Good morning, ladies and gentlemen, welcome to BRP Inc.'s FY 2021 First Quarter Conference Call. I would now like to turn the meeting over to Mr. Philippe Deschênes. Go ahead, Mr. Deschênes.
Thank you, Julie. Good morning, and welcome to BRP's conference call for the first quarter of fiscal year 2021. Joining me this morning are José Boisjoli, President and Chief Executive Officer, and Sébastien 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 that are subject to a number of risks and uncertainties. I invite you to read BRP's MD&A for a listing 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. With that, I'll turn the call over to José.
Thank you, Philippe. Good morning, everyone, and thank you for joining us. About two months ago, when we presented our year-end result, we were on a roll. We had incredible momentum with every product line worldwide, and we were anticipating another great year ahead. Like the rest of the world, we were faced with the sudden impact of the COVID-19 crisis, which brought rapid changes that significantly disrupted our business and operation and forced us to quickly adapt our plan. It began when our dealer had to close their business as the situation worsened in China in January. Closure followed in Western Europe in February, where local government enforced severe containment measures. As you can see on this slide, retail in North America had been strong until mid-March. It was negative for one month, and once dealers started to reopen, retail has been strong since mid-April.
Our manufacturing has reopened or is in the process of reopening, and we are adapting to the present reality. With retail tracking better than expected, we are now focused on getting production back to capacity globally. I am proud of the team's swift action taken to limit the potential impact of the crisis on our business and protect our financial flexibility. Amongst others, we deployed global protocol to ensure that our employees can work in a safe environment and reduce risk. We adjusted our production plan in line with government health regulations and expected market demand. We implemented cost mitigation measure, notably to temporarily offset salary reduction and an exhaustive review of discretionary spending, resulting in overhead saving of up to CAD 450 million for the rest of the year.
We focus on liquidity preservation, notably focusing our CapEx investment on key projects with high impacted return, resulting in a total CapEx target of CAD 220 million to CAD 250 million for the year, representing a reduction of about CAD 130 million to CAD 160 million from last year's level. We were successful in extending our Term Loan B by $600 million and maintain our covenant- lite condition. As a result of this effort, with our cash on hand and CAD 700 million of revolver availability following the completion of the Term Loan B transaction, we have about CAD 1.3 billion of financial flexibility. While we remain cautious about the future, we expect that these different initiatives will allow us to navigate through the uncertain times while allowing us to continue investing for the long-term growth of the company.
However, these measures do not come with sacrifice, and one of the toughest decisions we had to make, as we announced yesterday evening, is the discontinuation of outboard engine production. As you have witnessed over the last few years, despite its innovative technology, our outboard engine lineup has been losing share in a market that was already difficult. Our strength was in the repower segment, while the industry growth was driven by the package sector, which led to continued share erosion. Given this trend, our outboard engine had fallen behind in terms of profitability and cash generation potential. As the current situation forced us to reduce our investment plan and review downward our growth expectation for the business, the path to profitability improvement for outboard engine was too long. It became apparent that we had to discontinue production.
For our Evinrude employee, let me say that I'm very proud of the part they have played over the past years, and in particular, their effort over the past 18 months. Although we have made progress, the impact of the COVID-19 has left us no choice. I wish to thank them for their dedication and commitment in helping us create the Marine Group. This decision will allow us to refocus our marine investment on higher expected return and sustainable projects, such as innovative technology and enhancing our boat offer. We remain committed to our marine strategy with an evolution to our approach. Along with the announcement last night, we also announced a global supply agreement with Mercury, which is securing access to engine and is expected to support our dealer network development efforts.
Our strategy has always been about building a strong marine business by offering customers a superior boating experience through product innovation. The discontinuation of outboard engine production does not change that objective. The development of Project Ghost and Project M are progressing as planned, and we are confident that they will be game changers in the industry. Before we get into the quarterly result, I wanted to provide you with an update on our manufacturing operation. As you know, we suspended or slowed down most of our operations starting in late March until mid-May, responding to local government containment measures. This obviously limited our ability to ship product in the first quarter and impacted our financial result. The good news is that we have been able to take extensive measure to protect our people while resuming capacity.
Production has restarted or is ramping up in most of our facilities and we are set to be operational everywhere starting next week. As mentioned, our result was significantly impacted by mandatory closure of plants and dealerships. However, our retail performance was solid given the current context, with North American Powersports retail being up 4% or 10% when excluding snowmobile. Contributing to that strong retail performance was our focus on supporting our dealers as we strive to continue delivering the best-in-class dealer value proposition in the industry. Ensuring the health of our dealer network is a key priority, and we made sure to find solutions to ease the financial burden on our dealers, notably as we extended floorplan support until the end of June, adjusted performance targets until the end of July to account for potential reduced demand.
We proactively adjusted dealer orders, and we extended warranties for all our powersports products. We also implemented measures to simplify business processes for dealers and to drive consumer demand. The response from our dealer network on this initiative was very positive and should help us to continue to gain momentum. Taking a closer look at the North American quarterly retail performance on slide 10. Our product portfolio performed above our expectations during the first quarter. We continued to outperform the off-road industry, with side-by-side retail growing above 40% and ATV retail being up high single-digit, driven by a strong first half of the quarter and very strong second half of April.
The three-wheel vehicle category is suffering the most in the current context, since the confinement measures taken have had the most impact on this category, with the closure of riding schools and cancellation of demo tours, two key projects to support the growth of this sector. I will explain more on this in a moment. Finally, while are both down for the quarter, personal watercraft and snowmobiles outpaced their respective industries. As summer is approaching, there appear to also be a clear trend that people will be staying at home for their vacation, or as they say, a staycation, which would work in our favor. We added this slide to give you some color on a retail analysis that we did, showing that our retail performance was very strong in regions where access to powersports dealer and playground remained more available during the containment period.
You can see a clear difference between the U.S. and Canada, where the provinces of Quebec and Ontario were completely closed for six weeks. The middle graph show the data taken April 15, and as you can see, the gaps in retail between the dealers that were open versus closed, and on the right, between rural and urban dealers. Retail was up 20% when dealers were open for most of the month of April, and up 24% in rural areas. When dealers are open, sales remain strong. This bode well for our industry as gradually enter the confinement stages in many regions around the world. Let's turn to slide 12 for the year-round product highlight. Revenue were up 2%, driven by a strong start of the quarter, partially offset by the impact of the crisis.
On the retail side, 10 months into season 2020, the side-by-side industry was up high single-digit. The demand for our Can-Am Side-by-Side was very strong, and our retail was up low 40% season to date. Can-Am Side-by-Side was also performing well in international market despite the situation with retail for the quarter up over 40% in Latin America and up over 20% in EMEA and 20% in Asia Pacific. Under the current context, these are incredible results. Turning to ATV. The North American ATV industry was also 10 months into the season, and retail was up low single-digit. For the same period, Can-Am ATV retail was up low teens, notably gaining share in the mid-cc segment. We are pleased with the performance of our off-road business, which had a very strong end of April, and the positive trend continued in May. Now looking at three-wheeled vehicle.
Early in season 2020, the North American three-wheeled vehicle industry was down low 30%, while we were down low 40%. There are a few factors to note. First, we are lapping an excellent quarter due to the launch of the Ryker last year. As I mentioned, the on-road industry suffered the most from containment measure due to the closure of riding school and license issuer and the cancellation of demo tours. We also had to cancel our marketing effort since we had no project to support new entrant into the market, a key driver for this category. We have now launched a new marketing campaign that is adapted to the improving situation. As schools are reopening, demand for classes is growing, and we are confident we will regain traction. Turning to seasonal product on slide 13.
Seasonal product revenue were down 14%, primarily driven by lower shipment as many dealers were closed. Looking at retail. The North American snowmobile industry ended its season 2020 on March 30th, with retail down mid-single-digit percentage. Our Ski-Doo lineup continued to drive strong consumer demand, resulting in retail that was up mid-single-digit percentage and ended the season with the highest market share in its history. In Scandinavia, 10 months into the season 2020, the snowmobile industry is down mid-teen percentage, driven by unfavorable snow condition last winter. Ski-Doo and Lynx outperform all other brands, with retail only down high-single-digit percentage. Our complete lineup and new product introduction, notably the new Summit Turbo models, have put us in a very favorable position in the industry with continued market share gain potential.
Although we had to cancel our demo tour, we are encouraged by the level of spring certificate unit sold to customers. Our performance is very similar to last year, which is testament to the strength of our Ski-Doo and Lynx brand. Turning to personal watercraft. It is still early in the season, and the North American personal watercraft is flat, with Sea-Doo retail is up low single digit percentage. Given the current situation, which halted manufacturing plus a cold spring, our retail was affected and we reduced our model year 20 production plan by 18% compared to last year. We decided to advance the cutoff of model year change, and we will be ready to ship model year 21 units starting this summer. May retail so far for watercraft has been very encouraging, and with our production adjustment, we will be ready to supply the demand as needed.
Continuing with a look at Powersport parts, accessories, and apparel and OEM engines. Revenue were down 15% as a result of dealer closure due to the pandemic. Parts order, which represent an important portion of our PA&A business, are directly correlated to the ability of dealer to service unit and, as a result, suffer the most from dealer being closed. As dealerships started to reopen, we saw an improvement in parts sales. Finally, looking at our marine business. Revenue were down 26% due to a lower volume of outboard engine and boats sold, partially offset by the impact of the acquisition of Telwater during last year. At the retail level, Alumacraft was down over 20%, resulting from weak industry trend in key market, while Manitou performed well with retail up low-teen percentage.
With the confinement measure lifting and spring weather getting better, we see retail improving for both Manitou and Alumacraft. With that, I will turn the call over to Sébastien.
Thank you, José, and good morning, everyone. As mentioned, we had a very strong start of the quarter, continue our growth trajectory from recent years until the COVID-19 pandemic led to global containment measures, resulting in dealer closures and suspension of production in most of our sites starting in late March. This impacted our ability to ship products, resulting in revenues that were down 8% from last year and normalized EBITDA down 16%. Our normalized EPS ended the quarter at CAD 0.26. As part of our initiatives to preserve our financial flexibility, we reprioritized our CapEx plan for the year, resulting in investments of CAD 43 million in Q1, down CAD 9 million from last year. We managed working capital leading to CAD 100 million of positive working capital contribution and CAD 169 million of Free Cash Flow for the quarter.
As José mentioned, following the end of the quarter, we secured a $600 million U.S. Term Loan B with a covenant light structure that matures in 2027. With the added Term Loan B, we have significantly strengthened our liquidity position, allowing us to focus on managing the business through these uncertain times and continuing investing for the long-term growth of the company. As I mentioned, our revenues were impacted by our ability to ship in certain markets. Our retail remained strong in the United States as many dealers were able to stay open, allowing us to continue shipping products, which resulted in Q1 revenues that were up 5% for the region.
The situation was different in other key markets where a higher proportion of our dealer network had to close, leading to retail decline and lower shipments. This was particularly true in Europe, where we had a very strong start of the year, the trend worsened early in March as containment measures were more comprehensive and were put in place much earlier than in North America. Our gross profit margin was also impacted by the situation, notably due to the closure of our manufacturing sites in late March and all of April. On a comparable basis, our gross profit margin was up 10 basis points from last year, as the negative impacts from volume mix pricing and sales programs and production costs and depreciation were more than offset by favorable foreign exchange rate variation.
However, COVID-19 had a 350 basis point impact on our margin, primarily driven by less efficient fixed cost absorption due to production shutdown and higher yard inventory depletion. Turning to slide 19. Our quarterly normalized income was down CAD 30 million compared to last year, driven by negative impacts of CAD 62 million coming from volume mix pricing sales programs and CAD 16 million from production and distribution costs, which were partly offset by lower overhead resulting from our cost mitigation efforts, offset in part by higher depreciation for a net positive impact of CAD 38 million, lower net financing costs and normalized income tax expense for CAD 3 million and a favorable foreign exchange rate impact for CAD 7 million.
Given the impact of COVID-19 on the outlook for our industries, we took CAD 171 million non-cash impairment in the quarter for our Marine business, which is facing more challenging industry dynamics compared to when we acquired them. This amount accounts for the revaluation of the boat companies we have acquired over the past couple of years and the impact of the decision to discontinue the production of outboard engines. This amount has been excluded from our normalized metrics. Looking at network inventory on slide 21. Our network inventory was up 7% over the same period last year. Well-positioned despite the current situation as we experienced better-than-expected retail trends across most of our product lines.
The increase is primarily driven by three-wheel vehicle as it was the most impacted product line within our portfolio due to the closure of riding schools, demo tours, and more dealers being closed in urban areas. SSV industry was also up as we had positioned the network inventory early in the year for the expected continued solid retail growth. This allowed us to support the strong consumer demand we experienced, with retail being up over 40% for the quarter, despite that we had to suspend our production due to the pandemic. Our number of days of inventory are lower than usual for both SSV and ATV, which may lead to certain models being difficult to access in certain regions. With our operations restarting, we expect to be able to sustain the continued strong consumer demand for our lineup.
Our network inventory growth was partly offset by a lower level of inventory of PWC due to the production shutdown. Still, we believe the level of inventory is appropriate for the expected demand, and as José mentioned, we will be able to produce and ship model year 2021 earlier than usual if there is additional demand. Lastly, for snowmobile, we ended the season with a healthy inventory position, allowing us to start the next one in a good place. Turning to slide 22. The coming weeks and months will be determinant in how our fiscal year 2021 will play out.
As many regions of North America and Europe are deconfining and restarting their economies, we will get greater visibility on the potential impacts of the pandemic on consumer demand, which will be impacted by the severity and length of the economic uncertainty, the agility of the global supply chain and its ability to adapt and resume operations in a safe and sustainable manner, and people's confidence, which will undoubtedly be linked to the evolution of the virus and will impact both demand and workforce availability across multiple industries. Given the uncertainty related to these elements, we are not in a position to provide a guidance for fiscal year 2021 at the moment. We are sharing with you our high-level view on how we expect the year to progress.
This outlook assumes the restart of our manufacturing operations as scheduled, no further closure of operations in our factories or suppliers in our dealer network, and continued positive consumer demand in North America, but lower year-over-year overall demand in other regions of the world. Based on this, we anticipate a challenging second quarter as revenues are expected to be down about 40% due to the production suspension across most of our sites during April and May, and then a progressive ramp-up to resume full capacity and replenish yard and dealer inventories, and the impact of the discontinuation of outboard engine production. We expect the trend to progressively improve for Q3 and Q4 as we complete our production ramp-up.
However, revenues are still expected to be down year-over-year 10% to 20% in the second half of the year due to the anticipated lower demand for our products in international markets and the impact of the discontinuation of outboard engine production. We expect CapEx for the year to be CAD 220 million to CAD 250 million, depreciation of about CAD 265 million, net financing cost of about CAD 135 million, and the effective tax rate to be between 26% and 27%. Finally, end the year with a diluted share count of about 89 million shares. While our results for the year will suffer from the pandemic, the fundamentals of our business remain solid as we continue to outpace our industries and gain market share.
Furthermore, our ability to secure our financial flexibility is allowing us to continue investing in our growth initiatives to put the company in a solid position for the rebound in years to come. With this, I'll turn the call back to José.
Thank you, Sébastien. These are not easy times, but what makes me happy and proud is the agility and resilience of our employees, suppliers, and dealers. I would like to thank them for their efforts and continued dedication. Going forward, our priority are focused on two things, how we manage in response to the current environment, and making sure we are prepared for what the future holds. As always, we are committed to ensuring a safe working environment for our employees globally, and now more than ever. We are also focused on staying agile. Our agility allow us to react quickly to the crisis, and now to successfully ramp up again, while making sure our dealer network is healthy and ready to be back in action. We will maintain our market leadership through our best-in-class marketing, go-to-market, and retail strategy.
There has never been a better time to promote the customer experience riding our products. Now, to prepare for the future, we need to continue our growth objective adapted to this new reality. Although we reduced our CapEx, we are protecting our key growth project and initiative to maintain our momentum in the industry. To do this, we will need to rethink now how we do business and adapt to the new normal in our operation, our strategy, and our mindset. We believe this new reality will give us opportunities to demonstrate our leadership as things will continue to evolve. For example, we believe the way people purchase has definitely changed, with more interest than ever in e-commerce.
With global travel remaining restricted in the short term, more staycations, prolonged social distancing, and fewer large gathering and event, consumer will look for activities that can be practiced closer to home. With our product, our knowhow, and our solid financial flexibility, we are well-positioned to navigate through the crisis, respond to new trends, and emerge stronger than ever. Lastly, I would like to remind you, we make the ideal product for social distancing. On that note, I will now turn the call to the operator for question.
Thank you. At this time, if you'd like to ask a question, press star one on your telephone keypad. If you'd like to withdraw your question, press the pound key. Please wait while we compile the questions. Your first question comes from the line of Steve Arthur with RBC Capital Markets. Please go ahead.
Yes. Thank you very much. I'm wondering if first we could just, a little bit more color on what you're seeing with some of the retail trends into May. In the U.S., it sounds like a strong recovery starting in late April and continuing, but just any comments on what you're seeing now with dealer traffic levels, the restrictions that they're working through and such in the U.S., and also the patterns that you're seeing emerging now in Canada and Europe?
Good morning, Steve. Obviously, for competitive reasons, I will not give you all the data that we see, I will give you some. First, our dealers right now, about 90% of our dealers are reopened in the U.S. There are still some states, in the East and in California that are closed, 90%-plus are open. In Europe, where everything was closed for a period of time in Germany, France, Italy, and Spain, about 80% of our dealers are operational. I won't give you the details by product line or by country, since the beginning of May, we are up about 35%, worldwide between all product lines and all countries. We don't know how long this will continue, definitely a trend that is positive for our type of product.
I guess just squaring that, if retail into May is that strong versus the net look for down 40% in Q2, is the difference there, I guess, just a lag in terms of production versus retail? The production's been down for six weeks.
Yeah, that's for sure. That's for sure.
Yeah.
Okay.
Okay, good point. Secondly, just in terms of the production ramp, I guess at your primary facilities in Mexico, it sounds like they're ramping up now. Just any comments on the level of utilization you're at now, and how you see that ramping, what the limiting factors are, whether it's local restrictions or supply chain or just matching demand?
In Mexico, the government gave us the okay to restart on June 1st, which is next week and w e've been working on the ramping up the production for the last two weeks. We were allowed to let our people in and prepare for ramping up. That's what we're doing right now, because you don't just flip the switch on us. We will be fully operational in our three factory, starting next week. Obviously, we expect to have some difficulty here and there with suppliers because we're managing about 550 key supplier around the world, and I think we will go through some difficulty overall for the rest of the year. As we speak right now, everything looks good, that everything will be operational next week.
Okay. Just a final one. Thank you. Final one on operating costs and overhead savings. You've been pretty aggressive with that, looking at a CAD 450 million reduction, presumably as things start to ramp back up, some of those costs come back online, but any sense of how much of those savings might be permanent or structural in the business now and therefore support longer term margins?
Good morning, Steve. What we've communicated is we have plans in place to reduce our expenses up to CAD 450 million versus what we were planning initially for fiscal year 2021. Obviously, we'll remain agile and adapt our plans. We'll see how things are trending. One thing I can tell you with the discontinuation of the outboard engine business, that's a reduction of about CAD 80 million of overhead, that's going to be recurring year-over-year. As things evolve, we'll be nimble as we've been in the past and in the last few months, we'll balance the short-term financial priorities with our long-term aspirations. The good news is we have flexibility to adjust accordingly.
Okay. Thank you very much.
Your next question comes from the line of Craig Kennison. Please go ahead.
Hey, good morning. Thank you for taking my questions. Seb, I think you just mentioned some metrics regarding the engine business that you're exiting. Could you share with us the annualized revenue and margin profile of that business so we can try to exclude it from future results?
Yeah. Well, actually, on the OE business, there's actually two components. There's the unit business and there's the parts business. The parts business is a business that we're going to be continuing. Obviously, we're going to be servicing our dealers for warranty, but also for our consumers that are no longer under warranty but need service. That business is going to keep going on. As José mentioned, the unit business, so the actual engine, was a business that we were subscale. We've been losing market share over the last few years. From a margin perspective, it's a business that was almost breakeven. From a profitability, it was a business that was actually at a loss position. That's why we took the decision to discontinue it.
When you look at OE in terms of the whole portfolio of our marine segment, the engine business is about 45% of total revenue. If you carve that part out, it should give you a good appreciation of what the remaining business is.
What would you estimate your market share to have been in that?
In the mid-single digit.
Thanks. Going back to the comment on May retail trends, which appear to be really strong, is there any way to look at that data and deconstruct it for whether you're seeing an influx of first-time buyers or there may be some kind of catch-up demand from earlier periods where dealers were closed? Just trying to get a real feel for the extent to which this outdoor theme is really capturing new eyeballs.
Yeah. We've done some survey about the customer who purchased our unit in the last month, and we see more new entrants than typical. Typically, we have about 20% of our sales is to new entrants. From our survey, and again, it's a small sample, but we are more around 30% right now. There is definitely a trend there where some people who was not considering our type of product, we see them entering into our type of industry. This is very positive. There is obviously a lot of money in the system, a lot of government invested in economy, and with, again, the staycation and the social distancing, canceling vacation and travel restriction, there is definitely a hype there. This phenomena is there. We can see it. We can feel it. On the other hand, we cannot ignore that the unemployment rate is going up.
Consumer confidence is low and the housing start as we do, then all of this at one point will catch up. We feel pretty confident for the next few months, but how this will play on the second half of the year, that's a bit difficult to predict.
Great. Thank you.
Your next question comes from the line of Gerrick Johnson with BMO Capital Markets. Please go ahead.
Hey, good morning, guys. Couple questions. First, you're talking about lower demand in the rest of the world. Just why aren't folks elsewhere looking for outdoor recreational products just like we're doing here in the U.S. and North America? Is this just a North America phenomenon?
I think, Gerrick, there is some timing. Like LATAM right now is down. The COVID hit Brazil and Mexico later than in Europe and in Canada and U.S. I think it's just a question of timing. Those country were upbeat later than North America, than Canada, U.S., sorry, and now they are in the middle of it. I think it's only a question of timing. I think the phenomena is exactly the same.
Yeah, aren't your markets bigger in Europe and Asia compared to Latin America? What about those markets?
Yeah. Obviously, what we're seeing is that the confinement measures were more, I don't want to say drastic or severe, and so is there a bigger aftershock event there for the consumers? We're not seeing the pickup that we're seeing in the U.S. in terms of retail.
Okay. Going back, say, two years ago, would you have acquired these boat brands if you did not have the Evinrude business?
Absolutely. You saw the few presentation we've done about the boat strategy. BRP is a diversified company, and I think this is one of our strength. We needed to diversify outside powersport. Marine is a good complement to what we do, and you see how many customer who buy ATV, Sea-Doo, or snowmobile are buying boat. We see a big opportunity in the boat industry. Obviously, our thinking is about creating new experience by pushing innovation and technology. That's what we're doing right now by redesigning the complete lineup of Alumacraft, Manitou, and Telwater Boat. For us, it's a bit sad that we discontinued the production of the Evinrude, the outboard engine. We will continue to invest in new technology in the new boat, because we believe that our long-term strategy make a ton of sense.
Okay. Project Ghost was not reliant on you having the outboard engine technology?
Project Ghost, and I won't tell you the detail about it, but Project Ghost and Project M are ongoing right now.
Okay. I'll leave it at that. Thank you very much.
Thank you, too.
Your next question comes from the line of Robin Farley with UBS. Please go ahead.
Great. Thank you. I have two questions. First, on the off-road business. You mentioned, well, I guess you didn't give a specific product line but you mentioned sales up very strongly so far in May, and we're assuming a lot of that in off-road. With the restart just taking place next week, I guess, do you think that retail from here going forward is going to be lower than it would have been? In other words, is there not enough product that it's going to impact your retail negatively in the next months? Is it by six weeks from now that you feel like you would have enough inventory in the system to be able to meet the level of retail demand? So how long will that period last? Thanks.
Well, as you saw, Robin, at the end of Q1, our inventory was up in the network about 7%. Part of that was driven by side-by-sides. Year-over-year, side-by-side at the end of Q1 was up mid-teens. We had a good level of inventory. Obviously, the retail is very strong, we had anticipated strong retail when we started the quarter, and we had, I guess, filled the network with some inventory. It might be tight for a few models in some regions. The retail in May continues to be strong, and as José mentioned, next week we're going to be in full production, and we're going to be starting shipping units to dealers again.
Obviously, we'll be shipping the units that are in high demand, and so we believe that we'll be able to meet consumer demand and continue driving strong retail in the second quarter as well.
Okay. I guess just looking at if side-by-side inventory is at mid-teens, in theory, retail seems to be pacing up 40% still in the month of May.
Yeah.
I know those are on different bases, right? The retail pace and the inventory base are different numbers. Do you have enough inventory? Is the mid-teens increase at the end of Q1 enough to support that kind of retail through Q2?
It's enough to support strong retail. We're going to finish Q2 probably with inventory down year-over-year. As I said in my prepared remarks, we might run out of certain models in certain regions. Unfortunately, some consumers may not necessarily have the choice of color they wanted. We believe that there's going to be enough inventory in the network to meet the overall demand. As we restart production and refill the pipeline, we believe that we'll be able to sustain that momentum. Are we losing retail maybe in the second quarter? Yes. We believe that with our production ramp-up, we'll be able to catch up pretty quickly.
Okay, great. No, that's very helpful. Thank you. Just the other question. We had thought that the outboard engine business was operating at a loss, and you kind of confirmed that. Can you quantify what addition to EPS you get just from maybe taking that loss out? In other words, how much does that add to the bottom line?
Yeah, good question. When I look back to fiscal year 2020, and I carve out the OE business, I'm looking at a CAD 0.60 to CAD 0.70 negative EPS impact.
Oh, great. Very helpful. Thank you.
Your next question comes from line of Mark Petrie with CIBC. Please go ahead.
Hey, good morning. I just wanted to follow up on two things. First, with operational constraints and social distancing on manufacturing, does that ultimately impact your capacity or throughput, or do you expect to be able to ramp to previous levels?
Good morning, Mark. No. Obviously, we were lucky enough to restart engineering in Canada about five weeks ago because we needed to plan the transition from model year 2020 to 2021, and we could not lose the momentum we had. We developed a lot of good measure to make sure that our employee are safe. Right now, we are implementing this protocol everywhere where we have factory. We believe that in term of assembly and all the manufacturing operation, we will be as efficient as before. That being said, as Sébastien explained, we need to rebuild our own inventory to be efficient in shipping. You need a certain level of product, and we are lucky we have many product line. Right now when we ship, we have a mix of watercraft, ATV, side-by-side. We optimizing the load for few dealers in certain area.
This will take a time to rebuild. In the factory, our efficiency will go back quickly. I think it will take a few months before we are overall as efficient as before.
Okay, thanks. Wondering if you could just give any other comments around the type of demand that you're seeing at the dealer level in terms of price points and the type of product, then maybe by at least within side-by-side, rec sport utility, how the demand profiles or the sales performance varies by those subcategories.
I would say it's all over. The demand is strong for every product line. Was a bit difficult for three-wheel because we had to stop all our different activity to continue our momentum. Even today, you cannot have a license, or you cannot plate your vehicle because license office are still closed. Except for three-wheel, now it's ramping up. I think we will recover the year, but the demand for all the product line are strong.
Okay, just the last one. Seb, you had mentioned the positive working capital flow-through for Q1. Just wondering about expectations for the balance of the year as production ramps up and inventories get moved around.
Yeah, I'm expecting Q2 to be a consumer of cash on the working capital side as we pay off suppliers, we rebuild inventory. That's going to be a negative, probably in the range of CAD 100 million. For the back half of the year, I'm expecting things to stabilize as they were in prior years and prior quarters.
Okay, thanks a lot, guys. All the best.
Thanks.
Thank you.
Your next question comes from the line of Tim Conder with Wells Fargo Securities. Please go ahead.
Thank you. Good morning, gentlemen. A couple of items. Just wanted to clarify and confirm a prior question here. Seb, you said that for fiscal 2020, the impact of the engine business that you're discontinuing was about CAD 0.60-CAD 0.70 in earnings?
Yes.
Okay. Gentlemen, can you talk about the potential incremental investments you may be making in e-commerce, either at the company level or with the dealer network that have maybe, as you've reexamined things through coming through the trough of COVID and now on hopefully the continued positive slope of recovery, to say, "We maybe need some more additional investments on e-com here," both again, at the company level or at the dealer level?
Yeah, Tim, it's more rebalancing our portfolio of IT investments. Obviously, we believe that there might be a continued phenomenon of people working from home. Obviously, everyone sees that. I've seen the trend of people shopping online, how do we make sure that we have the best tools for consumers or dealers? It's shifting of money, but it's not a huge capital investment that we're talking about. It's more reprioritized.
Okay. Then, José or Seb, whoever wants to take this. The pricing and promotions. Any way to bucket what you're seeing, what you saw in Q1 and are expecting here over the balance of the fiscal year into what may be, let's call it normal promotions, ex-COVID, and then COVID related, what you're having to do because of COVID. It's maybe a difficult question, but any way to sort of parse that?
Yeah, it's a difficult question. Let's say that promotion was quite aggressive on non-current, like it always do. Off-road, obviously, everyone want to benefit of the situation. On current, I would say it's about similar to what we see from some of our competitor over the last few years. I would say no big change before and after the COVID. Non-current, very aggressive, some model on the current. We were aggressive on retail promotion for consumers with a very good financing offer, zero interest for five years, and that definitely helped the retail because two, three weeks ago we didn't know how this would play. Overall off-road watercraft, I would qualify it as normal and three-wheel as normal. Going forward, it's very difficult to predict.
I think right now every OEM are chasing capacity and want to make sure to ramp up. Most likely people will be maybe a bit less aggressive on program. Very difficult to predict what will happen in the coming months.
Okay. Helpful. Then two last questions. One, do you see any furtherance of a working relationship with Brunswick outside of the supply agreement on the marine side? Lastly, your thoughts on the potential of when you could potentially return to fiscal 2020 levels in terms of revenue or, I would think profitability may have a quicker ramp given at least the CAD 80 million of structural savings on the engine side that you've eliminated.
On your question about Brunswick obviously is the perfect partner for us because they don't compete in powersports. It's a very good complement. We obviously are happy with the outboard supply agreement that we have with them, and we could in the future exchange technology but we'll see how this will play in the future.
On your question, obviously, I'd love to give you an answer this morning, to you and to the rest of the organization at BRP. There is obviously, as you can appreciate, there is still a lot of uncertainty how things will pan out, how the economy will react to massive job losses. Today, I'd say it is much too early to call when we believe things will come back to normal. The good news is, again, at BRP, I believe we are in a much better position than we were back in 2008 and 2009 with the Great Recession. You guys understand well the leadership positions we have in all our brands, and we believe that that momentum is going to continue as we are seeing it continuing when things come back to normal. Do we believe we will come back to fiscal year 2020 levels someday? Absolutely.
Today it's too early to give any outlook.
Thank you, gentlemen.
Your next question comes from the line of Benoit Poirier with Desjardins. Please go ahead.
Yes, thank you very much, and good morning, gentlemen. With respect to the engine contribution in fiscal 2020, was this CAD 0.60, CAD 0.70 on EPS was positive or negative contribution?
It was negative, Benoit.
Okay, perfect. Now with respect to Project Ghost and Project M, I understand the timing is unchanged, everything, but could you talk more specifically about who will be responsible of providing the engine and whether there's exclusivity or does Mercury need to build a new engine for this particular project?
Good morning, Benoit. Obviously, Benoit, for competitive reason, I cannot go into detail of your question. The only thing I can say is Project Ghost and Project M are ongoing. We are confident about our reoriented our strategy.
It will be an internally sourced technology, Benoit.
That will be manufactured by Mercury.
Well, we won't go into the detail, but again, our partnership with Brunswick is for the supply of traditional outboard engine. Our plans for Ghost do not change, and our plan for Project M do not change as well.
Okay, perfect. Okay, that's great color. José, you mentioned that CapEx will come back and will be reduced, obviously, and spending will be made on key projects. Would you maybe share some color on what you would consider as key projects right now? Maybe if you could share some discussion you had with the dealers, following the announcement around the electric bikes last fall. Thanks.
Benoit, we had before COVID an incredible momentum with all our product line around the world. In those reduction that we made, we did make sure that we protect as much as we can our five-year lineups for all product line. There is some adjustment here and there, but globally, we are very confident with what we're planning for the years to come. A lot of CapEx was related to plant maintenance, equipment turnover. That will slow down for a period of time, but we protected our five-year lineup. Electrification is ongoing. Again, we didn't disclose when those product will be offered. We'll see how all of this will play and how fast we can come back to the level that we had before the COVID-19.
Okay, perfect. Now when we look at your kids lineup, could you let us know how this product line is doing these days, and how would you compare your kids product lineup against your peers right now in terms of product offering?
You're talking which product line, Benoit?
I'm talking about the kids lineup, the DS 90, the DS 70, 225, I believe so. You have on the ATV side, you don't have your snowmobile for kids anymore, but just wondering whether you've seen more momentum around the kids products and whether you have the good offering as opposed to peers?
I think we have a competitive lineup in every segment that we are competing. We decide to compete. Overall, we didn't see any drastic change with what happened in the last month and a half for those product line. Like I said before, right now the surge in demand is touching every single product line, every price point, low-end, high-end. We didn't see a surge on the product for youth people.
Okay, perfect. Last one for me.
Hey, Ben, we need to move to the next caller on the line. Yeah.
Okay. Perfect. Thanks.
Sorry. Thanks.
Your next question comes from the line of Greg Badishkanian with Wolfe Research. Please go ahead.
Hey, guys. Good morning. It's Fred Wightman on for Greg. Just one quick one from us. If we look at the share gains in side-by-sides in the quarter, that was a big acceleration versus what we've seen over the past few quarters. How should we think about that gap going forward and what is driving that? Is it really just product availability in the channel, or is it something else?
Again, I believe we have very good competitive product. The Can-Am brand is more and more known. The awareness is improving. People like the quality of our product and how they ride. I think it's all those thing that are happening. Again, good product, dealer making good money, better margin with our product line. It's a combination of all this that created the momentum.
Great. Thanks.
Sure.
Your next question comes from the line of Derek Dley with Canaccord. Please go ahead.
Yeah. Hi, guys. Just a quick one for me. Just in terms of your dealer network, have any of them decided not to reopen due to the financial distress that was caused to some of them over the past month or two?
We've been very lucky. None of our dealers have defaulted on their obligations with either their financial institution or the floor plan partners. Obviously, the dealers came into this in a very good financial position because obviously our business with them has been growing, and they've made a lot of money with us. We've been proactive as well early in the COVID-19 by supporting our dealers with extended floor plan, working with TCF also to provide extended payment terms on interest that may be due, so they deferred payments by over 90 days. Now with the retail that we're seeing, obviously, that's providing good cash flows for the dealers. As of now, we're not seeing anything concerning on the dealer health side.
Is that more specific to you guys, the fact that you had zero of them have to close or what did you see overall in the industry?
Well, obviously, we know how our dealers are performing. It's not a business that we're looking at closely. Obviously, we work hand in hand with TCF. They're very proactive in assessing dealer health. Overall, I think, as I said, given that the dealers have made money with us and maybe had a period of two to three weeks where things were tougher, things restarted pretty quickly. I'm sure that brought a breath of fresh air to a lot of our dealers.
Okay. Thank you very much.
Your next question comes from the line of Jaime Katz with Morningstar. Please go ahead.
Hi. Good morning. Thanks for taking my questions. I'm curious, piggybacking on Tim's question, since we don't know when we get back to 2020 levels, are you guys basically tabling the 2025 plan for now and rethinking it o r do you think that there's enough road ahead of us that you guys can get back on track to achieve those goals? Thanks.
No, we don't know. The pillar of the M25 plan are still there, but before the situation stabilize and the situation, we have a better view on when we'll go back to what we call new normal, we don't want to commit on anything. At the right time, we'll definitely, if there is a need, realign M25, but for the time being, it's too early.
Jaime, when we announced M25 last fall, we did get the question, "Well, what happens if there's a recession?" What we said then, and it's still relevant today as well, if a recession happens, maybe it's going to slow us down by a year or a year and a half, but the ultimate goal does not change. Today, that's still our position.
Okay. At the end of the MD&A discussion, there was some commentary that internal controls for financial reporting were ineffective, and it looks like there were no material restatements surrounding that. I'm curious what the timeline for the mitigation of that is, just to get my head around what the timeline of maybe anything down the road that might come up with a restatement.
Yeah. Obviously, when we listed in the U.S. on NASDAQ, we were obligated to comply with the SOX requirements over the control environment. Related to financial reporting, obviously, we've always had clean audit opinions as you have seen, the quality of our numbers still remain, and José and I sign them every quarter, and we stand behind them. Related to the material weakness that was noted is around access controls around our systems. Obviously, we have compensating controls, the nature of the preventive controls need to be strengthened. The timeline to do this is over the next two years. Our objective is for fiscal year 2022 to be fully compliant.
Thank you. That's very helpful.
Your next question comes from the line of Cameron Doerksen with National Bank Financial. Please go ahead.
Yeah, thanks. Good morning. Just really one question from me, just with regarding gross margins, you talked about in Q1, kind of a 350 basis points impact from, I guess, COVID-19 related stuff. How should we think about gross margins in Q2 with revenue down 40%? I guess maybe also, if you could talk a little bit about what the second half of the year gross margin profile might look like on lower revenue, but on the offset, you've got the outboard engine that's not gonna be there. Just some commentary about gross margins in Q2, but also the second half of the year.
Well, I'm expecting gross margins to be impacted quite significantly in the second quarter. Obviously, well, our plant's gonna be closed for a month out of the full quarter. Inventory ramp-ups should help a bit on the margin side. Obviously with a significant reduction in volume, margins will be hit. When I look at the full year, I'll go to probably the EBITDA margin there. Again, if we hit those revenue numbers that I talked about, I'm expecting my EBITDA margin probably to be in the range of what we reported back in fiscal year 2018, fiscal year 2019 there. Those would be the numbers that I'd expected to meet for the full year, Cameron.
Okay. No, that's very helpful. I'll leave it there. Thanks very much.
Thanks.
Your next question comes from line of Brian Morrison with TD Securities. Please go ahead.
Thanks very much. I'll keep this quick. Appreciate your comments on working capital. Just in terms of Free Cash Flow for the year based on what you've just said, is it fair to say that you're looking at breakeven to slightly positive?
Free Cash Flow, we'll call it Free Cash Flow from operations, Brian. Yes, breakeven, but obviously with the discontinuation of outboard engine, there will be a cash outflow coming with that. The expected cash outflow is about CAD 60 million to CAD 85 million that we reported in our financials. That's gonna be a headwind to cash generation. I'm expecting to burn cash this year with the closure of outboard engine.
Okay, thank you. Just market share with the growth that you've had in side-by-side vehicles, specifically utility. Can you update us where you think you are?
Can you repeat your question? The sound is bad.
Sure. Sorry, just in terms of your market share with side-by-side vehicles, what do you think your current market share is with the growth that you've had, and specifically in the utility side?
Obviously, for competitive reason, we don't disclose the detail, but we are around 20% market share globally.
Thank you. Thank you very much.
Your next question comes from line of Brandon Rollé with Northcoast Research . Please go ahead.
Good morning. Thank you for squeezing me in here. Our conversation with dealers exiting Memorial Day weekend indicated a lack of inventory in four to six-seat units for side-by-sides, just from a surge of demand of families wanting to get into ORVs. Could you talk about, I guess, the timing for production ramp-up for those units and any risk you see from maybe families going to alternative maybe going to boats or RVs or going away from ORVs because of a lack of inventory of those larger seated units. Thank you.
Yeah. Like Sébastien explained, for sure, there is some customer who will show up at the dealership and will not have the exact model that he's looking for. He won't have the blue or the red that he is looking for. No doubt about that. If the customer want exactly what he need, he might be unhappy. That being said, we try to encourage transfer of inventory between dealership. Again, like we said, we're ramping up production. We're restarting production this coming week and we will try to refill the pipeline as fast as we can. Again, we know that in some area, some model will be out of some product.
Okay. Thank you. There was some fears that one of your competitors was ramping up production maybe a week or two before you, and they have product in the field. Do you see that as a concern at all?
For sure. Like Sébastien presented, our inventory level at the end of the quarter was higher than last year. We feel that we have sufficient inventory. We believe that for restarting the factories, we are all about at the same timing because we're all waiting for government to give us the green light to restart, maybe a week apart, but overall, we are in the same situation.
Okay. Thank you for that, José.
There are no further questions at this time. I will turn the call back over to the presenters for closing remarks.
Great. Thank you. Thanks, everyone, for joining us this morning. We look forward to speaking with you again for our Q2 call on August 27th. Thanks again. Have a good day.
This concludes today's conference call. You may now disconnect.