exception of last year. A few words on our network inventory. As we mentioned last quarter, historically, we have been operating with about 170 days of inventory in the network. Last year, we were down to about 80 days. And in our most recent quarter, we were down to an average of 26 days. This low inventory level combined with ongoing supply chain uncertainty are limiting our ability to grow retail. As a result, we expect retail to remain under pressure throughout Q3 and start to grow and improve in Q4, driven by limited -- by the timing of snowmobile shipment and the additional production capacity from Juarez 3 and Querétaro. Looking at the global retail picture on Slide 6. Although our North American retail sales were down in comparison to last year, we still outpaced the industry, which was down mid-30%. You can notice that our lineup continued to perform well in North America as we've gained market share in most product lines. Similarly, in international market, retail sales decreased in Q2 due to the lack of inventory, combined with it being a very strong quarter last year. However, compared to the corresponding quarters 2 years ago, retail was up 9%. With our new product introduction, combined with the additional capacity, we are very well positioned to continue to outpace the industry. Another positive sign is the continued strong traction we are experiencing with new entrants, as you can observe on Slide 7. To seize this growth opportunity, we are focusing on key initiatives to attract and retain new entrants. Our strategy consists of continuing to strengthen our product portfolio and provide a broad lineup of entry-level product through innovation, creating and reinventing categories and generating value for customers. Inspiring them to join powersports by leveraging our ambassador and expanding our offer within Uncharted Society, easing their learning curve to education with initiatives such as the Rider Education Program and How-to videos content series and growing and further developing our community with programs such as Woman of On-Road. With this strategy, we believe we are well positioned to leverage the growing interest of new customers in our industry. Our recent statistics indicate that new entrants represent 43% of our buyers in the second quarter compared to 41% last year. As a reminder, it was roughly 20% historically. They are a more varied group than our traditional customer with younger and more diverse people, including more women and families. In addition, our surveying continued to confirm that this new entrants intend to remain in the industry with only a mere 4% indicating having purchased a product as a COVID distraction. Also, the repurchase rate of our customer is higher than what we typically observe. These are all positive trends for the mid- to long-term growth of our industry. Turning to Slide 8 for an overview of the key products we introduced at our recent Virtual Can-Am and Sea-Doo club that was helped mid-August. Once again, the event was extremely popular with over 85% attendance by our dealers from around the world. It also allows us to reach a growing consumer audience at the same time. In terms of product launches on the personal watercraft side, we expanded our Fish Pro line-up with the addition of 2 key models. The Fish Pro Trophy, a top-of-the-line fishing personal watercraft equipped with many of the key feature of full-size fishing boats and the Fish Pro Scout, a more accessible option. This product has been very popular since its introduction in 2018. It is the fastest-growing segment in our personal watercraft lineup with over 65% of buyer being new entrants to personal watercraft. With over 50 million anglers in the U.S. and over 700 million worldwide there is a significant market opportunity for the Fish Pro Line-up. This is another example of our ability to identify market opportunities and create subcategories. For Can-Am, our product introduction include the upgrade of Maverick Turbo RR engine to 200 horsepower, which is a first in the industry. This new engine power, coupled with all our -- with our all-new pDrive roller clutch system ensure that we maintain the performance leadership in the sports segment, the fastest-growing category in the industry. We also introduced new engine option in our utility lineup with the HD7 and HD9, that offer leading class power and capabilities. And we improved the ruggedness and capabilities of the Can-Am Ryker Rally to maximize performance and comfort off road. These new products were very well received by dealers and the media and our booking results are tracking very strong. Turning to Slide 9. The main highlight of the club was the official introduction of the game-changing Sea-Doo Switch. When we reentered the boat industry in 2018, we realized there were many opportunities for us to reinvent the pontoon space, which accounts for about 30% of U.S. power boats and is quite sizable. In addition, it has one of the fastest-growing rate in the industry with an 8% CAGR over the last 5 years. Turning to Slide 10. The Switch is a product that combines all the onboard space and stability of a pontoon, with the driving performance and watersport friendly capabilities of a runner boat. It provides the most convenient, accessible, adaptable and fun boating experience. One of the key innovative feature of this switch is its plug-and-play Lego inspired system, which provides flexibility to change around your interior layout to adapt to your need as the day evolves. The boat will also appeal to new borders as it is easy to use, easy to dock and is the first ever boat to come with a braking system. It is available in a variety of length and engine configuration with different package starting at the very accessible price of USD 17,999 and will be sold through our Sea-Doo dealer network. The product also represents a sizable opportunity for our accessories business. It is highly adaptable with over 65 dedicated accessories available at lunch and is also compatible with all linked system. Production is planned to start in the latter part of the fourth quarter with deliveries expected for the next boating season. Having talked to many dealers, having talked to many dealers -- many are already sold out of model year '22, which is expected to be delivered to customers by the end of June, and some are taking orders for model year '23. We strongly believe that the Sea-Doo Switch is a game changer for the boating world as it is a unique, innovative product that is well positioned to attract new boater and the younger generation. Over the years, we have proven we are able to disrupt the industry by creating new segments. We did it with the Sea-Doo Spark, which helped the personal watercraft industry grow 86% since its introduction, and more recently with the Ryker, which allowed the 3-wheel vehicle industry to grow 48% in 2 years following its introduction. And now we believe we will do the same in the pontoon industry. Now let's turn to Slide 11 for our year-round product. Revenue were up 54% to $956 million, mainly driven by higher volume, lower sales program and a richer mix for side-by-side vehicle. On Saturday, July 17, there was a fire in the outdoor storage yard of the Juarez 2 Mexico facility where side-by-side vehicles are produced. All employees on-site were safely evacuated and no damage was caused to the manufacturing facility. Production resumed on the following Tuesday, -- And once again, I wish to essentially thank our employees for their quick response. I'm very grateful to the firefighter, local businessmen -- local businesses and authorities for their help and support. Now looking at side-by-side North American retail. In the second quarter, Can-Am side-by-side retail was down low 20%, outpacing the industry, which was down mid-40%. As a result, Can-Am side-by-side made some solid market share gain despite being constrained by very low network inventory. Similarly, we've closed the North American season at the end of June, with an increase of high single digits compared to mid-single digits for the industry. Note that this growth come over and above record level growth last year for the full season, when the industry grew low 20%, while Can-Am low 40%. The future looks very promising for our Can-Am side-by-side business. Consumer demand for our lineup remains very strong. Our new products are very well received, and on August 23, we started the production of our Juarez 3 facility on plan. We'll be ramping up through the end of the year to a full second shift and plan to have the full benefit of the additional 50% of capacity at the beginning of January 2022. Turning to ATV. Can-Am North American retail was in line with the industry for both the quarter and full season. Both were down in the low 40% for the quarter due to the limited product availability and high single digit for the full season. Now 3-wheel vehicle. Can-Am 3-wheel vehicle continue to perform well compared to the industry gaining market share both in the quarter and season to date. It remained the fastest-growing brand in the motorcycle industry so far this season. The Rider Education Program registration continues to trend above expectation. In fact, we continue to be successful at attracting a younger and more diverse consumer base with a high level of new entrants, women and visible minorities. This trend is very positive, and we are very excited at the outlook for the 3-wheel vehicle business. Turning to seasonal product on Slide 12. Seasonal product revenue were up 78% to $575 million, driven primarily from higher shipment, a richer mix of personal watercraft and lower sales program. Now looking at personal watercraft retail. See-Doo continued to gain market share in the quarter. In North American retail season to date is now up low teen percent compared to an industry that is down low single digit. Currently, the brand holds the #1 market position in all segments in the industry. Based on the way the season is performing, we expect it to end with a very low level of network inventory again this year, which will lead to strong shipment in the next fiscal year. For snowmobile, we are currently in the slow period of the season. Our retail was down due to limited product availability as we ended last season with an all-time low level of inventory in the network. Still, we are very well positioned for the upcoming season with a record level of units presold to consumers. Continuing on Slide 13 with a look at powersports part, accessories and apparel and OEM engines. Revenue were up 19% to $249 million for the quarter. Year-to-date, revenue increased by about 30% in each of our product lines. This growth is driven by higher volume of replacement part due to increased product usage, combined with strong unit retail, which has generated -- which generates increased accessory sales across our product line. Our extensive lineup of part, apparel and accessories, notably our proprietary LinQ system is driving strong consumer demand. Now looking to Marine on Slide 14. Revenue were up 56% to $125 million. The benefit from a favorable mix of boats sold and lower sales program more than offset the lower volume of outboard engines sold due to the wind down of Evinrude. Looking at retail sales, both Alumacraft and Manitou saw retail decline in the quarter as sales were more -- made earlier in the season compared to last year. However, both brands are performing well year-to-date, with North American retail up low single digit for Alumacraft and high teen percent for Manitou. As for Telwater, we were at the end of the boating season in Australia, Retail continued to perform well and was up high single digits for the quarter. We also host a virtual event with our Alumacraft and Manitou dealers 3 weeks ago. where we introduced our 2022 lineup. It included improvement to our Alumacraft Pro Series Bass boats and to our Manitou XT and LX models. We are pleased with the progress we've made in our Marine business and are looking forward to launching new boats with the Ghost engine in each of our 3 brands in the second half of 2022. With that, I turn the call over to Sebastien.

[Sebastien Martel, Chief Financial Officer]

Thank you, Jose, and good morning, everyone. As Jose mentioned, we carried our strong momentum into the second quarter and closed the first half of the year with very solid results that came in above our expectations. This performance was broad-based with robust revenue growth across all product categories and regions. From a profitability standpoint, we had another exceptional quarter as we generated $570 million of gross profit on $1.9 billion of revenue, resulting in a 29.9% margin. Compared to last year, the gross profit margin benefited from better fixed cost absorption as last year's second quarter margin suffered from the temporary production shut down. The exit from outboard engines business, especially as we had additional costs related to the wind down of Evinrude in last year's second quarter and a positive impact from higher volume, favorable product mix and lower sales programs, which were partly offset by higher production and distribution costs and unfavorable FX. With this strong gross profit generation and lower-than-expected operating expenses, we delivered $415 million of normalized EBITDA and generated $2.89 of normalized diluted earnings per share. Worth noting that these were our strongest quarterly results ever. From a cash flow perspective, we generated $417 million of cash from operations and invested $217 million in working capital, notably as we continue operating with higher level of work in process inventory and are managing through supply chain constraints. We also invested $132 million in CapEx and returned $361 million to shareholders, primarily through the successful completion of our SIB, under which we repurchased 3.4 million shares. Turning to Slide 17 for a more detailed look at the key drivers of our normalized net income growth for the quarter. As you can see from the chart, our normalized net income grew $149 million from last year's second quarter, driven by a positive impact from volume, mix, pricing and sales program representing $393 million, which was partly offset by the negative impact of increased production costs and depreciation expense for $66 million, higher operating expense for $83 million as we continue investing for our long-term growth, higher normalized tax expense for $52 million and unfavorable foreign exchange variation for $43 million. This resulted in $250 million of normalized net income for the quarter coming in stronger than expected, mainly because we were able to ship more units than we had initially planned. We benefited from lower-than-anticipated sales programs, and we continue to diligently manage our spending, which resulted in lower operating expenses versus our plan. Now moving on to Slide 18 for a quick look at our network inventory situation. As Jose mentioned, we continue operating with very low levels of network inventory, which is limiting our ability to generate retail growth. In fact, despite increasing our production output in the quarter, consumer demand for our products continued to outpace the capacity to supply products and resulted in an inventory decline of 51% versus last year and 76% versus 2 years ago. While this situation is definitely not optimal, we believe that low levels of inventory are widespread across the industry. And once we gain the full benefit of our additional production capacity in the coming months, and supply chain disruptions are mitigated, we will be very well positioned to take advantage of the sustained consumer interest in our products. Now let me provide you with a bit of context before getting into the updated guidance by looking at Slide 19. As you know, many industries, including powersports have been dealing with supply chain challenges for the better part of the year. So far, we have been able to manage through this turbulence while limiting the negative impact on our business. Still, we remain vigilant as the situation is constantly evolving with pressure coming from the semiconductor shortage, COVID-related factory shutdowns, especially in Southeast Asia and labor shortages in North America. While we have limited direct exposure to these issues, many of our suppliers have to deal with such challenges on a daily basis, putting pressure on their operations and limiting their ability to commit the firm delivery schedules for parts. As such, we expect increased variability in the timing of reception of components from suppliers during the second half of the year. This may impact our production schedules and the timing of product shipments over the next few quarters. Still, we continue to aim to deliver on all dealer orders we have on hand, and we plan to continue to produce at capacity, store or ship to dealers some unfinished products, and retrofit them once missing components are received. Based on the visibility we have today, we expect that these supply chain issues will weigh in more on Q3, which will limit our wholesale in the quarter. Nonetheless, we expect to be in a good position to retrofit most of the units in the fourth quarter, leading to a much stronger fourth quarter. While we are comfortable with our plan, we are operating with lower visibility than we usually do, which may lead to delays in shipments of units between Q3 and Q4 and even between Q4 and the first quarter of next year. This is why we have updated our guidance with a wider than usual range as you can see on Slide 20. In light of the better-than-planned results achieved so far this year and the continued lower level of sales program throughout the rest of the year, we are comfortable increasing the higher end of our seasonal and powersports P&A and OEM engine revenue guidance ranges. And we are also maintaining the higher end of the year on products and Marine revenue guidance ranges intact despite the potential supply chain headwinds. Note that we have lowered the bottom end of the year end products revenue guidance range to reflect the impact of the loss of SSV units in the fire. With these adjustments, we now expect total company revenues to grow between 27% and 35%. We have also adjusted our profitability metrics to reflect elements previously mentioned and to account for higher commodity costs, which are mostly offset by pricing increases and additional costs resulting from inefficiencies due to the ongoing supply chain issues. Following the adjustments and accounting for our strong H1 results, we now expect normalized EBITDA to grow between 30% and 47%. And after taking into account our revised assumptions for financing costs and depreciation expense and using a lower share count as a result of the SIB, our normalized EPS is now expected to end between $8.25 and $9.75, representing a growth between 53% and 81%. As for expectations in terms of quarterly results for the back half of the year, as I already mentioned, our objective is to deliver on dealer orders we have, despite managing through supply chain pressures. We expect that these issues could weigh more on Q3 and then improve as the year progresses to provide more upside in Q4. At the midpoint of our guidance, we would expect normalized EPS to grow above 40% in Q4. On that, I'll turn the call over to Jose.

[Jose Boisjoli, President, CEO & Chairman]

Thank you, Sebastien. To conclude, we've delivered record results in the first half of the year. We're able to achieve this, thanks to our solid execution across the company and the very strong consumer demand. Short term, we'll concentrate on delivering a solid second half of the year. We'll focus on managing and mitigating supply interruption and deliver on our production plan. Our objective remains to deliver all order on hand. Based on this, we are confident in our ability to achieve our revised guidance. Furthermore, we are confident about the future, as we expect to benefit from numerous key initiatives and trends, including new product introduction, such as Project Ghost and the Sea-Doo Switch. The latter represents a new business for us and is already proving quite promising. In fact, you can expect more product introduction over the next 3 years than we have done in the past 3. The sustained consumer interest in powersports & Marine. Our strategy for new entrants, which is progressing well. Every day that passes provides us with greater confidence in our ability to turn them into lifelong customers. The upcoming significant inventory replenishment cycle that is expected to take place over the next 12 to 18 months. The additional production capacity from Juarez 3 and Queretaro, which is expected to have a positive impact over the next 2 years, starting in fiscal year '23 and the electrification of all our product lines. As you can see, we are well positioned to drive long-term growth and continue to outpace the industry. We are confident in our ability to execute our growth strategy in fiscal year '23 and beyond.I insist on expressing my sincere gratitude to our employees, dealer and suppliers for their collaboration, commitment and patience during these challenging times. In this ever-changing world, their agility, dedication and capacity to successfully manage is impressive and truly makes the difference. On that note, I turn the call over to the operator for questions.

[Operator]

[Operator Instructions] Your first question is from the line of Robin Farley with UBS.

[Robin Margaret Farley, Managing Director and Research Analyst]

Two questions. Obviously, a fantastic quarter. I'm just wondering, we hear a lot from dealers about some OEMs that have made market share gains where they don't have as much kind of as an availability issue. And I'm wondering some of them are newer entrants into the off-road market. And I'm wondering if those are counted in your industry measure of market share in that data? And I guess sort of either way, I wonder if you have general thoughts on some of these new entrants, who are taking advantage of the lack of availability and just kind of to the degree that could be sort of making inroads into the future?

[Jose Boisjoli, President, CEO & Chairman]

Robin. I mean, -- For sure, in the supply restriction that we have in the network from time to time, we hear dealers that are saying that they've lost some customers, but to be honest, it's minimal, it's quite a small number. And what we are very happy with, like I said in my intro, those new entrants are growing. We're at 43% in Q2 versus 41% and you know our historical average was 20%. But more and more, we observe them quarter after quarter, we see that they intend to stay within the industry. And the repurchase cycle is better and everything is pointing in the right direction to make them have a lifelong customer. And obviously, right now, when we do our projections for the future, we count them in because we believe that the trend is too strong, not to count them in our future planning.

[Robin Margaret Farley, Managing Director and Research Analyst]

Okay. Great. That's very helpful. And then second question is, looking at your comment about retail sales through the quarter and comparing to others' comments about the June quarter, it looks like July was a bit worse in terms of product availability in retail, not surprising. So I guess just looking at your guidance, I guess, what gives you the confidence that Q4 logistics would be getting so much better. I mean, is it just that you feel like it can't possibly get worse? Or I guess just to try and get that conviction that things won't sort of continue to be at these difficult levels into Q4 potentially?

[Jose Boisjoli, President, CEO & Chairman]

Then -- obviously, right now, the -- like Sebastien said, there is 3 areas of challenges, the semiconductor: the COVID restriction impact on manufacturing operation in the South Asia and the labor shortage mainly in North America. And the second one, the COVID restriction in South Asia OEM over there, company manufactured component are getting better with sanitary measures. Most of them vaccine themselves, their employees. And we believe we're going in the right direction. In terms of semiconductor, you know that many chips are produced in those countries. And there was a fire in Japan. After that, there was -- a few factories were shutdown in Malaysia. But now those factories are back to normal. When we talk to our supplier who supply to us electronic component like engine, computer or a cluster for the vehicle, they believe with what they know today that the situation will improve on the back end of 2021 and through 2022. I don't think it will come back to normal in 2022, but we are confident that once we -- from where we are today, the situation will improve in the next 12 to 18 months. And that's why our guidance has a wide range because with what we know today will be closer to the high end. If there is some other uncertainty, it will be more difficult, but that's why we decided to widen the range.

[Operator]

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

[Joseph Nicholas Altobello, MD & Senior Analyst]

So first question is back to the guidance, EPS guidance in particular. The raise looks to be largely margin driven along with a lower share count to some degree. What's been better than you thought so far this year from a profitability standpoint. Is it mix? Is it input costs, et cetera?

[Sebastien Martel, Chief Financial Officer]

Joe, obviously, there are many factors that are driving the financial results. There are a lot of pluses and minuses. But the big pluses are obviously sales program. The promotional environment is still very healthy for OEMs and for dealers as well. And so we don't have to offer as much promotion as we initially anticipated, and that's what drove the better results in the second quarter. Obviously, with a high level of demand and the -- we'll call it the scarcity of production, OEMs and we are more selective in which product we make. And yes, the as the mix is richer as well. That's a plus. Obviously, there are some headwinds that we're seeing on commodity costs and logistics, but we're able to offset some of that with pricing and surcharges as well.

[Joseph Nicholas Altobello, MD & Senior Analyst]

Got it. That's helpful. And just maybe secondly, I apologize if I missed this. In terms of your full year outlook for retail, is it still flat to up high singles for this year?

[Sebastien Martel, Chief Financial Officer]

Yes, flat high to -- high to low single digit. That's a right number. Obviously, year-to-date, we're flattish. Q3 is going to be a tough one because we're going into the third quarter with super low network inventory and with the supply chain challenges that Jose just talked about is going to be a challenge. The expectation is for Q4 to be up and for the full year to be flat to high to low single digit.

[Operator]

Your next question is from the line of Martin Landry with Stifel GMP.

[Martin Landry, Managing Director of Equity Research]

I just wanted to get a bit more clarity on your guidance for the back half. You're seeing that you expect Q4 EPS to increase at 40% year-over-year and using the midpoint. So that would suggest that your Q3 would be weaker and could be down even lower than 2 years ago. So just trying to understand exactly what's putting pressure on your Q3? Looking at your inventory levels, on your balance sheet, it doesn't look super low. Has there been some pull-forward sales into Q2? Or like just a bit of color would be helpful.

[Sebastien Martel, Chief Financial Officer]

Sure. First, yes, as I said earlier, Q2 ended better because we shipped more units. Some of that was pulled forward. So we had finished good inventory that we were able to wholesale in the quarter. So that obviously reduces the units available for sale in the third quarter. But the big challenge in the third quarter is, as I mentioned earlier, with the supply chain and our ability to produce finished goods. We'll have more retrofit units at the end of Q3 than we have at the end of Q2. These units will be reworked, in our expectation, in the fourth quarter or so. From a volume perspective, obviously, that's going to impact Q3 and that's why the profitability will be down. But as Jose indicated, we talk with our suppliers, and we have -- they give us visibility as to when and the ranges of supply. And so we're confident that Q4 is a number that we can deliver.

[Martin Landry, Managing Director of Equity Research]

Okay. And then again, you've got some comments talking about 2023 -- fiscal '23 talking about -- you're expecting further growth. Just to clarify, when you're talking about further growth, are you talking about revenue growth or EPS growth?

[Sebastien Martel, Chief Financial Officer]

It's both. We itemize what the opportunities are for next year. Obviously, we have added capacity. We have Sea-Doo Switch. We have as well new products that we'll be introducing. And there's obviously an extremely low level of inventory in the network that needs to replenish. So from a top line perspective, we anticipate growth and from a profitability perspective as well. If you take just the midpoint of the guidance for this year, our expectation is that we're able to generate double-digit EPS growth next year.

[Martin Landry, Managing Director of Equity Research]

Double-digit EPS growth for fiscal '23?

[Sebastien Martel, Chief Financial Officer]

Yes.

[Operator]

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

[Gerrick Luke Johnson, Senior Toys and Leisure Analyst]

I want to talk about your distribution process. I understand you don't ship preorders. Polaris points to its use of preorders as an asset as well as its retail flow management. Can you talk about your process, and how you distribute and why it's better than the competition?

[Jose Boisjoli, President, CEO & Chairman]

Then maybe my answer will be a bit long, but I will give you the big picture. As Sebastien said, the main challenges right now are semiconductor, COVID restriction in the Southeast and labor shortage in North America. And we believe all the OEMs are facing the same challenges that we're not better than the others. But the way we do it, first, we -- in our -- we keep -- we try to keep what we control. Our production planning is very stable. We don't want to change production schedule. And for watercraft, snowmobile and 3-wheel, we're allocating product for 1 year. The dealer gave us the mix and the wish list, but when the booking is done, we freeze it -- we try to freeze it for the year on our side. For ATV side-by-side, right now, we're allocating the product by a period of 3 months. And again, we try to freeze what we produce to minimize the interruption from our end. After that, we work with suppliers to optimize the supply. And because we have a diversified product portfolio and the geographic diversification, we try to allocate and prioritize component depending on the retail season. Like right now, if we have a cluster, we'll put it on a snowmobile instead of a watercraft because nobody needs a watercraft. Not -- the peak season is next spring. Then this is how we prioritize component between product line. And also, we took the decision with the dealer. We consult a few key dealers to retrofit -- to produce with missing part, then we will retrofit units in our factory and at the dealer level. And the goal is to honor all orders. And our team is very agile, but disciplined to implement those principles. And that's our recipe. And so far, it's not obviously perfect, but it's working quite well.

[Gerrick Luke Johnson, Senior Toys and Leisure Analyst]

Okay. And one more. Just could you quantify perhaps the order of magnitude, the contribution expected from Switch. Do we hear sellouts and model year sellouts? But I really don't have any idea how to model Switch right now. So what should we anticipate in terms of top line contribution?

[Jose Boisjoli, President, CEO & Chairman]

But here, the boating industry is a $20 billion-plus business, and it's a big opportunity for us. And just to give you a sense, we estimated that this calendar year, 2021, the pontoon industry in North America will be about 80,000 units. But there is a fleet of used products. It's about 600,000 units that have been produced in the last 15 years. And we know that Switch like Spark will attract to the used market, the trade in. Then we believe quickly, the Switch could grow the industry from 80,000 to 100,000 units a year, let's say, in the next 3 years. And we're targeting 15% market share. Then we believe that Switch could become a $500 million business in about 3 years midterm time life.

[Operator]

Your next question is from the line of Mark Petrie with CIBC.

[Mark Robert Petrie]

Just with regards to the labor situation, just wondering if there's any effect in your Mexico operation?

[Jose Boisjoli, President, CEO & Chairman]

To be honest, no. The labor situation in Mexico is good. It's -- we don't have any labor shortage in Mexico, and this is obviously with now 4 factories in the country. This is giving us some flexibility. In Europe, Finland, Gunskirchen, it's the same thing, not much labor difficulty. Obviously, Canada and United States are more difficult, affecting all our manufacturing side, but also our supplier. But in Mexico, it's very well, very good.

[Mark Robert Petrie]

Okay. Excellent. And then could you -- I mean, that last answer was very helpful with regards to Switch. Can you give us a sense of how the capacity for that will be ramping. And then also, anything you can comment compares to the same idea for Ghost? And then also how that factors into your CapEx plans for fiscal '23?

[Jose Boisjoli, President, CEO & Chairman]

Then in terms of capacity and in any of our new product line, we always plan our capacity or capacity in 2 phases. And right now, Phase 1 is ready. As you remember, the hull -- the motorized hull will be assembled in Querétaro shipped to Sturtevant, and the production will start at the end of Q4. But capacity with what we see right now, the demand, obviously, is very good. A lot of units are already presold to consumer, and we are ready to increase the second phase of capacity if we see that the demand is there. It's a bit too early to call the shot. But like I said, I mean, we intend -- we believe that the pontoon industry in North America could be in the range of 100,000 units quite fast. And we are targeting a 15% market share, then we're ready to grow if -- ready to invest in more capacity if the need is there.

[Sebastien Martel, Chief Financial Officer]

On your question for CapEx for next year. Obviously, this year is a big year for CapEx investments, almost $600 million at the high end of the range. We are investing this year in assembly line capacity. We'll have investments next year on the manufacturing side, powertrain, PWC. So I'm expecting to have sustained investments next year, probably in the range of where we are this year. Obviously, we're investing in new products as well, and that's requiring CapEx. So -- and Jose mentioned that we're -- our pace of introduction is going to be high in the next 3 years. And so obviously, that comes with CapEx.

[Operator]

Your next question is from the line of Xian Siew with Exane BNP Paribas.

[Xian Siew Hew Sam, Research Analyst]

I just want to dig into Slide 19 a bit more. So you show how much you have expected production. I'm just curious, how does that compare to production? And if there were no supply chain disruption or full capacity? How does that -- is it 20% higher? 30% higher? Can you give a sense of that.

[Sebastien Martel, Chief Financial Officer]

Yes. When I'm looking at Q3 versus a year ago, capacity is expected to go up double digits. That's -- we'll call it the total output that is units that are going to be available for sale and also units that would be retrofitted. And if you're looking at Q4, you're going to see that line actually up versus Q3. So a further increase happening in Q4. So we are running at almost full capacity. We could produce more if the supply chain disruptions were not as bad. But we are taking advantage of all of our -- all of the ships available to produce units.

[Xian Siew Hew Sam, Research Analyst]

Okay. Got it. And then can you maybe put it into context versus Q2? So Q4 you're showing -- you're talking about improvement in the supply chain, is it even better than Q2? Or is it kind of getting back to Q2 after maybe a dip in Q3?

[Sebastien Martel, Chief Financial Officer]

Well, I think the first half of Q4 is still going to be tight probably in the bottom end of Q4, that's when things will be more normalized. In terms of output, obviously, Q4 is going to be higher than Q2 because now we have the new personal watercraft capacity that's coming online. And we also have [YS3] that's going to be online in the third and fourth quarter. So higher than Q2 in terms of output, yes.

[Operator]

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

[Jaime M. Katz, Senior Equity Analyst]

I actually sort of want to piggyback on that question because, I think, it looks like there's a little bit of slack in the capacity utilization and manufacturing chain. But I think you articulated that it would be something like 12 to 18 months until the dealer channel was replenished? And I guess I was expecting it to be a bit longer given that retail demand would theoretically be significantly higher if there was actually inventory in the channel. So is there a way to reconcile those dates to feel more confident that that's the right time line to get back to the appropriate inventory levels?

[Jose Boisjoli, President, CEO & Chairman]

Then just to come back on your capacity usage, typically, and if you look historically, our second half is always -- has been stronger than our first half because we introduced new products, let's say, in August for the new season. And typically, our factory for watercraft, snowmobile, all the seasonal product and year-round products are running at full capacity. Obviously, right now with Querétaro, a new line for watercraft and [URS3] that is ramping up. Capacity will be more in fiscal year -- beginning of 2022. But we've always been using our factories almost at max on H2. Take it from there.

[Sebastien Martel, Chief Financial Officer]

Yes. Maybe on your inventory question, we finished Q2 with the lowest level of inventory there since the beginning of the pandemic. Inventory in Q2 was actually down 25% compared to Q1. So our expectation is that there's going to be no replenishment this year. Replenishment is going to start next year, at the end of next year, and into fiscal year '24. That's our expectation for replenishment.

[Jaime M. Katz, Senior Equity Analyst]

Okay. And then for -- with inventory, does that -- can you sort of walk us through your expectations of what that looks like over the next few quarters as the supply chain becomes less strangled?

[Sebastien Martel, Chief Financial Officer]

It's still going to be tight. There's -- obviously, there's a tailwind of demand there. Consumers are waiting for their products. So everything that we ship to dealers in the next few quarters, it's most likely going to be retailed very quickly. Jose mentioned that a lot of dealers are resold out on Switch and Switch is going to be a wholesale up in June next year or so. Our expectation is that as there is a backlog of demand, we won't see inventory replenishment happening in the next few quarters, and it's only in the back half of next year that we should see inventory starting to build up.

[Operator]

Your next question is from the line of Benoit Poirier with Desjardins Capital Markets.

[Benoit Poirier]

Congratulations again for the good quarter. With respect to fiscal year '23, could you maybe talk a little bit about the margin expectation? And also, could you quantify the size of the inventory replenishment, whether it's still $1.3 billion of potential revenue over a 12 to 18 months period.

[Sebastien Martel, Chief Financial Officer]

Well, obviously, for next year, we are expecting some headwinds. Obviously, commodity are going to continue to be a headwind, but we should be able to offset that through pricing. If I look at this year, expected EBITDA margin is about 17% to 18%. I would expect that next year as well. Programs are going to be probably a headwind for us, but obviously, we'll be benefiting from the increased volume and better asset utilization, better operational leverage. And also Mission 2020 (sic), you all know that we have some cost saving targets. We'll also be getting those as we introduce new products with better margins. So our expectation is that margins should be similar to what we've had this year.

[Benoit Poirier]

Okay. That's great. And would you be able to quantify the size of the inventory replenishment, Sebastien?

[Sebastien Martel, Chief Financial Officer]

Well, as I said, the inventory is extremely low in this -- at the end of Q2, is a record low. When you look at historical levels where we were, obviously, the industries have grown a lot. The -- if I can simplify it for you, the inventory replenishment opportunity is almost equivalent to a quarter of wholesale. That's what it could be.

[Benoit Poirier]

Okay. Okay. Perfect. And last 1 for me. You already provided some color about the Switch in terms of market size down the road. But could you maybe provide some color about the mix and level of accessories ordered so far versus the initial expectation?

[Jose Boisjoli, President, CEO & Chairman]

Difficult. I mean, -- If you remember, just to give you a sense for all the analysts and the investor. The Switch, if you go the low end, the compact 113 foot, it's starting at $18,000, and the 21-foot Cruise go up to $36,500. But you can have some package. As you know, we have 3 package. We have the 3 package, and if I give you the example of the watersport and fun package, then it's a package of $7,000. Then if you take Cruise 21, which retails for 40 -- $36,000 and you had the water and fun package, you're ending up at $43,000. Then it's anywhere between $18,000 and, I would say, $45,000. And right now, it's a bit early. We have a lot of a lot of orders in the system, but I would say we're tracking slightly above USD 30,000.

[Operator]

Your next question is from the line of Fred Wightman with Wolfe Research.

[Frederick Charles Wightman, Research Analyst]

I just wanted to follow up on some of the expected tailwinds from the Juarez facility. I think you made the comment that you're still expecting that 50% capacity boost by January, just given how tight the supply chain is today. Can you maybe give us a sense for when you started to make some orders with suppliers, just how good the line of sight is to ramp? It just seems like a big ask for 4 months from now?

[Sebastien Martel, Chief Financial Officer]

Then obviously, the -- again, I'm coming back to the supply chain. Right now, the main difficulty is semiconductor. At the beginning of 2021, we had a lot of different components that was difficult. But going from one plastic to the others, it's a thing that now we manage well. Sometimes it's more expensive, but we're doing well. And right now, the roadblock that we see for growth next year is the semiconductor. And like we said, there was that fire in the Japan factory, some difficulty with some microchips supplier in South Asia. But now the situation is getting better. Then from where we start today, we believe and our component suppliers say the same that this will improve with some ups and downs. And we are right now planning with them to -- for a growth in fiscal year '23. And right now, this is our plan. We're planning for the growth, and we'll manage to reach there.

[Frederick Charles Wightman, Research Analyst]

Makes sense. If we just take a step back and look at some of the sort of the macro side of the equation, the consumer confidence numbers in the U.S. for August took a pretty big step down versus July. Are you seeing some of the forward indicators, whether it's sales leads or credit applications, start to mirror sort of that broader macro backdrop? Or is the vehicle space still sort of a good contraindicator to where people really are spooked about delta and traveling that they're sort of pivoting towards some of these safer vehicle discretionary purchases?

[Sebastien Martel, Chief Financial Officer]

I think our industry might be a bit different than general consumer demand in a sense that the COVID restriction forced many people to stop traveling. I think now people are restarting to travel, but now they realize it will be more complicated. It will take maybe a few years before it's back to what it used to be pre-COVID. And for us, we're still happy to see that the ratio of new entrants buying our product. And when we look at those new entrants and we survey them they are more family oriented. There are more women. They are younger, and even their household income have increased versus the traditional buyer that we had. And I think that's why we are quite optimistic about our future because we believe that those new entrants could change the dynamic into our industries.

[Operator]

Your next question is from the line of Derek Dley with Canaccord Genuity.

[Pulkit Sabharwal, Associate]

I'm actually Pulkit, Derek's associate, just filling in for him today. A couple of questions for you guys. Could you speak to your capital allocation preferences going forward after that ramp-up of Juarez is complete?

[Sebastien Martel, Chief Financial Officer]

Yes. Obviously, where we prioritize capital deployment, we've invested in CapEx, and that's always been a priority of us investing in organic growth, but we've been active in terms of deployment for share buybacks as we've done in the last quarter. Our balance sheet is very strong. And so we have obviously options to deploy capital going forward. And we're always mindful of what's the best opportunity for the business that drives the better returns. These are discussions we have regularly with the Board and with management. And as I said, next year, our expectation is we'll have another big year in terms of CapEx investments as we continue investing in new products such as electric, but also just new introductions that we've done with the Switch.

[Pulkit Sabharwal, Associate]

That's very helpful. And then as a follow-up, I know limited promotional activity was a factor this quarter in terms of the gross margins. But what do you view as more normalized gross margin target looking forward?

[Sebastien Martel, Chief Financial Officer]

Well, this quarter, we benefited from a good mix and also a better sales incentive. My expectation for the full year is that we'll probably get a 300 basis point positive coming from programs that would be versus fiscal year '20, not last year but versus fiscal year '20. And going forward, the expectation is that we probably keep 150 basis points of that.

[Operator]

Your next question is from the line of Brian Morrison with TD Securities.

[Meaghen Annett, Analyst]

This is Meaghen Annett, on for Brian. So understandably, there are challenges in securing semiconductors and components. But can you just talk about your ability to secure those components given the planned increase in your capacity? And did that contribute at all to the outperformance relative to the industry in Q2? And any thoughts you have on that dynamic for the second half of the year?

[Jose Boisjoli, President, CEO & Chairman]

On securing, obviously, with the shortage that is happening in the world, all electronic suppliers are asking for better visibility long term than we gave to our suppliers, our need for fiscal year '23 a few months ago. And there is no surprise there. And we have to commit maybe a bit longer than typically in the past. Then that's why our supplier know exactly what we expect to produce next year. We know the area where it will be tight, and we're working to improve either capacity or investing in more tolling. We have been working on this for the last few months. And that's why we are -- again, we believe that from where we are today, things will improve with ups and downs. But with what we know, we believe it will be better, but it will last probably till the end of 2022.

[Sebastien Martel, Chief Financial Officer]

And on your question on our performance in the second quarter compared to the overall industry. Obviously, our teams have been doing a phenomenal job. It is -- I don't want to say a nightmare to manage, but it's a daily battle to make sure we get the parts necessary to build the units. And we've seen in certain product lines where we've gained significant market share in the second quarter. And we believe it's because we've been able to produce more units to meet consumer demand than other OEMs. And so obviously, that's a kudos to our team. But obviously, we need to continue focusing on delivering great results in the next few quarters.

[Meaghen Annett, Analyst]

And just secondly, is there anything you can call out in terms of the operating expenses being below expectations in the quarter?

[Sebastien Martel, Chief Financial Officer]

It's tight management of expenses. Obviously, last year, we went through COVID. We reduced costs significantly. So this year, this quarter, we saw an increase in overhead expenses. But obviously, we're mindful of making sure that we spend money, if necessary, especially on the marketing front. Obviously, there's scarcity in the network. There's good awareness for our brands. And so sometimes we modulate what expenses we do based on what's needed.

[Operator]

Your final question comes from the line of Craig Kennison with Baird.

[Craig R. Kennison]

This has been a very helpful call. just a quick one. Will the supply chain issues that you're seeing have any impact on your electric vehicle time line?

[Jose Boisjoli, President, CEO & Chairman]

At this time, no. No. We -- obviously, we are at the period where we're building, where we're developing the product and its engineering work and building prototype, but no delay in our program.

[Operator]

That ends the question-and-answer session. Are there any closing remarks?

[Philippe Deschenes, Manager of Treasury & Investor Relations]

Yes. Thank you. Thank you all for joining us today, and we look forward to speaking with you again for our third quarter conference call on December 1. Thanks again, everyone, and have a good day.

[Operator]

This concludes the BRP Inc.'s second quarter results conference call. Thank you for your participation. You may now disconnect.