Polaris Inc. (PII) Q4 2007 Earnings Report, Transcript and Summary

Good morning. My name is Salina and I will be your conference operator today. At this time, I would like to welcome everyone to the Polaris Fourth Quarter and Full Year Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]. Thank you. Mr. Edwards, you may begin your conference.

Thank you, Salina and good morning and thank you for joining us for our fourth quarter 2007 earnings conference call. Here at Polaris today we have Tom Tiller, our Chief Executive Officer; Bennett Morgan, our President and Chief Operating Officer; and Mike Malone, our Chief Financial Officer. During the call today, we will be discussing certain topics, including product demand and shipments, sales and margin trends, income and profitability levels and other matters, including more specific guidance on our expectations for future periods, which should be considered forward-looking for the purposes of the Private Securities Reform Act of 1995. Actual results could differ from those projected in any forward-looking statements, which by the nature involve risks and uncertainties. As always, there are number of important factors that could cause results to differ materially from those anticipated. Additional information concerning a number of these factors can be found in Polaris’ 2006 Annual Report and in the 2006 Form 10-K, which are on file with the SEC. Now, I would turn it over to Tom.

Thank you, Richard. Good morning. Thank you for your interest in Polaris. Earlier this morning we reported results for both the fourth quarter and full year 2007. For the fourth quarter, the operating results met our expectations. Sales were $541 million, up 21% from last year and earnings per share from continuing operations were a $1.07 per share, up 15% from last year. The full year results for earnings per share up $3.10 per share, up 14% on a 7% increase in sales, which was at the high end of our guidance. 2007 was a good year for Polaris. Our overall goal was to get the company back on track following a disappointing 2006. We did that. We won in the core. In fact, we gained market share in every business both domestically and internationally. We began to execute our operational excellence initiative and saw significant improvements in cost, quality and speed. We lowered inventory at both the dealer and factory levels. Despite a very challenging economy, especially for consumer durables, we grew, propelled by some great new products like the RANGER RZR and Victory Vision. Our gross margins expanded. We invested smartly for the future and out-executed our competitors. We had a clear plan for 2007 and we delivered it. Like any year though, we also had some disappointments. Our end markets, especially the core North American ATV market, were weaker than we had expected. We did not anticipate such a significant decline in financial services income in the second half of the year, and while our factory inventory went down, it could have gone down more. But all in, the positive significantly outweighed the negatives in 2007. In 2008, in what will likely be an even tougher economic environment, we will take the company to the next level of performance. To deliver that objective, we will follow a similar strategy in 2008 as we did in 2007. But this year we’re starting from a stronger position. Before I talk in detail about 2008 though, I’d like to turn it over to our President and Chief Operating Officer, Bennett Morgan to update you on the individual business segments and our operational excellence initiatives.

Thanks, Tom. Let’s start with All-Terrain Vehicles. The ATV division, representing about 67% of the revenue of the company, had a mixed fourth quarter to cap what was a good year. The core North American ATV industry was very weak in the fourth quarter and declined 20% from year ago levels. For the full year, the industry was down 13%, which was weaker than we had forecasted. For Polaris, we performed better than the industry for the full year but still had a double-digit decline in retail sales. Core North American ATV promotions escalated during the fourth quarter and we anticipate they will remain elevated, as we believe that our competitors, who have high levels of ATV dealer inventory. Dealer inventory at Polaris ATVs is at a comfortable level and we are adjusting production plans to reflect the weaker industry. We anticipate for 2008 that the industry will decline again at a double-digit rate, with relatively weaker performance in the first half largely because the comparables are relatively stronger in the first half. The side-by-side segment remains very strong and now accounts for about 40% of our overall ATV business and that number is growing. Both the base RANGER utility line and the newer RZR sport model had outstanding years in 2007. The RZR remains in a highly oversold condition. We had anticipated that demand and supply would come more in line by now, but that just has not yet happened. Dealer inventory of RZR remains on average fewer than one unit per dealer, and dealers are still reporting very strong levels of demand despite the weaker economy. During the fourth quarter, we began shipments of our newest RANGER, the RANGER Crew. This one-of-a-kind machine has the same hard working features as the traditional RANGER, but has the ability to carry six passengers and their gear across the toughest terrain. The Crew, just like a crew cab pickup, is particularly well suited for customers who need to carry a large group across a ranch, a farm or a trail. And dealers have reported strong initial retail sales of the RANGER Crew. For the full year 2008, we expect the continued strength of the RANGER side-by-sides to more than offset the weakness in core ATVs, just as it did in 2007. The snowmobile industry, including Polaris, has had a very good season so far this year. Snowfall has been good or very good for much of the season across the vast majority of North America. I would say the snow conditions have been the best we have seen over the past 10 years. Season-to-date, the North American snowmobile industry is up about 10% and dealers are reporting strong new snowmobile sales and good parts and service traffic. That’s just what the doctor ordered for the snowmobile industry, and hopefully we can get a couple of years in a row to rekindle the enthusiasm for this sport by both the dealer and the consumer. We are very pleased with how our Snowmobile business has been performing this year. New product quality has been excellent and dealers have made more money by selling units earlier in the season. As we project the remainder of the year, it is very likely that Polaris dealers in total will end the season at the lowest level of inventory in many years − perhaps one-third as much as the season ending dealer inventory of just two years ago. That is tremendous progress for our dealers and for Polaris. And if the favorable riding conditions remain, we should see a nice lift in our Parts, Garments, and Accessory division, which enjoyed a strong fourth quarter from some of the snowmobile riding activity. As a result, we expect to see modest growth for snowmobiles in 2008 as compared to 2007. Victory motorcycles: The fourth quarter closed what was another good year for the Victory motorcycle division. Like the ATV industry, the overall motorcycle market in the U.S. had a soft fourth quarter with an 11% decline in retail sales. For the full year, the industry was down 7%. For the fourth consecutive year, Victory retail sales were much stronger than the overall industry. For the fourth quarter, our retail sales were up 31% and for the full year Victory sales were up 10%. We continued delivering retail sales of the Victory Vision during the fourth quarter and monitored the early customer reaction. So far the customers have been very pleased with their new Victory Vision motorcycles and the word of mouth has been excellent. We will continue to monitor this closely on this important new product. Consumer interest in Victory motorcycles continues to grow rapidly as we have seen throughout the fall and winter motorcycle shows, including the recent international motorcycle shows that are ongoing. 2008 will represent the 10th year for Victory, which hardly seems possible. Over that period of time we’ve accomplished a great deal. We are now the second largest American manufacturer of motorcycles. For several years we have been growing retail sales at a much faster rate than the overall industry. And we are building literally the finest motorcycles in the world as measured by credible third parties and our own internal data and have the most highly satisfied customers in the industry. We’ve created a unique brand positioning, Victory: “The New American Motorcycle” that is both relevant and sustainable, and awareness of the Victory brand continues to grow. And finally in 2007, we have successfully entered another large and profitable segment the luxury touring segment, with one of the most complex products we’ve ever manufactured, the Victory Vision. While there are many reasons for excitement around Victory, there are a few areas of concern as well starting with the declining industry. We will be more conservative with our traditional cruiser business and have reduced shipments and expect to see declines in dealer inventory of cruisers by the end of this model year. Vision should continue to grow nicely and we expect growth in 2008 to be driven from the touring segment and the Vision. Parts, Garments, and Accessories: The PG&A division had a great quarter and a strong year, with sales up 19% for the fourth quarter and 9% for the total year, both ahead of the overall company growth rates. In addition of the strong Snowmobile related sales, the strength of the RANGER side-by-side vehicles have translated into good accessory opportunities. The innovation around not just the vehicle but the integrated offering, including a full-line of innovative accessories, has paid off well for us. International sales were up 24% for the fourth quarter and were up 11% for the total year. There was strength across the business segments internationally. Like in North America, for the full year, we successfully gained market share in every business in the international market. We expect nice growth in 2008 outside of North America driven by relatively strong markets, a stronger economy than in the U.S. and share gains. The introduction of the RZR to the international market will also be an important growth driver. Adjacent markets: Our Military business, which is one of the so-called adjacent market opportunities that we are pursuing, had a good year in 2007. In the fourth quarter, we began delivery of the initial shipment of our TACOM order, and for the full year we doubled our sales versus 2006. And we also introduced two critical new products which will help us in 2008. Late in 2007, we committed internally to a second yet to be announced adjacency. An internal team and budget dollars have been committed and we expect to announce this publicly later this year, as we get closer to revenue recognition. Operational excellence: We began to deliver on our operational excellence initiative in 2007. You will recall that operational excellence at Polaris is centered around the objective of meeting and exceeding our end customer needs better than anyone in our industry. In other words, to become the Toyota of the Powersports business. There are three areas of focus, quality, cost and speed. For 2007, our quality improved significantly. Our Net Promoter Score, which is a measurement of the customers’ positive word of mouth, improved by over 10% and our two key new product introductions, the RZR and Victory Vision both had outstanding Net Promoter Scores. Our system wide costs and investments declined by 3% in 2007, fueled by reductions in dealer and factory inventory, cost reductions in product and tooling, and capital process efficiencies. Our gross margins expanded and our productivity improved. That system wide cost reduction also benefited our supplier and dealer partners. And we got faster in 2007 as well, over 15% faster by eliminating waste and unnecessary steps. The speed improvements came in a number of important areas including the new product development cycle, logistics, factory and dealer inventory and the quality feedback loop from our consumers. A tangible example of this improvement in speed was visible with the introduction of the new RANGER Crew, which was brought to market successfully in the fourth quarter. This project was done several months faster than what have been the case even just a year ago. Speed is a competitive weapon for Polaris. For 2008, we expect to improve even further. Quality as measured by our customers should improve by more than 10%. Our system-wide cost should go down by at least 5% and we should improve our speed to the customer by another 15%. We are more confident than ever that operational excellence will over time transform our competitive position. And with that, I’ll turn it back over to Tom.

Thanks, Bennett. I’d like to close my section by talking about 2008 and to a limited degree 2009. We expect that 2008 to be a good year in a tough and uncertain environment. I’m not sure that in my 10 years here I’ve seen a more volatile market, so our predictions are just that, our best guess into an uncertain future. As usual, there are a number of positive factors and things we’re concerned about. I’ll start with the concerns. At the top of our worry list and that of our dealers is the core North American ATV industry. The decline in 2007 was bigger than we had anticipated and the decline accelerated in the fourth quarter. We are also concerned about, but perhaps impacted to a lesser degree, by the softness in the overall motorcycle industry. We believe the softness in both end markets is primarily driven by housing and the overall economy. We certainly expect the economy to remain tough in the first half of 2008. We may see some moderate improvement in the second half as a result of the recent interest rate reductions and potential tax rebates. Our plan calls for another double-digit decline in the core ATV business for the full year. We are also concerned about the credit market and how that impacts both the profitability of our retail credit business and the potential availability of attractive financing for our end consumers. Mike will talk a little more about that subject in a minute. From a positive perspective, there are a number of reasons for optimism. The Snowmobile business is having an excellent year and unit sales should grow and also drive growth of the associated PG&A. RANGER side-by-sides including both the RZR and Utility platforms are continuing to grow very nicely and we expect that strength to continue. Our Victory Vision should continue to grow rapidly and our international business looks great. Our costs and quality should continue to benefit from the operational excellence initiative and inventory should continue to decline at both the dealer and factory level. Finally, the new product introductions in 2008 will again be strong, similar to 2007. And you’ll recall that product innovation was the primary driver of our success in 2007. Before I turn it over to Mike, let me summarize our expectations for 2008. 2008 will be better than 2007. For the full year, we expect revenue to grow modestly, up 3% to 5%. We expect to outperform our competitors at retail. Gross margins are expected to expand by up to 100 basis points. Earnings per share should grow 6% to 10% or in a range of $3.28 to $3.40 per share. We are confident that with the plans we have in place, 2008 should be another good year for Polaris. As we look beyond 2008 and into 2009, a number of you have asked how we feel about our progress to our 2009 goals. Are we on track and do we remain committed to reaching these objectives, and specifically, the $4.25 earnings per share objective for 2009? For us to get to $4.25 in 2009, we believe we need to get in the neighborhood of $3.60 earnings per share in 2008; otherwise the increase required for 2009 will be too large to realistically achieve. $3.60 is obviously $0.20 above the high end of our guidance at this point. So from that perspective, one will be pessimistic about reaching the 2009 target. But I mentioned earlier this is a very difficult environment for anyone to accurately forecast. $3.28 to $3.40 is our best estimate at this point in time. You’ll also recall that we over-delivered the upper end of our original 2007 earnings per share guidance by about $0.20 per share. If we can executive as well in 2008 as we did in 2007 and over-deliver again, I would not rule out achieving the $4.25 objective. Time will tell. We’ll simply have to wait to see how the year develops. We will continue to update you on our progress as we go. At this time, I’d like to turn it over to our Chief Financial Officer, Mike Malone.

Thanks, Tom and Ben and good morning to everyone. I will begin with a review of our guidance for the full year 2008 and we’ll then move on to more specific guidance for the first quarter and a brief review of certain aspects of our fourth quarter 2007 results. Total company sales for the full year 2008 are expected to increase in the 3% to 5% range. Diluted earnings per share for the full year ‘08 is expected to be between $3.28 and $3.40, which is an increase of 6% to 10% compared to the $3.10 per share earned for the full year 2007. Expectations for sales growth for the full year 2008 by product line are as follows: ATV sales are expected to increase in the range of up 3% to up 5%, with our core ATV shipments expected to be down again in 2008, primarily due to the anticipated further double-digit decline of the overall North American core ATV industry, again in 2008. However, as it was in 2007, this core ATV sales decline will be more than offset by continued double-digit increases in side-by-side product sales driven by the RANGER RZR and the new RANGER Crew vehicles in an overall expanding side-by-side market segment. We once again expect dealer inventories for our core ATVs at the year-end ‘08 to further decline when compared to 2007, reflecting the weaker industry environment and our operational excellence initiative progress. The snowmobile riding season has gotten off to a good start this year, helped by decent early snowfall across much of North America, which has been beneficial for our business and the entire industry. Although the selling season is still in progress, and we have not yet taken dealer orders, based on the current available information, we expect our snowmobile sales to be up in the single digit percent range for the full-year 2008 compared to 2007. Our snowmobile business is getting healthier, which is in line with our 2009 objectives of winning in the core businesses, including snowmobiles. With the slow down in the motorcycle industry last year, and the expectation that the industry will continue to be challenging, Victory motorcycle sales are expected to increase modestly in 2008 in the single-digit percent range, driven by reduced shipments of Cruiser models, being more than offset by shipments of our new luxury touring models, the Vision Street and the Vision Tour. And finally, PG&A sales are expected to grow at similar growth rates of the overall company sales as in previous years. For the first quarter 2008, total company sales are expected to increase in the range of 12% to 14% from the first quarter of last year, due primarily to incremental growth from shipments of the new RANGER RZR, Crew and Victory Vision models during the first quarter of ‘08. You’ll recall those models were not available in the first quarter of last year. Earnings are expected to be in the range of $0.39 to $0.44 per diluted share for the first quarter, compared to $0.34 in the first quarter of last year. The actual gross profit margin percentage generated for the full year 2007 of 22.1%, expanded 40 basis points from last year, but was less than our previous guidance, primarily as a result of additional promotional costs required for core ATVs to react to the weaker industry environment in the fourth quarter and expected going forward into 2008. The gross profit margin percentage for the full year 2008 is expected to expand again as favorable product mix changes continue to benefit gross margins as we sell more side-by-side vehicles, which typically have higher margins, as well as from lower warranty expenses as our product quality improves. We do expect a promotional environment particularly in core ATVs to remain aggressive and competitive throughout 2008 as the industry continues to deal with consumer spending concerns and heavier-than-desired dealer inventory levels for many competitors. In total, we expect gross margins to improve upwards of 100 basis points in 2008 over the 22.1% generated in 2007. Operating expenses are expected to increase modestly in dollar terms and are expected to maintain about flat as a percentage of sales for the full year 2008 compared to last year. Operating expenses in dollars will increase primarily due to further increases in advertising expenses to support the brand and the launch of our key new products in 2008. This strategy proved very effective for us in 2007, as we gained market share in each business. So we’ll do more of the same in 2008. Income from financial services is expected to decline significantly for the full year 2008 as the company’s revolving credit provider, HSBC, discontinued the financing of non-Polaris products at Polaris dealerships in July of last year. This caused significant declines in our retail credit fee income in the second half of ‘07 and will continue through the first half of ‘08. Additionally, we are becoming increasingly concerned about the impact of the overall consumer credit market weakness and its effect on our retail credit partners’ ability and appetite to work with us to provide cost-effective, attractive financing offers for our consumers, while continuing to provide an attractive fee income strength of Polaris. Although we saw no manifestations of those concerns in the 2007 results, 2008 may well be different and therefore we have planned conservatively. As the consumer retail credit market environment gets tougher, our number one priority will be to maintain strong approval rates for our retail consumers, which potentially may result in higher promotional support costs for Polaris as the manufacturer and/or lower fee income for Polaris reported as income from financial services. The consumer retail credit environment is very fluid and uncertain at the current time, and it will take time for us to have a clear view on this part of our business. If there is any good news here, it is that Polaris has no credit risk in the retail credit portfolios. We may have pressure on our fee income, but we will not be taking any big hits for bad debt losses or loss reserve adjustments. For the full year 2007, we financed through our retail credit programs HSBC and GE combined about 40% of products sold to consumers in United States, equal to last year’s rate. Approval rates for our consumers have remained consistently above the 40% level. And although the volume of revolving and installment retail credit contracts written for the full year 2007 increased somewhat over 2006, the trend in the second half of the year was down significantly due to the loss of the non-Polaris financing in July. At year end 2007, the wholesale portfolio related to the floor plan financing for our dealers in the United States was approximately $723 million, a decrease of 3% from the end of last year, reflecting a decline in the dollar amount of dealer inventories in the United States. This decline of 3% is in dollars. The units outstanding in the portfolio were actually down 7% compared to last year due to the mix change to higher priced RANGER and Victory inventory. Core ATV unit inventories in the wholesale portfolio at year end 2007 are down over 10% due to our efforts to assist the dealers in reducing their core ATV inventory during the year. Credit losses in this dealer wholesale portfolio remain very reasonable averaging well less than 1% of the portfolio. For the full year 2008, our expectation is for wholesale financing income generated from Polaris Acceptance to be lower than 2007 due to the combination of expected lower dealer inventories and a declining interest rate environment. The income tax provision was recorded at a rate of approximately 35.8% of pre-tax income for the fourth quarter ‘07 and at a rate of about 33.9% of pre-tax income for the full year 2007, each of which are higher than last year due primarily to favorable tax events during the 2006 periods. For the full year 2008, our current expectation is for the income tax provision rate to be similar to 2007 at about 34% of pre-tax income. During the fourth quarter, we were again buying our stock aggressively and repurchased 1.1 million shares under our share repurchase program at a cost of about $52 million, bringing our total repurchases for the full year 2007 to about 1.9 million shares for $103 million. As we announced last week, the Board of Directors has authorized an additional 3.5 million shares for repurchase. The additional share repurchase authorization together with the 2.9 million shares remaining available for repurchase under the prior authorization represents approximately 19% of the shares of Polaris common stock currently outstanding. Given our strong cash flow attributes, we expect to be aggressively buying back our stock during 2008 given the current weak stock price. Taking a look at some cash flow and balance sheet information for the 2007 year, our net cash flow provided by continuing operating activities was $213 million for 2007 or a 40% increase over last year. The increase in cash flow was primarily due to a reduction in factory inventory levels and an increase in accrued expenses, primarily due to a more normalized incentive compensation expenses and increased promotional cost accrued in 2007. We expect cash flow provided by continuing operating activities to increase for the full year 2008 as well. On the balance sheet, accounts receivable at year end 2007 of $83 million is a 30% increase from last year, due to a 24% increase in international sales during the fourth quarter and the doubling of our military business during 2007. Inventories at the end of the year were $218 million, a 5% decrease from a year ago. We expect factory inventory levels to continue to decline in 2008 as our operational excellence initiatives gain momentum throughout the year. For the full year 2007, we made investments in the business through capital expenditures and new product development tooling totaling $64 million, which is higher than a year ago due to the significant new product introductions. Full year 2008, capital expenditures are expected again to be in the range of $60 to $65 million, as we continue to invest in new product development tooling and our growth businesses and capital projects to reduce our production costs and improve product margins. This is another area where we are utilizing our operational excellence initiative to get more leverage for our investments. We expect depreciation for the full year 2008 to be in the range of $65 to $70 million. Last week, we announced that our Board of Directors approved a 12% increase in the regular quarterly cash dividend to $0.38 per share, which currently represents nearly a 4% yield. This is our 13th consecutive year of increase in the dividend paid to shareholders, a record that we’re very proud of. Total debt levels finished at $200 million at the end of the year, a result of the term loan utilized to complete the accelerated share repurchase transaction in December of a year ago. Debt to total capital was 54% at December 31 compared to 60% last year. EBITDA from continuing operations was $248 million for 2007, up slightly from $245 million a year ago. We expect the increase in EBITDA to accelerate in 2008, over 2007 given the expected increase in net income in ‘08. In conclusion, we feel we have built a balanced and achievable plan for 2008 based on the realities of the current external market environment. We are actively pursuing contingency plans to offset a weaker than expected industry environment, if that were to occur, or perhaps deliver performance in 2008 that exceeds our plan if we’ve called the external market correctly. To recap, our 2008 guidance for the full year, total sales are expected to increase in the range of 3% to 5%, with EPS growing to $3.28 to $3.40 per share for the full year, an increase of 6% to 10%. First quarter 2008 sales are expected to be up 12% to 14% with earnings per share expected to be in the $0.39 to $0.44 per share range. At this time, we would like to take any questions that the analysts may have. Salina, would you please open up the line for questions.

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

Just a couple of questions. First, I wanted to ask just some clarification on the gross margin. I understand the factors that you mentioned, I was a little bit surprised by the change there just given the strong sales and the mix benefit that you would have had. So, if I look at the impact from promotions, it seems like it would probably have to be as much as few hundred basis points to cause that much of a gross margin change? Can you help me understand that? That just seems like a bigger increase than I would have expected.

The primary impact for the fourth quarter was our sales promotions environment, particularly in ATVs, as the market got significantly weaker, and we’re preparing for that both in our fourth quarter activity as well as our ending accruals left on the balance sheet for the remaining dealer inventory going into 2008, where we again expect the industry to be particularly weak early this year. So that’s the primary impact on the gross margins. If you recall there was a positive impact a year ago in the fourth quarter with some recovery of duties in the EU that we booked in the fourth quarter last year, which created a fair amount of upside a year ago that obviously we didn’t have repeating this year.

That’s helpful. And then on the Victory business I think you said you had over 30% retail sales growth in Q4 which is in the context of the industry data a really good number. Just trying to understand a little bit more of where that came from? What drove it? Was it primarily the Vision or was it more dealers working through Cruiser inventory?

It was primarily Vision sales. Base Cruisers were relatively flat for us and Vision was most of the upside.

And then moving just over to the RANGER business really quick, you said it was 40% of total ATV sales currently. Could you give us a number for 2007 as a whole? I’m assuming the 40% is a run rate.

No, 40% is 2007 for the full year; approaching 40%, I think is what it is. About 40%.

Your next question comes from the line of Greg Badishkanian - Citigroup.

I want to follow up a little bit more on the RZR, and as you ramp up on this, do you think the gross margin would also improve as well?

As we bring it to higher volume rates and as the product matures, we generally work multiple year cost reductions as we get more experience on that. So, we would expect that the gross margins on the RZR should expand nicely over time.

And looking at the RANGER Crew, what products are out there that are competing in that particular segment now? And then what do you think the potential for this product could be?

Really the only competitor in this class would be the Kawasaki Trans Mule, which has been in the marketplace for a couple of years. The Crew has much more people carrying capacity. The Trans Mule actually is a hybrid that can convert. The Crew has a much, much higher rate of speed. It has much, much more suspension. And so, obviously we are biased, but we think we have a completely superior product in this category. The initial response from dealers and consumers alike has been outstanding and we see this as a very significant player in our RANGER mix as we go forward.

Do you think it could actually be as big as the RZR or is it just maybe the demand won’t be there?

That would be wonderful. We’ve said the RZR perhaps is the best new product in the last decade, maybe ever. So that would be wonderful. I doubt that it will be as big as the RZR, but we do see it being a significant model as we go forward complementing our base utility RANGER product.

And just following up on the RZR too, the inventory, you said at one per dealer. Obviously keeping in mind that you want to keep a little bit of scarcity of the product out there, but you also want to maximize your revenues if you can, so what type of inventory would you be comfortable with?

We’ve taken the rate up four times. We keep thinking we’re going to approach and catch up with demand; we haven’t been able to do that yet. Clearly, more than an average of one per dealer is appropriate, and I’m not sure I want to quote you a number because it’s factored a little bit based on the velocity of the product. We would like to keep some scarcity. We are short right now where the selling season is in RZRs, particularly in the Southwest and where they are riding. We’re nowhere near close to supplying that, but 2 to 3 per dealer would be a very comfortable number that would create scarcity based on the velocity of this model perhaps even higher.

That’s helpful and good job in a real tough environment.

The next question comes from the line of Assia Georgieva - Infinity Research.

I wanted to also add my congratulations and thank you for providing so much detail in your prepared remarks. I had a couple of questions. Can you talk in a little more detail on the margins the Victory motorcycle segment?

Over time we would expect as we continue to grow volume in the Victory motorcycle business that we would expect to see margins continue to trend up much like the Bennett’s answer to the RZR question.We have multi-year cost reduction plans, the overall operational excellence initiative. But in terms of a more detailed response, we really don’t get too awful much into individual business segment margins for competitive reasons. But I think we’ve seen nice expansion over the last several years in Victory margins and we would expect that general trend to continue.

And to go into, but not getting into too much detail on each segment, can you or Mike maybe talk a little bit about your expectations by product line for Q1 of ‘08, in terms of sales?

No, we haven’t given that level of detail on sales. You can look historically at the seasonality of our businesses and see that snowmobiles, for instance, is very, very low in the first quarter. That won’t be any different this year. But as far as growth rates specifically, we won’t be discussing that.

The question is, if you look at the RZR Crew target market, and it’s obviously a relatively new market, but three years down the road how big do you think it can get?

We think it can get quite a bit bigger. The sport or recreation segment with RZR is a relatively new segment, previously occupied by the Yamaha Rhino, but the RZR provides sport and performance aspects that really have never been seen on a side-by-side product. And based on the initial demand, which we thought would be very good, it’s been far better than that. So we’re nowhere near, at least in our mind, the potential of the RZR and I would tell you this is,still a fairly young market and I think there is plenty of product opportunities from ourselves and our competitors to expand this segment and meet customer needs. So, I would tell you that the sport or recreation segment of the side-by-side business could and should get much larger. The Crew segment I think is derivative of a reasonably established segment, but nobody has ever provided multiple-passenger carrying capability of six people, and I think that will be a very nice segment that will grow nicely over the few years, but I wouldn’t have the same kind of expectations that I do for the sport or recreation segment.

We don’t have precise industry data in side-by-side vehicles, it’s just not available. But our best quantitative estimates were that the overall market for side-by-sides was growing at something like 15% a year. We don’t know exactly how the economic slowdown will affect the overall market, but we believe that it’s still growing at a double-digit rate and we would expect that to continue. We’re not the only company that’s bringing innovative product into the segment, which actually helps the overall business. The sports segment is growing much more rapidly than the overall side-by-side segment at a number something like 40% a year, the last we had quantitative data and certainly the RZR has added to that growth rate. So, very strong double-digit growth in the overall market for the sport segment. So hopefully, that will help you a little bit. It’s not like the other segments where we have good hard quantitative information to share with you, it’s simply not available.

The next question comes from Bob Evans - Craig-Hallum Capital.

First, I wanted to echo nice job in a tough environment. But on the ATV promotional environment, can you comment a little bit more in terms of trends you’re seeing now and what you expect to see in ‘08? Your spending accelerated, it sounds like, in Q4. Just give us a little further color there in terms of what you’re planning?

As we said in the prepared remarks, we did see it escalate in the fourth quarter as the industry weakened. We, accordingly based on our commitments to you last year that we were going to attempt to win in the core, spent more to remain competitive in a more aggressive industry, and we’ve made provisions in our plan and I think Mike covered that so that we can remain competitive in what we expect will be a more aggressive promotional environment at least in the first half of 2008. I think if there’s good news here as we head into 2008, the Polaris dealer ATV inventory situation is substantially lower than it was last year. It’s healthier than it was last year in the sense that our inventory tends to be more current less non-current, which will help us from a competitive standpoint. But again, we are committed to winning in the core which means market share wins and so we want to make sure in our plan we can remain competitive if our competitors increase their spending and that is so to speak what we’ve modeled into our plan for 2008.

Would you view this as the greatest impact to gross margins in ‘08 as you look at pluses and minuses to gross margin, would this probably be the biggest negative factor? On a year-over-year comparison?

I think from a year-over-year perspective, we’re modeling that it will remain high, but remember our volumes of core ATVs are expected to come down in 2008 again. It is pressuring, and we’re guiding upwards of a 100 basis points of margin expansion in 2008, so obviously the promotional environment isn’t impacting us too dramatically as we look forward. The biggest impact from a positive perspective on margins is the continuing expansion of our side-by-side business and healthy margins that that generates as well as an expected decline in our warranty costs.

That was my next question actually. It sounds like the biggest impact is probably mix followed by warranty?

Yes.

On the positive side?

Yes.

Okay. And then how about foreign currency? What do you expect from a net-net impact from foreign currency on ‘08?

The currency impacts for ‘07 were positive in our actual results. For ‘08, it’s hard to tell so early in the year, but right now we’re expecting a slight net negative to currencies. We are hedged with the Canadian dollar through the first half of the year, which will at this point be favorable to 2007. We are hedged on the yen for the first half of the year, which will be negative to 2007. And net-net, it looks to be modestly negative for 2008 − at the current exchange rates.

Obviously, that can move as the year progresses, but just wondering what your assumptions were. And finally, can you give us a little bit more color in terms of how you view the linearity of the year from an earnings standpoint? Obviously, last year, second half was the stronger part. Obviously the comparisons are easier in the first half ‘08 versus ‘07. But just if you could maybe elaborate a little bit more in terms of the progression through the year?

We’ve given first quarter guidance. We haven’t obviously mapped out the full year by quarter for you. I guess the way I would characterize it is, it will be stronger in the first half of the year on a comparison basis. If you’re looking for these on income year-over-year, the first half would be stronger than the second half. The first half we get the benefit of the incremental RZR sales and Crew sales that we didn’t have in the first half of last year as well as the continued Vision shipments in motorcycles. So, I’d say stronger in the first half from the second half.

At least from a comparison standpoint.

From a comparison perspective, yes.

The next question comes from the line of Kathryn Thompson - Avondale Partners.

You specifically noted that you had a positive impact from currency on your snowmobile sales. Could you quantify at least qualitatively what that impact was for your sales in the fourth quarter? In other words, the overall growth driven more by units or was any meaningful portion driven by currency?

Kathryn, you’re specifically talking about snowmobiles?

Yes.

The snowmobile growth in the fourth quarter was driven both by units’ growth as well as a mix change. So, both factors were involved. The Canadian dollar was very positive for us. We sell a lot of snowmobiles in Canada as well as the EU countries and each of those were positive to us in the fourth quarter. So, the answer is all of the above; it’s mix, it’s currency and it’s volume.

Would you say that volume had a greater impact than currency?

Yes.

And when you gave your guidance for fiscal ‘08, how much of an impact of buybacks were included in that guidance? Because obviously you have the 3.5 million authorized and remaining 2.9. Does guidance assume that you complete both of those buybacks?

No, it doesn’t, Kathryn. As I said, that’s 19% percent of our total shares is the total authorization at this point. We’ve never purchased that much in any one year.

I didn’t think so, but I just wanted to make sure we were on the same page. And you might have mentioned this in the prepared comments, but I missed it, but what is your target for your interest expense for fiscal ‘08?

We didn’t give guidance to that specific detail. We would expect our interest expense in ‘08 to go down from what it was in 2007 given the lower interest rate environment today. We have our $200 million term loan that’s long-term in nature and we would expect that to be outstanding for the full year. And then, as we always do, we’ve got some level of incremental borrowing needs on a short-term basis for cash flow needs throughout the year. But given the interest rate environment, it will be less in ‘08 than it was in ‘07.

Finally, and there was a mention that you were fine and pleased with your current factory inventory levels, but really would like to make additional progress into ‘08. What type of overall inventory level would you be comfortable with on a dollars basis?

We did make progress. We took it down to 218. I think we indicated in the third quarter call we were shooting for something just north of 200 million. So, as the market slowed, we were a little disappointed we didn’t achieve that target. Our plan has significant reductions in it and it’s really around our operational excellence initiative. As we try to drive excess and waste out our system in both factory and dealer inventories, not only do we get system-wide cost out but we also get speed and speed to market, which is a key strategy of ours. So, we’d like to see improvements in the neighborhood of 10% as we go throughout the year. In this environment, it’s a little bit unpredictable, but that’s certainly what we’re shooting for.

The next question comes from the line of Hakan Ipekci - Merrill Lynch.

A couple of questions. First on the international side, it seems you had a good growth this quarter, was there any product that was driving it? Are there any initiatives in international markets that could be resulting in this growth and looking forward, should we expect that trend?

Hakan, we did have a good quarter and a good year, I think, in the international. We’re pleased with where the business was. We’re up 24% for the quarter, so that was a darn good quarter for us. There was strength across the whole portfolio. It wasn’t just one product line or whatever. It was balanced strength. And I think that we will continue to see good growth in 2008. Again, balanced with one perhaps unusual factor and that would be the addition of the RZR. The RZR will be made available on a more volume basis internationally really for the first time, so in ‘07 we launched in North America. There’s a handful of units out there, but in terms of any volume ‘08 will be the first year for RZR internationally. So that’s created quite a bit of an excitement in Europe especially.

Is there a breakdown that you can provide for international kind of ATVs versus snowmobiles versus motorcycles at this point or?

Historically that percentage has been similar to our overall company percentage of product mix with the exception of motorcycles which is virtually non-overseas at this point.

Again, given the difficult conditions in the market, how is the dealership network holding up, in terms of the overall financial health of the network? Can you make any comments?

I think our dealers are hanging in there. It’s a difficult time for powersports dealers generally. Obviously, people are talking about a recession, you got a discretionary big-ticket item, many of these businesses are not real well-capitalized. So, there is pressure when there is not a lot of floor traffic and the difficulty of competing for every sale reduces their margin. So, it’s a challenging time for not just Polaris dealers but I think powersports dealers generally. I think the positive factors are I think we’re working together quite well. I think the dealers are very appreciative of the steps we’ve made in reducing inventory. I think we’ve gotten very high marks from them on our new products in 2007: the Vision, the RZR, the 800 RMK, the Crew. We’ve had a very good year, and I think that that has helped not just Polaris but it’s helped our dealers in growing margin when they have really differentiated product. I think for the snowmobile dealers this season’s snow fall could not have come at a better time because it helps them not just with new units sales but also with service traffic and used machine sales and that certainly helps their cash flow. So, I’d say that the dealers are hanging in there. It’s a tough lot. They’ve been through ups and downs, and I think that they’ll come through this just fine as long as we can continue to work together, be careful about managing the inventory situation and deliver innovative products.

Tom, one final question. Following the announcement two weeks ago, one area that still puzzles me a little is, you had a good start to the three-year program and you’re delivering, and why not wait until the end and leave at the end of the second year?

We could. Whether I left in 2007-2008-2009 really didn’t matter a whole lot one way or another. Basically what I discussed with the Board was whether we wanted to extend basically another five years. We’ve talked about this in 3-, 4-, 5-year chunks and I felt like both from a personal perspective, from a family perspective and from a Polaris perspective, that probably five more years would not have made sense. I think that the company needs a fresh approach from time to time and so we decided now. Now, I think every year there is a reason to stay another year. Last year I didn’t want to leave because I didn’t think that the company was really in really good shape. We’ve had a tough 2006 and I didn’t want to leave when the business wasn’t in a strong position. Next year it’s the 2009, we’re going to hit the $4.25 piece. One year it’s a war. The next year it’s a recession. It could go either way a year or whatever. I think the key point is that the company is in good shape now. I think we have a good, very disciplined succession process in place and as we mentioned, we are trying very, very hard to have both a good internal and external option available for the Board and when the Board is comfortable I’ll go ahead and make that decision and we should have kind of a seamless transition and life will go on just fine here at Polaris. So, that’s kind of what drove the timing.

The final question comes from the line of Joe Hovorka - Raymond James.

A couple of things. First on the RANGER business. So if it’s roughly 40% or so of your ATV revenues, if I’m doing the math right, that suggest like a 50% growth rate in 2007. Is that correct?

I don’t know if it’s quite that strong. It’s good. It’s good, Joe.

It’s good, all right.

Your math is pretty good.

Okay. Thank you. Your R&D spend in the fourth quarter was down. What’s driving that? Is that a trend we’re going to see in 2008?

No, I think that’s just timing, in all honesty. You saw in R&D over the past year, we’ve moderated that. I would tell you internally though as we’ve driven these operational excellence initiatives, we’re getting more for the same so to speak as we really drive speed and productivity. We’re tweaking our investment portfolios so that we can get our investments into the opportunities that provide the greatest shareholder value. You should expect us to continue to be very aggressive from a standpoint of inside the walls of Polaris about developing innovative products. So we have not come off the gas one iota on that.

Okay. So, we’ll see an increase again in ‘08 or no? In R&D spend?

You’ll see a modest increase. Again, we’re trying to make sure we control costs in this environment and really the credo that we’re leading internally is we want more for the same and with the tools and the strategies we have in place, we’re very confident that we can deliver that.

And when you say timing issue, was that timing between 4Q ‘07 and 1Q ‘08 or something else?

I was referencing that when you said you saw it go down 4Q ‘07 probably versus 4Q ‘06.

I’m saying so the timing of that is some of that R&D spend from 4Q will be spent in 1Q or?

The whole timing of investment spend, it’s based on projects and loads that are going on and there is going to be quarter-to-quarter wobble, Joe.

Don’t worry about it. Okay?

All right, thank you.

Our R&D spending I think is fine. You’re going to get a little noise, right? It’s going to move around a little bit quarter-to-quarter. I think you can expect modest growth in spending. But I think Bennett’s main point is that, the key thing is not what we spend on the projects, it’s the quality of the products that come out the other end. And I think in ‘07 we were really, really pleased and I think in ‘08 we’re going to be really, really pleased and in ‘09 and 2010. The strategic point goes back several years and that’s when we built the Wyoming new product development center, we hired about 100 engineers, and we said we’re going to be on the gas hard in new products and that’s really key for the future of the company. And you saw the first round of those products in 2007 were the 800 RMK, the Vision, the RZR and you’re going to see continued strong new product development. And the spending will bounce around a little bit quarter-by-quarter, but the number of people and facilities and all the structural costs are the same, you just see some project spending that might bounce around a little bit.

Okay. And can you give the warranty claims and provisions for the quarter?

Certainly. Fourth quarter warranty provision on the P&L is $9.6 million. The claims paid in the fourth quarter was about the same $9.6 million. So our warranty ending reserve on the balance sheet is about $31.8 million at the end of 2007.

Do you also have the ending accrual for the sales promos on the balance sheet? And two other housekeeping ones while you’re looking: the share count at year end as opposed to the average?

The share count shows on the balance sheet and the number of shares outstanding on the balance sheet of 34,212 is the best way to find the year end share count. The accruals, I don’t have that in front of me. We’ll be filing that in our 10-K. The sales promotion accrual is up significantly from a year ago reflecting the ATV promotional environment that we talked about.

Thanks. That’s all the time we have this morning. I want to thank everyone for participating in the call today and we’ll speak with you in the next quarter. Thanks again.