Good morning, ladies and gentlemen, and welcome to the BRP Inc.'s FY 2018 third quarter results conference call. I would now like to turn the meeting over to Mr. Philippe Deschênes. Please go ahead, Mr. Deschênes.
Thank you, Mo. Good morning, and welcome to BRP's third quarter conference call for fiscal 2018. Joining me on the call 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 under the investor relations section. With that, I'll turn the call over to José.
Thank you, Philippe. Good morning, everyone, and thank you for joining us. The third quarter is always very busy at BRP as we change model year lineups for five product lines, and we launch new models during our fall dealer event. In addition, this year, our snowmobile shipments are returning to a normal cycle. I'm very pleased with our retail momentum, particularly in our off-road and snowmobile businesses. Through it all, we stayed focused on our execution in all our operations. I'm happy to report this morning that the team once again did an excellent job and delivered solid results, which put us in good position heading into the fourth quarter. Let's start by taking a look at our financial results.
Our revenue grew 15% versus Q3 last year to reach CAD 1.2 billion, notably driven by the continued strong demand for our Can-Am side-by-side lineup and earlier snowmobile shipment compared to last year. Our normalized EBITDA ended just shy of CAD 200 million, up CAD 2 million from last year, third quarter, which was itself very strong, growing 39% from the previous year. Our normalized earnings per share reached CAD 1.05, up 13% from last year. While our financial performance was solid, the highlight of the quarter was certainly the strength of our retail sales. We just ranked 25% growth compared to an industry that we estimate was up high single digit percentage. This strong increase was in part driven by our snowmobile business as we had better unit availability in the network earlier in the season compared to last year.
Excluding snowmobile, our retail sales were up 12%, driven by another solid quarter for Can-Am side-by-side business, with retail up in the low 30% in an industry that was up a high single-digit percentage. Can-Am ATV also performed well with a high single-digit retail growth, gaining share in an industry that was up mid-single digit. Watercraft and Spyder had a more difficult quarter as retail was impacted by hurricanes Harvey and Irma. Spyder and Watercraft combined were down 18% in Texas and Florida. Another high point of the quarter was our annual Can-Am and Sea-Doo club that we held in September. Over 2,800 people joined us in Dallas, Texas, for one of the biggest dealer events in our history. It was certainly the most intense in terms of product introduction.
Delivering on our commitment to introduce a new side-by-side every six months until 2020, the highlight of the club was the launch of the Maverick Trail vehicle. This new 1,500 side-by-side opened a whole new world for Can-Am, since it is the first trail-ready side-by-side ever made by BRP. With its superior comfort, agility, and handling, we are convinced it will be a success with consumer. Production and shipment have already begun in the third quarter as planned. We also took steps to consolidate our number one position in the watercraft industry. We revealed an all-new platform that completely changed the onboard experience with its industry-leading stability and feature, notably with the introduction of the first OEM-installed, fully waterproof audio system. Likewise, we had significant news for Can-Am Spyder.
First, we introduced BRP Connect, a digital instrument panel that will enhance the consumer experience by offering smartphone connectivity for seamless apps integration while riding. This new user interface will be available on most of our 2018 Spyder lineup. The other key news for Spyder is the upcoming introduction in the fall of 2018 of an entry-level Spyder family for an MSRP starting at under $10,000 U.S. Following the success of our Sea-Doo SPARK watercraft, we believe this new model will be key to bringing the Spyder business to the next level. Finally, we also strengthened our Can-Am side-by-side lineup with multiple new models, especially adapted to the need of our riders. One of them is the Maverick X3 X rc, a vehicle with unique and advanced feature that are sure to please the rock crawling community.
Other key models were the mud-ready Defender X mr and the Defender MAX Lone Star edition, specially designed for the Texas market. Yesterday, we announced the extension of the Maverick X3 family of vehicle. The Can-Am Maverick X3 900 H.O., with all the popular X3 feature at the competitive entry-level price point, an MSRP of under $18,000. This is our first non-turbo X3 model, expanding our offering in the mid HP sport side-by-side market, which is more than twice the size of the high HP sport side-by-side segment in which the Maverick X3 Turbo R competes. The industry most powerful and first factory-made turbocharged mud vehicle, the Can-Am Maverick X3 X mr, sure to please the mud lovers who are looking for extreme racing performance and the extension of the industry exclusive Smart-Lok differential on more models of side-by-side, making our lineup even more competitive.
We will begin shipping these vehicles in January. Since the introduction of the Defender and Maverick X3 models, our side-by-side retail momentum is performing above expectation. In June, we invested in additional equipment in Juárez 2 to increase our capacity by 30%, which should be operational in the first quarter of fiscal year 2019. We are announcing today a second phase of investment to enlarge and add equipment to our Juárez 2 facility that should be ready in fiscal year 2020. The second capacity increase is earlier than originally planned. It was the optimal and most efficient solution to our capacity constraint since the retail momentum of the Defender and X3 model continues. The Maverick Trail was well-received and should create more side-by-side demand. We are confident that yesterday's extension to the Maverick X3 family will increase demand, and we have big plan for upcoming platforms.
This decision is a testament to the strong growth we see with our Can-Am side-by-side business and our commitment to further developing it. Let's turn to the product category review, starting with year-round product on slide nine. Year-round product revenue were up 20% in the quarter, driven by a higher volume and richer mix of side-by-side as we continue to see the strong demand for the Can-Am Maverick X3 and Defender models. We also started shipping the Can-Am Maverick Trail. Looking at the retail performance four months into the season, the ATV industry is up low single digit. For the same period, Can-Am ATV retail is up high single digit. Can-Am ATV is also gaining share internationally with double-digit retail growth in Western Europe, Brazil, Mexico and Australia, New Zealand. Can-Am ATV is performing well in both the high and the mid CC segment. Turning to side-by-side.
Four months into the season, the North American industry is up low teen percentage. Can-Am side-by-side continued to outperform the industry in the quarter with retail up over 30%. Globally, the trend is even better with our international side-by-side retail sales being up over 80% into the quarter. The Defender and Maverick MAX models are generating retail growth of over 100% in multiple market, most importantly in Mexico, China and Western Europe. Turning to Spyder. The North American three-wheel motorcycle industry ended its 2017 season with retail down low teen percentage. Spyder outperformed the industry for the season with retail down high single digit. As for the seven states in which we had dedicated teams, retail ended the season up low single digit, despite the fact that two key states were impacted by both Hurricane Harvey and Hurricane Irma.
We're also successful in right-sizing our network inventory level as we ended the season with inventory down about 40%. While we are aiming for more, we are pleased with the success we had in these key states. The insight from this past season will be applied to more states over the coming years. Turning to seasonal product on slide 10. Seasonal product revenue were up 18%, driven by earlier snowmobile shipments compared to last year. You may remember, due to the introduction of our new snowmobile platform last year, we had to shift production to later in the year. We had better unit availability in the network earlier in the year. Looking at retail, although still early in the season, the snowmobile industry is up in the high 20 percentage.
Ski-Doo retail is up in the high 70% range. Our retail growth was strongly influenced by the timing of shipment compared to last year, this performance is in line with our expectation at this point in the season and should normalize as time goes on. Turning to Watercraft. The industry ended its 2017 season at the end of September with retail up high single-digit. Sea-Doo experienced growth in both the traditional watercraft and SPARK segments and ended the season with retail sales up mid-single-digit. As a reminder, this is the first season where the SPARK model had competition in the entry-level segment, which had an impact on our market share for this product category. We are just starting the season in counter-seasonal markets such as Brazil, Australia, and New Zealand, where we are already seeing positive signs for 2018.
The watercraft industry is in a very good position. Since the introduction of the SPARK, the North American industry has grown by 55%, in part because of the entry-level segment. Sea-Doo continued to gain market share with three additional percentage points during the season 2017. The North American success is similar to many markets worldwide, which shows that this industry is well-positioned to continue to grow. This is why we are investing in increasing capacity in our Querétaro facility by 20%, which should be operational in the second quarter of fiscal year 2019. With the strong Sea-Doo brand, the most complete lineup in the industry, and more production capacity, we are well-positioned to continue to grow in this business category. Looking at propulsion systems on slide 12. Revenue for propulsion systems were pretty much flat in the quarter.
We have previously explained, the trend of package with boat over loose engine is continuing, with the engine-only segment weakening. In terms of retail, four months into the season, the North American outboard engine industry is up mid-single-digits. For the same period, Evinrude retail is down mid-single-digit percentage. We attribute this in part to our belief that we were not aggressive enough in our promotion this quarter. On November 1st, we've launched our 10-year warranty coverage promotion that should last until next April. We are already seeing positive results to date. We also had great news for our Rotax propulsion system business, where we introduced our first-ever Rotax electric power pack for karting. This new power pack provides a new customer experience with extremely good performance and unique features, such as the boost function to pass competitors, low noise, and low emission.
It represents an important step into electrification for the karting business. Looking at Parts, Accessories, and Clothing. Revenue of Parts, Accessories, and Clothing increased by 5%, resulting from higher volume of side-by-side accessories and snowmobile parts sold. Accessories are a significant part of the customer experience, and with the new Maverick Trail, this experience was enhanced with the development of 125 accessories available at launch. With that, I will turn the call over to Sébastien, and will return for closing remarks.
Thank you, José, and good morning, everyone. We are pleased with our results, which have been very solid so far this year, with year-to-date revenue growth of 12%, normalized EBITDA growth of 21%, and normalized earnings per share growth of 48%. With two months to go before the end of the year, the demand for our products remains strong and is allowing us to aim for the higher end of revenue guidance ranges for year-round products, seasonal products, and PA&C. While our guidance implies for results that may come in below last year for the fourth quarter, this is simply a result of a change in timing of snowmobile shipments. Our business fundamentals remain strong. We are well positioned to deliver our guidance and continue our growth path into next year. Let's turn to the quarterly financial results.
Today, we reported revenues of CAD 1.24 billion for the quarter, representing an increase of over 15% over the same period last year. As José mentioned, the growth was primarily driven by higher volume of side-by-sides and earlier snowmobile shipments compared to last year. Revenues grew across all regions, with the U.S. being up 8%, Canada up 25%, and international up 20%. We generated CAD 329 million of gross profit, representing a gross profit margin of 26.6%, down 180 basis points from last year's third quarter, primarily due to higher production costs and unfavorable foreign exchange rate impact. We achieved CAD 199 million of normalized EBITDA and a quarterly normalized earnings per share of CAD 1.05, an increase of 13% over last year. Finally, we generated CAD 156 million of free cash flow, an increase of CAD 27 million over last year.
On the term loan, we successfully completed a $100 million U.S. increase, as well as a reduction of 50 basis points in pricing, providing us with additional financial flexibility to invest in our growth plans. Looking at slide 15, our normalized net income was up CAD 5 million in the quarter, primarily driven by a positive impact coming from volume and mix, resulting from incremental shipments of our Can-Am SSV lineup, as well as the new snowmobile platform. Partly offsetting this gain were a slight negative impact from pricing and sales program for CAD 15 million, driven by a strong growth in retail sales, higher production costs and operating expenses for CAD 44 million, and a negative impact from foreign exchange rates for CAD 16 million. Turning to slide 16 for a look at our network inventory, which ended the quarter up 9% versus last year.
Overall, the level and quality of our network inventory remains very healthy. The growth continues to be driven by our side-by-side business, for which inventory is growing in line with retail demand and by the expanding business with the new dealers we added over the last years. Our snowmobile inventory is also up slightly over last year and is currently at an appropriate level ahead of the upcoming season. The increase was partly offset by the successful right-sizing of our Spyder network inventory, which we were able to reduce by about 45%. Finally, turning to slide 17 for more details about our guidance for FY 2018. As I mentioned earlier, the strong demand for our products is allowing us to aim for the higher end of our year-round products, seasonal products, and PA&C revenue guidance ranges.
We are now expecting year-round products revenues to be up 11%-12%, seasonal products to be up 1%-3%, and PA&C to be up 7%-9%. However, due to the slower-than-expected retail in the quarter for Evinrude, we are reviewing downward the propulsion systems revenue guidance to -2% to 1%. The net impact of all these adjustments brings our total company revenue guidance to up 6%-8% for the year. Other than these adjustments, the rest of the guidance remains essentially unchanged, with the exception of the effective tax rate, which we now expect will end the year between 27% and 28%. This change in tax rate is allowing us to increase the lower end of our normalized earnings per share guidance by CAD 0.02, resulting in a range of CAD 2.25-CAD 2.35, a growth of 15%-20% compared to last year's result.
As usual, at this time of the year, we have good visibility on our shipment volumes and our expenses for the rest of the year. Our focus at this point is on executing our plans, including the capacity expansion and on ensuring a successful snowmobile season. Again, as mentioned earlier, we are facing a very tough comparable in the fourth quarter, as last year was heavier than usual in snowmobile shipments due to the introduction of the new snowmobile platform. For this reason, our guidance implies a fourth quarter that might come in slightly lower than last year. Still, as you can see with our retail growth, our recent product introductions, and our ongoing incremental capacity investments, our business remains very strong, and we are well-positioned to deliver a strong Q4 and continue to grow in the future. With that, I will turn the call back to José.
Thank you, Sébastien. To recap, with the exception of our Evinrude brand, all our businesses are doing well, and our results for the third quarter are in line with expectations. All new products were well received by the network and media, and we are sure our customers will feel the same. Quarter after quarter, our off-road retail results continue to beat the industry. Our snowmobile momentum is ongoing due to the new Ski-Doo Gen4 model that are creating a lot of excitement. We are building the future with our expansion of the Querétaro facility to support watercraft growth, which will be operational in the second quarter of fiscal year 2019. To support our side-by-side momentum, we have initiated 2 phases of Juárez 2 capacity increase.
The first should be ready in the first quarter of fiscal year 2019, the second is planned to be operational in the first quarter of fiscal year 2020, which combined more than double our current capacity. In addition, we are opening a regional business hub on the outskirts of Dallas, Texas in February 2018. This will provide us greater proximity to that market and the U.S. at large, allow us to be better connected to our dealers and customers there, and position us to seize its growth opportunities. These are some of the highlights that show our commitment to generate growth from launching innovative products to increasing production capacity and transforming our sales operation.
I am very pleased with the team's execution in this last quarter, I'm confident that we will deliver our year-end guidance, which is a 15%-20% growth of our normalized earning per share, we plan to continue this momentum next year. With that, I will turn the call over to Mo for questions.
Thank you. Please press star one at this time if you have a question. There will be a brief pause while participants register for questions. We thank you for your patience. Our first question is from Steve Arthur from RBC Capital Markets. Please go ahead.
Yes, hi. Thanks very much. Just the first question in terms of the capacity expansions. In the MD&A, talked about allocating yesterday CAD 100 million for these expansions. Not really looking for specific numbers on the forward years, but, if we look at those CapEx plans, does that tend to keep it in that kind of CAD 250 million range that we're seeing this year? Is this kind of incremental, and we'll likely see higher numbers to support these growth initiatives?
Yeah. Good morning, Steve. Obviously, this year, as you know, we announced capacity increase investments, which we adjusted our guidance upward to the range of about what you see today, the CAD 240 million-CAD 255 million. Obviously, with that CAD 100 million investment, a good part of it is going to be next year, We're still going to continue investing in our lineups and modernizing our other facilities. Yes, I would expect our CapEx to be above the CAD 250 million for next year.
Okay. With these kind of investments in the Mexican facilities, should we read into that your view of there being likely fairly modest changes to NAFTA? Or if there are changes, nothing that would materially alter your manufacturing footprint?
Yeah. Well, the investment is not only in our Mexican facilities, it's also in our engine capacity as well. Some investments are happening in Austria. Some investments are also for supplier tooling. Not all of that CAD 100 million is being put into Mexico. Obviously, when you have strong consumer demand for products, the worst thing you can do is not meet that demand. We are very focused on making sure that we can meet that demand and satisfy the dealers as well. Our view on NAFTA, it hasn't changed for us. It's the status quo. We run our business as we believe it should be run. There are many variables that are still pending on NAFTA, and we've shared these variables with the investor community in the past, but maybe I'll just cover them again.
The first one is, well, what are, if any, U.S. content or NAFTA content adjustments that are going to be imposed? For today, that's a big question. What are the penalties or tariffs that can be imposed if you do not meet those requirements? Also the impact coming from tax legislation in the U.S. That also could influence investment decisions when NAFTA is known. Also the time to be compliant. There is going to be a transition period. For us, given all these variables and given the uncertainty, or the unknown related to these variables, we're just proceeding ahead. These are businesses or investments which have a good return, and that's why we believe it's the right decision to make.
Maybe to add, Steve, to the comment on NAFTA. We cannot wait for the government to agree to run our business. We're running our business, and if there is some change, we have the agility to adapt and move forward.
That makes good sense. Just one final one for me. You both mentioned looking for continued growth momentum into next year. I expect you will offer a more formal outlook with the Q4 results in a few months. Any commentary related to the kind of anticipated growth rates, margin improvement, any deviation, higher or lower from what you previously talked about with your five-year longer term plans?
Yeah. As you said, we will give you full disclosure on guidance at the fiscal year 2019 in March when we report on our fiscal year 2018 results. I have been looking, obviously, we are planning for next year, our financial planning is underway. In the recent days, I looked what the market is expecting for next year, in terms of EPS growth, I feel comfortable that we will be able to deliver that next year. That would be, if you look at the midpoint of the EPS range that we have in our guidance this year, we are at above a 15% EPS growth for next year as well.
Okay. Good comments. Thank you.
Thank you. Our following question is from Anthony Zicha from Scotiabank. Please go ahead.
Yes. Good morning, gentlemen. José, could you please provide us a bit more color on your snowmobile sales and looking into fiscal 2019, which areas do you have the least amount of visibility?
On the snowmobile sales, I would say if you look at our retail curve this year, it's similar to what we had in fiscal year 2016, not 2017. We are back to a normal curve, plus or minus a week or two. It was planned like this, and we're very happy because so far, we are tracking to the normal cyclical curve of snowmobile. I would say a bit early to celebrate, but so far, the snowmobile season seems to have a good start. Talking yesterday, one of our board members is going to ride snowmobile up north over the weekend. It's a bit earlier than we typically do, but like we say, we won't celebrate right away. In terms of fiscal year 2019, obviously we have order on our hand for the Spyder model year 2018, the first half of the season.
Watercraft, we have order on hand. Snowmobile will take order for next year at our February event, finalize the order booking in April. ATV and side-by-side, we're taking orders on a monthly basis. Right now we know exactly how much off-road will deliver till the end of January, till the end of this year. The momentum with off-road, to be honest, it's going extremely well, and we're very pleased to outbeat the market quarter after quarter. Overall, if the global situation remains as is, we are quite confident about the capacity to continue our retail momentum.
Okay, great. One last question. Could you give us a bit of a perspective on the M&A outlook? If you're looking at a deal, how large would you consider a deal, and what would be the maximum amount of leverage you'd be comfortable with?
Obviously, when we announce something, we'll be announcing it to the general public at large. For now, there's nothing new to announce. The teams are still looking at opportunities. We're having discussions with the board as to where could be our next play. That's ongoing. In terms of leverage, when we IPO'd, we were slightly below three times leverage, and that's a place we were comfortable at IPO time, and it's a place we could be comfortable operating as well, if we were to do an acquisition and needed to lever up.
Thank you very much.
Thank you. Our following question is from Seth Woolf from Northcoast Research. Please go ahead.
Thank you, guys, and thanks for taking my question. Congrats on a good quarter. Two quick questions for me. First, José, on the product portfolio, I think big news getting into the entry-level market. It's obviously much bigger than the premium market you started with in the sport category. Just what are your thoughts on the price point? Because you've got some competitors that have lower price points, and do you feel like over time that's an area that you need to address as well, or do you feel comfortable with where we're at?
Yeah. Assuming you're speaking side-by-side?
Correct. Excuse me.
The side-by-side, obviously when you're launching a new platform and with the DNA of Can-Am, you start at the high end of the spectrum, and in time you're going in the lower end of the spectrum. It makes a ton of sense. What we're doing right now is just continuing to expand or to leverage the investment that was made in our two key platform, the Defender and the X3. Defender, if I look at the base Defender HD5, we're very well positioned versus the competition. When I look at the Maverick X3 900 H.O., no turbocharge that we've launched yesterday, we're extremely well positioned with some plus and minus versus the product of our competitor, but exactly at the same price point than the biggest seller into the industry.
Overall, we continuing to expand to leverage the investment we made in our two key platform, and we are extremely well positioned. The new one, the Maverick Trail, also extremely well positioned in pricing. We're just starting, to be honest, to expand our lineup in those entry level price point, you can expect from us to continue to expand in more model, more variation in those price points.
Okay. Thank you for the color. I appreciate it. Real quick, Sébastien, you may have touched on it, and if you did, I apologize for the redundancy, but looks like the sales and marketing, the rate of change kind of accelerated a lot. Is there something, like a timing event or one time that's going into that, and how should we think about that going forward?
Yeah. This year we shifted our marketing dollars from Q1 more towards Q3 for ORV. That's why you have an increase of about CAD 13 million, CAD 14 million in marketing spend this quarter. It's something that I would expect to continue going forward. Retail period for ORV is big in the fall, and making sure that we're out there being seen is essential, and that's why we're going to likely continue that strategy.
Okay. All right. Thanks, guys.
Thank you.
Thank you. Our following question is from Cameron Doerksen from National Bank Financial. Please go ahead.
Yeah, thanks. Good morning. Wonder if I could maybe just ask a kind of a bigger picture industry question, and that is, we've got, I think, very strong sort of economic indicators out there. Consumer confidence is at a 17-year high. It seemed that the sort of underlying dynamics in the industry, certainly in North America, would be very positive. I'm just wondering if you can comment on what you're seeing out there, maybe some commentary about what markets geographically are particularly strong and what ones are maybe lagging a bit.
Yeah. Obviously North America is doing well, I think it's positioned to continue to do well. If I look at the big picture, if you take APAC, that's the beauty of BRP. Maybe as a general statement, right now we're growing in every country in the world. APAC is having a constant stable growth. China, for us, is growing at a fast pace. Small number, but growing at a fast pace. I think the highlight of the beginning of the year is Latin America. We see Brazil, Chile, coming back. We have very strong. We put Mexico and Latin America. We put Mexico, very strong momentum in Mexico, particularly on off-road. If you look at Europe, Western Europe is a continued growth. Not the fast pace that you see in other country, but constant continued growth.
Scandinavia, now we're starting to see some positive sign of Russia. We still are in the 25%-30% of what it used to be. We started to see some positive signs from Russia. When you look at the big picture, what I'm very pleased with, the six product line we have are extremely competitive. On top of it, there is always plus and minus, managing our business. There is right now a good momentum in most of the region in the world. We believe if the global economy don't change, we are pretty well-positioned to continue to grow in the few years.
Okay. Excellent. Maybe just a quick question on the, I guess, the Q4 guidance items. Just, I guess, a couple of things I wanted to ask is first on the CapEx in Q4, the guidance sort of implies that Q4 is going to be significantly higher than what we've had in the previous quarters. I wonder if you can just comment on that. Sort of the same question on depreciation. It seems like there's going to potentially be a big increase in Q4.
Yeah. Q4 historically has always been a big quarter in terms of CapEx investments. This year, similar to last year, will be the same case. Well, as this year, our CapEx is much higher than last year. That's why you're seeing a bump in Q4. In terms of depreciation expense, same phenomena as last year. We had higher investments coming in. You'll see that impact on depreciation being reflected as well in the fourth quarter.
Okay. Very good. Thanks very much.
Thank you.
Thank you. Our next question is from Mark Petrie from CIBC. Please go ahead.
Hi, good morning. I actually just wanted to follow up quickly on a couple of the topics that you've already touched on. José, when you're speaking about the regional sort of commentary, could you just give us a sense of how Western Canada is performing for you guys?
Western Canada is still below Eastern. I would say it stabilized in the last, since the beginning of the year. We see a better momentum in the East than we saw in the West. Let's say I would call it stable. East is still better.
Okay, thanks. Sébastien, with regards to your comments around NAFTA, obviously you guys have grown quite a bit since you last gave us a sense on terms of the dollar shipments moving from Mexico into the U.S. and from Canada into the U.S. Could you just give us a sense or a range of where you guys sit today?
Yeah. The growth has happened mostly in between the U.S. and Mexico. Last year, we were talking about CAD 1 billion of trade happening between those two countries. Today, we're looking more at a CAD 1.2 billion of trade. Now, if NAFTA were to be, let's say, abolished, what are the consequences? We'd fall to pre-NAFTA free trade agreement that existed between Canada and the U.S. That could be a likely outcome. As we had talked 12 months ago, you're probably looking at WTO tariffs between Mexico and the U.S., and that could be in the range of 2%-2.5% on a total trade volume of, let's say, CAD 1.2 billion. Obviously, it's not a scenario that we would prefer.
We would prefer the status quo, but if it were to happen, if we're talking about, let's say, a CAD 25 million-CAD 30 million impact on our results, it's something that we could most certainly manage. That would be addressed through either supplier reductions or increases over to the consumer. Do as we do every year. We optimize our business. A 1%-2% optimization every year is something that we target. It's something that we could absorb.
Okay, thanks. That's helpful. Then just with regards to the additional capacity expansion with Juárez 2, I think the Spyder S is going to be produced there, if I'm not mistaken. Could you just help us sort of think about how that investment supports potential growth for that product?
Yeah. The investment we are announcing today is only for Juárez 2. You visit the site, and right now, we are investing for more side-by-side in Juárez 2. The Project S will be assembled in Juarez 1. Still there, we have ATV and the Commander. The Commander is still assembled in Juarez 1. Because of the configuration of the vehicle, we cannot bring it to Juárez 2. All the investment we talked this morning is Juárez 2.
Okay, perfect. Thank you.
Thank you. Our following question is from Jaime Katz from Morningstar. Please go ahead.
Hi. Good morning. Thanks for taking my questions. I'm curious if you guys can talk a little bit about in-house inventory. It looks like total inventories have grown a little bit faster than top line, but I think a lot of that is work-in-process inventory and not finished goods. Just want to make sure that's to facilitate new products rather than anything else.
Yeah. One of the items that impacts inventory as well is as we're building capacity, obviously, we're building raw material inventory for shipments in January and through Q4. Also the personal watercraft business, which is growing and international, and the lead time to get the vehicles in market or international are a bit longer. That's why we, as that business is growing, that's why we have additional inventory.
Okay. Can you give us an update on how you think about dealer programs going forward, how that might impact gross margin ahead, whether you think you can sort of take the pedal off of that a little bit, and whether or not maybe some of Arctic Cat's old inventory has been sort of cleaned out of the channel, so there's not so much promotional cadence to get that stale inventory out, sort of helping the health of the entire industry?
Yeah. We don't plan to change drastically our program. If things continue to go as is going right now, we don't plan to change drastically our program. We keep every end of the season of a model year, like snowmobile, the end of the season will be February, March 2018. Depending of how the retail goes, we could adjust, but except those end-of-season adjustment, we don't plan major change into the program. In the Q3, some of our competitor were very aggressive with program, and we didn't follow. We decided to keep the course. Definitely, despite our 30% up growth for off-road, we were able to deliver that growth without following our competitor. We believe and we hope right now that most of their model year 2017 is retail, and it will come back to a more normal, I would say, situation.
We're very pleased with our momentum in Q3, despite we didn't follow some of our competitor.
Okay. Lastly, just as sort of a housekeeping, I guess, question. For Ski-Doo, you guys had mentioned that the retail was up in the high 70% range and that the industry was obviously significantly slower than that. Can you remind us what percentage of sales happens this early in the season, just to sort of get a perspective on what the read-through for that might be?
That's a good question. We might have to come back to you, but I would say probably 70%, 60% happened before Christmas, I would say.
Okay. That's helpful. Thank you so much.
Thank you.
Thank you. Our following question is from Craig Kennison from Baird. Please go ahead.
Good morning. Thanks for taking my questions as well. Clearly, your side-by-side retail strength is a function of your own share gains. I'm curious to what extent you're seeing improving trends in agriculture or rural markets. We've certainly seen some companies in that universe begin to perform better. Maybe there's some percolating demand in that market.
I think all the product that the OEMs are introducing are better. Our product have more feature than five years ago and ride better and better performance. I think this is generating this renewal cycle that we're looking for. I think the side-by-side market right now is healthy because there is a lot of good product that are offered by OEM. This is what keep the industry growing.
Maybe just to follow up on that, in addition to all of the product innovation that you've really led, to what extent do you think that rural consumer just has more discretionary income to spend? To what extent is that driving any of the upside?
Obviously, this is something I forgot. The utility side-by-side, our Defender category, this is about 60% of the side-by-side market. That's a segment where we were not there. Right now, every quarter, we're growing in the Defender category at a good pace. This is for us, a very, very important white space that we're trying to continue to benefit as much as we can. Again, depending of the quarter, there is ups and down. We see that the utility segment, the farmers, the utility, the company that are buying those products, this is a more stable purchase with less variability than the sports segment or the trail segment.
Great. With respect to your move into Texas with an additional headquarters there, maybe you could just develop the rationale behind that move and maybe cover whether there are any tax implications that are material from that move.
No. It's more a business decision, that decision was taken about a year ago, I would say. The situation is this, is more and more you need to have the national tactic in country, but you need to also to have regional tactic. We're doing here from Canada, the national tactic, but we believe that being based in Dallas, in the Southwest, an area where we need to get better, it will be easier when the people are sitting there together to define what are the regional tactic. Today, marketing is getting more sophisticated. We're trying to do as much as we can, but it's a combination of the national campaign reinforced with tactic in each of the region.
This is the main reason why we decided to have a business hub in United States, particularly Dallas, because this is an area where it's offering a huge potential, we believe that if our people are sitting in Dallas, in the Southwest, they will do a better job to define regional tactic.
Great. Thank you.
Thank you.
Thank you. Our following question is from Robin Farley from UBS. Please go ahead.
Great. Thanks. I wanted to clarify two things on the off-road market. You mentioned in your opening remarks that the industry side-by-side was up high single digits for the third quarter. The presentation shows up low teens for the season to date, which I guess the difference is really just the one month. Does that imply that maybe the industry for just the month of October is actually up less than high single digits? It seems like for there to be such a difference between those two periods, that maybe October, I'm just curious if you could give us some color on what's happened just with that more recent trend.
Well, we don't necessarily have the month-by-month industry trends with us this morning, and we'll be glad to share more detail if needed, but obviously, depending on what's being offered in terms of promotion, that's influencing the overall industry demand. Key message is that we're seeing continued growth in the side-by-side industry. Season to date is extremely favorable. The quarter was favorable as well, and our performance as well is above industry, so we couldn't be any happier. Obviously, the tactics on product introductions and also expansion of the dealer network is paying off, as you see. We can give you more granularity once we get the data.
The thing, Robin, there is no industry data in the side-by-side business. We're doing our own survey to better understand, and we do it on a quarterly basis. We'll look at it what we have on the monthly basis.
Just the math of it, just based on what you said for the quarter, it seems like the math would suggest that, great.
Yeah.
Looking at your changes in guidance, kind of bumping up to the higher end for revenue, with the FX impact, it kind of implies that you're going above your guide, that your guidance range would be up more on a sort of a constant currency basis in revenue. I just want to confirm that I'm looking at that the right way. Your margin guidance, maybe sort of the implied margin guidance, maybe down 10 basis points or something. You mentioned the promotional environment and the selling environment contributing to some of the margins being down year-over-year.
Is that something that you see ongoing or just a moment ago, you made a comment that maybe implied that there's a little bit less aggressive promotional environment in more recent weeks as some of the model year 2017 out in the market has been retailed already. What are you seeing sort of now that we've gone through November in terms of the promotional environment? Do you think that's something that you're going to continue to see at levels as aggressive as what you saw in the October quarter? It sounds like maybe you could see that stabilize a little bit.
Yeah, let me try to nail off the three questions that I captured from your statement.
I thought you would.
That's okay. The first one on the overall on the revenue versus when we announced guidance back in March, the FX is slightly unfavorable to us with the strengthening of the Canadian dollar. That's about an impact of 2% negative on our revenue number. Yes, we're still maintaining the initial guidance that we had back in March coming from better volume that we've experienced throughout the year. On the margin side, a bit compressed, yes. The fact that we're running above what I'll qualify as design capacity obviously makes us incur a bit more cost. On the labor side, you're paying more overtime and not all of the hours when you're running overtime, especially seven or three shifts a day, not all of the hours that are paid are productive hours.
You're also farming out a bit more work, especially on the engine side, in order to allow us to meet capacity. We're incurring a bit more cost there. On the promotion side, in terms of margin impact, yes, it is unfavorable as our retail is higher than our wholesale. If you look at Q3 for just North America, our wholesale was up 17% while our retail was up overall 25%. That obviously means that you're paying or expensing a bit more promotion dollars versus on a unit per unit basis. Then on your third question on promotional activity, depending on which OEM has inventory and how they're positioned, that influences, obviously, the promotional environment. We've had some OEMs that had some inventory issues that have, I guess, resolved some of that, so there's a bit less promotional activity happening.
The OEMs are still mindful that consumers are looking for discounts and looking for deals. That's going to continue going on in the near future, especially on ORV, as a lot of the retail that happens in a given model year or season is non-current inventory. For seasonal product, it depends on weather and how OEMs forecasted the industry, and if they have too much inventory, then yes, they'll probably be tempted to push more programs. It's something we monitor on a monthly basis, and we adjust to market conditions and inventory positions. Hopefully that covered all topics.
Yeah. That does. Thank you.
Thanks.
Thank you. Our following question is from Gerrick Johnson from BMO Capital Markets. Please go ahead.
On the promotion question, you're saying that the impact from promotions is 100% from higher retail sales and there's no impact from higher levels of promotion on each unit?
No, our promotional level is pretty consistent with last year. Our non-current inventory as well is healthy, let's say, on ORV. We've looked at some numbers on our promotional activity versus the competition, and we were not more aggressive than some of the other OEMs.
Okay, can you talk about the impact that's coming through from rising input costs? I'm not talking about your overtime, but materials and things like that.
We are seeing commodity prices go up. However, the way we have our contract structured with our suppliers, we'll call it contractually hedged with our suppliers, and therefore, we're not seeing those input costs coming in immediately. If the commodity prices were to maintain at that level, we would see prices go up for next year in our overall production costs. As of today, we haven't felt the pinch of commodity increases.
Right. Okay. Then on outboard, you have the new mid-range G2s out there. If you just looked at the G2 alone and excluded the legacy Evinrude, how is the G2 performing year-over-year in retail?
Yeah, the G2 is gaining momentum. Obviously, we enter with the 150 to 100 about a year ago, and we're gaining momentum, I would say, worldwide. We are in that transition phase where we're still producing the G1 in that category and the G2, and we will drop some G1 in time to come in the next few years. The G2 is doing quite well worldwide, and we're convinced that we will continue to grow that business.
Okay. Since I'm probably the last guy here, I'll ask a couple more. I'm surprised PAC wasn't better considering tow, SSV, and snow was pretty good at retail. Why is PAC not performing better than plus 5%?
Yeah. Well, PAC, we've done some, we'll call it initial order shipments happening in Q2. We are going to be delivering as well increased PAC in the fourth quarter. It's very dependent on the snow season and the riding. The dealers finished off with a bit more inventory as well last year following a soft snowmobile season, so they did not need as much replenishment as usual, and that's one factor as well influencing overall PAC sales.
All right. That makes sense. Thank you.
Thanks.
Thank you. Our following question is from Jean-François Lavoie from Desjardins Capital Markets. Please go ahead.
Yeah, good morning, gentlemen, and thanks for taking my question. I was wondering if you could circle back a little bit on the Commander market and give us a bit color on this particular vehicle, please.
Yeah. Good morning. The Commander, this segment is and I'm going by memory. This segment is about flat. Here, I have the data. The segment right now is growing low double digit year to date, and we've lost some market share. We lost low single digit market share in that product category. Overall, we're growing in that segment because of more competitive product.
Okay. Thanks. Good color. On the Maverick Trail, I was wondering, given the excellent reaction with this new project, are you kind of looking at the overall market, and is it something that you think could be bigger than initially expected or?
Yeah. First, I believe in that product category, there was not any major product news in the last five years, we're coming out with, we believe, a better product than what exists out there. Overall, the reception of the vehicle is extremely good by media, we already started some of the retail. We believe that this is a smaller segment of the industry, we believe that this segment could get bigger because we believe we did bring to the industry a better unit than what have been introduced in the last five years. It's too early, that's our feeling at this point.
Okay, perfect. Maybe a last one on the gross margin side. You may mention some production costs related to the capacity. Going forward, how should we look at this impact on the gross margin for maybe Q4 or the beginning of next year?
Yeah. We'll also have some challenges in Q4 and next year as well. We talked about when that capacity's going to be coming into play. Next year, we'll be seeing a step in the second quarter in terms of capacity. We are running, let's say, above design capacity in Querétaro for the hull and deck. We're running 24/7 in Juárez as well. We're running 24/7 on the fabrication side. When you're running at these levels, obviously you're incurring a bit more cost in order to fulfill the assembly line. We'll be seeing that trend, as I said, in Q4 and the beginning of next year as well.
Okay, perfect. Thank you very much, congratulations on the strong quarter.
Thank you.
Thank you.
Thank you. Our following question is from Tim Conder from Wells Fargo. Please go ahead.
Hey, good morning. This is actually Marc Torrente on for Tim. Great quarter again. You provided some good color on ORV promotions. Just any color you could provide on snowmobile promotions early in the season from a competitive standpoint? Then you guys are also making very good progress on Spyder inventories against your goal. How much further do you have to go, and do you expect to have inventories ready and retail stabilized ahead of the Project S launch?
First, on snowmobile front at this point, I would qualify the retail environment as normal. Typical level of promotion on non-current and so far on new model, there is not much promotion out there. I would qualify the start of the season for snowmobile as normal. Typically, in snowmobile, you have a trend after Christmas. It's rare that before Christmas you see a big gap between the normal situation. On the Spyder inventory, the plan was to deplete the inventory over 2 years. We are right on where we were targeting at the beginning of the season. We'll continue on this next year, and we believe it will be in very good shape. That was the idea. We believe it will be in very good shape at the end of next season 2018, prior to the Project S intro. We are on plan, basically.
Okay, great. Thank you.
Thank you.
Thank you. We have no further questions registered at this time. I would now like to turn the meeting back over to Mr. Deschênes.
Great. Thanks, everyone, for joining us this morning and for your interest in BRP. We look forward to speaking with you again in March for our fourth quarter conference call. Thanks again, everyone, and have a good day.
Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.