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Polaris Industries, Inc. (NYSE:PII)

Q3 2011 Earnings Conference Call

October 18, 2011, 11:00 a.m. ET

Executives

Richard Edwards - Director, IR

Scott Wine - CEO

Bennett Morgan - President and COO

Mike Malone - VP, Finance and CFO

Analysts

Tim Conder - Wells Fargo Securities

Greg Badishkanian - Citigroup

Ed Aaron - RBC Capital Markets

Scott Stember - Sidoti & Company

James Hardiman - Longbow Research

Rommel Dionisio - Wedbush Securities

Shawn Bitzan - Feltl and Company

Gerrick Johnson - BMO Capital Markets

Craig Kennison - Robert W. Baird

Jimmy Baker - B. Riley & Company

Scott Hamann - KeyBanc Capital Markets

Good morning. My name is Alicia, and I will be your conference operator today. At this time, I would like to welcome everyone to the Polaris Third Quarter Earnings Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you. Mr. Richard Edwards, Director of Investor Relations, you may begin your conference.

Richard Edwards

Thank you, Alicia, and good morning, and thank you for joining us for our Third Quarter 2011 Earnings Conference Call. As before a slide presentation is accessible at our website at www.polarisindustries.com/irhome, which has additional information for this morning’s call. The speakers today are Scott Wine, our Chief Executive Officer; Bennett Morgan, our President and Chief Operating Officer; and Mike Malone, our Chief Financial Officer.

During the call today, we will be discussing certain topics including product demand and shipments, sales and margin trends, income and profitability levels, and other matters, including more specific guidance on our expectations for 2011 and 2012, which should be considered forward-looking for the purposes of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those projections in the forward-looking statements. Additional information concerning these factors can be found in Polaris’ 2010 Annual Report and Form 10-K, which are on file with the SEC.

Now, I'll turn it over to Scott. Scott?

Scott Wine

Good morning. Thank you for joining us and for your interest in Polaris. We recently completed third quarter it was quite busy for our Polaris team. Since we last spoke in July we hosted a great dealer show in Nashville, completed a major reorganization of our leadership team, launched an exciting new model year ’12 lineup, split the stock, continued the integration of our Indian and GEM acquisition and shipped our 10,000 side-by-side from our Monterrey facility.

This team has been very effective in executing our priorities and growth plans and while we do not pretend to be immune to the impact of market volatility, our commitment to staying nimble, winning the competitive battle and making growth happen remain strong.

Results for the third quarter were robust and reflected broad strength in our portfolio as we delivered record sales, net income and earnings per share. Sales for the third quarter increased 26% to $729.9 million, marking the first time in our history where quarterly sales surpassed 700 million. Year-to-date, overall Polaris revenue was up 37% including a remarkable 58% third quarter sales increase from our team in Europe where they are proving that innovation and value can trump adverse market condition. Not to be out done, our Asia Pacific, Latin America team increased revenues by 64% in the quarter and they are up 54% year-to-date.

Net income for the third quarter increased 43% to $67.6 million yielding record earnings per share of $0.95, 38% improvement over the prior year period. Gross margins expanded 230 basis points to 28.3% as our operations team efficiently met heavy shipment demand and continued successful ramp up and leverage of our Monterrey facility. Our margin improvement initiatives went well beyond the gross margin line with operating income up 340 basis points to 15.1%, and net income expansion of 120 basis points to 9.3%. Like most quarters in the past year these positive earnings results include significant investments in our business which we expect to contribute to profitable growth in 2012 and beyond.

Our third quarter results also included larger than normal movements in commodities, currencies and share based incentive compensation plan expenses which Mike will discuss more fully during his comments.

We finished the third quarter with positive momentum and that is how we expect to finish the year. For the first time in our history we will deliver annual sales in excess of $2 billion, and in true Polaris fashion anticipate crushing that record with sales in the range of 2.59 to $2.63 billion up 30 to 32% over 2010. We are also raising our full-year 2011 earnings per share guidance to $3.10 to $3.16 resulting from net income growth of 51 to 53% over 2010. This team has worked diligently to drive net income margin expansion and these anticipated results will yield net income as a percent of sales of at least 8.5%, a 250 basis point improvement in the last three years.

During the third quarter we completed our annual strategic plan review with the Board of Directors and conducted a deep dive into our five year product plans. While there was prudent acknowledgement of potential pitfalls in the global economy and our end markets, I left these meetings excited about the future of Polaris and confident in our ability to drive sustainable profitable growth.

One of the key reasons for my bullishness is the talent on our team and the simplicity of our plan. Like a good football team we work hard at blocking and tackling and have products and initiatives that can deliver the big play when needed. That is what you have seen and will continue to see from us in our effort to be the Best in Powersports PLUS. Bennett will cover the highlights, but from our expanding lead in ORV market share to our strong start to the Snow-Go season, we are on top of our game in Powersports and expect to stay there. With impressive year-to-date growth in our military and Bobcat businesses and productive activity supporting our GEM and Indian acquisition, it is clear that growth through adjacencies objective is real at Polaris. These investments will make Polaris a stronger, more diversified company.

I previously mentioned the strength of Polaris International, but the real excitement in our global market initiative is the tremendous progress towards long-term growth that each of our regional leaders and teams are making. With Matthew Homan now in Switzerland leading the EMEA business, we expect even bigger things from that team. Mike Dougherty in Asia Pacific Latin America team are quite determent to replicate and then surpassed the success that Polaris had on Europe. There will be fun race to watch and certainly a win for Polaris and our shareholders.

Our operational excellence initiative and extensive work would mean directly impact our ability to deliver shorter lead times, better inventory turns, improved quality and of course profitable growth. Similar to our product road map, we have a playbook of LEAN initiatives that should deliver significant value to our customer, dealers, employees and shareholders. We are committed delivering sustainable profitable growth for our shareholders and have the team and talent to execute each of our strategic objectives. We will not refrain from making the tough decisions and critical investments that are necessary for Polaris to achieve our long-term goals.

With that I will turn it over to our Chief Operating Officer, Bennett Morgan, who will provide additional insights into our operations and business unit performance.

Bennett Morgan

Thanks Scott. In the third quarter Polaris operational performance kept gaining momentum across the entire business and globe. North American retail sales were up 16% driven by strength in side-by-side, Victory and snowmobiles marking the 6th consecutive quarter of double-digit year-over-year growth.

Dealer inventory is down 5% year-over-year and is nearing optimum levels, although certain side-by-side models remain a bit tight despite supply increases to meet strong demand.

MVP continues to be a competitive advantage and we recently began a test with a subset of our motorcycle dealers.

Moving on to specific business unit performance. Off-Road Vehicles. Polaris ORV business continues to surpass our expectations with third quarter sales up 25%, thanks to strong side-by-side, Military and International performance. Year-to-date ORV revenue was up 38%.

Polaris retail sales again significantly outperformed the industry with North American third quarter ATV retail down mid single-digits and side-by-side delivering record retail volume up well over 20%. In comparison, the third quarter North American core ATV industry sales were down low double-digits and the side-by-side industry sales appear to continue to grow nicely up low double-digits.

Despite increased competitive activity, Polaris’ robust retail performance led to further market share gains in both ATVs and side-by-sides driven by our strong fall program and on-going success of our industry leading RZR and RANGER model line ups.

During the quarter we held our annual dealer meeting and announced our new model year ’12 products led by our new 50 inch RZR 570 which will expand our large and strategically important side-by-side trail capable segment by appealing to a broader set of value consumers. We will begin shipments for the 570 in the fourth quarter.

Our ORV adjacency performance remains excellent. Bobcat calendar year ‘11 sales forecast continue to increase, most encouraging is that as we had expected the Bobcat brand and distribution channel is penetrating incremental commercial and rental customers that Polaris had not traditionally reached.

Our Military business reported third quarter sales up over 100% and also demonstrated meaningful progress in other areas. Customer orders and order backlogs increased that we made significant strides in investments in new business and technology opportunities. As a testament to our Military product capabilities, during the third quarter we will awarded a $54 million three year contract through (inaudible) for other allied and U.S. Military forces.

Snowmobiles. Polaris snowmobile business is off to a great early season start. Third quarter wholesale sales increased 23% while year-to-date revenue was up 31%. Industry retail sales have started the season with strong double-digits growth, largely driven by Polaris’ early retail performance of up over a 100% due to heavy snow check sales of our model year ’12 RMKs and Switchbacks. Since 10 of the seasons retail has occurred, so like always the next 120 days will be the critical months for Polaris and the rest of the industry.

Dealer inventory is in excellent shape, we have got innovative new model year ’12 product and early season consumer events have been well attended, so we are confident in our prospects for the upcoming snow season.

On-Road Vehicles and Victory motorcycles. Our On-Road business delivered third quarter sales up 77% led by increasing Victory business momentum across the globe and our newly acquired GEM business. Year-to-date On-Road revenue is up 83%. The North American 1400 CC heavy weight motorcycle industry segment maintained its growth trend with third quarter retail sales up mid single-digits driven by strength in the touring category. Victory saw further market share gains in the third quarter with retail sales increasing in the upper teen’s percent range, thanks to cross country, cross roads and high ball growth. Dealer inventory is in excellent shape, up slightly from last year and our recently completed model year ’12 Victory dealer orders exceeded our expectations.

We have been very busy in the third quarter with our new Indian motorcycle business. We successfully relocated production to its new home in Spirit Lake. We met with our new Indian dealers in Nashville, and launched our model year ’12 Indian line including a special edition 110th anniversary model. We also made substantial progress on our brand and product strategies. We have much more to report in upcoming quarters as we prepare to re-launch the bikes and brand and return Indian to its rightful place in the global motorcycle industry.

Our new GEM business unit had a solid quarter, both retail and wholesale sales have improved significantly since the acquisition was completed. We met with the GEM dealer network in Nashville for the first time, manufacturing to Spirit Lake in the first quarter of 2012 and our team remains focused on driving our value tracks and executing the successful transition.

Parts, garments and accessories. PG&A delivered record sales in the third quarter up 21% for the quarter and year-to-date with strong growth in all geographic regions. Side-by-side and On-Road product categories led our growth. Margins across all of our product lines remain healthy and climbing.

International. Our international business had an outstanding third quarter with sales up 59%, we saw strong growth in all product lines including ORVs up 59%, On-Road up 74% and snowmobiles up over a 100%. All regions contributed the growth, Asia Pacific, EMEA and Latin America.

Polaris remains number one in European ORV sales. Polaris European ORV industry retail sales remain stable down single-digits for the third quarter and for the year-to-date 2011.

European motorcycle industry grew nicely in the third quarter and year-to-date is up low double-digits. Victory continues to gain a lot of market share, thanks to Victory retail sales significantly outperforming the European industry. We are making lots of progress in our Asia Pacific region. We launched our ORV line in India in the third quarter and already established a solid dealer network. China continues to expand robustly and Australia currently our largest global subsidiary is up over 45% year-to-date with all product lines solidly rising are building substantial momentum and continue to see international as a significant short and long-term growth opportunity for Polaris.

Operational excellence. Operational excellence initiatives continue to fuel growth and net margin expansion. Growth in net margins rose 230 and 120 basis points, respectively versus the third quarter of 2010. Volume leverage, manufacturing product driven, the improvements of over 12%, on-going value engineering and sourcing initiatives, and higher selling prices thanks to innovative new products were the primary drivers of our expansion. We have achieved this expansion despite growing year-over-year commodity inflation, most recently and notably in rare metals, its component used in our charging systems in most of engines and diesel fuel. We anticipate that commodities will continue to provide headwinds for the next few quarters.

On a positive note, our new Monterrey plant is quickly ramping towards to fall production and its two existing vehicle assembly lines and became profitable in the third quarter. Our strategic manufacturing realignment is still a work in progress, but we are very pleased with the accomplishments of the team to-date, and that the project has reached to a point where we will now generate significant cost and capacity advantages for years to come.

Now I will turn it over to Mike Malone, our Chief Financial Officer.

Mike Malone

Thanks Bennett, and good morning to everyone. I will begin with a more detailed discussion of our full-year guidance for 2011, which we are once again increasing and some additional summary comments about our record third quarter and qualitative comments on fourth quarter expectations.

Let me first review our revised full-year 2011 guidance. Total company sales are expected to increase 30 to 32% for the full-year up from prior guidance of up 25% to 28% with the individual business unit sales projections as follows.

For Off-Road Vehicles, we anticipate about a 30% increase with side-by-side and ATV retail sales once again outpacing the industry particularly in North America. Snowmobile sales are projected to grow roughly 40% over last year unchanged from our previous guidance. For On-Road Vehicles, we now expect sales to be up 70 to 75% in 2011 due to the aggressive growth in our motorcycle business and the inclusion of the initial sales from GEM.

We now expect PG&A sales will increase in the high teens percent range over last year’s level. International sales are now expected to increase 30 to 32%, thanks to growth across all product lines and regions.

Operating expenses for the third quarter decreased to 14.1% of sales compared to 15.0% for the third quarter of last year. Operating expenses in absolute dollars for the third quarter of 2011 increased 18% from the third quarter last year primarily due to continued investments in international and adjacent markets and incremental expenses related to our recent acquisitions.

As you will see in our foot note 2 disclosures in the upcoming Form 10-Q financial statements filings, these increases and spending where somewhat offset by a significant decrease of $12 million from third quarter of 2010 to the third quarter of 2011 in share-based incentive compensation plan expenses, resulting primarily from the 10% lower sequential stock price at the end of September of 2011 when compared to the end of June 2011.

Substantial majority of these share based incentive compensation plan expenses are classified as operating expenses with the remainder in cost of sales. Our expectation is that stock price will recover by the end of December and therefore, our guidance for fourth quarter operating expenses includes the reversal of the benefit received in the third quarter.

As described in detail in our annual proxy statement, our overall compensation plan philosophy is very much performance based and designed to enable employees to benefit when financial results are strong and shareholders see a sustainable increase in the stock price.

A volatility we are experiencing in 2011 is expected to diminish somewhat after this fourth quarter as the three year long-term incentive plan initiated in 2009 (inaudible). All that said for the full-year 2011 we projected decrease operating expenses as a percent of sales compared to 2010.

The income tax provision rate for the full-year 2011 is estimated to be in the range of 34 to 34.5%, a pre-tax income which is unchanged from our previous guidance. As Scott stated earlier our earnings per share for the full-year is now projected to be up 45 to 48%, so $3.10 to $3.16 on a full split basis.

Net income for the full-year 2011 should rise at a higher percentage rate than EPS, up 51 to 53%. As I have mentioned before this difference is due to an increase in the number of diluted shares outstanding throughout this year.

The growth profit margin percentage generated during the third quarter of 2011 was 28.3% a 230 basis point improvement over the same period last year. As has been the case, throughout 2011 this margin expansion was driven by production efficiencies on increased volume, product cost reduction and engineering design improvement and higher selling prices.

In the third quarter these positive impacts were partially offset by higher commodity cost environment that Bennett has talked about, as well as unfavorable currency movements. Currency movements were volatile towards the end of the third quarter which resulted in currency rates which we now expect will put adverse pressure on our fourth quarter gross margin. For example, at the end of the September 2011, a Canadian dollar was trading at the rate of US$0.96 compared to well over parity for much of this year. This late move had some negative impact on our Q3 gross margins and our updated guidance assumes continued weakness in the Canadian dollar. This movement is expected to have an even more significant negative impact on our fourth quarter gross margin percentage, compounded by recent trends showing other global currencies following a similar path.

We do have financial hedges on most of the Canadian dollar P&L exposure for the fourth quarter of 2011. So, some of the pressure on the gross margin line will likely be offset by benefits on the other income line.

In addition, commodity costs are becoming more volatile. For example, while the price of steel and alumina have stabilized off late, the cost of rare earth metals engine components has spiked with no major corrections foreseen in the near-term. We have revised our gross margin percentage expansion guidance to reflect this currency and commodity pressure and now expect gross margins for the 2011 full-year to increase in the range of 140 to 160 basis points over the full-year 2010 gross profit margin.

As Bennett noted, the manufacturing realignment project remains on schedule and on budget. We expect transition cost charged to the P&L to be in the 13 to $14 million range for the full-year 2011 partially offset by the savings the project has beginning to generate.

Moving now to our balance sheet and liquidity profile. At quarter end our cash balance was 336 million an increase of $71 million from the third quarter of last year. During the third quarter we entered into a new $350 million unsecured revolving loan facility to replace the credit facility that was due to expire at the end of this year. The new revolving loan facility runs through August of 2016. There were no borrowings under this new facility during the third quarter. A $100 million unsecured senior note issued earlier this remains outstanding.

Factory inventories at the end of September were $338 million, up 21% over the third quarter a year ago. The increase is driven primarily by additional raw material and finished goods inventory for the Monterrey production ramp up, additional inventory to support side-by-side and international growth and the shipment timing of snowmobiles. We have several LEAN initiatives ongoing to improve our lead time response to our customers while reducing waste.

Year-to-date, investments and capital expenditures and new product development tooling totaled $62 million, up 78% than last year, largely due to $20 million spent year-to-date in capital expenditures for the manufacturing realignment project. Full year 2011 CapEx expectations are now approximately $80 million.

Net cash provided by operating activities was $198 million for the first nine months of 2011, up 26% from last year due to increased net income, offset by increased working capital requirements. We continue to expect cash flow provided by operating activities for the full year 2011 to increase at a double-digit percentage pace over last year.

Our retail credit programs with Sheffield, GE and HSBC continued to perform at stabilized levels as the approval rate for the first nine months of the year was unchanged from last year’s attractive 57%, while the penetration rate for the first nine months of 2011 was 35%, up slightly from last year. The Polaris acceptance receivables from dealers in the U.S. were $535 million at the end of September, an increase of 7% from a year ago on lower units outstanding.

In closing, I would like to point out that we expect the fourth quarter 2011 to set forth quarter records for sales, net income and earnings per share. This is in spite of the comparisons being much more difficult this quarter, the short-term gross margins pressures due to commodities and currencies and lastly the net margin pressure from the September quarter-end stock price which in essence benefited the third quarter at the expense of the fourth quarter.

I will now turn the call back over to Scott for some concluding comments.

Scott Wine

Thanks, Mike. I will conclude our prepared remarks with some initial thoughts on 2012. Despite our continued strength uncertainty is prevalent as we prepare for next year. We do not have a crystal ball or a special formula to decipher the markets or anticipate the decisions or lack of decisions coming out of Washington and Brussels, so we are constructing a wide range of scenarios and will evaluate data and trends until late in the fourth quarter before we finalize our budgets.

While the risk of the developed world sliding into a recession remains elevated, our current outlook is for the U.S. and European economies to deliver flat to 2% GDP growth next year. The regulatory environment and constant discussion of higher taxes definitely has an impact on our customers, dealers, and suppliers.

We face real and persistent economic challenges, but I remain confident that with the right leadership and political will, there is an opportunity and in fact the obligation to get this economy growing and creating jobs. When that happens, it will be very good for Polaris.

With the ongoing economic uncertainty and a multitude of actions being deployed to improve the current outlook, it is no surprise that commodity prices and currency markets are volatile. We have a fairly robust process for managing risk but significant swings like those seen recently can impact our margins. We expect more pressure in the fourth quarter than we will see next year. We will remain vigilant in assessing and managing these risks.

This year’s slight improvement in the overall powersports industry has, as expected, corresponded to an increase in competitive products and spending. We project that trend to continue through 2012, but we also expect to win the competitive battle in each of our product lines.

Our confidence in extending our market share gains is not based on wishful thinking, but rather on the products, people, and plans that Polaris brings to each business. We are making major investments in new custom preferred RANGER and RZR products and we expect our snow product line to drive another year of market share expansions.

Our new, Ride One and You’ll Own One, advertising campaign for Victory is indicative of the confidence we have in our motorcycle business where we fully expect our successful turnaround to continue.

All of these products are selling well in Europe and will support our international growth next year. We also have plenty of opportunities both in terms of our cash balance and our list of strategic targets to drive inorganic growth.

We will remain disciplined, but we expect to leverage our strong balance sheet in the year ahead to augment, internal, international, and adjacent market growth. While we are pleased with our margin expansion efforts over the past several years, we are by no means satisfied. With Monterrey coming online and LEAN activities gaining momentum across the company, we expect 2012 to be another year of improving profitability.

Expanding margins and delivering profitable growth is more than an objective at Polaris. It is a long-term commitment that becomes part of every decision and opportunity we pursue. While we are confident in our ability to make growth happen again in 2012, we are keenly aware that the global economy could deal us a more challenging hand.

We will remain steadfast in planning for and dealing with risk that may arise and prime to respond to any downward shifts in demand. Operational flexibility and aggressive cost control is a core strength of Polaris and we’ll be prepared to demonstrate those skills if required.

That being said, we have no intention to stepping on the brakes and slowing growth. We play to win and 2012 will be no different.

With that, I’ll turn it over to Alisha to open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Tim Conder with Wells Fargo Securities, your line open.

Tim Conder - Wells Fargo Securities

Mike or whoever wants to take this question; we’ve heard from Harley earlier today and from a couple of other companies on the FX side to whereby there was some revaluations that occurred at the end of the quarter due to the dramatic moves in the euro, Brazilian real, Aussie dollar and so forth. Given that, you don’t have a lot of operations internationally yet other than some warehouses and some things, was there any of those revaluations on intercompany transactions? Was that a component of the FX hit, Mike or was it the true what we see in the normal transactions with outside customers?

Mike Malone

That’s a great question, Tim. It’s both for us. We do have as you know lots of sales in Canada, lots of sales in other countries, the late move in the currency would impact that just for a few days, so that on an average basis, the sales didn’t impact that much. Now, we expect that will have more of an impact in the fourth quarter. You’re absolutely right through. Even though we don’t have manufacturing operations in other countries, we do have subsidiaries and we have assets and intercompany balances, and your observation is very perceptive. We did have some adjustments on those to the month-end currency rate in September and we again expect that to be impacting fourth quarter as well.

Tim Conder - Wells Fargo Securities

Okay. And again that’s on the intercompany transactions that you have to revalue at the end of the quarter at the spot rate, correct?

Mike Malone

That’s correct.

Tim Conder - Wells Fargo Securities

Okay. And then you mentioned that you were had some hedges in place on the Canadian dollar, any addition detail there that you can provide us and are you just remind us again are you hedging your transaction or you hedging more the intercompany issues?

Mike Malone

When we hedge, we hedge our cash flow exposures, so this intercompany balance sheet stuff you refer to is not hedge, it’s very difficult to do. We do have hedges for the fourth quarter, a majority of our Canadian dollar exposure is hedged at about parity and we’ve actually hedged in the 2011 on the Canadian dollar quite a bit actually a little over half of our P&L exposure on the Canadian dollars. We have some hedges on other currencies around the world, but they are not material.

Tim Conder - Wells Fargo Securities

Okay. And then lastly, just any similar question there as it relates to commodities hedging?

Mike Malone

We hedged some commodities with financial instruments, principally aluminum and diesel fuel. There is other commodities that are not so easily hedged that we range with our suppliers to lock-in prices for the short-term three to four month period. So, we try to diminish the impact of the commodity movements with these hedges and locks, but you can only defer that, you don’t avoid it.

Tim Conder - Wells Fargo Securities

Okay. And last question, Bennett could you reiterate your commentary, the color on what you’re doing in the European market regarding the market and relative to your retail sales and obviously that translates into market share?

Bennett Morgan

Yes, basically, the European market remains at least in ORVs pretty stable. It’s down low single digits. We’re number one and gaining a modest amount of share, and the European team continues to outperform significantly, at least, what you would read in the papers, so we’re quite encouraged by their ability to plough through this.

Operator

Our next question comes from the line of Greg Badishkanian with Citigroup, your line is open.

Greg Badishkanian - Citigroup

Two questions; one just in terms of inventory levels, you mentioned I think it was a little bit higher relative to your sales and then historically when we did our some of our (inaudible) a little bit of shortages at some of your side-by-side. So, I’m just wondering how comfortably you feel there and you still have a little bit of scarcity that’s going to help drive momentum and also comparing that to inventory of your competitors?

Bennett Morgan

Yes. Greg. This is Bennett. We did take our inventory up sequentially from the second to the third quarter. It’s down as I said year-over-year. Remember, we’ve seen tremendous growth in side-by-side. So, we’re still a little tight on a few key models. So, again, I don’t think we’re missing a lot of retail sales despite what you hear, but side-by-side is an area with all the growth we’ve seen that you should expect that maybe inventory levels in a perfectly harmonious state might be up a little bit from where we are today. Second part of the question was?

Greg Badishkanian - Citigroup

Competitions’ inventory.

Bennett Morgan

Competitions inventory; again, we don’t have exposure to that. I would generally characterize from what we know, I think competitive inventories versus what we’ve seen over the last three, four years are in a pretty good shape. I would tell you that the industry inventory levels are pretty healthy. I think the Japanese maybe were, in some cases, a little tight, at least what we’ve heard from some of their dealers, and that might have to do with some of the effects of the tsunami and from disrupted production, but we don’t have anything specific Greg.

Greg Badishkanian - Citigroup

Then also just in terms of from a cost perspective looking at the fourth quarter, what are you modeling in, in terms or guiding in terms of the macro and you mentioned I think that maybe some of the cost like commodities and currency won’t have as big of a impact in 2012 as it did in fourth quarter, did I hear that right that that’s going to moderate next year?

Mike Malone

Yes, we do think that there is a blip here that’s going to impact us in the fourth quarter. Some of these commodities that we’re seeing taper off, we’re not necessarily getting the benefit of that early because of our locks and hedges, but we expect that that will taper into next year. So we don’t expect quite as much pressure from that. The spike in this rare earth metals issue, we view that as somewhat temporary as well where we and I’m sure others are trying to figure out how to design around some of these components as we speak. So, as the years goes on into 2012 we expect to be able to mitigate some of that as short-term issue.

Greg Badishkanian - Citigroup

I’m sorry. I may have missed, what was the total impact from currency and commodities in the fourth quarter where we expect that to be?

Mike Malone

We didn’t disclose that specifically, Greg. We did reduce our full year guidance for gross margins about 60 basis points for more or less before. Most of that change frankly is due to the pressure from commodities and trends.

Operator

Our next question comes from the line of Ed Aaron with RBC Capital Markets, your line is open.

Ed Aaron - RBC Capital Markets

I was hoping to follow-up on the commodity situation with the rare earth metals, could you just maybe give us a little bit more perspective of how much of your costs come from that, and how much inflation you’re currently seeing on a spot rate basis?

Bennett Morgan

Ed, this is Bennett. Again, rare earth is frankly a very, very small usage piece in our general product cost, but again, if you’ve been following and read that, obviously there has been tremendous spikes in inflation over the last 12 months. So, it’s not what I would call normally a material cost of our product at all. It’s very, very small amount, but due to the heightened spikes on the prices, it’s been a material inflation for us that we’re just starting to see, and again as Mike just mentioned we’re actively designing around it and looking at other potential supply options. So, we believe this is a short-term impact versus anything that we will deal with over sustained basis.

Ed Aaron - RBC Capital Markets

Okay. Then I wanted to just also pick your brain on product mix a little bit, obviously, the mix has been shifting generally positive with the move towards side-by-side, but you’re coming into the market with more for value price side-by-side products, so if you kind of think about model year 2012 and the overall net impact of mix, how would you frame our expectations around at this point?

Bennett Morgan

You’re right, Ed. Historically, we’ve seen quite a bit of benefit in sales from our product mix and we continue to see that. More recently the benefit that we’ve seen in the gross margins has turned around on us, and for instance in the third quarter of this year, the mix was actually negative to our gross margin percentage. We expected to be negative for the full year as well. So, the most recent trends are that it’s a bit of pressure to our gross margins. We’d expect that to continue as we look forward to some extent, although we will anniversary to some extent as we move into next year, some of this more value priced product in certain of our categories, but on the other hand with our RZR 570 is again a lower priced product on the top-line as that will get benefit from the next year, so I would say the trends aren’t going to materially change.

Ed Aaron - RBC Capital Markets

So, you’re not looking for that mix pressure to accelerate with the 570 necessarily on a short-term basis?

Bennett Morgan

No, not at all.

Operator

Our next question comes from the line of Scott Stember with Sidoti & Company, your line is open.

Scott Stember - Sidoti & Company

Did you guys talk about the promotional environment right now, where we stand? Have you seen any competitors like the Wildcat, you know, any pressures coming from that side of it?

Scott Wine

Yes, in relation to specifically to the competitive environment, again, we’ve been fairly pleased with how the competitor environment has looked from a promotion standpoint through most of the year. We did see a little more activity increases in the third quarter, maybe most notably from Honda, a little bit from Can-Am, but again, everything generally within our expectations, but clearly as we’ve talked about competition is increasing, we have seen more side-by-side product releases, but you know from a promotion standpoint on those new products, Scott, it’s too early to measure on that, but again, we’ve seen heightened competitive activity and as we’ve told you before, we feel really good about our product line, our ability to innovate and our speed to market and we’ll take our chances.

Scott Stember - Sidoti & Company

Going to the international side, some of the success you’ve seen there with Europe, one of the more developed areas; on what could you attribute to that to, any specific product, the diesel offering or it just continued blocking and tackling?

Scott Wine

Well, it’s a number of factors, again, getting where the pucks going, so we’re seeing really nice side-by-side growth, we’re seeing nice Victory growth, the teams are executing across all of our markets extremely well and the Russian market is in our EMEA number and Russia is back right now and is performing at a very high level, so that’s also fuelling a lot of the EMEA growth as well.

Scott Stember - Sidoti & Company

Just moving over to India; you talked about getting your toehold over there; could you talk about a sales ramp up and how many dealerships you have doing business with right now over there?

Scott Wine

Scott, we’re really confident in our team in India, you know, kind of like our team in China ramping things up. But let’s not get too excited about the volume we’re going to see out of these emerging markets too quickly. I mean, the fact is we are adding high quality dealers in India, I mean probably the best quality of anywhere we’ve got in the world, so we feel confident about their ability to represent the brand well and get us started. But it’s going to be meaningful percentage growths next year, but the actual dollars are not going to be impactful for a couple of years I wouldn’t have guessed.

Scott Stember - Sidoti & Company

Last question; could you just talk about the new value price RZR, what the order pipeline looks like right now for the fourth quarter heading into next year?

Bennett Morgan

Again, we began shipments for the 570 in the fourth quarter. Our orders that’s kind of on an allocation basis with new products versus just a pure MBP and the orders were better than expected, but you’ll see us with some modest, modest shipments in the fourth quarter and then that pipeline will probably accelerate as we get to the first quarter of next year. So, we feel really good about it. The dealer and early consumer response has been very favorable. The orders look good; everything is tracking from a shipment standpoint, so we’re pretty excited this is going to be a nice addition to our armada of side-by-sides.

Operator

Our next question comes from the line of James Hardiman with Longbow Research, your line is open.

James Hardiman - Longbow Research

I’m going to ask about the wholesale versus retail dynamic; one of your favorite questions here, but if I’m hearing you right it doesn’t sound like you’re getting that much of a benefit from pricing which is typically one of the deltas. Obviously, international helps, but ultimately when I think about your wholesale growth of 26% and retail growth in the 16% neighborhood, is the majority of that now the difference now coming from Bobcat and military and ultimately then is that gap sustainable going forward, or is there still maybe a little bit of benefit that you get from returning to a more normalized shipment patterns into the channel?

Scott Wine

James, it’s Scott. Not only is it sustainable, it’s likely to increase. You mentioned the couple of the things that gets factored out, but this is a North American retail number, so all of our international sales which we talked about up 58% and Europe in the third quarter, up dramatically in Asia pacific, but none of those were included in that retail number. Our military sales were not included in the retail number and it was a very strong third quarter for military. The new acquisitions although Indian sales are quite limited at this point, GEM starting to contribute, those sales are not included in the number. So again, I literally come to work every day, trying to drive that variance higher and right now we don’t see that directory changing at all.

James Hardiman - Longbow Research

Just to dig a little bit further into the international momentum, 59% growth for a wholesale perspective, I know it’s really hard to know exactly what retail is doing on country-by-country basis, I am assuming it’s not up 59% at retail internationally, what’s sort of driving the really strong wholesale performance over and above sort of what you’re seeing from retail?

Mike Malone

James, I would be clear. Again, when we report the numbers that we communicate, we’re communicating developed Europe and so, no, you’re not seeing 59% growth in developed Europe, but again just as Scott talked about the Russian numbers aren’t in there, the Indian, the Chinese numbers, a lot of these distributor or markets where we’re seeing frankly hyper type levels of percentage year-over-year retail growth are not included in that. I would tell you in our developed subsidiary channel, our dealer inventories and our subsidiary inventories are frankly very much in control and flat. We are not increasing our day supply or any kind of our inventory levels.

Scott Wine

James, you had two other elements going on in our international business. You have both product proliferations as we increased our side-by-sides going in Europe. We’re increasing our sales of Victory in the international markets and we’re entering into new countries. All the sales in China are incremental; all the sales in India are incremental, so you’ve got both geographical expansion and product expansion helping to contribute to that growth.

James Hardiman - Longbow Research

Then just one question of clarification the incentive comp, you mentioned that there would be a reversal in the fourth quarter, I just want to make sure I understand that correctly. If I think about the second quarter level of incentive comp is sort of the baseline, is the point here that you’re going to be returning back to second quarter levels, or are we going to be returning back to second quarter levels and then in addition to that there is going to be a reversal which adds incremental expense to that number?

Mike Malone

Well, that’s really hard to answer because it depends on what the stock price is going to be at the end of the year, and as we’ve seen over the last few weeks that’s pretty hard to predict. What happened was the stock price has been rapidly increasing over the last year, and as you look at footnote two to the financial statements in the Q; historically you’ll see that that’s ramping up quite a bit in the incentive comp expense. What you’ll see in the third quarter is that turned around quite a bit, and the number is about $12 million less in the third quarter of 2011 versus the third quarter of 2010, and the reason for that is that the quarter end stock price was under $50, and it was over $55 at the end of the second quarter. So, that 10% or so decline in the stock price impacted to result in a lower expense during the third quarter and we don’t know what the stock price is going to be at the end of the year, but we assume it’s better than under $50, and so the expectation is that that will reverse and hit the fourth quarter incentive comp expense which largely will show up on the operating expense line.

Operator

Our next question comes from the line of Rommel Dionisio with Wedbush Securities, your line is open.

Rommel Dionisio - Wedbush Securities

I wonder if you could just share with us either anecdotally or statistically if anyway you can, just in terms of product quality from the products being produced by the new Monterrey facility, is there anything you could just help us (inaudible)?

Bennett Morgan

Yes. Rommel, this is Bennett. We actually not surprisingly track that very, very closely, and it was a key, key strategic priority as we put Monterrey and put the team in place and we put a number of I think, you know, really took our quality processes to another level, but we’ve been shipping now for four or five months. We’re tracking warranty and consumer feedback on that and right now Monterrey is actually, believe it or not, slightly better than what we’ve seen out of our northern plants right now. So, again, it’s still early from an ageing standpoint, but as Scott mentioned, we shipped over 10,000 units out to dealers and a lot of those are in consumers’ hand, and so far so good. So, we’re really encouraged.

Rommel Dionisio - Wedbush Securities

Great. Okay. Just one quick follow-up if I could then. Have you seen any sort of pushback from either dealers or consumers about the whole mid-Mexico versus mid-America thing at all?

Scott Wine

I think we talked about that quite a bit when we announced the Monterrey a year ago, and obviously that’s something we tracked very, very closely. There is always a component where we heard the voices early, but again, we’ve done a lot of studies and documentation on that and we’ll continue to track our dealer network, and again, generally what Americans are looking for is high quality product, tremendous innovation at a good price, and as we’re delivering that out of Monterrey, frankly it’s been at least quiet from what our ears hear, and again, most of our competitors are building in places outside of America as well. So, we’re feeling pretty good about that.

Operator

Our next question comes from the line of Mark Smith with Feltl and Company, your line is open.

Shawn Bitzan - Feltl and Company

This is Shawn Bitzan sitting in for Mark Smith. With the difficult economic environment, have you seen any trade down effect or price sensitivity in the last quarter with any of your products?

Scott Wine

Shawn, I think you saw it in our press release and probably heard in our remarks; the third quarter was good for us. The recent trends on demand for products, there still continues to be demand for our highest and best performing product lines and while we’re excited to be offer our customers these value options, we’re not seeing any of that trade down, decrease and demand for the high-end stuff, especially if you look at our snowmobile is an example, the highest performing products are what continues to be in the highest demand.

Operator

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

Gerrick Johnson - BMO Capital Markets

Some of your RZRs are about three years old, some of the RZRs that are in the market. Are you seeing any increased competition from say your own brand on a used basis and something we haven’t had to talk about before used pricing is that something that you’re following?

Bennett Morgan

Gerrick, this is Bennett. Traditionally, what we’ve seen in ORV market is frankly used products hard to get your hands on, at least our products traditionally both on the rack utility as well as the RANGER RZR stuff, so we’re not seeing any kind of impact at all from used pricing chip into our new product sales.

Scott Wine

Gerrick, you kind of follows how I answered John’s questions a second ago. Our customer tends to want the highest performing best product you can get and that almost by definition takes the used option out. There is used market, but it’s nothing like you see in motorcycle, so not an impact on our business.

Gerrick Johnson - BMO Capital Markets

Lastly, can you just tell us how much acquisitions added to the quarter sales?

Scott Wine

Not much.

Operator

Our next question comes from the line of Craig Kennison with Robert W. Baird, your line is open.

Craig Kennison - Robert W. Baird

I wanted to follow-up on question from James earlier, but you had mentioned there is a big opportunity to grow in Europe and I am wondering relative to the portfolio products you’re selling in the U.S. what percentage of that portfolio is available in Europe, and what ultimately get to the full complement of products you have in the U.S.?

Scott Wine

Craig, part of sending Matt over there was to help us make sure we could pull on the full resources of Polaris to drive growth and he is pretty demanding. We’ve already seen some of that now. What do you think Bennett, 70%?

Bennett Morgan

Yes. I’d probably say higher than 80%.

Scott Wine

I think the positive Craig is that again what we’re seeing in Europe while they have their own unique trends like the diesel trends much better in that market and we will continue to build more and more products specifically for that marketplace. The side-by-side trends are following North America where that’s becoming more and more important product category which again I think bodes very, very well for us in upcoming quarters and years.

Craig Kennison - Robert W. Baird

Relative to Bobcat, you had talked in the past about phase 1 being an opportunity to provide basic ATV products to that channel and phase 2 being to co-develop more, when might we see more co-developed products?

Scott Wine

In the future. We’re probably not going to talk specifically about timing Craig, but we continue to make progress along with the Bobcat engineering team and we’re feeling really good. That project is essentially right on schedule and patience my young man, patience.

Craig Kennison - Robert W. Baird

Is it fair to say though that you still see the same opportunity but for competitive reasons you’re unwilling to talk about it or have things not developed quite as you or as quickly as you thought.

Bennett Morgan

No, I think from a standpoint of Bobcat strategic alliance, the early phase I supply agreement has met all of our expectations and frankly we’re very encouraged with the momentum the Bobcat channel has seen as well as the mix that customers are getting, very, very encouraging and again, the phase 2 stuff, we’re not going to talk about it, but we’re encouraged and we think that could be even bigger frankly than what we’ve seen in phase I.

Scott Wine

Craig, I think the time to life from perhaps us announcing the agreement is simply the product development cycle. I mean, there is nothing more there other than the product development cycle, and Ben had said, the commercial aspects have been very encouraging.

Bennett Morgan

And the other thing I’d point out is, as opposed to some of our competitors, generally when we have an announcement of a product, we have the product available very, very soon after that. So, it’s not like we’re going to announce a product and then wait significant amount of time before we actually have it available.

Operator

Our final question comes from the line of Jimmy Baker with B. Riley & Company, your line is open.

Jimmy Baker - B. Riley & Company

A follow-on to an earlier question, I think it was regarding the impact of side-by-side mix shift and to some more value priced products. Have you observed or do you anticipate a meaningful difference in the PG&A attach rate in those lower priced offering?

Bennett Morgan

Jimmy, this is Bennett. Frankly, there is a modest difference from a mid price and value product customer on our accessory penetration rate versus the highest end products and it’s something that the team continues to work on building it. I don’t think it’s significant from a standpoint of an impact but there is a modest difference.

Jimmy Baker - B. Riley & Company

The positive revision to your ORV expectation, is the delta there relative to prior guidance being driven more by side-by-side or ATVs and what affect do those anticipated incremental sales have on your margin expectation?

Bennett Morgan

I think our sense is that frankly, both categories have been outperforming throughout the year and so both are driving revised guidance upward and obviously side-by-sides is one of our highest margin product categories and so as that has great success that fuels margin expansion for us.

Jimmy Baker - B. Riley & Company

Then lastly, just a quick question here on your in terms of the factory inventory. I believe you were expecting that to be relatively flat in terms of dollars at year end but that’s changed a little bit here with $338 million at the end of Q3. You talked a little bit about what’s driving that, but I’m hoping maybe you could elaborate a little, and especially if you consider any of that increase at Monterrey as temporary or kind of startup related and do you still expect to improve in terms of turns year-over-year?

Bennett Morgan

I think that obviously inventory has grown and sales have gone up, sales were up 26%, inventories up 21%. That being said, we expect and will drive it down. A couple of things happened at the end of the third quarter that probably make it artificially a high number. The timing of our snowmobiles shipments, we build throughout the summer and then ship in the fourth quarter and only moderately, so there is a much higher finished goods level of snowmobiles on their balance sheet at the end of the third quarter that won’t be on at the end of the fourth quarter. We also have a little bit more inventory coming on from the two acquisitions that are in the rugs units the transitionary time from brining Monterrey up. So that’s going to start to come down. So overall, throughout the fourth quarter, you’ll see a steady downward trend and I would expect that to continue to through 2012 as well.

Operator

Our next question comes from the line of Ed Aaron with RBC Capital Markets, your line is open.

Ed Aaron - RBC Capital Markets

Just had a quick follow-up on the Europe business that you had pretty impressive growth there this quarter, but then Ben when you’re talking about the market I think I heard you say that the ORV market was down modestly and that you might have gained modest share. Did I hear that right, because it’s kind of hard to get to reconcile to your total Europe growth number?

Bennett Morgan

We did gain modest share and I think you did hear correctly, but again, remember we’re reporting only the industry sales for the countries that report and there is still a number of countries in the EMEA region that had tremendous growth that do not report, Russia, Dubai and the list goes on. There is a number of those that would drive that.

Operator

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

Tim Conder - Wells Fargo Securities

I wanted to stay on Monterrey there for a little bit, you I think had alluded that as the content coming out of Monterrey the content components produced in Mexico is that escalates beyond a certain point. It could give you some advantages shipping to Brazil in particular another Latin American countries, could you just maybe elaborate on that a little bit and then secondly related to Brazil just give us an update where your distribution roll out is and the overall assembly operations there?

Bennett Morgan

Yes. Tim, this is Bennett. I’ll let Scott and if the other boys want to jump in. The Monterrey plant as we drive more Mexican content will be very helpful for shipping side-by-side product into Brazil from a duty standpoint based on some of their trade agreements, and so as we start to ramp up Brazil particularly in future years, and we get our baseline Mexican content which has not been frankly the focus early. It’s been obviously taken our existing supply base and bringing that down to control; make sure we have a quality. We’ll now start to expand that, then that we’ll open up that door of opportunity so to speak, and that should be something that should be nice leverage piece for us in upcoming years. From a standpoint of where we are with Brazil, that’s probably the final subsidiary that we’ve talked about in earnest that we’ll really get rolling. We do some knockdown kit assembly down there and that continues to progress, but as we’ve been working through and getting the team in place frankly we’ve been in a little bit of wait-and-see mode there, just as we’ve been working through a couple of other issues. So, I think we’ll have more to talk about Brazil in upcoming quarters.

Operator

Our next question comes from the line of James Hardiman with Longbow Research, your line is open.

James Hardiman - Longbow Research

Just on the snowmobiles side, I wanted to give that segment a little bit of love here; obviously, given the fact that it’s pretty meaningful in the fourth quarter, basically your guidance for the year implies about 50% growth for the quarter. I’m just curious, my understanding is that with the Snow Check, the vast majority of those sales are already spoken for, asked for, what’s the variability on that fourth quarter number, meaning, if trends are a little bit better or a little bit worse than expected, how much does that number move around or is that more of an impact on the first quarter?

Bennett Morgan

The variability James frankly from a shipment standpoint, we have the orders and people are hungry for those orders. So, from a standpoint of at least from a wholesale shipment standpoint, that being the vast majority of the revenue from the Snowmobiles division, that’s pretty well locked and loaded. There can be some modest variability based on, you know, if there is promotion or no snow or competitive activity, but frankly you should feel pretty good about that number.

James Hardiman - Longbow Research

Perfect. Then just last question here your cash balance continues to ramp up. Obviously, the assumption is that you are continuing to weigh some acquisition opportunities, and I think most of your shareholders appreciate your patience and ultimately your returns-based focus. But I guess the question is, to the extent that you don’t do something significant here in the short to medium-term, do you consider putting some of that cash to use in other ways or is it still going to sit on your balance sheet until you find some acquisitions?

Scott Wine

I think we are putting it to use and we’re spending a lot on capital investments back into the business to drive organic growth as we’ve talked about. We’re first going to commit to driving growth in the business, both organically and inorganically. Our share buybacks have increased significantly this year. We still got a long way to go to get back, so there is no dilution throughout the year, but we’re going to continue to make that part of our capital allocation model, and as you know, we’re committed to paying strong dividends. So, yeah, I’m not at all worried about the cash balances and really we’re not waiting for a big acquisition to use all the cash, and I think the size of our first two are not indicative of what the rest of them will be, but don’t think that we’re looking for swing for the fences and put all of that to use on one acquisition.

Operator

And our final question comes from the line of Scott Hamann with KeyBanc Capital Markets, your line is open.

Scott Hamann - KeyBanc Capital Markets

Hey, guys, just one quick one; in terms of the retail trends that you saw throughout the quarter, were there any fluctuations, I mean, an acceleration, deceleration of note in the different segments that you might call out?

Bennett Morgan

Scott, it’s Bennett. No, I think again the momentum we’ve seen over the last, frankly, several quarters has been frankly remarkably consistent, and I wouldn’t call out if there was anything meaningful in month to month or week to week swings, so we’re feeling good as the quarter ended, so all is good.

Richard Edwards

Okay. Thanks, everyone. I want to again thank everyone for participating, and we look forward to talking to you next quarter. Thanks again and goodbye.

Operator

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

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Source: Polaris Industries CEO Discusses Q3 2011 Results - Conference Call Transcript
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