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Executives

Richard Edwards - Director of IR

Scott W. Wine – CEO

Bennett J. Morgan - President and COO

Michael W. Malone - VP - Finance and CFO

Analysts

Jaime Katz – Morningstar, Inc.

Greg Badishkanian – Citigroup

Scott Hamann – KeyBanc Capital Markets

Gerrick Johnson – BMO Capital Markets

Jimmy Baker – B. Riley & Company

Craig Kennison – Robert W. Baird

Ed Aaron – RBC Capital Markets

Rommel Dionisio – Wedbush Securities

Scott Stember – Sidoti & Company, LLC

Tim Conder – Wells Fargo Securities

Mark Smith – Feltl and Company

Joe Hovorka - Raymond James Company

Polaris Industries, Inc. (PII) Q2 2012 Earnings Call July 24, 2012 10:00 AM ET

Operator

Good morning. My name is Sarah, and I’ll be your conference operator today. At this time, I would like to welcome everyone to the Polaris Second Quarter Earnings Results Conference Call. (Operator Instructions)

I would now like to turn the call over to Mr. Richard Edwards, Director of Investor Relations. Mr. Edwards, you may begin your conference.

Richard Edwards

Thank you, Sarah. Good morning and thank you for joining us for our 2012 second quarter 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, 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 the balance of 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 will turn it over to Scott. Scott?

Scott Wine

Good morning and thank you for joining us. With the second quarter and first half of 2012 in the books, I am encouraged by the performance of the team and the results of the business. While weak U.S. GDP growth and a likely recession in Europe are concerning, we continue to enjoy surprising strength in our core North American Power Sports business. We are capturing healthy market share gains in both off-road vehicles and motorcycles, in a climate of increasing competition, and the entire Polaris team is executing at a high level. I am more than comfortable betting on them to successfully lead us through this period of economic uncertainty.

Sales for the second quarter increased 24%, to a record $755.4 million, as robust North American retail demand and corresponding dealer orders counterbalanced a 7% growth rate for international business. Slowing off-road vehicle sales in Europe were offset by the addition of Goupil revenue, while our Asia Pacific Latin America business grew over 20% again this quarter. Overall, off-road vehicle revenue was up 20%, with our Ranger and RZR side-by-sides carrying most of the load. On-road sales were up 110%, fueled by substantial motorcycle gains and purely incremental GEM and Goupil sales from our small vehicle business.

Second quarter net income rose 43% to 69.8 million, yielding record earnings per share of $.98, a 44% improvement over the prior year period. Much of the earnings growth resulted from higher volumes, although our manufacturing and product-related cost reduction efforts continue to pay dividends. These gains were not enough to overcome reduced, but still present, commodity headwinds, and a dramatic shift in currencies, which alone cost well over 100 basis points hit to gross margins. For the quarter, overall gross profit margins were down 50 basis points, however as we have emphasized now for the past few years, our ultimate goal is to expand net income margins, which climbed 120 basis points in the second quarter to 9.2%.

Buoyed by the strength of the off-road vehicle category, and with confidence in our new model year ’13 product offerings, we are again raising our full-year sales and earnings guidance. Despite a soft and potentially slowing U.S. economy, we expect a positive reaction to the outstanding lineup we’ll introduce in next week’s dealer meeting. New products and process improvement should contribute to market share gains and margin enhancement throughout the remainder of the year. We are lowering second half expectations for our EMEA business, although they should still surpass 2011 results.

Growth in Asia Pacific Latin America is steady, and international sales overall will be solidly positive for the second half. We are increasing our full-year sales guidance for the entire company to up 14 to 17% over 2011. Coupling this sales growth with productivity gains and relaxing commodity pressure, we now anticipate full-year earnings per share in the $4.05 to $4.15 range, up 27 to 30% over 2011.

Earlier today, we announced we have signed an agreement to create a new joint venture in India with Eicher Motors Limited. We have made excellent progress over the past two years building our Polaris business in India, and are confident that Eicher is the right partner to help us accelerate growth in this important region. Eicher is a New Delhi-based $1.3 billion manufacturer of commercial vehicles and motorcycles, with a rich history and a sterling reputation. Eicher introduced India’s first tractors in 1959, and it was a proud legacy of innovation, including successful stewardship of the iconic Royal Infield motorcycle business. The largest part of the company is their joint venture with Volvo, which produces modern commercial vehicles and components. The 50-50 joint venture anticipates both Polaris and Eicher will invest approximately $25 million over the next three years. The joint venture plans to establish a manufacturing business in India, to develop and commercialize new vehicles for India and other emerging markets. The joint venture will combine Polaris’s innovative designs and engineering acumen with Eicher’s power train expertise, low cost supplier base and intimate knowledge of local consumer trends. Eicher’s strong financial position and powerful brand provide Polaris with firm footing in one of the world’s fastest-growing economies, and this joint venture establishes an important platform from which we can access an expansive group of new Asian customers.

We are in the midst of our annual strategic plan review, and the long-term outlook for Polaris is improving as our teams gain traction and build capability toward each of our strategic objectives. We’ll remain steadfastly committed to becoming a more diversified, highly-profitable global enterprise, further enhancing our position as the world leader in Power Sports. Our scenario planning includes the probability of another recession within the next five years, and we will be prepared to again demonstrate how our experienced team, organizational speed and corporate agility can serve as a competitive advantage during any set of economic conditions.

In the first half of 2012, our off-road vehicle team exemplified what it means to be the best in Power Sports Plus. We delivered our best ATV retail growth in years, and despite competitors entering or upgrading existing vehicles in the side-by-side category, our industry-leading product lineup and unparalleled dealer network enabled significant sales and market share growth. Meanwhile, the sustained progress of our Victory business provides confidence that our investment in motorcycles will yield exceptional returns. We are on schedule with our Indian bikes, and are building a business model worth of this storied brand. Parts, garments and accessories will play a major role supporting our motorcycle business, as well as an increasingly important part in our overall strategy.

Outperforming our competition, especially during the various up and down cycles in Power Sports, involves diversifying and strengthening Polaris’s growth through adjacency initiatives. Although our military business was down slightly in the second quarter, they made outstanding progress in their product and strategic growth initiatives. In a move that will initially support our defense business, but should ultimately provide value to military and commercial consumers alike, we acquired Resilient Technologies in the second quarter, a small company offering exceptionally high performance non-pneumatic tires.

In small vehicles, we are seeing weakness in Goupil’s core French market, but we are making solid progress, establishing a platform for growth with GEM and Goupil at the core. We remain busy with our various M&A activities, many of which, like our Eicher joint venture, support our global market leadership initiatives.

Our opportunities outside of North America are significant, and while we have made less progress than I would like in improving the percentage of total company sales that this represents, the organizational strength and infrastructure we have established over the past few years has us posed for success. Our EMEA team is battling hard for market share gains amidst slowing sales in Western Europe, while aggressively pursuing expansion in Russia, Middle East and Africa. We are likewise counting on our Asia Pacific Latin America business to capitalize on its promising early success and become a significant long-term growth platform for Polaris.

Our rapid sales and volume increases over the past couple of years offer a good case study on the importance of operational excellence. From generating savings and expanding capacity through Monterrey, to reducing warranty costs and improving lead times, we are reaping the rewards of our lean initiatives and investments. However, this progress does not signify we have met our objectives, so expect us to continue to build capability and work hard to capture the numerous additional opportunities identified on our LEAN roadmap.

Strong financial performance, including long-term shareholder returns, is the ultimate scorecard for our strategy. Although quarterly metrics will be occasionally affected by currency fluctuations or other events, our commitment to long-term margin expansion and overall profitable growth is unflagging. With that, I’ll turn it over to our chief operating officer, Bennett Morgan, who will provide additional insights in our operations and business unit performance.

Bennett Morgan

Thanks Scott, and good morning. Polaris second quarter retail sales remained very strong, up 17% on rising consumer demand for Polaris products across all our businesses, and a growing healthy Power Sports industry. Dealer inventory was up 17% year-over-year, off artificially low comparables last year, as side-by-side and motorcycle inventory climbed to meet increased consumer and dealer demand, dealer expansion and support of new product segments that we’ve recently developed. Despite the increases, we still remain a bit too tight in certain key side-by-side and motorcycle segments, and improving delivery remains a key corporate priority.

Moving on to business unit performance. Off-road vehicles. The Polaris ORV business continues to deliver outstanding quarterly results and exceed even our lofty expectations. Second quarter sales were up 20%, driven by strength in core side-by-side and ATVs. Year-to-date, sales are up 25%. Once again, we gained market share in both ATVs and side-by-sides. Polaris North American ATV retail increased nearly 10%, outperforming an ATV industry which again grew nicely, up mid-single digits. Polaris North American side-by-side retail sales were up over 20%, as both Ranger and RZR platforms gained share, and the side-by-side industry, we estimated, grew around 15%.

Our retail success and competitive advantage has never been stronger, thanks to a comprehensive fleet of products, not just one or two key successful models, each that serve a distinct customer need. We relentless expand and upgrade this product portfolio, and add to our industry-leading collection by leveraging our innovation and our speed to market. We are eagerly looking forward to our upcoming dealer show in Las Vegas next week, where we will unveil our new model year ’13 products to further build upon our ORV leadership.

Sales to Bobcat were down in the second quarter, on lower Bobcat national account sales, due to the acquisition and consolidation of a key Bobcat rental customer. However, Bobcat did report retail sales grew upper single digits, and that their dealer inventory remains in very good shape. The co-developed project with Bobcat remains on schedule, and we are anticipating launch of the new product in calendar year 2013.

Second quarter defense sales decreased, due entirely to order timing. Year-to-date, sales remain up year-over-year, as we build the business and solidify our leadership position in the ultra-light vehicle segment. Our success with the Special Operations Forces accelerated as we began our first shipment of our new MV850 ATV to SOCOM, and we are receiving strong early interest in our newest military product, the M RZR, which will be available in the third quarter. A non-pneumatic tire technology, or NPTs, that we acquired in the second quarter, will be available on the MV850s in the fourth quarter. For 2012, we maintain our expectation that defense sales will increase significantly.

Snowmobiles. Although second quarter is a seasonally slow quarter for snowmobiles, our second quarter sales increased 30%, to $8.9 million. Model year ’13 worldwide orders and Snow Check sales have been finalized, meeting our expectations, and we are looking forward to the upcoming season to build further upon our competitive momentum.

On-road vehicles and Victory motorcycles. On-road second quarter revenue was up 110%, led by Victory expansion and solid contributions from our acquisitions, Indian motorcycles plus GEM and Goupil small electric vehicles. The North American heavyweight motorcycle industry continued to grow in the second quarter, but slowed below single digits due to some sales being pulled into the first quarter as a result of the unseasonably warm and early spring weather. Year-to-date, the industry is healthy and up upper single digits. Victory again gained market share, with retail sales up over 10% in the second quarter and year-to-date is up over twice the industry growth rate, propelled by the performance of our cross country tour, Hardball, Highball and the new Judge models. Indian motorcycles remain right on-plan as we develop the next generation of products and distribution of this storied, premium American motorcycle brand. Our GEM business is showing encouraging signs. Second quarter dealer orders more than doubled, reaching their highest quarterly levels since the fourth quarter of 2009. Our focus on expanding and improving distribution is paying dividends. We’ve added more than 60 dealers year-to-date, and expect to add more by year-end. Goupil is facing some challenges from the struggling European economy, as some government customers delayed purchases, yet first-half revenue was up year-over-year. The new G5 Hybrid launch is progressing, and our costs and operational efficiency improvements are meaningfully impacting the bottom line.

Parts, garments and accessories. Our PG&A business accelerated and recorded a stout second quarter, with sales up 15%, led by strong growth in both parts and accessories. ORV PG&A sales were up 17%, and on-road PG&A was up 54%. Year-to-date, PG&A sales are now up 9%. Next week, we will launch over 200 great new accessory products at our dealer show in Vegas, building on our strong track record of PG&A innovation.

International. International sales, which include the Goupil business, were up 7% in the second quarter, as our team again outperformed the competition despite a tougher global economy. Our on-road business was up over 130%, as Victory continued to grow and pick up market share across the globe. Year-to-date, international sales are up 13%, driven by strength in Asia Pacific and on-road motorcycles. Our European team delivered growth again in the second quarter, up 3%, and year-to-date we are still up 9%, but we are seeing real signs of slowing in Western Europe due to the broader economic and currency challenges we face. While we still gained significant market share in ORV, where we remain the industry leader, and motorcycles, both industries were weaker, each down double digits in the second quarter. We are monitoring this closely, and we expect new model year ’13 ORV and motorcycle products, strong snowmobile order commitments from the spring and continued solid growth outside of Western Europe, to be helpful sales catalysts in the second half. Latin America sales were down 19% in the second quarter, due primarily to lower-than-expected distributor orders in Mexico and Argentina. Asia Pacific, driven by strength in both Australia and China, again grew very rapidly, up 38% in the second quarter, and we are thrilled to expand our capability and presence in India with our new joint venture.

Operational excellence. Scott and Mike are covering second quarter gross margin details, but I wanted to provide some color on our operational excellence initiatives. Manufacturing realignment savings and higher volumes continue to spearhead margin expansion. Monterrey is producing engines and side-by-sides right on plan, and generating escalating savings as the plant matures. Our second engine line is now operational, and we are in the process of adding a third assembly line to meet rapidly rising side-by-side demand. Manufacturing productivity efforts are consistently impacting the bottom line, and we expect moderating commodity prices to begin to be helpful to us sometime late in the second half. Despite ongoing aggressive investment in our future, we remain able to drive our efficiencies to the bottom line. Factory inventory was up, but in control in the second quarter as we moved to support higher side-by-side and motorcycle demand, and new model year ’13 products that we will introduce next week. With that, I’ll turn it over to Mike.

Michael Malone

Thanks, Bennett, and good morning to everyone. I will begin with a more detailed discussion of our full-year guidance for 2012, which we are once again increasing, and some additional summary comments about our record second quarter and qualitative comments on our second half expectations.

First let me review our current revised full-year 2012 guidance. We now expect total company sales to increase 14 to 17% for the full year, with individual businesses contributing as follows. Given the strong first half retail sales results of off-road vehicles, sales to dealers are now expected to increase in the mid-double digit percentage range, with retail sales of side-by-side vehicles and ATVs outpacing the overall market, both in North America and internationally. We expect to continue to gain ORV market share in the balance of 2012.

On-road vehicle sales, comprised of Victory and Indian brand motorcycles as well as the company’s small electric vehicles GEM and Goupil, are expected to increase 50 to 60% in 2012, up from our previously-issued guidance due to strong worldwide retail sales in our Victory motorcycle business. Snowmobile sales are expected to decrease in the mid-single digit percentage range, unchanged from previously-issued guidance, as we have the dealer orders now for the model year 2013 snowmobiles.

We expect PG&A sales to grow low double digits percent, with growth coming from ORV, motorcycles and international divisions and the launch of over 200 new model year 2013 products. We now expect 2012 sales to customers outside of north America to increase in the low double digit percentage range over 2011, down slightly from our previously-issued guidance due to the weak European economies and the resulting effect on their respective currencies. Note that our international business includes the acquisition of Goupil beginning in the fourth quarter of last year.

Gross margins are now expected to expand in the range of 60 to 80 basis points from last year, which is lower than our previously-issued guidance. This reduction is entirely due to unfavorable currency movements, which had a significant impact in the second quarter and which are expected to continue to negatively impact gross margins for the balance of the year. I will provide more details in a few minutes.

We continue to expect operating expenses to decrease as percentage of sales for the full year 2012, due to leverage obtained from the higher sales volume and more normalized incentive compensation expenses in 2012. The reduction in the stock price during the second quarter of 2012, compared to the significant increase in the stock price during the second quarter a year ago, was the primary reason for the 12% decline in general and administrative expenses during the second quarter of 2012. We will continue to invest in new businesses, growth opportunities and global expansion to fulfill our long-term strategies.

The income tax provision rate for the full year 2012 is expected to be in the range of 34 to 34.5%, a pre-tax income similar to the rate reported last year. Earnings per share for the full year 2012 are expected to be in the range of $4.05 to $4.15, up 27 to 30% compared to the full year last year.

In 2012, the number of diluted shares outstanding throughout the year is expected to remain approximately flat with 2011, as we plan to target share repurchases that approximate the dilutive impact of shares issued under our employee plans. During the second quarter, we repurchased about 600,000 shares for $43 million, leaving 2.9 million shares remaining on our repurchase authorization.

In the 2012 second quarter, the gross profit margin percentage was down 50 basis points from an elevated 29.2% last year, in which we saw 300 basis points of expansion. The decline in gross margins was entirely due to the negative foreign currency fluctuations, which adversely affected gross margins by well over 100 basis points during the second quarter. As one example, during the 2011 second quarter a year ago, the Canadian dollar averaged about $1.035, compared to below-parity during the 2012 second quarter. This significant year-over-year change in the Canadian currency rate resulted in about a $5 million reduction in our reported second quarter Canadian subsidiary sales, nearly all of which flows down to gross margins since we source very few component parts out of Canada.

Fluctuations in the currency rates in other countries in Europe, Scandinavia and Australia, also contributed to the negative gross margin impact in the second quarter. As you may remember, currency fluctuations impact not only our sales and cash flow transactions, but also the translation of certain balance sheet and intercompany positions.

Our updated full-year 2012 guidance assumes continued weakness versus a year ago in the Canadian dollar for the balance of the year, as well as most other foreign currencies we have exposure to. We do have financial hedges on about a third of the Canadian dollar cash flow exposure for the second half of the year, and for over half of the cash flow exposures for some of the other currencies, so some of the pressure on the gross margin line will likely be offset by benefits on the other income line of the P&L.

Gross profit margin percentage for the full year 2012 is now expected to increase 60 to 80 basis points from 2011, after reflecting the currency pressure. On the positive side, we anticipate gross margins will benefit from ongoing product cost reductions, higher selling prices and most importantly, manufacturing realignment savings.

Commodity costs, which have been trending lower recently, but have still been higher than a year ago in the first half of 2012, are expected to provide benefit to the gross profit margin in the second half of 2012. Our expectations from a manufacturing realignment project have not changed. For the full year 2012, we continue to expect savings to be in the previously-issued range of $12 to 15 million, all of which will show up benefiting gross margins.

As Bennett mentioned, our production and quality levels are meeting expectations and we’re ramping up production at the Monterrey facility to meet the increased side-by-side retail demand. Anticipated savings from the manufacturing realignment project, upon reaching our targeted production levels at Monterrey and including other changes made at our U.S. facilities, is expected to be $30 million+ annually, when fully complete in 2013, which is unchanged from our prior guidance.

Moving now to the balance sheet and liquidity profile, net cash provided by operating expenses was $78 million for the first half of 2012, up from last year primarily due to the higher net income. We expect cash flow provided by operating activities for the full year 2012 to increase at a double digit percentage rate over last year, as the momentum we have generated in the first half of the year is expected to continue into the second half. At the end of the second quarter, our cash balance was $289 million, an increase of 27 million from June of a year ago, primarily due to the increase in net income, and our debt balance continues to be slightly over $100 million.

For the first half of 2012, our investments in capital expenditures and new product development tooling totaled 41.6 million, similar to the first half of last year. For the full year 2012, we now expect capital expenditures to increase over last year at a similar percentage rate as sales, with expanded investments in product development tooling for new products, including the Indian motorcycle re-launch and production capacity. Depreciation for the first half of 2012 was 32.7 million. WE continue to expect depreciation for the full year to be similar to last year’s levels.

The Polaris acceptance receivables from dealers in the U.S. were $579 million at the end of June, an increase of 27% from a year ago. This increase reflects the mix change of higher value side-by-sides and motorcycles, and the higher unit inventories at dealers in support of the retail sales growth. The retail credit environment continues to be stable, with year-to-date approval rates of 58% and penetration rates of 34% on a 36% volume increase.

In conclusion, we’re pleased with the financial performance of our businesses and the continued strength of our end markets in North America for the first half of the year. The second half of 2012 certainly presents some challenges, but we are confident that the full year will be another successful year for the company. With that, I will turn the call back over to Scott for concluding comments.

Scott Wine

Thanks, Mike. We introduced the theme “Make Growth Happen” a couple years ago, to reinforce our commitment to returning Polaris to profitable growth following the last recession. While we are very disappointed with the economy’s lackluster performance, we are proud of our team’s proven ability to leverage innovation and execution to outperform in a difficult environment. We began 2012 with a vow to stay on offense, and midway through the year I am encouraged by the surprising strength of the North American Power Sports industry and how Polaris is positioned for the second half.

A strong industry almost by definition means heightened competition, but market share increases and rising dealer demand demonstrate that we are winning the competitive battle. Those of you who join us in Las Vegas next week will see that our innovation engine is firing on all cylinders, and our business execution is improving as well. As we have noted throughout the year, our biggest concern is the risk to our industry and our business arising from a sharp slowdown in the second half. We see a likely recession in Europe, and continued volatility in currencies, and have adjusted our outlook accordingly.

It is difficult to gauge how much worse the U.S. economy will get, although we remain very apprehensive that the fiscal cleft and current path towards more regulations, more debt and higher taxes could further dampen or stall U.S. GDP growth. We spend the vast majority of our energy and our effort on levers within our control, but we’ll closely watch the landscape ahead and be ready to adjust as required.

We take nothing for granted, and have a healthy respect for the challenges ahead. We have the utmost confidence in our strategy, our innovative products and our talented team that is the engine driving Polaris forward. With that, I will open up the lines, and Sarah please open it up for questions.

Question-and-Answer Session

Operator

(Operator instructions). And your first question comes from the line of Jaime Katz from Morningstar, your line is now open.

Jaime Katz – Morningstar, Inc.

Hi guys, good morning. I have a couple of questions. The first is on whether or not you guys have a good idea of what that market potential in India might be? I know that the actual manufacturing piece will not happen for a few years, but I assume the target market is for people movers, which you guys would be able to use like the Gem and Goupil kind of styles for, but is there an idea of what that can grow to?

Scott W. Wine

Jaime, this is Scott, I wouldn’t assume that it’s necessarily a Gem and Goupil type people mover, I would tell you that based on [inaudible] capabilities, and our innovation. We feel like we can bring something very interesting and new to the Indian market. Because of the nature of what we’re working on, we’re trying not to open it up to competition to understand where we’re going, and therefore we are very much limiting either the design of the product, or the size of the market. I will tell you if Polaris is going to make a, you know, $20 to $25 million investment, it’s something that we expect to have solid returns, and you can figure out, you know, over the years what that might look like. But at this point we’re not going to give further guidance on the product or the size of the market.

Jaime Katz – Morningstar, Inc.

Okay, and then, I know in the past there used to be kind of a goal for net income margins to reach, I think, 9.5% by 2014, and it seems like that continues to kind of shift forward. Do you have any updated advise on that?

Scott W. Wine

You know, we, at the annual shareholder meeting, we actually officially changed the mid-term target so that 2014 target from 8% to 9.5%, and three months later you’re already asking me to adjust that 9.5 – thanks Jaime.

Jaime Katz – Morningstar, Inc.

You guys set the bar high, I’m sorry.

Scott W. Wine

Now, we continue to be encouraged by our progress on moving the net margin a number up, we do think that the 10% longer-term target is about right – you know, projects like what we’re doing with Isure are by nature going to start off at lower margins and as we grow in some of these parts of the world, you know, we think we could be – I wouldn’t say stuck, but you know, the 9.5 to 10% range is likely where we are going to be for a little while.

Jaime Katz – Morningstar, Inc.

Perfect, thank you so much.

Richard Edwards

Next question.

Operator

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

Greg Badishkanian – Citigroup

Great, thank you. Hey guys, so, good quarter obviously, and in terms of ORV retail sales, any color by geography, or was there any – also, over the last, you know, two months, have you seen any major slowdown, or has it been pretty consistent? What – you know, any color you can provide would be great.

Bennett J. Morgan

Greg, this is Bennett. No, I think we’re quite pleased where ORV was, it’s been basically all year long, it’s been stronger almost as expected and quite steady, so trends have remained, you know, what I call robust. We’ve seen, frankly, a strength across all regions, you know, of North America, which is encouraging, and frankly, we’re seeing strength in all of our platforms – Ranger is quite strong, Razor is quite strong driven by the new Razor 570, and the XPs have been quite good, Multi Passenger has been very good – frankly, Sportsman has been very good. So, you know, as we kind of try to key in the remarks, you know, I think our success really is – it’s not one product or two products, it’s really the most of the Armata, frankly, and that is really allowing us to hit on all cylinders. So, we’re quite encouraged as we head into the second half.

Greg Badishkanian – Citigroup

Great, and I know you can’t give too much info, but next week you’ve got the, you know, the dealership show and some new product launches – how innovative do you think they will be versus maybe what we say, you know, over the last year or two? Are we going to see a decent level of innovation in there?

Bennett J. Morgan

Are you going to be there Greg?

Greg Badishkanian – Citigroup

I – someone from my team will be there.

Bennett J. Morgan

Okay, good to hear. I think you’re going to be pleased – you know, over the last four or five years we have had a tremendous amount of product news, probably, frankly, surpassing the rest of the industry combined – you know, I think last year we stated by our standards was a – I don’t want to use the word modest, but that wasn’t as strong. We think we have a very, very strong model year 2013 line up, and we have some really nice compelling innovations that you’ll see. So, I think people are going to be very pleased with the product offerings they see in Las Vegas next week, so make sure your team is there.

Greg Badishkanian – Citigroup

Great, thank you very much.

Operator

Your next question…

Richard Edwards

Next question.

Operator

Your next question comes from the line of Scott Hamann from KeyBanc Capital Markets, your line is now open.

Scott Hamann – KeyBanc Capital Markets

Yes, thanks, good morning guys. Just in terms of your guidance for the back half of the year, what are you assuming for retail sales, and I guess I’m just trying to square up, you know, where you’re trying to keep inventory levels with your wholesale shipment in the back half of the year.

Bennett J. Morgan

Scott, you know, this morning our reactions on dealer inventory. Frankly, the dealer inventory increase was really – you know, we – is really a reflection of, you know, as we’ve expanded our segments and we were frankly too low last year, inventory by nature had to rise as we committed to really improving, you know, delivery and response to our dealers. I think you should still expect dealer inventory to rise modestly as we go through the second half, you know, no faster than sales, frankly. And from a retail standpoint, Mike wants to take that.

Michael W. Malone

Yes, so, retail in the first half of the year was obviously up higher than what we had anticipated coming into the year at plus 17% in the first and the second quarter. As you know, we don’t expect to get that level of significant retail growth, we plan a little bit more conservatively, so I would say that we, in the second half of the year, we continue to expect to gain market share as we have. We continue to expect the markets to be healthy as they have, and we would expect our retail sales to grow in the second half, but probably not at the pace that it did in the first half. Now we are coming up tougher comps – I mean, off tougher comps in the second half, but also, we need to play into the equation.

Scott Hamann – KeyBanc Capital Markets

Okay, and then just on Latin America, kind of a weakening of quarter, quarter-to-quarter here, is that a timing issue? Was there – I mean, what’s going to help the underlying demand there?

Bennett J. Morgan

Again, it’s really off of relatively low comps – I mean, what you got is – you know, Argentina is, you know, not a large market for us, there is some protectionist measures going on in Argentina that is, frankly, limiting our ability to import in there and which is a timing issue. I think Mexico is a timing issue, and you know, the Brazil subsidiary is really just starting to ramp up, so again, we expect that, we will accelerate in the second half. So, I do think this is primarily timing, Scott.

Scott Hamann – KeyBanc Capital Markets

Okay, thanks.

Richard Edwards

Next question.

Operator

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

Gerrick Johnson – BMO Capital Markets

Hey, good morning. Mike, you discussed hedging activity to the back half, but what were the exposures, or what were the coverage of hedging in the quarter if you can discuss that?

Michael W. Malone

Yes, I don’t have it exactly, but it was probably about half of our – half of the cash flow for Canadian dollar was hedged, which doesn’t protect us from sales movement, or protect us from gross margin erosion that the benefit of that would be down another income.

Gerrick Johnson – BMO Capital Markets

Okay, great, and then on product mix, as a factor to gross margin, if we exclude the parts garment and accessories, can you discuss the vehicle mix and how that effected margin?

Michael W. Malone

Sure, you know, off road – or on road vehicles [inaudible] being dramatically higher than the overall sales certainly has a significant impact. The on roads is up 110% when total sales are up 24, on road with motorcycles and electric vehicles are below the total vehicle average, so that has significant impact as well as the PGNA that you mentioned.

Gerrick Johnson – BMO Capital Markets

Okay, and I just want to throw one more in there. Can you talk about the Terix Four recall at all, is there any positive, negative impact because of that?

Bennett J. Morgan

Hey Gerrick, this is Bennett. While – you know, again, we are not actually going to comment on the competitor’s issues with that – you know, it’s a modest recall, you know, I don’t think there will be a material opportunity one way or the other, and again we will let our products speak for themselves, and again, usually when you see stuff of that nature while it can be short term painful, they usually find a way to work through that reasonably quickly, so I don’t think that is going to be a material sales or share event in the marketplace.

Gerrick Johnson – BMO Capital Markets

All right, thank you very much, guys.

Richard Edwards

Next question.

Operator

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

Jimmy Baker – B. Riley & Company

Hi, good morning. Just wanted to touch on factory inventory, if I could. You know, year-over- year essentially in line with your sales growth, but yet, you kind of continue to indicate that you expect that to be down year-over-year, you know, at year-end despite this mid to high teen’s sales growth. So, can you just kind of elaborate on your expectations for maybe what categories you feel like you might be a little heavy in right now, and just any color as to maybe what’s driving that year-end expectation?

Bennett Morgan

Hi, Jimmy, this is Bennett. You know, as you look at Wine and I, we continue to be aggravated that we’re this high. But as you guys have heard us talk about, we made a real corporate commitment that we were going to put our money where our mouth was, and really work with all of this sales growth we’ve had to make sure that we respond to our dealers and our consumers increased demand needs. And so what we’ve tried to do is put a little bit more of our factory inventory to respond in our growth segments, most notably side-by-side’s and now motorcycles where we really got some pretty significant delivery initiatives. So, there’s some more inventory in that place.

We also got a little bit of timing around second quarter as we start to prep to start shipping in model year ’13 products. And then, you know, I don’t want to say the complexity or the broader range of what Polaris is. You know, we have acquisitions in those inventories. We have new subsidiaries across the globe that we have to have our products in position in. And, you know, we have an extra plant in Monterey that we’re moving raw materials around. So it’s really a multitude of things that are driving the increases. You know, as we continue to work on our lean initiatives and we move forward, you know, most of our teams have pretty robust plans in place where we think we’re going to be able to lean that down as we go to the end of the year, and that’s still our expectation that you will see that, you know, drop in a consistent and smooth manner over the second half of the year.

Jimmy Baker – B. Riley & Company

Okay, that’s helpful. And Mike, probably a question for you here. Your gross margin outlook while revised, still implies pretty significant margin expansion in the back half. I know you hate to speak on a quarterly basis, but would you be expecting substantially more of that gain in Q4 given that you’ll be comp’ing against the 2011 snowmobile accruals?

Michael Malone

I think that’s exactly right. You know, as you look at the quarter’s, the third quarter sequentially from the second quarter of this year, it maybe a little bit weaker, but it still would be in the range of where it was a year ago. And then in the fourth quarter, you’re absolutely right, we have a very easy comp, and we would expect a significant gross margin expansion in the fourth quarter.

Jimmy Baker – B. Riley & Company

Okay thanks. Nice quarter guys, we’ll look to seeing more next week.

Operator

Your next question comes from the line of Craig Kennison from Robert W. Baird. Your line is open.

Craig Kennison – Robert W. Baird

Good morning and congratulations. I had a lot of great questions on Eicher, but it doesn’t sound like you want to reveal too much their? So, I’d like to ask about the drought we’re seeing in parts of the Midwest, and whether that’s affecting any of your agricultural driven market’s?

Bennet Morgan

Craig, this is Bennet. We haven’t seen an impact as of yet, at least, you know, with that fairly broad range and appeal of consumer uses. You know what, we continue to watch and monitor that, but frankly we have not seen an impact. And traditionally when we’ve seen even significant droughts in certain parts of the country, generally we have not seen a material impact on our retail. I’m sure it can affect in a few local areas, but we generally haven’t seen an impact.

Craig Kennison – Robert W. Baird

And then if I could ask just maybe a backdoor question on Eicher. To what extent does the electric vehicle strategy you’re assembling interface at all with your Indian joint venture?

Bennett Morgan

Craig, I think, you know as I mentioned in my prepared remarks. Eicher has an excellent joint venture with Volvo, they’ve got a great business, you know, resurrecting (Royal Enfield) to be a great brand in the Indian market, they have great power train capability.

We will leverage the best of Eicher and the best of Polaris, to bring a product to market that we think has significant competitive advantages.

Since you’re trying to get backdoor, I will tell you that if you look at the history of Polaris, we have not yet demonstrated that we’re perfect market leaders, we will, I’m very competent we will. But our core strength is not yet in electric vehicles.

Craig Kennison – Robert W. Baird

Very good. And then Bennett, just could you comment on any discounting, promotional activity relative to prior a period? Thank you.

Bennett Morgan

Yes, you know with the healthy-end markets, which is again a really encouraging sign. You know, competition is, you know, I think is active. You know, both on the product front and from the sales and marketing front. Promotions are, you know, up a little bit year-over-year, but again completely within our expectations, but you know, it’s an aggressive competitive environment out there. And again as the markets grow we expect our competitors to continue to pay more attention to this marketplace. So, we thing again with what we’ll show next week, and what our teams have planned on that front, we’re in excellent position.

Craig Kennison – Robert W. Baird

Thanks, we’ll see you next week.

Operator

Your next question comes from the line of Ed Aaron from RBC. Your line is open.

Ed Aaron – RBC Capital Markets

Great guys good morning. I guess I was a little bit surprised that maybe you didn’t take the International sales, kind down a little bit more. It looks like you’re expecting a reacceleration in International in the back half relative to the second quarter, and just was curious to understand what the kind of the key drivers behind that are?

Bennett Morgan

I will tell you we had a long hard look at what to expect from our International businesses in the second half. As we mentioned the Asia Pacific, Latin American businesses continue to do well. You know, and that combined with the incremental benefits of Goupil in the second half that wasn’t in the second half last year. You know, we think we’re going to still be, as we said, solidly up in the second half.

Western Europe, certainly the slowing markets there we’ve factored into our forecast, and we think we have it sufficiently covered. Now we are not forecasting a complete meltdown in Europe. You know, we’re expecting continued weakness and they’re probably sliding into a recession for the overall 17 country Euros own region, but based on what we see today, the orders we have, and the conversations we’re having with our distribution network across the globe, now we think we have it down and about right.

Ed Aaron – RBC Capital Markets

Okay, and then just as a follow-up, you know, Bennet may you maybe speak to the (inaudible) inventory levels for the motorcycle business. I know you had some pretty nice upside on the topline in on-road, you know the retail number was up nicely, but not to the same magnitude. So that just sort of seems to be a bit of a change in inventory there, and I just was hoping you could elaborate on that a little.

Bennett Morgan

Yes, actually we feel Ed pretty good about the motorcycle story is a pretty nice story. Frankly, obviously our sales were a little bit slow in the second quarter than they were in the first quarter, but again a lot of that had to do with, what we would call in the industry the seasonality timing due to the unseasonably, you know, warm and early spring that I think probably pulled some industry sales into the first quarter, and we got the benefit of that in the first quarter. You know we continue to gain share.

The primary thing that is driving, you know, dealer inventory, again when you’re doing your surveys and you’re talking to the Victory dealers, they’ll tell you, you know, they want more product. We are not able to feed them as fast as we could particularly in some of those key products that I outlined, you know, highball, hardball, judge, and cross country tours. And we’ve been able to expand our distribution nicely over the last year, so we have more points of distribution. And that’s primarily what’s driving it. So, we feel pretty good about where we are.

Let me just add to that, if you’re going to be there next week, I think you’ll hear Steven (Suresh) talk about, we see an opportunity to improve the way we are providing. I mean, kind of MVP has been good, but not perfectly executed, and we’ve really put a concerted effort across the enterprise, to make sure that as we bring on India next year, that we know exactly how to manage delivery in the most efficient way possible for our motorcycle dealers. So, I think you’ll see a little more collar around the work we’re doing on lean, and how that’s going to positively impact our motorcycle delivery over the years ahead. So, just standby next week, but that is a very, very important opportunity and we’re excited about what the team is doing there.

Scott W. Wine

But the other thing I would point out Ed is that if we’re looking at the 110% growth in the on-road vehicle category, that includes 130% increase of on-road outside of North America, and over a third of the dollar growth is due to the acquisitions year-over-year, so there’s a lot of stuff going on in that 110%.

Ed Aaron – RBC Capital Markets

Understood, thank you.

Operator

Your next question comes from of the lien of Rommel Dionisio of Wedbush Securities. Your line is open.

Rommel Dionisio – Wedbush Securities

Yes, thanks, good morning. A question about the distribution in Europe. Given some of the macro weakness there guys, are you seeing any dealer titration or any real weakness there with regards to floor plan financing that would impact your distribution structure there?

Bennett J. Morgan

Rommel, this is Bennett. No, we haven't seen any impact. Again, the European dealer model, it's a little bit different than what you see in North America. They generally have far less inventory on the floor because of space constraints. And so generally, your subs, or your subsidiaries, or your distributors will be carrying that inventory in lots of cases. So the issue would be more of a velocity issue. We haven't seen any financing really dry up that has rolled up. And so far, so good from a dealer's standpoint in Europe. We'll continue to monitor that if we see ongoing weakness in Europe. But so far, we have not seen any of those issues raise their ugly head.

Rommel Dionisio – Wedbush Securities

Okay, thanks, I think all my other questions were answered. Thanks a lot.

Richard Edwards

Thanks, next question.

Operator

Your next question comes from the line of Scott Stember from Sidoti. Your line is open.

Scott Stember – Sidoti & Company, LLC

Good morning.

Scott W. Wine

Good morning, Scott.

Scott Stember – Sidoti & Company, LLC

Can you maybe talk about the military? You mentioned that we were flattish given pretty much the timing of orders. Can you talk about how that would reverse itself in the back half of the year, the cadence of that? And just talk about the prospects there, maybe some new winds that you've gotten?

Scott W. Wine

Yes, we're very excited as I mentioned about the progress we're making on the strategic product initiatives. We publicly announced today the resilience acquisition, which gives us an incredibly good monumental tire stuff, which will start to flow in in the second half.

But predominantly the order time, we won last year a major contract with the National Guard. We had a great initial shipment. And that order flow has not – the contract's still there, but the order flow has now been as steady as we would have liked. We're working with the Guard to try to make sure that those come through in the second half.

But we have numerous initiatives from our unmanned steel vehicle technology to the new RZR, militarized RZR that we'll be selling to the Special Forces. A lot of that stuff starts to flow in the second half. The new MBA 50 has been very well received.

So lots of good product category. We still continue to feel like the team's working hard. We're going to have significant upside to the full year as Bennett, said, so we feel good about where we are. Just we've always said and always known that military orders will be lumpy. And the second quarter was one of those lumps.

Scott Stember – Sidoti & Company, LLC

Great, and last question. Related to Eicher and the $50 million or the $25 million of cost to Polaris over the next three years, can you talk about when exactly, which quarter we'll start to see those costs flow through? And will any costs be capitalized and how much expense if any?

Scott W. Wine

I think quite a bit of it will be capitalized. I mean we've got to build plants. I mean that's – not the initial opportunity, if you just think about how this is going to transpire, we've been working with them for about a year and a half in project teams, and building the plants, and understanding what to do. We have to finalize a location. We have to build a plant. We have to hire a team. And ultimately bring the product to market. So I'd say ¾ of that is probably capitalized. Mike, what do you think?

Michael W. Malone

Yes, I think that's a good estimate. As a 50/50 joint venture, we're planning on treating this as an unconsolidated subsidiary. So as such, we won't be recognizing any revenue or any costs in the P&L. We will have one line of investment on the balance sheet. And one line of equity in the income or loss of this unconsolidated subsidiary down below in the P&L. So that's how we'll account for this once we start to have transactions.

Scott Stember – Sidoti & Company, LLC

Got you, that's all I have. Thank you so much.

Richard Edwards

Next question.

Operator

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

Tim Conder – Wells Fargo Securities

Thank you, just a couple of clarifications in a little bit larger salt. I'll take the harder ones first here. Could we, Mike, I think you were hinting on some of the color related to inventories, but your organic ORV growth in the second quarter and year-to-date, what's that? And then, Mike, did you say roughly a third roughly in the increase in inventory, did I hear that right, was related to the acquisition?

Michael W. Malone

A third of the growth in dollar sales of on-road vehicles was, over a third of that is attributed to the acquisitions. That wasn’t inventory. That was sales.

Tim Conder – Wells Fargo Securities

Okay.

Michael W. Malone

And I didn’t understand the first half of your question.

Tim Conder – Wells Fargo Securities

Well, that basically it, looking for the organic growth of the ORV, so that answered that part. But then I guess the second part then is the inventory question. If you look at your year-over-year company inventory growth here, how much of that is due to acquisitions?

Michael W. Malone

Oh, okay. I'll look that up. I have it. Go on to your next question.

Tim Conder – Wells Fargo Securities

Just sort of a little bit more color on an earlier question, the cadence across the quarter and into July, Bennett, I think you answered it in terms of North America. You said that all product categories and everything in price points was pretty good. The cadence I guess across the quarter and into July and then the same thing for Asia, Europe, and Latin American in general?

Scott W. Wine

You know, Tim, we're not going into providing weekly trends of sales. But Bennett hit it fairly directly on the momentum through the quarter was very solid here in North America. As we alluded to, throughout the quarter, we did see Europe trending down. We saw the Euro trending down. And we revised our guidance accordingly. As I said earlier, I think we've got that dialed in about right.

Australia and the Asia Pacific Latin American market, I think our comment was right. That's a steady business for us. I mean they're working very, very hard to get orders and build that business up. but we like where we are there.

Tim Conder – Wells Fargo Securities

Okay, and then again, a little more of the pieces here, a little more mundane. Just an update on your Latin American distribution build out, Scott. And so it sounds like again there's, the Latin American, the way you just answered the question, it's more of a timing issue, so just an update on the build out there.

And then a clarification, your motorcycle industry comments in North America, that's only for the 1,400 and above CC market, correct?

Scott W. Wine

That's correct.

Bennett J. Morgan

And in Brazil, I mean just to kind of put it in context, we went out to these markets, kind of with China first, India second, Brazil third. And then with the distribution challenge we had getting that resolved, there's always lagging a little bit further. So the team is in place. They've executing I think a very, very good plan. We're going to have our international show down in Latin America in August. We feel comfortable with where they are right now. I mean I think there's certainly a lot of upside from here for that business, not only in Brazil, but across Latin America.

Michael W. Malone

Tim, to answer your earlier question, the factory inventories are up 25%. And 5% of that is due to the acquisitions.

Tim Conder – Wells Fargo Securities

Great, okay, thank you gentlemen, and great quarter.

Scott W. Wine

Thanks, Tim. We have time for a couple more questions.

Richard Edwards

Next question.

Operator

Your next question comes from the line of Mark Smith from Feltl. Your line is open.

Mark Smith – Feltl and Company

Hi, guys. Real quick, I know you were doing some work down on Spirit Lake on some expansion. Are you guys complete with that and are you all set with continued growth with GEM and rollout of Indian?

Bennett J. Morgan

Yes, Mark, this is Bennett. There's obviously with all the growth, $1.5 billion of growth, our ops guys are very busy with almost continual expansion. But that phase one of Spirit Lake that we discussed is essentially complete. They're doing a little bit more lean activity. But the footprint's in, and key stuff is moved around. We've got most of our lines in place. And we'll making some additional adjustments or improvements over the next year or two as we really prepare for Indian to go into the plant and be a really high volume line as we move forward. So it's going to be a consistent evolution in Spirit Lake. But the key stuff we talked about a few months back is complete.

Mark Smith – Feltl and Company

Perfect, that's all I have. Thank you.

Richard Edwards

Our last question please.

Operator

Your last question comes from the line Joe Horvaka from Raymond James. Your line is open.

Joe Horvaka – Raymond James Company

Hi, guys, just two quick numbers. Could you give the wholesale portfolio at the end of the quarter and then the ASP increase for the ORV segment in the quarter?

Michael W. Malone

Yes, the …

Scott W. Wine

You can do better than that, Joe.

Joe Horvaka – Raymond James Company

Going easy today.

Michael W. Malone

The first acceptance receivable portfolio is $579 million. And the second question was ASP for ORV's, is that what you asked?

Joe Horvaka – Raymond James Company

Yes.

Michael W. Malone

ASP for, do you have it there? For the quarter, it's pretty small. It's less than 1%.

Joe Hivorta – Lehmann James

Okay. That's all I had.

Michael W. Malone

All right, thanks guys.

Richard Edwards

Okay, thanks. We want to thank everyone for joining us again this quarter and we look forward to those that are coming to the analyst meeting next week. Look forward to seeing you there. Otherwise, we'll talk to everyone again next quarter. Thanks again. Good bye.

Operator

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

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