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Polaris Industries, Inc (NYSE:PII)

Q4 2011 Earnings Call

January 25, 2012 10:00 a.m. ET

Executives

Scott W. Wine - CEO

Bennett J. Morgan - President and COO

Michael W. Malone - VP - Finance and CFO

Richard Edwards - Director of IR

Analysts

James Hardiman – Longbow Research

Scott Stember - Sidoti & Company, LLC

Tim Conder - Wells Fargo Securities

Jaime Katz - Morningstar, Inc.

Ed Aaron - RBC Capital Markets

Greg Badishkanian - Citigroup Investment Research

Jimmy Baker - B. Riley & Co.

Mark Smith - Feltl and Company

Gerrick Johnson - BMO Capital Markets

Joe Hovorka - Raymond James Company

Craig Kennison - Robert W. Baird & Co.

Operator

Good morning. My name is Steve, and I will be your conference operator today. At this time, I would like to welcome everyone to the Polaris Fourth Quarter and Full Year 2011 Earnings 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. I'll now turn the call over to Richard Edwards, please go ahead.

Richard Edwards

Thank you, Steve, and good morning, and thank you for joining us for our 2011 Fourth Quarter and Full Year Earnings Conference Call. 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 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.

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

Scott Wine

Good morning and thank you for joining us. Following a longstanding Polaris tradition we began each year with a two-day meeting of our extended leadership team. We review our results and progress from the past year, discuss our goals and align our plans for the year ahead.

With football as the backdrop for this year's meeting, we chose to stay on off and so as our team. Coming off two straight years of exceptional performance this team remains, humble and determined to continue our winning streak and keep advancing the ball. In both football and business momentum is vital and it is clear that our strong fourth quarter finish coupled with heavy investment in our future positioned us to once again prove in 2012 that we have the best team in Powersports and increasingly other businesses as well.

With much discussion of increased competitive pressure and presence of a sturdy 31% sales growth comparable from the fourth quarter of 2010, no one at Polaris expected to close through the end of the year. Across the business the team maintained their growth focus driving at 26% increase in sales to a record $782 million dollars. We projected margin pressure in the quarter and commodities, currencies and dismal snow conditions did combine to reduce fourth quarter gross profit margins by 160 basis points.

Despite this decrease earnings growth was solid and net income increased 17% to $63.9 million supporting earnings per share of $0.90 up 15%. These sales in earnings result demonstrate the fundamental strength of the business as we enter into 2012.

Our fourth quarter results contributed a full year 2011 sales and earnings growth rate that rapidly accelerated past this 40 results Polaris delivered in 2010. While the global economy and the Powersports industry each fell in line with our predictions, big market share gains coupled with strong international adjacency growth enable us to once again outperform the competition.

Full year North American retail sales were up 14%, driving total company sales to a record $2.66 billion up 33% from 2010. This is the first year that Polaris revenue has exceeded $2 billion and with that significant milestone behind us, we now have our sight clearly set on to passing the $3 billion market.

Organic growth remains broad based as sales grew in every product and in every part of the world. Thanks to industry leading, innovative new products, our side-by-side business extended their market share leadership while contributing significantly to our sales growth.

With Victory hitting its stride in most every respect and the Indian brand now part of the Polaris, our motorcycle business is once again a key contributor to our revenue growth. Despite this is lack of snow, last seen success in our great line of new sledge contribute to a very strong 2011 for a snow business. And in a true testament to the caliber of our international team they drove 37% growth in Europe in 2011 supporting 39% overall growth.

And as we expanded our international business, we also benefitted from the late year contributions from our small electric vehicle business. Full year earning clearly reflect the success of our ongoing margin expansion efforts as the team exceeded expectations by delivering 120 basis point increase in net income margin to a record 8.6%. The combination of rapid sales growth and expanding margins drove net income up 55% to $227.6 million with earnings per share increasing 50% to a record $3.20. During the fourth quarter we increased our rate of share repurchases which will support our efforts to reduce or eliminate earnings per share dilution in 2012.

As you will hear throughout the call today, Polaris accomplished much more than posting record top line numbers in 2011. Across the business and around the globe each of our 4,400 employees help deliver solid improvements in our operating and financial metrics. From sales through cash flow, our financial metrics illustrate the consistency and quality of our earnings which we will feel is a key component of our ability to increase shareholder value.

While the 46% shareholder return in 2011 ranks among the top 4% of all companies listed on the New York Stock Exchange it is the 330% return to Polaris shareholders over the three years that more accurately summarizes the market's reaction to our performance.

One of the most encouraging aspect of leading Polaris is this team's ability to achieve short term results without sacrificing long term strategic investments. We often emphasize and over are and the significant progress made during the 2011 year to advance our strategic objective demonstrates how alignment and focus enable us to execute both tactically and strategically with exception precision.

Our effort to diversify any new products and new markets notwithstanding Polaris primary objective is to be the best in Powersports PLUS. The strongest testimony to this commitment comes from our results. Bennett will summarize our outstanding business unit performance, but the most dramatic developments in our Powersports business may well be the exciting innovations and product pipeline enhancements that we will not discuss today. We are staying on our fence and have no plan to relinquish our lead.

Growth through adjacency moved meaningfully from concept to reality in 2011 as we completed three acquisitions, made small investments in two cutting edge technology companies and greatly expanded our military and Bobcat businesses.

With GEM and Goupil both holding strong positions in the growing $4 billion small electric vehicle industry we are excited to have Scott Swenson spearheading our efforts to build on that solid foundation.

Our integration and development of Indian motorcycles is preceding exceptionally well and I am encouraged by the energy and excitement although perhaps not the spending that Steve Menneto is bringing to resurrection of the storied brand.

Given the potential of these initiatives and our continuing measure pursued of other complimentary opportunity we are confident that by 2014, our adjacency effort will deliver sales at the upper end and are projected to $200 million to $500 million range.

Global market leadership is perhaps the largest most promising growth initiative in the company and we fully expect our international business generate at least a quarter of our sales within the next few years.

In 2011 we took an important step and asked two of our most senior and experienced leader to drive our international growth. Matt Homan brings a wealth of experience to the significant opportunities and challenges in the EMEA region and Mike Dougherty has already demonstrated his proficiency in building teams and accelerating in the important Asia Pacific and Latin American markets. While these regions are quite different we will consistently pursue our proven strategy of creating organic growth through new product introductions and dealer expansion while intensifying our M&A activity, augment and region capability.

Supporting quality growth and ensuring customer satisfaction are key objectives of our operational excellence and lean initiatives. And in 2011, Suresh Krishna in our operations team accomplished these in much more. They executed the challenging and complex Monterrey plan to startup on time and within budget providing much needed capacity to meet rising demand.

Additionally the team integrated three acquisitions, increased vehicle production by 26% and delivered 7% productivity for the second year in a row. Thanks to their herculean efforts, our manufacturing arm is strong as ever.

Strong financial performance is a critical parameter of progress, not just because it expected by shareholders but also because the results from the successful execution of our other strategic priorities. Following two years of exceptional performance we have raised our 2014 net income target y 150 basis points to now exceed 9.5% and now project revenue target for that year to be above $3 billion.

With strong momentum and aggressive thoughtful plans in place, we expect 2012 to be a third straight year of profitable sales growth. Once more, we do not expect help from the US economy which will likely struggle to deliver GDP about 2.5%.

The overall North American Powersports industry remained sluggish, so our growth will again come from share gains and global market expansion. We anticipate overall revenue growth of 5% to 8% which outpaces our industry and the economy to most of our markets.

Net income is projected to increase in range of 14% to 19% over 2011, which would equates earnings per share of $3.65 to $3.80 also at 14% to 19%. This guidance includes continuous investments in our Indian motorcycle and international businesses both of which offer solid returns and excellent long term potential.

With that I'll 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, and good morning. North American fourth quarter retail sales were up 11% of record comparables and for the year finished up 14%. MBP remains a competitive advantage and we are pleased with the execution and improvement by our dealers. As we continue to refine MBP, our top operational priority for 2012 is to improve product deliver response or providing our dealers with better order visibility.

Our dealer inventory saw a slight 4% rise to support the 14% retail volume velocity, it remains near optimal levels. And finally, we are seeing encouraging signs from the North American Powersports industry. In the fourth quarter the overall Powersports industry grew mid single digit and for 2011 it actually grew slightly for the first time since 2005.

Moving onto business unit performance, we will start with Off-Road Vehicles. Polaris ORV business continues to perform at a high level. Fourth quarter sales were up 18% driven by growth in all areas, including side-by-side, ATVs, international, military and Bobcat.

For the full year sales increased by 32%. Polaris ATV retail increased upper single digit in the fourth quarter and for the first time since 2004 Polaris's annual core ATV retail grew year-over-year. In comparison the core ATV industry declined mid single digits in the fourth quarter and for the year was down low double digits.

Polaris's side-by-side retail sales continued to outpace the industry in the fourth quarter with sales up around 20% in an industry that appears to be growing in the low double digits. We continue to gain significant amount of market share both for the quarter and 2011 in both ATVs and side-by-side and we are the undisputed leader in the Off-Road Vehicle market.

Late in the quarter we announced our latest side-by-side, a RZR XP4 900, a first four passenger vehicle in the extreme performance side-by-side segment that Polaris pioneered earlier in 2011. The RZR XP4 900 has already begun shipping to our dealers and has successfully completed its first race at Parker 250. This innovative product should be largely incremental to our industry leading full line of RZR products and in addition the new 50 inch RZR 570 shipments in retail are ramping up nicely providing a solid momentum as we head into 2012.

For 2012, we expect that the North American ORV industry will be essentially flat year-over-year versus 2010, while we again anticipate that Polaris will outperform the industry and gain market share.

Bobcat sales continued to trend up in the fourth quarter and for 2011 sales increased by over 60%. Bobcat retail sales increases are flattening within the Bobcat channel so we expect more Monterrey growth in 2012 until our Phase II project is launched.

Our defense business grew over 30% in the fourth quarter and full year sales more than doubled our 2010 numbers. Though the $54 million Afghan military order we won in 2011 was protested by a competitor, the US General Accounting Officer reasonably denied the protest and we completed our first shipment of 700 units earlier this month. The team is making fantastic progress in business development, new product technology and order commitments. Our 2011 year end backlog was an all time high and we are well positioned for significant defense growth again in 2012.

Snowmobiles, fourth quarter snowmobile wholesale sales were up 63% driven by shipment tiny from a good snow riding season last winter, low dealer inventories and great new products. For calendar 2011, Polaris snowmobile revenue was up 48% and constituted about a 11% of total Polaris sales.

Concerns exist about the lack of snowfall in many Snow Belt areas the past month and there is no question and that some snow on the ground would be helpful for our snow dealers and our snow team. However, season-to-date results put these concerns in a bit better context.

North American fourth quarter industry retail sales actually grew low single digit despite a very weak December and season-to-date through December are up mid single digits. Polaris was up similar to the industry in the fourth quarter and season-to-date we are up high single digits so we are growing and picking some additional market share.

Our new model year '12 products have been well received in particular the new Switchback models, while the new RMK pro-RM mount sled is the number one selling product in the industry season-to-date.

Dealer inventories are in solid shape, up single digit year-over-year and we will monitor this closely to the balance of the remaining selling season with our dealers before finalizing our 2012, 2013 seasonal build plan.

On-Road Vehicles and Victory motorcycles, our On-Road business delivered fourth quarter sales up 69% led by strong Victory motorcycle growth and sales from GEM, Goupil and the Indian acquisitions. For full year 2011, our On-Road revenue increased 79%. The North American 1,400 plus CC heavyweight motorcycles industries segment continues to strengthen with retail sales up low double digits in the fourth quarter and mid single digit growth for 2011. Victory grew market share again both fourth quarter and 2011 with retail sales up around 20% for both period driven by growth in both our cruiser and touring categories. Victory is now number in market share in the 1,400 CC segment in North America.

Dealer inventory is in excellent shape up about 5% year-over-year and the Victory dealer network has increased by about 15% in 2011, it is now just over 400 strong. Victory has been busy on a new product front as well. In December we introduced the Victory Hard-Ball, a touring bagger with attitude featuring Ape-Hanger or Handlebars and just this last weekend at the New York international motorcycle show, we introduced the all new Victory Judge Custom Cruiser. Both new products will begin shipping in Q1 and will provide the strong Victory line up with two more incremental retail drivers for calendar year 2012.

For 2012, we expect continued growth from the North American heavyweight industry segment up low to single digits and the Victory brand and dealer network is clearly on an upward trajectory and we again expect to outperform by growing market share.

In the fourth quarter our first Indian motorcycle shipments were delivered to dealers and Indian retail met our expectation. Our primary focus for Indian in 2012, however, is developing and executing the brand, distribution and product strategies that will restore the first motorcycle brand to its rightful place in the global motorcycle industry.

Our small electric vehicle business continued to take shape with the acquisition of Goupil in November. Goupil is the market leader and the fast growing European electric commercial light work vehicle segment and compliments our GEM brand and business which is the market leader in the North American electric people segment.

Fourth quarter GEM retail and revenue met our expectations and late in the fourth quarter we successfully began production in Spirit Lake while moving the balance of our GEM headquarters down to twin cities from Fargo. In order to better focus on GEM and Goupil we have ceased production of the Breeze product and shifted our energy toward integration activity, driving our value tracks, taking out ways and creating profitable growth in 2012 and beyond.

Parts, garments and accessories, PG&A fourth quarter sales increased 13% driven by strong double digit growth in all global regions and strong accessory sales that were somewhat offset by slower snow part sales. For the full year 2011, we concluded a record sales year up 19% versus 2010 again driven by strong accessory sales.

International, international sales continued to outpace our rapid North American growth with fourth quarter sales up 43% thanks to strong growth from all product lines and all grow able regions.

ORVs, On-Road and snowmobiles all grew in excess of 40%. 2011 was a record for an international business with sales up 39% for the year. Despite fears of a slowing European economy, our EMEA team continues to deliver with the fourth quarter and 2011 sales that exceeded 35%. The European ORV industry was down mid single digits for both the fourth quarter and the full year with Polaris ORV retail trends following the similar while retaining our market share leadership.

Unlike North America, Scandinavia had decent snow cover and industry sale season-to-date are up low single digit. Polaris's gain in some share with season-to-date retail sales up mid single digit. Likewise the European heavyweight motorcycle industry was up single digit in the fourth quarter and for 2011 increased low double digit.

Victory retail momentum and market share continues to build with sales up over 50% for the quarter and the year. and finally, our Russian sales are up over a 100% in 2011 driven by outstanding growth in both ORVs and snowmobiles.

As we head in 2012, we are monitoring the European economy carefully and will accordingly be cautious in our expectations. However, we are encouraged by our team and our dealers ability to growing a top and uncertain 2011 environment and believe we will grow again in 2012.

Asia Pacific and Latin America grew about 30% in total in the fourth quarter and for 2011 were our fastest growing global regions and a long term prospects for these areas are extremely encouraging. Our new local subsidiary teams in Brazil, India and China are talented and experienced and are executing their market development plans rapidly and effectively.

In the Asia Pacific region Australia just concluded another record year for ORV and Victory sales, while China and India both continued at high quality dealers that will drive strong Polaris's brand experience in these key markets. For 2012, we again expect that Asia Pacific and Latin America will be our fastest growing global regions.

Operational excellence, we continue to see tangible results from our operational excellence initiatives focused on quality, cost and speed. For 2011 gross margins increased a 130 basis points to a record level, even more impressively net margins improved a 120 basis points to a record 8.6% for 2011.

However, fourth quarter gross margins did decline a 160 basis points off of the record comparables due to currently fluctuations and significant commodity pressures notable rare earth and steel. While we expect to face continued commodity and currency headwinds particularly in the first half of 2012, we are confident in our ability to improve both gross and net margins, thanks to our speed the market, relentless global sourcing efforts and value engineering and lean plant productivity initiatives.

Polaris manufacturing realignment projects continues to make significant progress, moderating network exceeded all financial and project timing targets during 2011. More importantly it outperformed our expectations on quality and provided much needed capacity for our rapidly growing global consumer demand. As we move into 2012, Monterrey will have an importance as we expand to our planned third assembly line, migrate some more of our supply chain down to Mexico and produce at higher volume wind rates throughout the year.

Our quality continues to improve as reported by our customers, net promoter scores increased by 4% and we are industry leaders again in side-by-sides and motorcycles. Factory inventory declined sequentially 12% in the fourth quarter but was up 26% versus 2010 year end as we accommodated significantly higher retail demand, supported growing international subsidiaries in the big countries and took on inventory from our acquired companies.

Factory inventory reduction remains an opportunity for Polaris and we have key 2012 lean initiatives focused on improving both customer response and eliminating inventory waste.

And with that I'll turn it over to our CFO, Mike Malone.

Michael Malone

Thanks Bennett and good morning to everyone. As both Scott and Bennett mentioned 2011 was another extremely successful year for Polaris. We significantly exceeded our initial plans at the beginning of the year through higher volume and improved margins.

2012 is expected to be another record year for the company, our full year guidance is as follows:

Total company sales are expected to increase 5% to 8% for the full year with individual businesses contributing as follows:

Sales of Off-Road Vehicles are expected to increase in the mid single digits percent range with retail sales of side-by-side vehicles and ATVs continuing to outpace the overall market in both North American and internationally.

We expect to gain additional ORV market share in 2012, although at a more moderate rate than the past two years. The lack of snowfall we have seen in much of the Snow Belt, we expect our snowmobile sales to be down in the mid single digit percent range from a very strong 2011.

As usual, we will know much more as the winter selling season winds down and we take dealer orders starting in March. On-Road Vehicles which now comprise of Victory and Indian brand motorcycles as well as the company's small electric vehicles GEM and Goupil is expected to be up 30% to 40% in 2012 due to continued solid retail sales demand and additional market share gains for Victory motorcycles globally plus a full year of sales of GEM and Goupil electric vehicles.

We expect PG&A sales to increase slightly faster than the overall company growth rate and we expect sales in 2012 to customers outside of North America to increase in the low double digit percent over 2011, which now includes the acquisition of Goupil in the fourth quarter.

Gross margins are expected to expand up to 100 basis points from 2011 and I will provide a bit more detail shortly on that one. Operating expenses are expected to decrease as a percent of sales in 2012 compared to 2011 due to the leverage obtained from the higher sales volume and more normalized incentive compensation expenses in 2012.

The income tax provision rate for the full year 2012 is expected to be in the 34% to 34.5% pre-tax income similar to the 34.3% reported in 2011. Earnings per share for the full year 2012 are expected to be in the range of $3.65 to $3.80 up 14% to 19% compared to 2011.

During the fourth quarter of 2011, we repurchased approximately 1.2 million of the company's shares for a total of about $70 million bringing the full year total repurchases to $132 million that leaves about 3.6 million shares as of year end remaining on the existing share repurchase authorization from the Board of Directors.

In 2012, the number of diluted shares outstanding throughout the year is expected to be approximately flat for 2011, as we plan to target share repurchases that approximate the dilutive of shares issued under the employee plans during 2012.

In the 2011 fourth quarter, the gross profit margin percentage was down 160 basis point slightly worse than we expected when we last updated our guidance. We anticipated pressure from higher commodity cost and continued negative currency movement and those came in about as planned. What we did not predict was the extent of the lack of the snowfall which impacted the high margin PG&A sales resulting in a negative product mix impact on the overall gross margins.

Additionally the lack of snowfall as an increase in snowmobile promotional tools in the fourth quarter. The gross profit margin percentage for 2012 is expected to increase up to a 100 basis point from 2011. We believe significant commodity pressures we have experienced in the second half of 2011 will continue to pressure gross first half of 2012 but will moderate as we move through 2012 and end up about neutral to gross margins for the full year 2011.

Based on today's rates currencies are expected to be significantly negative to the gross margins for the full year 2012, and currency movements are expected to volatile and unpredictable.

On the positive side, we expect gross margins to benefit from ongoing product cost reductions, higher selling prices and most importantly the manufacturing realignment sales. As Ben and Scott noted the manufacturing realignment project has been a huge operational success during 2011. From a numbers perspective not much has changed. The upfront spending of transition costs and capital expenditures is largely complete with only small amounts remaining in the 2012.

As anticipated we began generating savings from the project in the second half of 2011 totaling about $2 million. For 2012 we expect savings from the manufacturing realignment to be in the range of $12 million to $15 million for the full year most of which will show up benefitting gross margins. We continue to anticipate the manufacturing realignment project, will generate over $30 million of annualized savings when fully complete in 2013.

Moving now to our balance sheet and liquidity profile, net cash provided by operating activities was $302.5 million for the full year 2011 up slightly from last year due to improved profitability mostly offset by the higher investment in working capital particularly increased accounts receivable related to the company's continued international expansion, higher factory inventory levels and a short term income tax receivable.

We expect cash flow provided by operating activities for the full year 2012 to increase over 2011 as factory inventories expected to decrease and the short term tax receivable is applied to the estimated 2012 tax payment offset somewhat by higher incentive compensation payments expected in 2012.

At year end our cash balance was $325 million, a decrease of $68 million from 2010. We maintain $350 million borrowing capacity under our new unsecured revolving credit facility that we entered into during the third quarter. A $100 million unsecured senior notes issued earlier replace the $200 million term loan outstanding at the end of last year.

For the full year 2011, our investments in capital expenditures and new product development tooling totaled $84.5 million an increase of 52% from last year which includes the capital for the realignment project.

For the full year 2012 we expect capital expenditures to be similar to 2011 with increased investments in product development tooling for new products including the Indian motorcycle re-launch.

Depreciation for 2011 was $66 million and we expect appreciation for 2012 to be similar to the 2011 levels. Polaris acceptance receivables from dealers in the US were $568 million at the end of December 2011, an increase of 14% from a year ago. This increase reflects the mixed change of higher value, side-by-side vehicles and motorcycles and a slightly higher unit inventories of dealers.

In conclusion, we are very pleased with our financial throughout 2011 and we are confident 2012 will be a continuation of recent success. With that I will now turn the call back over to Scott for further comments on 2012 and some concluding comments.

Scott Wine

Thanks Mike. To wrap I will offer a little color on how we view the playing conditions for the rest of 2012. Typically, I would expect an election here to bring a bit of optimism to the US economy. But, it appears we will have to wait until 2013 to see a more market friendly decisions and policies out of Washington.

Our team in Europe expects to deal with the modest recession across the Euro zone who will be ready for the possibility of a more severe debt driven downturn, making growth happen will continue to be their mantra.

Economic expansion is expected to remain in our Asia Pacific and Latin American markets although the rate of growth in China and India may slow slightly. The bigger risk to our international business is currency volatility which could be a major headwind in 2012.

Our M&A fund was active and we see numerous opportunities to enhance shareholder value by acquiring and investing in companies that can Polaris a stronger, more diversified global enterprise.

We anticipate new entrants in the side-by-side market and look forward to demonstrating how well our strong growing, stable of RANGERS and RZR can compete. While growth will get much of the headlines, our margin expansion efforts are far from over.

Monterrey volume will ramp as will savings and our lean activities will accelerate across the business to further reduced cost, improved quality and delivery. We have a balanced plan and fully expect to maintain momentum to drive profitable again in 2012. I look forward to sharing our progress with throughout the year.

With that I'll turn it over to Steve to open the lines for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of James Hardiman from Longbow Research, your line is now open.

James Hardiman – Longbow Research

Hi, good morning, thanks for taking my call. Maybe I will start with you Mike, it sounds like currency was a pretty big factor in not only the gross margin performance in the fourth quarter, but also what you are guiding for next year, could you just real quickly hopefully quantify the impact of currency on the top line to gross margins and then other income and just sort of walk us through how well that works and ultimately, if the assumption is you are assuming negative currency impacts in 2012, how should I think about that income line because it seems like some other offset?

Michael Malone

Yes, currencies have been very volatile, we talked about that quite a bit actually on our third quarter, they were moving around quite in a bit. In September, we anticipated that they would have a fair amount of impact in the fourth quarter and it came to fruition as we had called. The impact for the full year on sale of currency is actually positive about 1.6 for the full year. but, the fourth quarter impact was negligible on the top line sales.

On margins however, gross margin was the significant impact in the fourth quarter. I am not going to quantify it, but it was a significant negative impact some of which was hedged and to the extent that there is hedging activity we get some of benefit of those weaker currencies down on the other income line. So, as you noted other income was positive for the quarter and much of that related to the hedging activities on the currency.

So, the pressure up in gross margins for the fourth quarter was somewhat offset by the other income impact down below. Looking forward into 2012, and our expectation right now is that with the rates where they currently are, just to remind we are dependent in Canada with Yen, the Euro, Australian Dollar, all those have significant impact as well as some of the Scandinavian currencies.

So, right now the rates that the way they are, we are anticipating, what I am calling a significant negative impact in gross margin for next year and that is netted into gross margin guidance of up to 100 basis points of expansion. So that offset some of the benefit that we are getting Monterrey and other areas.

James Hardiman – Longbow Research

And so, I guess, as part of that, I guess, the question comes then onto how much of that negative impact hedges and should I be modeling significant positive income in terms of your other income line?

Michael Malone

We have some hedges for 2012 in place. Our Canadian dollar is approximately 50% hedged result, we also have hedges in place for some of the Australian and Scandinavian currencies. So, we have some protection, it's very, very difficult to model or budget or guide impact on another income that’s very volatile and uncertain and I am not guiding or suggesting any benefit down below.

James Hardiman – Longbow Research

Okay, that’s helpful. And then, just in terms of your top line guidance it really looks like the ORV growth assumption of mid single digit is really the launch pin in terms of your overall company sales target, that segment grew 30% each of the past two years, grew 18% in the fourth quarter, so obviously you are looking at a pretty significant deceleration. Can you talk about some of obviously that type of growth can't last forever, but can you talk about some of the reasons why that would need to come down so dramatically and as I am modeling that for 2012, how should I think about some of the quarters, I mean if you are thinking about a slow down, you might assume that maybe that’s a more of a back-off issue than a front-off issues, but then I look at the comparisons last year and the first half of the year, seems like it’s the much tougher comparison. So, how should I think about that?

Scott Wine

James, its Scott. I will take a crack at it and Bennett will probably throw his wisdom in as well. We have much tougher comparables as you acknowledge. I think, as I hope you heard us all three talk about, we did end the year and into the December with a quite bit of momentum in our ORV business. So, we expect, so first half is likely to be good, as I said in my comments our optimism about a strong US economy and getting anything other than headwinds and sluggish growth in the second half is not very high. So, we think we will have a pretty decent first quarter and I think the second half is where we see more risk, we will see how that plays out.

But, right now, I think from a competitive standpoint, dealer inventory standpoint, Bennett, you might want to talk, you are just out in the field so.

Bennett Morgan

Yeah, I will tell you, James, I understand the question. It goes back to exactly I think which are inferring to me. The amount of market share that Polaris has been able garner in the ORV space over the last three years is frankly, its historically unprecedented. I might, it truly is, and so we modeled the industry for the upcoming year about flat which is, that’s an important from where we have been. But, we see more competition come in and we are going to be prudent not getting too far in front of our headlights and we expect that with the product line we have again I was just talking about 25 viewers over the last 60 days and I would tell, our competitive position, I would tell you has never been stronger. Our viewers are feeling really good about the product lines and consumer.

But, I think, again, based on the movements we made over the last three years, we prefer to prove it rather than get too far in front of our headlights, its really I think the bottom line.

James Hardiman – Longbow Research

That’s truly helpful. But, I just want to make sure clear, even though the comparisons in the first half are meaningfully then they are in the second half, you guys actually feel better about first half growth than second half at this point, is that fair?

Michael Malone

James, do you want to send me a spreadsheet. I think the only thing I would tell you James is in typical Polaris fashion that we obviously have pretty good visibility of what’s as we head into the first half of the year and the second half a little further and with the economy the way it is and potential new competitive entrants that’s where it gets a little more cloudy. So, you are hearing the confidence from us based on the momentum we are carrying and what we are doing right now as we headed into the first half.

James Hardiman – Longbow Research

That’s really helpful.

Scott Wine

James, we got to move on.

James Hardiman – Longbow Research

That’s great, thanks guys.

Scott Wine

Okay, then. Next question please.

Operator

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

Scott Stember - Sidoti & Company, LLC

Good morning.

Scott Wine

Good morning, Scott.

Scott Stember - Sidoti & Company, LLC

Could you talk about with the Phase I of Bobcat now seem to be slowing a little bit, what's the timeline for the second phase of Bobcat, are we still looking possibly at the end of this year, early 2013?

Bennett Morgan

Scott, this is Bennett. We are right on the timeline we develop, we try not to comment that too much about future product development. I would say, what you have lined is a range of wind that you might see in that Phase II product.

Scott Stember - Sidoti & Company, LLC

Okay. And last quarter you guys talked about a potential deck from having to rebook some compensation cost in the fourth quarter, did you talk about the impact in this quarter and what your assumptions for 2012?

Scott Wine

Sure. The impact for 2011 fourth quarter was about what we expected its comparable to last year's fourth quarter impact. So, no real big surprises as there was in the third quarter when it was quite volatile.

Looking forward into 2012, as I said in my comments we do expect some of this incentive compensation stuff to normalize in 2012, it will be less than in '11 as kind of roll-off if you will the initial three year long term incentive, expense that was based off of an extremely low share price three years ago. So, we got that behind us and 2012 will be more normalized.

Scott Stember - Sidoti & Company, LLC

And my last question, could you just update us where you are as far as the deploying savings from the facility realignment, whether its putting it into a new product or whether it just showing it down to the bottom line?

Scott Wine

I think Mike gave a pretty good explain of what the savings look like. And, we can't really script for exactly where that money is going to go, it lot of depends on what the economic environment if things continue to go well, we will put more of it to the bottom line. If it don’t go well, we will just allocate based on the market circumstances. But, as Bennett said, the facility is performing right on plan and we expect to have that opportunity to make the investments where they need to go.

Scott Stember - Sidoti & Company, LLC

Got you, that’s all I have, thank you so much.

Operator

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

Tim Conder - Wells Fargo Securities

Thank you, gentlemen, a couple of things here. Bennett, on one of the slides we were talking about the strategic objective, you stated that factory inventory is off plan. Could you elaborate on that statement you have in the slide deck?

Bennett Morgan

Yeah, I think, when we put the budget together that’s we are talking about and we are staying off plan for 2011, we had modeled in much lower growth than what we actually experienced in 2011, we didn’t have all the acquisitions planed for and accounted for and those two factors primarily drove factory inventory off the plan. We are not really uncomfortable with our unit inventory positions, but we are not necessarily satisfied with the dollar level and again with all the work and the capability of this team and the value we think we get out of driving out inventory waste, this is an area that frankly Wine and I continued to be mercilessly on the team. We just think, we can do better, and we think as we do that we can actually improve customer response. So, you will kind of continue to hear us beat this drum probably pretty regularly until we get it down to a number that we are satisfied with.

Tim Conder - Wells Fargo Securities

Okay. It was a little bit of strange statement, but that helps a lot, thank you. Mike, on the gross margin, you said that FX and commodities in the fourth quarter were sort of as expected, you did accrue some promos on the sleds in the fourth quarter, it appears what would be to put on the channel inventories a little bit in the first quarter. The other thing in the slide deck that you said was a variance and it appear to be unexpected was warranty. Could you expand on that a little bit?

Michael Malone

Yeah, you are right. The warranty arrow is down in the fourth quarter, there is no real issues I would say to speak off with warranty. It was slightly negative for the quarter, but for the year we are in fine shape and as you look to next year its about as one would expect with slight impact on margin. So, some timing, no real issues to speak off on warranty.

Tim Conder - Wells Fargo Securities

Was there any particular category Mike or?

Michael Malone

No.

Tim Conder - Wells Fargo Securities

And then, gentlemen, in the military sales helped by some contracts and timing up over a 100%, should we assume that those are roughly around a $100 million and significant increase next year, I mean, over 50% is that fair to sort of a ballpark characterization?

Michael Malone

No.

Tim Conder - Wells Fargo Securities

No?

Michael Malone

You might recall we had a tough year last year in 2010 with our military so a lot of the heavy growth was just on a fairly low comparable. We are not approaching the $100 million business yet, I am confident over the next of years we will get there, but really as Bennett indicated the backlog of actual orders that we end in 2011 with plus the exciting array of new products, new technologies and ultimately new customers. We are very bullish on a very strong year of growth from the military team. Despite the announced cutbacks and increased cutbacks, you are talking about Washington, we think with our value oriented products in the military, we're going to do specially well with this special forces and some unmanned technology is doing quite well also.

Tim Conder - Wells Fargo Securities

Okay.

Scott Wine

Tim, we got to move on to the next question.

Tim Conder - Wells Fargo Securities

Okay, thanks.

Scott Wine

All right, thanks. Next question please?

Operator

Your next question comes from the line of Jaime Katz with Morningstar, Inc., your line is now open.

Jaime Katz - Morningstar, Inc.

Good morning, guys. I have two questions, I will be short. The first one is, it appears that guys have moved those net income margins up to 9.5 percentage to 14 and should we be thinking about as mostly through costs that’s already in growth margin improvement than or is there G&A factor that we should be thinking about coming down? And also, will you guys talk a little about the reception of entry level products that you guys put out earlier?

Scott Wine

I will take the first one, Jaime and let Bennett talk about 570. Yeah, we are actually just relentless on margin expansion. There is not an element of the P&L that doesn’t provide itself an opportunity for us to expand margins. We still see as Monterrey comes online and we drive some of our lean initiatives, we feel lot about putting the cost goods sold online. But, as we have talked about in the past, the last couple of years have been heavy years of investment in some of our new products and new business area. So, we certainly see an opportunity as Mike alluded to in the compensation line as well. So, I think, SG&A in both gross margins are going to be a positive contributor to that march up towards 10%.

Jaime Katz - Morningstar, Inc.

Okay.

Bennett Morgan

We are referring to the 570 RZR and if I am not, you can correct me. But that product really just hit the dealerships and the marketplace essentially late in Q4. So, maybe the last 30 days or so, so retail is really just starting to ramp up and the feedback from the dealers and consumers has been good, its not the same level before you that you some time see on your big high end products, but you are not really chasing some of those one percentors. But, we have had the product with the press and I would kind of on our way out training to our demos and reaction to the capability of the product and the value of the product is fantastic. So, we expect to see very nice lift from that product based on the reception so far throughout 2012.

Jaime Katz - Morningstar, Inc.

Great, thank you.

Operator

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

Ed Aaron - RBC Capital Markets

Hi, great, thank you. Just had a question on mix, if you look back on the downturn side-by-sides, we are driving your growth and mix was real positive and it now seems like side-by-sides are still driving a growth mixes more of a negative. Can you just help me understand why that dynamics seemed to have changed as much as it had?

Michael Malone

Sure. There is some of it related to our significant percentage growth in On-Road Vehicles and those of things as that part of business grows significantly faster, those margins aren’t quite as good as side-by-side. And then, with ORV itself, we have been expanding significantly our product line in being more diverse within ATVs and within side-by-sides to develop things like more value price product, the 570 is an example of that, they're moving to 2012 and have an impact on that. So, those are the things that are more or less impacting the product mix, impact on gross margin.

Scott Wine

Yeah, I think, the last comment would be, obviously PG&A are most profitable business unit at the margin level and with the really unprecedented growth we have seen in almost all of our home goods unit, because you have that significant service business. The parts business isn’t growing as fast right now as the top line that will kind of have a little bit of longer affect at and so I think that’s the other variable to build on like Mike said. We will get that benefit down the road.

Michael Malone

Yeah, you see that especially in 2011 and more so even in the fourth quarter.

Ed Aaron - RBC Capital Markets

Okay. And just a follow up if I could, on snowmobiles, you gave some feed-in today metrics which I think were through December, how much of those kind of season-to-date numbers change if you incorporate what happened in the month of January from a sales through perspective. And then, in terms of the increased promotional costs that were in Q4, does that fully the promotions that you are going to do in the first quarter that go through the inventory versus those being entirely accrued for? Thanks.

Scott Wine

Ed, I will take a crack and then Mike can jump in on some accounting stuff if you want. You are actually trying to give me the comment on January retail sales, you know, we don’t do that. But, let me give you a little bit of color, the end December was weak, January from an industry standpoint has been weak, we are starting to get some snow filled over last week or so across the good part of the flaps and the moments finally have been hit pretty hard.

So, I think, we are getting, I don’t know if we would say, we are optimistic, but we are encouraged that we are finally seeing some white stuff on the ground through most of the Snow Belt and we expect that we will see an improvement in the rate that we have seen really the second half of December and the first half of January. So, I think its too early to really call what's going to happen in the first quarter. To give you some perspective if this helps, about third of industry sales are generally in the first quarter that last half of the riding season. So, I guess, the way I said is, if the trajectory didn’t change, you could expect that we would be down a little bit. But, its just too early to call and I would say right now its inconvenient, it is not certainly not a crisis level for Polaris.

Michael Malone

Okay. On the accrual question, yes we accrue an estimate in the fourth quarter, since we have shipped all the snowmobiles to the dealers, we need to make an estimate of the cost to move those units and we make every year, we do our best of making an estimate of the accrual of promotion that’s going to ultimately take to move those things through.

So, we look at everything we can at this point in time and with the lower snowfall level and little bit higher inventories, we had a bulk of those accruals a bit. But, we don’t expect there to be any hit in Q1 to move through the inventory.

Ed Aaron - RBC Capital Markets

Thank you.

Scott Wine

Next question?

Operator

Your next question comes from the line of Greg Badishkanian with Citi, your line is now open.

Greg Badishkanian - Citigroup Investment Research

Great thanks. Maybe just a little bit on the international market doing well for you and how is Europe, what did you kind of see there in the market place and overall in terms of your mix, how they do you think impact over the next, I don’t know, call two or three years?

Scott Wine

Hi, Greg, this is Scott, I will take that one. As I mentioned in my comments we are incredibly encouraged by the ability of our team in Europe. We setup the headquarters in spring of last year and that continues to drive the momentum. We were 37% last year and had good growth really throughout the year. We are projecting a little bit softer sales in Europe this year obviously given the potential term. But, over the next couple of years, we sent Matt Homan over and its really great to have someone of his experience in leadership background to help really make us think differently about how we approach that market.

Obviously so much demanding more from this side of the pond as we supported. So, we expect that business over the next couple of years to grow quite significantly in spite of a little bit of a bumpy road in the next year or so.

Greg Badishkanian - Citigroup Investment Research

Okay. And just as a clarification on Ed's question, did you say you have the 30% of the selling season left over the next month or two?

Bennett Morgan

Roughly the first quarter is about 30% of MCs, total sales.

Greg Badishkanian - Citigroup Investment Research

At the retail level?

Bennett Morgan

Yes.

Greg Badishkanian - Citigroup Investment Research

Okay, perfect, thank you.

Scott Wine

Next question, Steve.

Operator

Your next question comes from the line of Jimmy Baker with B. Riley & Co. Your line is open.

Jimmy Baker - B. Riley & Co.

Hi, good morning guys. Can you talk a little bit about the ramp in R&D spends here in the quarter where you are seeing opportunities for that investment, maybe how much of that is related to some you recently acquired On-Road businesses and if we should think this is kind of new spend rate going forward?

Scott Wine

You are correct, Jimmy. It is largely related to our – the incremental increase is largely related to our On-Road business and that specifically is mostly related to end-end. As we said we want that business we thought we are going to have to do a lot to bring those back to meet the expectations and standards of the heavyweight motorcycle market for that iconic brand and we are taking a time, putting a lot of resources to make sure we get that right. And that’s driving some of the spike. We are making a little bit of the investment in the GEM and Goupil vehicles but significant spike, but as you know innovation really is what drives this company, so we are not looking to reduce R&D other than becoming more efficient with our R&D dollars and I think throughout 2012, you are seeing us get a lot more for the dollars that we spend in R&D, and you will see the benefits of that throughout '12 and beyond.

Michael Malone

I think maybe thinking a little bit about almost as a percent of revenue, us being in a product and innovation company that’s really how we determine how to spend our money is what do we got in the innovation and that’s always top priority for us. But, look at the percent of revenue that should be a good driver.

Jimmy Baker - B. Riley & Co.

Okay, great. And then could you just give the ORV ASP change in Q4 that usually shows up in the 10-Qs and I guess as it pertains to your 2012 ORV target, could you maybe provide a little color as to kind of how you get there in terms of ASP and mix versus volume?

Michael Malone

So, ORV ASP increased in a quarter about 4% and about 8% for the year.

Jimmy Baker - B. Riley & Co.

And maybe how you see that pulling out versus volume in 2012?

Michael Malone

I don’t have a number on that. I guess I would expect that the trend would continue, our trend toward more side-by-sides and less ATVs will continue, our military business will increase, those ASPs tend to be a bit higher. If I had to guess, I would guess that they would be up year-over-year but I don’t have a number.

Jimmy Baker - B. Riley & Co.

Okay, fair enough, thanks very much.

Scott Wine

We are going to go a few more minutes here. So, Steve we will take the next question?

Operator

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

Mark Smith - Feltl and Company

Hi, guys. Can you just quantify for Canadian sales in Q4?

Scott Wine

Canadian sales in Q4 were up 8% to approximately US$96 million.

Mark Smith - Feltl and Company

Perfect and then just so that I understand on product mix rate, just looking at guidance PG&A should grow a little faster than the rest, is that just not enough to make up for the mix of On-Road vehicles in the margin differential there?

Michael Malone

Yeah, you got it, right.

Mark Smith - Feltl and Company

Okay, perfect, thanks guys.

Scott Wine

Next question?

Operator

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

Gerrick Johnson - BMO Capital Markets

Hi, good morning. Question on GEM, if you look at that let's say you had owned it in fourth quarter of last year, what would the sales growth look like both wholesale and retail for the GEM business?

Michael Malone

Good. Got it.

Gerrick Johnson - BMO Capital Markets

Good, okay. On the 570, was the delivery schedule on plan did you experience any sort of delays or any constraints getting that product out to dealers?

Scott Wine

No, it was basically as planned, we started to leak shipments out in essentially mid to late November and didn’t have a huge amount in the ship plan for the calendar year '11. So, it probably felt slower to the dealers but it was right on our ship plan.

Gerrick Johnson - BMO Capital Markets

Okay. And related to that do you think the dealers are constraint on the particular as your product that the dealers are saying, yeah, we need more and more, more and more, and how can we don’t have it?

Scott Wine

I don’t think, Gerrick, there is a particular product right now, after being out in a number of dealership over the last couple of months. In general they have continued to feel little tied on certain allies or models on a few side-by-sides and a lot of times that can be a little bit regional in perspective. In general, if you are little tight on a few products, but we are not missing retail, they don’t instead of having three they have one and that makes them uncomfortable.

Gerrick Johnson - BMO Capital Markets

Okay, thanks.

Scott Wine

Next question?

Operator

Your next question comes from the line of Joe Hovorka with Raymond James, your line is open.

Joe Hovorka - Raymond James Company

Thank you, guys. I think my question was asked, but I was distracted and I missed the answer, did you give the ASP increase ORVs and for overall in the fourth quarter?

Scott Wine

I did.

Joe Hovorka - Raymond James Company

I apologize asking again, could you give that more time?

Bennett Morgan

ASP for ORVs in the fourth quarter increased about 4%, full year is about 8%.

Joe Hovorka - Raymond James Company

Do you have the overall as well, for the whole products?

Bennett Morgan

For the full year?

Joe Hovorka - Raymond James Company

Yeah and for 4Q?

Michael Malone

About 6% for the full year and about 2% for the fourth quarter.

Joe Hovorka - Raymond James Company

And presumably you will another ASP increase in 2012 in ORVs or no?

Scott Wine

I got asked that question before, I don’t have a number, but I think its going to be a bit higher.

Joe Hovorka - Raymond James Company

A bit higher, a bit higher, what is it bit higher in general?

Scott Wine

Bit higher than 2011. Not the percentage higher. ASP will increase in 2012 over 2011.

Joe Hovorka - Raymond James Company

Right. So, I look at the guidance for ORVs about mid single digit, I think is what you said for 2012, that would imply, I mean, probably again they are right with ASP and treat you international business, Bobcat, military that’s bought, it doesn’t seem like there is much of unit increase in that number, am I correct in reading it that way. If I look at retail sales?

Scott Wine

Yeah, I think that’s a fair way to read it. I mean what we are having is continued growth in side-by-sides but moderating and continuing to be offset by some declines in ATV which has traditionally been the larger business so its up largely.

Joe Hovorka - Raymond James Company

Right, okay. And ORV you said I think was flat for, the industry was flat for 2012, was that the comment?

Scott Wine

That’s what we are expecting, yes.

Joe Hovorka - Raymond James Company

I'm sorry for 2011, it was my mistake, 2011?

Scott Wine

2011, ORV was down low single digits.

Joe Hovorka - Raymond James Company

The entire ORV or just?

Scott Wine

The entire ORV industry.

Joe Hovorka - Raymond James Company

So that would imply that you are picking up maybe one or two points or you are growing one or two points in an area that’s growing flat, is that the way I would read the guidance?

Scott Wine

You are close, Joe.

Joe Hovorka - Raymond James Company

Okay. I just wanted to clarify that. That’s all I have right now, thanks.

Scott Wine

Okay, last question Steve?

Operator

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

Craig Kennison - Robert W. Baird & Co.

Good morning, thanks for taking my question as well. Bennett, your provided very helpful color on North American sell in and inventory on a ORV basis, could you just provide some color on what you are seeing internationally as well?

Bennett Morgan

Make sure I understand the question, Craig. From a standpoint of what we are expecting?

Craig Kennison - Robert W. Baird & Co.

Just in terms of the current law, I'm interested in the current, your view of the current status of inventory internationally and how that product is selling through?

Bennett Morgan

Again, we have slightly different setup with our subsidiaries and our dealer network in Europe and you have had traditional North America. So, dealer inventories have never been an issue in all honesty in Europe and they are not an issue today, subsidiary inventories from standpoint I think are stable even with the growth and you feel really good about our inventory position, they are sometimes with the rapid we have had really over the last year. So, we have starved international guys a little bit on timeliness of the product with the better than expected demand. So, if anything that had been a little bit too lean on certain models.

Craig Kennison - Robert W. Baird & Co.

But, you would say, maybe they are no longer starving for inventory today?

Bennett Morgan

I would say that we are in a – like I said, I think our inventories are near optimal levels.

Craig Kennison - Robert W. Baird & Co.

Very good, thank you so much.

Scott Wine

Okay that’s all the questions we have and the time we have so, I want to thank everyone again for participating this morning and we look forward to talking to you again in next quarter. Thanks again and good bye.

Operator

Ladies and gentlemen, this concludes today's conference call, you may now disconnect.

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