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Executives

Richard Edwards – IR

Tom Tiller – CEO

Bennett Morgan – President & COO

Michael Malone - CFO

Analysts

Gregory Badishkanian - Citigroup

James Hardiman - FTN Midwest Securities

Edward Aaron - RBC Capital Markets

Timothy Conder - Wachovia Capital Markets

Craig Kennison - Robert W. Baird & Co.

Robert Evans - Craig-Hallum Capital

Mark Mulholland – Matthew 25 Funds

Polaris Industries Inc. (PII) Q2 2008 Earnings Call July 15, 2008 10:00 AM ET

Operator

Good morning, I would like to welcome everyone to the Polaris Industries second quarter 2008 earnings call. (Operator Instructions) Mr. Edwards, you may begin your conference.

Richard Edwards

Good morning and thank you for joining us for our second quarter 2008 earnings conference call. The speakers today are Tom Tiller, our Chief Executive Officer; Bennett Morgan, our President and Chief Operating Officer; and Mike Malone, our Chief Financial Officer.

During the call this morning 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 future periods which should be considered forward-looking for the purposes of the Private Securities Litigation Reform Act of 1995. Actual results could differ from those projected in any forward-looking statements, which by their nature involve risks and uncertainties.

There are a number of important factors that could cause results to differ materially from those anticipated. Additional information concerning these factors can be found in our 2007 Annual Report and 2007 Form 10-K which are on file with the SEC.

Now I will turn it over to Tom.

Tom Tiller

Thanks Richard and good morning everyone. Thank you for your interest in Polaris. Earlier this morning we reported financial results for the second quarter. For the quarter sales were $456 million, up 21% and earnings were $0.72 per share, a 16% increase over last year. This was a record second quarter for both sales and earnings per share.

Polaris has had an excellent first half of 2008 despite a very difficult external environment. Consumer confidence is at a 16 year low due to the challenges of high energy prices, the continued housing slump and the tougher credit environment. Cost pressures have gotten more challenging recently due to increasing prices for many commodities, most notably diesel fuel and steel.

As a result, companies in our industry and similar industries are facing big challenges with both demand and cost. Polaris’ ability to weather these challenges and thrive in this environment can be traced back to having a solid strategy, designed to work in a tough environment and solid execution of that plan.

We are winning the market share battles across our businesses and around the world while continuing to drive dealer inventory levels down. We are controlling our costs by improving our efficiencies and productivity through our operation excellence initiative and we’re growing our top line through compelling product innovation. Over the past few years, we’ve made important investments in compelling growth segments, like international, military, Victory and side-by-sides, and those investments are paying off with revenue and earnings growth even during these tough times.

While we are pleased with our continued success we are managing through this cycle prudently. We are planning for the difficult industry conditions to persist and are going into our upcoming dealer meeting in Las Vegas with grounded order expectations. We will continue to be aggressive in product development and will announce some fantastic new products later this month.

Polaris has proven that innovative products sell, and sell well, even in this difficult environment. As we look toward the remainder of the year we are balancing our optimism from our strong first half results, strong business momentum and great new products against the caution of a tougher external environment and nervous dealers and nervous consumers. After considering each of these factors we’re modestly raising and narrowing our guidance range for the full year 2008 to $3.40 to $3.48 earnings per share on sales growth of 9% to 11%.

This represents a $0.04 increase in the low end of the EPS range and a $0.02 increase in the upper end. This conservative approach is appropriate until we can gain greater clarity on both third quarter retail sales and the dealer orders we receive at our show next week. With that overview, I’d like to turn it over to Bennett Morgan, our President and Chief Operating Officer to update you on our individual business segments.

Bennett Morgan

Thanks Tom; I’ll begin with all terrain vehicles. Our ATV business had another excellent quarter with sales up 24%, again driven by strong side-by-side and international sales. The core US ATV market remains very weak and a bit worse then we had expected through the first half of 2008. Industry sales are down 23% year-to-date in the US.

We expect the US ATV industry to remain challenging for the foreseeable future. Comparables do become somewhat easier as we move forward particularly in the fourth quarter so we still expect some modest relative improvement in the second half. But we now believe the ATV market will be a bit worse for 2008 then we did 90 days ago.

We have already proactively adjusted our builds and supply down appropriately based on the evolving market conditions. To put this in perspective, remember that US core ATVs represent only about 20% of our total ATV business gross margins. Despite the weakness there are a number of positive signs in our core ATV business. Our retail sales on full-size Sportsman’s are actually up year-over-year, dealer inventory levels continue to come down; they’re down 10% from year-ago levels. And we expect continued reductions over the next 12 months. The Canadian market remains much healthier then the US and we are significantly outperforming our competitors in this important market.

Year-to-date in North America we continue to win the market share battle gaining a modest amount of share and our new 2008 Sportsman 800 Touring two-up ATV recently won ATV of the Year from the largest ATV industry magazine. We remain very committed to this part of our business and we’ll be introducing some great new products later this month in Las Vegas.

Sales of Polaris side-by-sides continue to grow rapidly. Retail sales and shipments both continue to grow at a very healthy rate, up over 50% year-to-date. Our innovative product platforms with RANGER on the work side and RZR on the recreation side continue to capture market share at an extremely impressive rate. We recently learned from an independent industry research source that we achieved the number one US market share position in side-by-sides for calendar year 2007 and we are clearly aggressively growing our lead in 2008 based on our year-to-date retail results.

Second quarter retail sales for the RZR and our multi-passenger RANGER Crew remain very strong. We continue to make progress towards getting supply in balance with demand on both of these products but shortages still remain in some key markets. As Tom mentioned we have significant new side-by-side product announcements planned for later this month and we expect to continue to outperform the side-by-side market based on these new product introductions.

Snowmobiles, due to the time of the year there’s not a lot to report about snowmobiles and not a lot has changed from 90 days ago. Production for model year 2009 has started normally and as is our recent [adda] few shipments to dealers occurred in the second quarter. As I mentioned in last quarter’s call dealer orders slightly exceeded our expectations as did pre-season snow check sales for our new model year 2009 products. Dealer inventory levels are at their lowest level in 10 years and we are anxiously anticipating the beginning of a new snow season.

Moving to Victory motorcycles, the Victory motorcycle business has had a mixed start to 2008. The heavyweight motorcycle market segments in which Victory compete in are sluggish, down mid single-digits year-to-date. Victory retail sales continue to outperform the segments and the overall market but are not achieving our internal growth targets year-to-date. For Victory retail cruisers remain soft and Vision sales are good. Second quarter wholesale shipments to dealers were down 19% as a result of reducing the model year 2008 cruiser build as we announced in earlier calls. We will continue to manage our supply for model 2009 product cautiously to ensure we help manage dealer inventory levels tightly and protect the premium brand image of our Victory brand.

In light of this we now expect calendar year 2008 Victory sales to be down versus 2007. On the positive side, this upcoming dealer meeting in Las Vegas will mark our 10-year anniversary of Victory. We are the first successful American entrant in over 60 years into the motorcycle business. I think there are three compelling reasons why Victory has been successful; we have the best product, we provide the most value in our class, and we have the most satisfied customers.

Now we have a comprehensive line of cruisers and luxury touring motorcycles with plans for future segment and geographic expansion. Our Vision models continue to penetrate the luxury touring segment and the customers that own Visions are thrilled with the product and the quality. We believe the long-term future for Victory remains very bright.

Parts, garments and accessories, our PG&A division had another very strong second quarter with a 24% increase in sales and year-to-date sales are up 28%. We are seeing sales gains across each of our businesses, each of the geographies and each of the product groups. Product innovation, improved integration with vehicle and the vehicle teams and excellent execution is driving our growth in PG&A. We successfully completed our transition out of our Winnipeg PG&A warehouse to our expanded Vermillion distribution center during the second quarter. We have a host of innovative new products planned for the second half that will be introduced later this month in Las Vegas, so we are optimistic that PG&A performance will continue to outpace company growth.

Moving to international, international sales growth was very strong again in the second quarter, up 40% and up 34% for the first half of 2008. International sales account for 19% of total Polaris sales through the first half of 2008. This international growth is being driven from market share wins across our international businesses, key market growth and RZR. While RZR sales did increase significantly in the second quarter supply remains behind demand and will probably remain so throughout calendar year 2008. European ATV markets continue to be relatively stronger then the US, down low single-digits year-to-date. We continue to gain market share internationally and we are approaching number one in Europe in ATVs for the first time.

We continue to expand our subsidiary presence in key markets; we go direct in Spain, which is the fourth largest European ATV market effective August 1st of this year. We also plan to enter the Australian motorcycle market with Victory later this year. As I said in last quarter’s call, our investments in building strong global teams outside of North America are paying off. We are more diversified, we are outperforming the market, and the growth outlook for international sales in 2008 remains strong.

Operational excellence, we continue to make some real progress on our operational excellence objectives with the ultimate goal of transforming the competitive advantage of Polaris. This initiative has become more critical then ever as commodity costs escalate rapidly and the difficult external environment adds volatility and uncertainty to the demand side of our business. Our focus on quality, cost and speed has allowed us to continue to offset much of this cost pressure by driving out the non value-added waste throughout our value chain. Our second quarter gross margins actually expanded by 70 basis points.

Transportation costs and key input commodities like steel and diesel fuel up significantly, we are planning to take targeted modest price increases for model year 2009 on many of our products to try to offset the higher material costs that we are experiencing. We expect to remain competitively priced based on the model year 2009 pricing communicated already by many of our competitors.

Factory inventory is up 4% year-over-year on a sales increase of 22% year-to-date. The increase is being driven by higher side-by-side and international inventories, as these businesses grow rapidly. We have made positive progress internally in taking steps to improve our inventory but at this time it remains a key focal point and an opportunity. We expect factory inventory to continue to improve throughout the balance of the year and still expect to end the year at about $200 million.

Inside Polaris we are working relentlessly to improve our speed to market. This speed gives us nimbleness to react and move faster then others. Overall dealer inventories continue to come down year-over-year; down over 8% across our portfolio. We’ve improved our purchasing lead times by 25% with plans for more. We’ve increased our mixed model manufacturing line capabilities so that we can build virtually every model, every week in our factories, and we continue to reduce our new product development cycle time which allows us to get new products to market faster and more efficiently.

In Las Vegas we will unveil a major phased regional test of a new way of doing business with our dealers for our core ATV and side-by-sides that changes the fundamental power sports business model premise of one to two times a year ordering. So we are on the gas in transforming Polaris through operational excellence. It’s clear within the walls of Polaris that it can be done and over the upcoming quarters it will become more apparent to our consumers, our dealers, our suppliers and our shareholders and of course, our competitors.

With that, I’ll hand it back to Tom.

Tom Tiller

Thanks Bennett, before I turn it over to Michael, let me close by summarizing our remarks. Polaris is performing at a high level in a tough market. Second quarter sales of 21% increase and earnings per share increases of 16% are results we’re proud of. And operationally the results were even stronger.

Operating income excluding financial services for the second quarter was up 56%. We’re winning in the core; we’re starting to transform the company to our operational excellence initiative and growing through innovation; exactly what we said we would do two years ago. The environment is challenging and we’re not expecting it will improve significantly over the upcoming few quarters. With that said, Polaris expects to continue to grow and deliver, our strategy is working well and we’re executing at a high level and we have some fantastic new product news coming just next week.

So I’m cautiously optimistic for the balance of 2008 based on carefully weighing the internal and external factors. We are increasing and narrowing our guidance for the full year 2008 to $3.40 to $3.48 and sales growth of 9% to 11%. We’ll see how the dealers and consumers respond to our new products in Las Vegas, monitor third quarter retail sales and respond accordingly.

With that summary, I’ll turn it over to Michael Malone, our Chief Financial Officer.

Michael Malone

Thanks Tom and good morning to everyone. As Tom and Bennett stated we had a great start to the 2008 year in a continuing challenging external environment. My comments today will focus on more specifics of our second quarter reported results and the updated 2008 guidance.

As Tom and Bennett have stated, given the continued strength of our performance in the first half and the expectations for the balance of the year, we’re increasing and narrowing our full year 2008 total company sales and earnings guidance. Updated expectations for sales growth for the full year by product line are as follows.

For ATVs we now expect sales to grow in the 9% to 11% range for the full year 2008, which is increased from 90 days ago. Our core ATV shipments to dealers in North America are expected to continue to be significantly lower then last year due to the anticipated double-digit decline of the overall North American core ATV industry in 2008. This decline in the core will be more then offset by increased shipments of core ATVs to the international and military markets as well as continued double-digit increases in RANGER side-by-side vehicles.

Given that the year-to-date actual total ATV growth is now at 22% increase, this full year guidance of 9% to 11% increase implies that second half 2008 growth rates of low single-digit increases as we anniversary the initial shipments of the RZR last year. With orders in hand from our dealers for model 2009 snowmobiles we are confident that our snowmobile sales for the full year 2008 should increase in the mid teens percent increase range compared to last year. This sales guidance is slightly improved from 90 days ago.

Sales for Victory motorcycles for the full year 2008 are now expected to decline in the low double-digit percentage range given the continued weakness in the US heavyweight motorcycle segment as Bennett mentioned earlier. This sales guidance is slightly less then 90 days ago. It’s very important for us to protect our premium brand image that we’ve built over the past 10 ten years by closely monitoring dealer inventories and we are making adjustments to production and shipments to react as necessary.

And for PG&A sales given the successful start in the first half of 2008 we continue to expect the PG&A business to grow at a faster percentage rate pace then the overall sales for the company for the full 2008 year.

For the third quarter 2008 total company sales are expected to increase in the 2% to 5% range compared to the third quarter last year driven primarily by increased side-by-side vehicles, international sales, and PG&A sales. The third quarter percentage sales increase is less then we have experienced in the first half of 2008 as we began shipping the RANGER RZRs in significant quantities beginning in the third quarter of last year.

Earnings from continuing operations are expected to be in the range of $1.07 to $1.11 per diluted share for the third quarter of 2008 compared to $1.07 in the third quarter of last year. The gross profit margin percentage for the full year 2008 is expected to improve up to 80 basis points which is slightly less favorable then the up to 100 basis points of our prior guidance. Product mix changes continues to benefit gross margins as we sell more side-by-sides vehicles and growth continues in our international and PG&A businesses, each of which enjoy a higher then average gross margin percentage, as well as lower floor plan interest cost from the lower interest rates and lower dealer inventories that we are experiencing this year.

These gross margin improvements are offset somewhat by increased commodity costs that we’ve been experiencing in each of our businesses, particularly relating to input costs like steel, aluminum, and plastic resins, as well as diesel fuel transportation costs. These higher commodity costs have impaired our gross margins by over 100 basis points so far this year. These increased commodity costs are the primary driver of the more modest gross margin expansion expectations in the second half of 2008, compared to the actual improvement of 140 basis points achieved in the first half of the year.

We continue to expect operating expenses to increase in dollar terms but be about flat as percentage of sales for the full year 2008 compared to last year. Operating expenses in dollars have and will continue to increase primarily due to increases in research and development, and advertising expenses to support the design and launch of our new innovative products, many of which we will unveil next week.

Our guidance for financial services income for the full year 2008 remains unchanged and is expected to decline by more then one-half of the $45 million generated for the full year 2007. As we discussed in previous calls this decline is primarily driven by the impact of changes made by HSBC of discontinuing the financing of non-Polaris products at Polaris dealerships in July of last year, and eliminating the volume-based fee income payment to Polaris in March of this year. We discussed in detail in the previous conference calls the changes made by HSBC and our response to those changes. There’s not really anything new to report today regarding the actions taken as a result of HSBC’s decision.

Our customers continue to look to HSBC for revolving retail credit and to GE for installment retail credit opportunities to finance the purchase of our products. The availability of revolving and installment retail credit to our customers remains at acceptable levels. We measure that through approval rates and penetration rates. During the second quarter of 2008 the approval rates for customers in the United States for GE and HSBC combined was well above the 40% approval rate achieved in 2007, with GE volume and approval rates increasing and HSBC volume and approval rates decreasing from their respective 2007 levels.

During the second quarter of 2008 the penetration rate which is a percentage of our retail customers in the US that are financing their whole good unit purchases through HSBC and GE combined was at about 36%, only slightly lower then the 39% rate in the second quarter of last year and the 38% penetration rate experienced in the first quarter of 2008. So in general our customers are still getting credit to purchase our products. However there are certain regions, like Florida, California, and Arizona that are under relatively more pressure and have lower then average approval and penetration rates.

At the end of June, 2008 the wholesale portfolio related to floor plan financing for dealers in the US was approximately $603 million, down 1% from last year’s second quarter level. However the total units outstanding in the portfolio are actually down quite a bit more then this 1% decline. The dollar amount does not decline as much as the product unit amount due to the strength of our PG&A sales in the second quarter as well as the mix of products that are being financed as more higher priced RANGERs and Victory Vision models are included this year compared to last year’s second quarter.

Credit losses in the dealer portfolio remain very reasonable, averaging well less then 1% of the portfolio with no material changes experienced lately. Interest expense of $2.5 million for the second quarter of 2008 is significantly less then last year as a result of the lower interest rate environment on our bank borrowings. The income tax provision was recorded at a rate of approximately 36% of pre-tax income for the second quarter of this year, similar to the second quarter of last year. For the full year 2008 our current expectation is for the income tax provision rate to be in the range of 33.0% to 33.5% of pre-tax income.

During the second quarter we repurchased 811,000 shares under our share repurchase program at a cost of $37 million bringing the year-to-date 2008 share repurchase to just over 2 million shares for $86 million. We expect to continue to be active in the repurchase program for the remainder of the year given the current weak stock price. As of the end of June, we have approximately 4.4 million shares remaining on the share repurchase authorization from The Board of Directors.

Net cash flow provided by continuing operating activities was $53 million for the second quarter of 2008, a 46% increase from the second quarter last year. The improvement in cash flow provided by operating activities is expected to continue during the second half of the year. During the second quarter of 2008 we made investments in the business through capital expenditures and new product development tooling totaling $18 million. For the full year 2008 our expectation for capital expenditures are to be in the range of $65 million to $70 million, unchanged from last quarter, as we continue to invest in new product development tooling and capital projects.

We expect depreciation for the full year to be in a similar range as our capital expenditures. Accounts receivable were up 37% to $73 million at the end of June due primarily to our 40% increase in international sales during the second quarter. Total debt levels finished at $261 million at the end of June, up from $200 million in June of last year due primarily to our share repurchase program. Debt-to-total capital was 65% at the end of June compared to 51% at this time last year. And EBITDA from continuing operations was $100 million for the year-to-date period this year, up 12% from a year ago.

So to recap our full year 2008 revised guidance, total sales for the year are now expected to increase in the range of 9% to 11% over last year with EPS from continuing operations growing to $3.40 to $3.48 per diluted share for the full year 2008, which is an increase of 10% to 12% over what we earned last year for the full year. Third quarter 2008 sales are expected to be up 2% to 5% with earnings per share expected to be in the $1.07 to $1.11 per diluted share range compared to the $1.07 in the third quarter of last year.

At this time we’d like to take any questions that the analysts may have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Gregory Badishkanian - Citigroup

Gregory Badishkanian – Citigroup

With respect to the RANGER RZR as you said and as we’ve done our checks there’s still a lot of scarcity out there, and I’m just wondering how you think about supply and demand. Do you want to try to keep at this level? Do you feel like you can maybe add more to the channel, inventory to the channel? What are kind of your thoughts on that?

Bennett Morgan

We’ve been working at it pretty hard since the introduction; we’ve taken supply up four times. We are making progress. There still is a scarcity as your checks would validate. We’d like to keep the product still relatively shorter then demand but we still think there’s some upside and an appropriate level of some additional supply in the channel as we move forward. Our day supply is still incredibly light in many, many places. We’re still seeing the highest month to month retail velocities we’ve seen from RZR over the last couple of months so the product continues to grow and I think there’s opportunity for additional supply without what I’d say, flooding the market. We also have some fantastic new product innovations coming with RZR which we expect will further potentially accelerate demand.

And then we have the whole global issue around RZR as well where we are clearly about where we were last year; far behind demand and supply. So we’ve still got some work to do to get RZRs out and fill the global market demand for that product.

Tom Tiller

Let me just add on that a little bit, I think we continue to chase it, not to the degree we did six months ago but I think if you look here in North America on average you see dealer inventory between two and three units per dealer. I think steady state inventory ought to be something like five, six units per dealer. So we’re still a little bit short. We are going to raise the production rate a fifth time here as we go forward and I think probably the big question mark is what happens with the new products that we’re going to introduce—we’ll see. We’ll see how that works out. But we’re pretty excited so we’ll see if the customers are.

Gregory Badishkanian – Citigroup

International, when did you start shipping that out and so you’re saying you have pretty severe scarcity in Europe then, right?

Bennett Morgan

Yes because of the just rampant North American shortages we had last year, they got a few units really during calendar year 2007. We have started to greatly accelerate the shipments particularly in the second quarter this year. I think the product is flowing normally now to the international marketplace but it will take a couple of quarters to fill that backlog demand.

Gregory Badishkanian – Citigroup

With respect to new products, when do those ship to dealers again?

Tom Tiller

It depend but generally speaking our model year 2009 products that we announce in Vegas later next week, will ship sometime either late third quarter through fourth quarter.

Bennett Morgan

Obviously there’s a pipeline fill that will take some time through that so we expect that hopefully will carry into 2009.

Gregory Badishkanian – Citigroup

In terms of guidance for the rest of this year, what type of—how would you categorize the success of the new products, are you expecting blockbusters like a RZR or just sort of a decent type of new product launch?

Tom Tiller

Well I think we said we’re pretty excited, we’ll see—we’ll be able to answer that question a little better next week. I think many of you are coming to Las Vegas and I don’t want to spoil the surprise but I think we’ve probably said enough. We’re pretty excited.

Gregory Badishkanian – Citigroup

I was thinking more in lines of guidance, what’s sort of baked in that?

Tom Tiller

Well as I said in the prepared remarks, you know you’ve got sort of a battle of good versus evil here right. So on the good side we’re—I feel really, really good about the innovations that we’ve delivered in the marketplace in the last 18 months and I feel really, really good about the innovations that we’re going to deliver in Las Vegas and longer term going forward it really goes back to investments we made four and five years ago when we increased the size of the engineering group, we built Wyoming.

For those of you that have followed the company for a long time, we said, you’re going to see an entirely different level of performance in terms of innovation going forward and we saw it first with the RZR and the Vision and now you’re going to see it next week in Las Vegas and that’s going to be, that pipeline is full for the next several years. So I feel really good about that. The part that’s very difficult to predict is all the obvious stuff, the macro stuff. You pick up the paper and yesterday it’s the mortgage companies and this morning it’s General Motors and who the heck knows where the price of oil is going to go. So it’s the tension between trying to figure out where the consumer is going to go and the overall macro environment and our focus on the controllable factors. We feel real good about how things are going from a controllable point of view and we’re just trying to balance as best we can the obviously difficult macro environment.

Bennett Morgan

I think just to build on Tom’s point, if you’re talking specifically about guidance we have not built in significant upside expectations based on these great new products. I think we’ve got a very balanced approach to that and we’re excited as heck but--

Tom Tiller

I think the word we used is grounded order expectations. We expect that core ATV orders even with the new products are going to be down year-over-year. And we expect based on both the market momentum and the great new products that we have that side-by-side orders will be up. So we’ll see, we’ll sit down with our dealers and understand what’s going on in their local markets and how they feel about it and then we’ll obviously be able to adjust following that.

Operator

Your next question comes from the line of James Hardiman - FTN Midwest Securities

James Hardiman - FTN Midwest Securities

The industry numbers that you put out there, core ATVs down 23% I believe and motorcycles down mid singles year-to-date, can you give us the numbers for the second quarter? It sounds like if I’m doing the math right that if you factor in the first quarter numbers, core ATVs were significantly worse, maybe and that the heavyweight motorcycles sound like they might have been a little bit better at least in terms of growth versus the first quarter. Do you have those numbers for the second quarter?

Richard Edwards

Second quarter for ATVs, US ATVs, that was down a little more then the year-to-date number for core US ATVs. And motorcycles were actually, the second quarter was actually up mid singles, that’s all motorcycles. Heavyweight was about flat.

Tom Tiller

Yes so just again, for other people listening on the call, the motorcycle market right now is a little bit goofy yet the overall market is performing really quite well and that tends to be in scooters which are runaway strong and very small motorcycle segments that we don’t compete in and that’s because of the gas prices. You’ve got people going out there and buying scooters to commute on or whatever. Our segment of the market, large touring segment and I think Richard gave you the numbers for those. That’s the part to watch, at least when you’re considering us.

James Hardiman - FTN Midwest Securities

I think you’ve touched on the fact that obviously you’re looking for a pretty big slowdown, at least deceleration versus the first half numbers when you look at ATV sales during the second half and you talked about them, and the biggest driver sounds like it comping against the RZR and just overall being conservative, does that factor in—what sort of core ATV numbers does that factor in? Are you expecting that to stay about where it was in the second quarter or are you expecting that to get worse, what are sort of expecting from that front?

Tom Tiller

I’d say core US ATVs to be about where they’ve been in the first half, not meaningfully different but we think the economy is going to continue to be difficult. The comps, I think as Bennett mentioned in his prepared remarks are a little easier particularly in the fourth quarter, so a number similar to what we’ve seen. It’s going to remain fairly soft.

James Hardiman - FTN Midwest Securities

From a seasonality standpoint, obviously there’s been a pretty seismic shift towards the side-by-sides, does that make—are more of those side-by-sides—obviously there’s a big hunting season coming up in the fall, does the shift help sales during the third quarter or hurt sales, how is the seasonality of your business changed based on the shift to the side-by-sides?

Tom Tiller

I don’t think there’s a big change with regard to seasonality, but I think what the shift to side-by-sides, out of core ATVs does, I think it helps us long-term and has nothing to do with seasonality. But we talked about this I think in some of the analyst presentations and so forth, if you look at each of the other segments that we compete in, snowmobiles, motorcycles, core ATVs, there’s some pretty darn tough competition and there’s a leader. So like in cruiser motorcycles Harley Davidson is obviously the leader with a very, very strong franchise and a very strong brand.

In core ATVs, Honda has been the leader in core ATVs in terms of market share forever and Honda is an extremely well run company with a very strong brand and very difficult to take market share. But in side-by-sides, really no one has owned that category. There’s no one that’s really said, okay this is going to be our game and I think seven years ago when we looked at this category, we thought we could do that. So we’ve made a lot of investments, not just the RZR in the last 18 months, but really over the last decade to go into this business; we started out number seven of seven. Each year we’ve gained market share, as Bennett said we’re now number one and distancing ourselves and our goal here is pretty simple. That’s to lead this category and establish a clear long-term number one position.

And if we can do that and do that successfully as this market continues to shift out of core ATVs into side-by-sides, that’s a tremendous advantage for Polaris. We go from being in a tough number two, number three position in core ATVs, to a strong number one. And I think that we’ve made investments over the last seven years that will take competitors quite awhile to catch up on. So I don’t think that seasonality is a big thing, I think it’s the share positions and the relative strength that we have in that category that’s significant.

James Hardiman - FTN Midwest Securities

On the finance side, what’s your level of confidence that GE is going to continue to be an ongoing financing partner given how they’ve been shedding some of their finance operations and if they were to drop out of power sports, do you feel comfortable that you’d be able to pick up the slack following that departure?

Michael Malone

There’s obviously a lot of uncertainty in the retail credit market and credit overall, certainly we’ve experienced the volatility in our business particularly with HSBC this year. Our relationship with GE is very strong. We’re not aware of any issues long-term with their desire to finance retail customers in the power sports areas that we participate in. We’ve had conversations with them on that. Obviously things change and the credit world is very turbulent and there are lots of changes. So at this point in time we think it’s very solid and we’re actually financing much more of our product with GE on a retail perspective then we did last year.

If they were to choose to exit it would obviously have a big impact on the whole industry and it would have a big impact on us. We are looking longer term at alternatives to the more traditional solutions for retail credit but at this point in time we’re continuing to finance our customers’ products with the combination of GE and HSBC and think that at least for the mid-term here, that that’s the most appropriate solution.

Operator

Your next question comes from the line of Edward Aaron - RBC Capital Markets

Edward Aaron - RBC Capital Markets

On the RZR international opportunity, I’m just trying to better understand the differences if there are any, in consumer preferences in Europe versus the US to try to figure out how big that opportunity might be in comparison?

Bennett Morgan

Clearly the RZR from a standpoint of international market response has opened up the side-by-side business for us and I think there are a couple of reasons for that. The international marketplace at least across the globe tends to be a little bit more recreational performance oriented and the RZR plays to that kind of customer very, very nicely. The other thing that you have in most international markets is the size and the footprint frankly of our RANGER makes it in a lot of cases too big for many international markets. It’s very expensive to ship. RZR provides a number of benefits on both that side as well.

It will not be as large as the US opportunity but again we are seeing literally hyper growth in our side-by-side business and that’s driven internationally and that’s being driven off of the RZR phenomenon. It’s really too early to say exactly where that will end up but we’re very bullish on the long-term growth opportunity that RZR will provide not just for the upcoming quarters but in the 2009 and beyond.

Edward Aaron - RBC Capital Markets

On the price increases planned for the model year 2009 change-over, I understand you’re competitors have raised price, but just trying to understand what gives you the confidence that throughout the industry that these price increases are going to be tolerated and then secondly, can you comment on why the dealer hold-back was up 35% on a year-over-year basis?

Tom Tiller

In terms of the price increases, I think as we’ve looked at the competitors that have announced 2009 stuff so far, they have taken some price increases and we’ll take some appropriate, balanced, modest, use the word you want, price increases, not across the board but in those segments where we really have some innovation. So its quite a bit easier to recover price when you have something that is obviously in higher demand so that’s more or less the model that we’re going to take. I feel pretty confident in our ability to do that.

I think the other thing that I would mention at least on the innovations that we’ve seen so far from the competition I think its fair to say that they’re—nothing too compelling so far. They’re kind of muted and I think that most of the people in our segment, just consumer durables generally, are kind of retracting right now. If you look at the motor home industry, if you look at the boat industry, you look at marine engines, you look at power sports, most companies are really kind of cutting back and they’re laying people off and closing plants and reducing R&D and that kind of thing and we’re obviously being very careful about our spending and that kind of thing but we’re leaning forward. We’re on the gas hard.

Our new product introduction in 2009 is as strong as any we’ve ever done and Michael talked about the advertising levels and so forth so we’re watching what’s going on out there but we think there is an opportunity to grow in this market and we’re going to go out and get it. That’s a little bit different approach then I think then most people are taking in this market.

Edward Aaron - RBC Capital Markets

Do you think that the product margins within your better performing segments like side-by-side and PG&A can improve from here even with cost headwinds? I understand core ATV margins are probably going to be lower with the tough environment and higher commodities, but just curious about the product margins in the better performing categories.

Tom Tiller

Pretty hard to say in the short-term, I think Michael gave some guidance there that we might be up 80 instead of up 100 for the year and the key thing are these commodity costs. If you can tell me what the price of oil is going to be I can give you a much better answer to that question. We certainly didn’t forecast $145 a barrel or where ever the heck it is this morning. So that’s the part that makes it pretty tough. I think if you look at the productivity effort, I feel really good about that. The innovation and being able to deliver value for customers and the mix shift, if you look at what’s growing. Its high margin, high profit stuff, side-by-sides generally, RANGERs, XPs, Crews, RZRs, PG&A business. So those are all very positive trends.

The one real wildcard is what the heck is going to happen to the input costs and we’re managing those as best we can but that’s a kind of day by day, week by week deal that we work with our suppliers and try to offset the cost. And the single biggest one of course is the diesel fuel. Just the cost of transporting the product around has just skyrocketed. So there’s not a lot we can do about that. We’ve got to just keep working on our operational excellence stuff and it’s going great. So we’ll see.

Michael Malone

You asked a question on dealer hold-back, I’ll answer. At the end of the second quarter our hold-back reserve on the balance sheet and the accruals was about $72 million. That’s a relatively normal level. A year ago it was significantly lower then that. What we normally do is pay hold-back to the dealers twice a year in the first and the third quarters so it’s a high level at the end of June. A year ago we made a one-time early quarterly payment during the second quarter to the dealers that lowered that accrual balance a year ago. But the balance today is more normalized.

Operator

Your next question comes from the line of Timothy Conder – Wachovia Capital Markets

Timothy Conder – Wachovia Capital Markets

You’d given some commentary in your prepared remarks regarding the side-by-side, could you repeat those numbers? I thought I heard a 50% number, was that Polaris—that’s what I thought I heard and then did you give an industry number?

Bennett Morgan

We did not give an industry number, what we said was our retail and our wholesale shipments are up well over 50% year-to-date, from a retail sales standpoint and a shipment standpoint and that’s across the world.

Tom Tiller

And we don’t have the industry data of course, as you know there’s no industry data collected, but we would guess its nothing like up 50%.

Timothy Conder – Wachovia Capital Markets

As a guesstimate, somewhere half of that with a two in front of it?

Tom Tiller

Less then that I think. I’ll guess zero to 10%.

Bennett Morgan

We did get 2007 data when we got the market share data. It was very close to what we said we were guiding you. I think last year at that we thought the side-by-side market in 2007 was going to be up around 15%. The data actually came in around 11%. We think that from what we know the market is still growing but are slower then where it was last year. So I think what Tom just gave you, I think is a pretty good guidance range there. We’re ripping market share from our competitors is the takeaway you should take from that.

Timothy Conder – Wachovia Capital Markets

Ripping, stealing, slicing whatever—it’s a good political phrase. Obviously you’re executing well but given we just seen this morning the bankruptcy of a Spanish housing manufacturer, and things that are going on as things are spreading a little bit to Europe, and Europe is a key part to your driver here. How can you balance that versus it appears your penetration rate especially in the side-by-side is very low, can you give us a little more color there and maybe rank your top five countries as far as sales importance year-to-date?

Bennett Morgan

I think one thing you may be taking our remarks a little too far is the European markets are relatively stronger. We’re not doing back handsprings from a standpoint that they’re growing rapidly; the ATV market in Europe is down mid single-digits. So they’re relatively better markets. We’re watching the European markets closely because we know there often can be a future correlation with the US slowdown. Again what’s allowing us to win is we are innovating and we have very strong global teams so we’re winning market share battles, we’re starting to develop European or internationally based products for the first time which meet the specific needs of those customers a little bit more effectively then perhaps the US based products we’ve had in the past. That’s what’s giving us some confidence along with phenomenal RZR growth.

Tom Tiller

A little bit longer term, I don’t know what the news was out of Spain this morning, but let’s look over the last 10 years and kind of project forward. So 10 years ago our sales outside of North America would have been about 5%. I think in the second quarter our international sales as a percentage of the total was about 20%; so four times higher, right, and significantly higher. The reason is we’ve built as Bennett talked about, a team in the local markets. We’ve been in seven international subsidiaries, we’re adding Spain as Bennett talked about and whether the economy is good or bad this week or next week, really doesn’t affect our decision too much. Over the long-term run do we see a potential there. And we do in Spain.

So we’re going to continue to invest in building the brand and building distribution. We’re adding additional products in the international market. So RZR is this week’s sensation but we’re going to be adding Victory in Australia as Bennett talked about, eventually in other markets as well. And then we’re opening new markets. So an example of a very rapidly growing market right now that we’re really just getting going in is Russia. At phenomenal growth rates. Just all the room in the world to ride recreational vehicles. We have that upper income customer that wants to buy expensive American toys and we’re just building very nice distribution model there.

If you saw the Victory stores in Russia, you’d just be amazed. Probably the nicest in the world. So international sales are up 40% in the quarter. There’s always going to be markets or individual countries that might be a little stronger or a little weaker, but I think over the next 10 years the idea of growing more global, more on-road, more outside power sports is a winning idea and we want to get that international percentage over the next several years up to the number like 25% of our total.

Timothy Conder – Wachovia Capital Markets

One clarification, the mid single-digit down in Europe, is that everything ATVs or is that similar to the US MIC?

Bennett Morgan

Generally speaking the way the international markets have reported they’ve reported it includes Asian competitors, so quite a big difference there. In many of the markets it can include side-by-sides as well.

Tom Tiller

There’s not a uniform standard of reporting. It’d take us 15 minutes to explain it.

Timothy Conder – Wachovia Capital Markets

What type of timetable, can you give us a little update as to naming a permanent replacer to yourself and then the end of quarter, 630 share count and then the foreign exchange benefit to sales, EBIT, EPS in the quarter?

Tom Tiller

I think what we had said 90 days ago and when we announced this thing is that we expect that 2008 to be my last year with Polaris and we are going through a comprehensive search. That search is going well. We’re pleased with the progress. I think in the first quarter call we also talked about you wouldn’t hear a whole bunch of communication. I think we used the example it’s a little bit like electing a new Pope; when you see the smoke you’ll know something happened. And so there’s no smoke to report this morning. I think everything is on track and we’ll let you let you know when we’re ready.

Timothy Conder – Wachovia Capital Markets

I know they’re worlds apart the Vatican the Vegas, could Vegas be a little bit of a puff of white smoke?

Tom Tiller

I don’t know you’ll have to go there to see I think. Nothing to announce this morning.

Michael Malone

On the balance sheet you’ll see the—in the equity section, on the common stock we show that there’s 32.666 million shares outstanding at the end of June so I think that’s the answer to your first question. The next one was the impact on the foreign exchange on sales, so the impact on sales of our 21% increase in sales for the quarter about 3% of that was related to movements in currencies.

Timothy Conder – Wachovia Capital Markets

Anything at the EBIT line?

Michael Malone

We don’t give specifics there, but there was a net benefit of currencies on the gross margin line and a modest improvement on bottom line from currencies in the second quarter.

Operator

Your next question comes from the line of Craig Kennison - Robert W. Baird & Co.

Craig Kennison - Robert W. Baird & Co.

On the last call you mentioned a pilot program to have dealers make smaller, more frequent orders and you seem to hint at that as an announcement in Vegas, could you just talk in general about the structure of that relationship, or the change in that relationship and while we would endorse it wholeheartedly what are you really giving up? Are you giving up some visibility in terms of your own manufacturing footprint in what you’re going to build?

Bennett Morgan

We’re probably not going to get into a tremendous amount of specifics for competitive reasons and the fact that we’re really just expanding the test. We will be talking about that a little bit more in Vegas for those of you that come. As I alluded in my prepared remarks we do think that this is a significant improvement to the power sports business model. As you deal with more uncertain volatile, a smaller global marketplace you need to be able to respond much more quickly and efficiently to consumers and marketplace demands both from our side and from our dealers’ side.

The advantages to Polaris in the dealer network is you’re obviously quicker to market, you’re nimble, you drive out a tremendous amount of waste and forecast error and I think you can focus on making sure you get the right product to the right customer at the right time. The trade-offs that you give up as a company and that’s why you see us working so hard behind the scenes, is you have to really fundamentally change and transform our behind the scenes business model. You have to get your entire supply chain to be able to react faster. You have to reduce your product development lead times. You have change your manufacturing footprint so you can build in smaller lots much more quickly and affectively and as we deal with the external community, if you can’t manage market share and demand affectively, you potentially run that risk of a little bit of predictability at least of your wholesale orders for a longer period of time.

So that’s why we’re being very, I don’t want to say deliberate, but controlled on how we go about and learn as we to with this process. We’ll talk a little bit more about it in Vegas.

Operator

Your next question comes from the line of Robert Evans - Craig-Hallum Capital

Robert Evans - Craig-Hallum Capital

Can you comment a little bit more in terms of similar to your comments before, looking two, three years out, your side-by-side segment, where do you see the percent of gross margin dollars being say now and say three years and then same with US core ATVs? Obviously that mix shift has changed a lot over the last three years, where do you see it going in the next three years?

Tom Tiller

If you look, we’ve really—three years ago if you looked at, I think this is even on our website, if you look at 2004 versus 2007 for example, and you looked at the percentage of gross margin in our ATV business that came from core ATVs, three years ago that number was approaching 50%. In 2007 round numbers, 20%. So just a tremendous shift away from the dependence on so-called core ATVs and I guess if there’s one thing about this company that is probably the single most misunderstood thing is that we’re all going to die here if the ATV industry is soft.

It reminds me of 10 years ago, we were all going to die when the snowmobile industry was soft because we were a snowmobile only company. We’ve diversified significantly away from US core ATVs and that trend I suspect if the current trends continue with side-by-sides really just with runaway growth and the ATV market contracting, that percentage is just going to get smaller and smaller and smaller. And we’ve see that. We saw it in snowmobiles. It used to be 100% of our sales, today its 10% of our sales. So Polaris is a very, very adaptable company and I think our speed to move in to emerging segments and sometimes predict where those segments are going to go correctly, really differentiates ourselves from our competition.

There are people going in the side-by-side business now, Honda for example, is going in the side-by-side business now. We did it 10 years ago. So trying to figure out what’s going to grow out in the future and putting yourself in a position to win before all the growth happens, is kind of a key, key thing. So as you look forward and you think the next two, three years, we’ve laid it out on a piece of paper. I don’t know how we can be more clear about it that—where we’re going to go. We’re going to try to grow in the growth initiatives. That means Victory. We want a motorcycle business that’s four or five times the size of our motorcycle business 10 years from now.

We want to dominate the side-by-side market. Our international business as we talked about, we think can be a significantly bigger part of what we do. We think military is a great growth opportunity. We’ve got some very exciting things happening there right now. And we have this new adjacent market. So we’ve laid out our cards on the table for investors and everybody else to see where we think we can go and we feel real good about the investment choices that we’ve made over the last few years, particularly given this tough market.

Robert Evans - Craig-Hallum Capital

Can you also comment, I’m not sure if you laid this out for international growth, but can you give us what the ATV growth was internationally?

Bennett Morgan

We don’t disclose that by product but our ATV business did grow internationally in the second quarter and we feel good about it.

Tom Tiller

Total ATVs would be, I think we said international was up 40%; total ATVs including core ATVs and side-by-sides would be—that’s the vast majority of that 40% number so its not going to be dramatically different from that. It’s a relatively small snowmobile quarter, Victory is a pretty small part of the total so, that’s directionally pretty close I think.

Robert Evans - Craig-Hallum Capital

The heavyweight cruiser number, what was it down in Q2?

Richard Edwards

It was about flat in Q2 for the industry.

Robert Evans - Craig-Hallum Capital

Where is—in terms of the European opportunity for RZR right now, if you’re going to pick an inning, what inning are you in in terms of getting that product out there?

Richard Edwards

First, second.

Operator

Your next question comes from the line of Mark Mulholland – Matthew 25 Funds

Mark Mulholland – Matthew 25 Funds

You had said to one of the questions that you don’t give out EBITDA estimates, is that correct?

Michael Malone

The question was the currency impact on EBITDA that I didn’t give any specifics to. Our EBITDA for the year-to-date was about $100 million.

Mark Mulholland – Matthew 25 Funds

Does that put you on pace for about $275 million for full year?

Michael Malone

I haven’t given specific guidance to that. EBITDA will grow in 2008 over 2007.

Mark Mulholland – Matthew 25 Funds

Well the second half is typically stronger, correct?

Michael Malone

Yes.

Mark Mulholland – Matthew 25 Funds

If I have my numbers right, I have your total Cap now, market value stock and bonds under 5.5x EBITDA, how seriously has any equity partnerships tried to buy you or made offers for you or do you seriously ever consider going private?

Tom Tiller

There’s nothing going on we’re going to announce this morning or anything like that. From time to time over the years, we’ve looked at that idea. As you know being a long term shareholder, you know that the markets’ interest in companies like Polaris does tend to seem to fluctuate. We kind of fall out of favor and then fall in favor. The overall sector right now, I don’t know that I’ve seen it in my tenure, the overall sector being so far out of favor. You look at some pretty high quality companies, they’re doing relatively well in a tough consumer environment and just the stocks are just getting beaten up so I think from a practical point of view, what are we going to do in the short-term is continue to buyback the stock very aggressively.

If the situation were to persist for a meaningful period of time would we look at other alternatives? Sure, but I don’t see anything happening this week, this month kind of a thing that we would over react to but if the situation didn’t get changed and we didn’t think that we could move the ball down the field with the current structure, it would be sure--it would be something that we potentially examine.

Richard Edwards

That’s all the time we have this morning. We want to thank everyone for participating in today’s call and we look forward to seeing many of you next week in Las Vegas. Thanks again for listening.

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Source: Polaris Industries Inc. F2Q08 (Qtr End 06/30/08) Earnings Call Transcript
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