Polaris Inc (PII) 2005 Q3 法說會逐字稿

Good morning. My name is Crystal and I will be your conference facilitator. At this time I would like to welcome everyone to the Polaris third-quarter 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 period. (OPERATOR INSTRUCTIONS) Mr. Edwards, you may begin your conference.

Thank you, Crystal and good morning and thank you for joining us for our third-quarter 2005 conference call. Mike Malone, our Chief Financial Officer and Tom Tiller, our Chief Executive Officer will be participating in the call. Bennett Morgan, our President, is also here this morning. Today we will be discussing our third-quarter earnings results announced earlier this morning and we will provide some additional comments regarding the remainder of the year and some qualitative comments about next year.

As before, during this presentation we will be discussing certain topics including product demand in 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 their nature involve risk and uncertainties. There are a 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' 2004 annual report and in the 2004 10-K which are on file with the SEC.

Now I will turn it over to Tom. Tom?

Thank you, Richard. Good morning everyone and thank you for your interest in Polaris. We're pleased to report increased sales and earnings per share for the 30th consecutive quarter. The third-quarter earnings were $1.17 per share, up 17% from last year, on 6% sales growth. This quarter's financial performance was the best in the history of our Company. The quarter exceeded our expectations driven by increasing sales across each division of the Company and a beneficial $0.06 per share income tax settlement.

There were a number of highlights from the quarter including announcing and starting Phase I of the KTM deal. We also completed a very successful introduction of our 2006 model year ATVs, utility vehicles and Victory motorcycles at our summer dealer meeting in Nashville.

There were also some challenges during the quarter, the most important of which was a slowing retail environment for ATV's in North America. Rapidly increasing energy costs following Hurricanes Katrina and Rita, higher interest rates and uncertain consumer confidence resulted in retail sales of ATVs which were below our expectations for both Polaris and for the industry, along with unexpectedly higher cost to produce and transport our products. As a result, we are reducing and narrowing our expectations for the balance of 2005. We now expect for the full year 2005 earnings per share will be in the range of $3.24 to $3.29 per share, down from our earlier guidance of $3.32 to $3.42 per share.

As I typically do during our third-quarter call, I'll give you some early qualitative thoughts on 2006. And as we do each year we will provide specific guidance for 2006 in our fourth-quarter call in January.

With that overview, let's turn to the individual business segments starting with ATVs. Our ATV business consists of three parts, our core North American business which accounts for about 65% of the business, along with our RANGER utility vehicle business and our international ATV business, each of which accounts for roughly 15 to 20% of the total.

As I mentioned earlier, the core North American ATV business had a tough quarter at retail both for us and for the industry and was below our expectations especially in September. We had entered the quarter with somewhat high dealer inventory and we were counting on a strong third-quarter to help clear out the inventory with our factory authorized clearance event which was so successful last year. Unfortunately this year there were a number of factors which resulted in us not being as successful as last year.

First from a competitive point of view, a number of companies used a promotional tactic similar to the FAC which hurt the relative strength of our offer. Secondly, a number of macroeconomic trends converged; higher energy prices, increasing interest rates and the unexpected shock of Hurricanes Rita and Katrina. Consumers are nervous about the cost of gasoline, the prospect of higher home heating costs and rising interest rates. That decline in consumer confidence has hurt the ATV business especially after the hurricanes.

So we retailed fewer units during the third quarter of 2005 than we did in the third quarter of 2004 but more than we did in the third quarter of 2003. The U.S. ATV industry data which should be announced in the next day or two by the Motorcycle Industry Council will also show a meaningful year-over-year decline for Q3. So the bottom line is that we didn't retail as many ATV units in North America as we had hoped and so we're going to reduce shipments and therefore earnings in the fourth quarter.

Both the RANGER and international businesses remained healthy and strong during the quarter and showed solid sales increases. Also from a positive perspective, we had a very successful 2006 model year introduction and received orders from our dealers that met our expectations. Dealers were especially excited about the all new 300 cc Hawkeye; the X2, our first two-up (ph) all-terrain vehicle; the Outlaw, the world's first sport ATV with independent rear suspension; and our decision to add electronic fuel injection to the Sportsman 500.

The vast majority of the new products we announced have yet to ship. Some will ship in the fourth quarter while others will ship in the first quarter. Based on both the qualitative comments and the dealers' orders, I would say the reaction to the 2006 line was more positive than the reaction to the 2005 introduction which was solid.

Going forward, we're going to be cautious with the North American ATV business. Over the next few months we will monitor closely retail sales for both us and the industry and make any necessary production and shipment adjustments on a timely basis. We believe that the consumer is uncertain right now and until some clarity comes back for a few consecutive months, we're going to remain conservative.

Victory Motorcycles. Victory had another very good quarter as we reported in the last several quarters; the new American motorcycle continues to build very solid momentum. Retail sales continued very strong throughout the quarter reflecting the building demand for the brand. We are growing our motorcycle business many times faster than the rest of the industry and expect that growth to continue despite the current economic challenges.

The excitement continued to build at this year's dealer show with a very strong reception to the 2006 lineup including the new Jackpot, our first entry into the so-called extreme custom segment. The Jackpot is the latest model in a series of very successful innovative bikes including the Victory Vegas, the Kingpin and the Hammer. The quality of the bike continues to get better and better; the dealer network is expanding; and the brand is gaining awareness and momentum. Our annual brand perception study indicates an increasingly positive view of Victory by both owners and nonowners alike and we expect these same trends to continue into 2006 and beyond.

Snowmobiles, the early snowmobile season has gotten off to a decent start. Retail sales of the industry through September were a little lower than they were a year ago but our retail sales were a little higher. Some of that positive comparison may be timing related since some of our hot new models shipped earlier this year than they did last year.

The popular models this year appear to be the new 600 and the new high-performance four stroke models. At consumer shows, press events and in the dealerships, consumers appear very interested in these products. Attendance at shows, races and events this fall has been good. As it is each year, the fourth quarter will be an important quarter for the snowmobile business. As the weather turns colder, we will carefully monitor snowfall, dealer traffic and retail sales, particularly of our new models. We have not yet seen a big impact to this business from the increased gas prices but that is something that we are watching closely.

Because we shipped units later than normal last year, we anticipate that fourth-quarter shipments of snowmobiles will be down at least 20% compared to last year's fourth quarter which is consistent with our earlier projections and guidance. All in, I would say so far so good with snowmobiles but it is still very early in the season.

Parts, Garments and Accessories. We had another very solid quarter in our highest margin business which grew 8% driven by growth in parts and ATV and Victory related accessories. We continued to introduce innovative new products for 2006 including expanding the successful Lock & Ride concept further in both the ATV and utility lines. Key new products included the RANGER Lock & Ride cab system, track kits for ATVs and the ATV Bodyguard Production System. PG&A group has had a nice run over the last 10 quarters and we anticipate 2006 to be another good year.

International. International sales were solid up 6% against a positive 60% comparable last year. We recently introduced two new on road ATVs or Quadra cycles at the Paris Motorcycle Show. One based on our Predator chassis and another built from the Sportsman 800 chassis, we continue to expand our presence in Europe; we continue to gain market share in Europe driven mainly by our growth in on road Quadra cycles which are based on our U.S. built ATV platforms.

Our subsidiaries in France, Scandinavia, Britain and Australia all continue to improve market share in Q3. Also we are moving quickly to add to significantly expand distribution with our new partner KTM in key markets in Europe including Germany.

Probably the biggest strategic news for the quarter was the announcement of the alliance with KTM, the Austrian company which is the second-largest motorcycle company in Europe. The reaction to the announcement has been very positive from our employees, dealers, suppliers and investors. In the first phase of the project, we're focusing our cooperation on seven specific projects including North American distribution, European production, powertrains, supply chain efficiencies, new product development, financing and European distribution. While it is very early in the project I think things have gotten off to a very good start. KTM had a very strong reception at our dealer meeting and each of the project teams is working well together. A number of these projects will take some time to develop and we will keep you posted as these results occur.

Finally, I've begun serving on the Board of KTM and KTM's CEO, Mr. Stefan Pierer is expected to join our Board soon.

So all in, where does that leave us and where are we going for the future? Obviously we're disappointed to take the numbers down for the fourth quarter. I'm sure that most of you are aware that we are not alone. Most of the publicly traded companies in the leisure sector including Arctic Cat, Harley-Davidson, Winnebago and Brunswick have reduced estimates this year as well. However difficult this decision is, reducing shipments is the right thing to do for the Company given the external environment.

But against that backdrop there are some positive things too. First, we just finished the best quarter in the history of the Company. Second, despite the downward revision for the fourth quarter this will still be a record year for Polaris, a 24th record year in a row. Third, we have a balance sheet that is essentially debt free which allows us to respond quickly to a changing environment.

We've made some good long-term strategic investments like Victory, building a utility vehicle business, investing in the new R&D center and most recently establishing the KTM alliance. These investments should help us well into the next decade.

We've also improved our portfolio by getting out of the watercraft business and restructuring the retail finance business to reduce risk, which Mike will talk about in more detail shortly. And perhaps most importantly, we have a solid pipeline of new products coming over the next few years.

Fourth, unlike some of our competitors, we are quite diversified across product lines and increasingly across geographies. Along with our non-union workforce, our high rate of employee ownership and our low fixed cost approach our structure allows us to adapt quickly to changes in the environment.

And finally, we've demonstrated a track record of not only adapting quickly but also successfully to rapidly changing environments like the one we face right now. Whether that was in the late '70s when the snowmobile market collapsed or in the late '80s following the regulatory ban of the three-wheeled ATV, or more recently with two Gulf wars, the 9-11 attacks, the flood in Roseau, the Polaris team always figures out a way to deliver. This is a very determined and adaptable organization and I'm confident in our ability to meet the current set of challenges better than our competitors.

So for 2006 despite the current challenges, I expect 2006 will be another record year for our Company, our 25th in a row, with positive sales and earnings per share increases over 2005. I suspect the earnings growth will be stronger than the revenue growth. I would expect the stronger contributions will come from the faster growing businesses like Victory, RANGER and International. It is probably too early for any intelligent predictions on snowmobiles and until we see the fourth-quarter retail, I'll reserve specific predictions on the North American ATV sales.

With that, I'll turn it over to Mike Malone.

Thanks, Tom, and good morning everyone. As Tom stated, during the third quarter we experienced both positive events and challenges. On one hand it represents our 30th consecutive quarter of earnings and sales growth, a very satisfying achievement. However, we recently experienced escalating transportation costs and a significant slowing of the North American ATV retail environment. We have been and will continue to make adjustments in our businesses to weather the challenges and I am confident that we can see our way through them.

I will talk more about the steps we are taking to overcome some of these challenges during my comments. As before, my comments today are related to the financial results of continuing operations unless specifically noted.

The execution of the exit of the personal autograph business that we announced a year ago has been proceeding as planned during this past selling season. Remaining dealer inventories of unsold watercraft in North America are minimal. Our current expectation for the results of discontinued operations remains unchanged. The loss from discontinued operations, which was $0.18 per diluted share for the full year last year, is anticipated to be a loss of about $0.02 per share for the full year in 2005. For the year to date period ended in September this year the loss was $685,000, which rounds up to a $0.02 impact to EPS.

For continuing operations, the full-year 2005 guidance, as Tom stated earlier, is as follows. We are reducing our previously announced sales growth guidance for the Company to the range of 5 to 6% for the full-year 2005. Previous guidance was a growth of 7 to 10%. We are reducing our full-year 2005 earnings per share guidance to the range of $3.24 to $3.29 per diluted share, a 7 to 8% increase over last year. Our previous guidance was $3.32 to $3.42.

For the fourth-quarter 2005, we are now expecting sales to be below last year's fourth-quarter sales in the range of down 1% to down 5%, with earnings per share expected to be in the range of $0.97 to $1.02 per diluted share compared to the $1.05 per share in the fourth quarter of last year. This guidance reflects our decision to reduce our expected ATV shipments to dealers during the fourth quarter in response to recent ATV retail sale disappointments.

Let me give you some additional details now starting with ATVs. Sales of ATVs for Polaris for the full year 2005 are expected to continue to grow although at a slightly lower rate than previous guidance. Sales growth continues to be driven by our very successful utility vehicle business, continued growth in our International business and the anticipated success of our new 2006 models as Tom discussed. Remember that our ATV reported sales include our RANGER and our International businesses that continue to grow significantly faster than the overall industry and faster than our base North American ATV business.

Although the North American ATV business has slowed near term, we expect to remain among the leaders in a very competitive ATV industry. We now expect total ATV sales to increase in the 6 to 7% range for the full year 2005. This guidance reflects the reduction in our expected shipments to dealers in the fourth quarter offset by the anticipated success of our new '06 model year introductions, continued growth in RANGERs and our International business, while operating in a continued competitive promotional environment.

Victory motorcycles are expected to continue to grow significantly during the balance of the year and have another strong year for the full year 2005. The Hammer and 8-Ball models are selling well and the new Vegas Jackpot is receiving good reviews since its introduction in July. Shipments of the Jackpot will commence in the fourth quarter.

Our guidance for Victory sales for the full year 2005 remains unchanged. We expect sales growth in the mid to upper 20% for the full year 2005. For snowmobiles, our guidance has not changed for the full year 2005. As we reported to you in the last call our snowmobile orders were below our expectations and below the prior year's level. Snowmobile sales are anticipated to be down in the upper single digit range for the full year 2005.

During the third quarter 2005, we actually shipped slightly fewer units of snowmobiles than the prior year, but due to a positive mix impact and an increase in the average selling price per unit, the dollar sales of snowmobiles in the third quarter actually increased 10%.

Parts, Garments and Accessories sales are expected to grow slightly faster than the overall growth rates of the Company for the full year 2005. The Lock & Ride accessories system for ATVs and utility models continues to sell well and our motorcycle apparel and accessories sales are improving as our motorcycle unit sales continues to grow.

On a consolidated basis, gross margins were negatively impacted during the third quarter by unanticipated higher commodity and fuel costs, higher interest rate expense related to floor plan financing and lower gross margins in our snowmobile business due to the lower volumes. We have taken a number of steps to offset the higher costs including increasing selling prices on select models, increasing the amount charged to customers for freight recovery, and qualifying new suppliers that are able to provide us with quality components at a lower cost.

Although we have benefited from the steps taken to reduce and/or avoid higher purchasing costs, the increases in costs have been too rapid and too steep to offset completely in the short term. We will continue to work diligently to reduce our cost of goods going forward.

Warranty expense in the third quarter was somewhat higher than we would like although it is much more in line than what we experienced in the second quarter. The warranty expense for the third quarter of this year was $10.6 million, or 1.9% of sales compared to $8.8 million or 1.7% of sales in the third quarter last year.

The ending warranty reserve on our balance sheet at the end of September this year is $26.9 million compared to $25.8 million at the end of September last year.

Our expectation for gross margins for the full year 2005 is a decline in the range of down 110 basis points to down 120 basis points, somewhat lower than our previous guidance.

Now operating expenses. Operating expenses for the full year 2005 are expected to remain lower in relation to last year as a percent of sales. As our production costs continue to increase, we are taking steps to compensate at the operating expense line by watching expenses closely to realize additional leverage from our sales growth. For the first nine months of this year we have realized 91 basis points of leverage in operating expenses generated from lower general and administrative expenses as well as lower selling and marketing expenses.

The lower stock price during the year and its effect on our stock base compensation programs has benefited the third quarter operating expenses by about 40 basis points. At the same time, we continue to invest in research and development efforts to drive future growth through new products. For example our R&D costs were up 16% in the third quarter and 17% year-to-date compared to last year's levels. So in total, operating expenses are expected to be lower as a percent of sales for the full year 2005 by about 60 to 70 basis points.

Income from financial services for the full year 2005 is now expected to grow in the midteens percentage range for the full year which has increased from our previous guidance. The third quarter income from financial services increased 37% compared to the third quarter a year ago resulting from improved profitability of both the wholesale and the retail credit arrangements.

One very important strategic step the Company took during the third quarter was our announcement that we had modified our retail credit financing relationship which HSBC Bank which is formally known as Household Bank. The new agreement provides for income to be paid to Polaris based on a percentage of the volume of retail credit business generated while at the same time reducing Polaris's risk. You will recall that the previous agreement provided for equal sharing of all income and losses with respect to the retail credit portfolio. This new structure allows Polaris to substantially reduce the risk associated with our retail credit program while maintaining the current income potential of the business.

The income reported by Polaris will no longer be directly impacted by interest rate movements or credit losses; rather it will be determined solely from the volume of retail sales finance. In addition, Polaris is no longer required to maintain retail credit cash deposit with HSBC, which was about $50 million. So those funds became available during the third quarter to pay down existing borrowings on our bank line of credit arrangement. We expect that this new structure will position Polaris for a strong and stable future in retail financial services and allow us to concentrate on growing our power sports business.

For the year-to-date period in 2005, we refinanced about 38% of our product sold to consumers in the United States through this HSBC arrangement, up from about 34% year-to-date last year.

At the end of September the wholesale portfolio related to floor plan financing for dealers in the United States was approximately 757 million, up significantly from last year's third-quarter receivable balance of 615 million. Credit losses in this dealer portfolio continue to be minimal averaging well less than 1% of the portfolio.

It's important to remember that as interest rates rise and dealer inventory increases, this wholesale receivable portfolio becomes more profitable to Polaris.

As Tom talked about, during the third quarter we announced our investment in the Austrian motorcycle manufacturer, KTM, by purchasing a 24.9% interest in that company from a third party for about $85 million. Income from this investment in KTM is recorded on an after-tax basis on the income statement as equity in income of manufacturing affiliates and totaled 900 -- or excuse me -- $0.9 million or about $0.02 per diluted share for the third quarter of 2005. The investment was funded with borrowings on our bank line of credit and the associated interest cost during the third quarter was about $0.01 EPS impact. So the net benefit of KTM in the third quarter was about $0.01 per share.

For the full year 2005, the net income from this investment is now expected to be positive by $0.02 or $0.03 per diluted share when you take into consideration the net impact of our interest and the income of KTM less the interest expense related to the investment.

The income tax provision for the third quarter of 2005 was recorded at a rate of approximately 29% of Polaris' pretax income, a reduction from 33% recorded in the third quarter of last year and the first half of 2005. The lower income tax rate for the third quarter is primarily the result of a tax benefit which was generated from the settlement of a state income tax audit for the years 1997 through 2000. As a result of the settlement, a portion of our tax reserves previously recorded on the balance sheet were no longer necessary resulting in a reduction in the third quarter income tax provision and a corresponding increase in third-quarter net income of about $2.6 million or $0.06 per diluted share.

For the fourth-quarter 2005, the income tax provision rate is expected to return to the previous rate of 33% of Polaris' pretax income.

One other item to note on taxes, the KTM income is reported on our income statement net of tax, so for modeling purposes it gets a little tricky. But the KTM income needs to be removed from Polaris' pretax income before you apply the Polaris income tax provision rate.

Now I'd like to make some comments on the impact of currency on our operating results. For the third quarter of 2005, the currency fluctuation of the Canadian dollar had a positive impact on sales and gross margins, while the Japanese yen has had a slightly negative impact on margins when compared to the third quarter of a year ago. We currently have foreign currency hedges in place for the remainder of calendar year 2005 and the first two quarters of 2006 for the Japanese yen which average about 109 yen to the dollar.

We also have hedges in place for the remainder of the calendar year and the first two quarters of 2006 for the Canadian dollar which average about $0.83. We currently do not have any Euro hedging contracts in place primarily due to the natural hedge that we have between purchases of component parts from Europe and shipments to our international operations in Europe.

Based on the foreign currency hedges that we have in place and the current exchange rates of each of the above-mentioned currencies, we expect a slightly positive impact on gross margins and profits from both the Canadian dollar and the yen for the hedged periods.

Some additional balance sheet and cash flow information for the period ended September '05 is as follows. We ended the quarter with 13.4 million of cash. The cash balances were after we paid cash dividends year to date of $35 million and made appropriate investments in the business through capital expenditures which for the year-to-date period have totaled $69 million. We've also invested 85 million in KTM and received the return of our cash deposit from HSBC Bank totaling 50 million.

During the quarter we continued to buy back our stock pursuant to the plan that we commenced in 1996 and repurchased 382,000 shares for $19.2 million. We currently have approximately 1.1 million shares remaining under the Board authorization and expect to continue our repurchase activity throughout the balance of the year.

Some cash flow items for the year-to-date period ended September 30th, '05 are as follows. Depreciation and amortization was 47.5 million; other non-cash items netted to a -2.4 million. Working capital items were a net use of cash flow of 31.3 million which is higher than the 1.7 million net cash provided in the same period a year ago. The resulting net cash flow provided by continuing operations is 114.2 million for the nine months ended September of '05 compared to a net cash flow provided of 137.6 million in a year ago.

As we have discussed earlier this year, the lower cash flow provided is primarily due to Polaris inventory levels that are higher than one year ago.

The net cash flow provided by continuing operations for the third quarter, however, did show improvement increasing 9% over last year to 108.7 million. Our expectation is that the full-year 2005 capital expenditures will be in the range of 90 to 95 million, as we continue to invest in new product tooling and engine and technology projects in addition to the incremental funding of 22 million for the new product development facility that was completed in the spring of this year. We expect appreciation for the full year to be about $65 million.

At the end of September, our receivable balance on the balance sheet was 68.5 million which is down 11% from last year's third quarter. Inventories at the end of September were 249.9 million, an increase of 26% from the third quarter last year. The recent softness in North America ATV retail sales has resulted in higher finished goods inventory than expected. As a result, we will be making some production reductions during both the fourth quarter of '05 and the first quarter of '06. We anticipate factory inventory levels to remain high through the balance of this year.

Our debt to capital ratio -- our debt to total capital ratio was just 5% at the end of September equal to last year's third quarter. And finally our EBITDA from continuing operations increased 10% to 197 million for the year-to-date 2005 period.

This concludes our prepared comments. At this time we'd like to take any questions that the analysts may have. Crystal, will you please open up the lines for questions?

(OPERATOR INSTRUCTIONS) Tim Conder with A.G. Edwards.

Thank you. Gentlemen, a few questions. Mike, just to clarify, you said ATVs on the inventory that about 26% increase year-over-year was due primarily to that. Any general breakdown of the inventories there? I mean you also mentioned earlier in the call that from the sled shipments are going to be up in the fourth quarter, what I guess is the general mix between the ATVs and the sleds there on that higher inventory?

This is a clarification. Our shipments of snowmobiles in the fourth quarter will be less than they were in the fourth quarter of last year. Our snowmobile inventories at the factory are higher than they were a year ago resulting from -- when we reduced our production of snowmobiles, that came pretty late this year. As we said before, we were disappointed in our orders that we've received. And so we had to cut our production late in our process. And we've got a fair amount of snowmobile inventory at the factory that will ship in the fourth quarter.

But the total shipments of snowmobiles will be down in the 20%'s for the fourth quarter for snowmobiles.

On the inventory, the 26% increase though -- if you had to kind of break that percentage increase down, is it 75% ATVs? Is that fair or so?

I would say the vast majority of the increase year-over-year is ATVs. And most of the balance is snowmobiles.

Okay.

Tim, let me just kind of jump in on the inventories because I'm sure that will be a question that you are not the only person will have. Inventories are high in the field and they are high at the factory; that is for sure. But I don't know that that 26% number is completely the only number that you want to take a look at.

If you go back and take a look at the '04 inventory number, you will recognize that that was actually a fairly significant reduction from the prior year, from '03. So maybe just give you a couple numbers here, if you've got a pen handy. If you looked at the '03 inventory, factory inventory I'm talking about now. At the end of the third quarter '03, that was 211. At the end of '04 I think it was 198. And in '05, it was 249. Right?

And then if you look at the sales over those same three quarters, in '03 it was 447; in '04, it was 511; and in '05 its 543. But if you look at the '03 to '05 change, inventory is up. It's up by 18%. Okay. But the sales are up by 21%. So the factory inventory is high and we're going to try to reduce the factory inventory but I don't think it's a situation that is completely out of whack here.

Okay. Looking at '02, Tom, as a percent of sales going back like in '98, we've seen a range of about 36% to 51. That kind of cranks out to about 46 -- so yes, kind of towards the upper end of that range, okay.

It is higher than we want it to be for sure, Tim, but it is not completely out of the range of where it has been in the past.

Okay. And clarification on your revised EPS guidance of 324 to 329 -- does that include the $0.06 tax audit recapture benefit?

Yes it does.

Okay. And, Tom, on KTM, I think you gave a little bit of an indication when you did announce the transaction that in '06 it could be modestly accretive. And now -- in '05 originally you were saying it wouldn't have any benefit and now you are saying to $0.02 to $0.03 for the year overall. Can you give us a little update on '06?

And then it sounds like Germany could be a pretty good benefit for you in '06 with ATVs as they are going to be your distributor. But also you talked about the potential that contract manufacturer with KTM -- maybe give us an update on that timetable.

Sure. In terms of specific financial benefit from KTM for '06, that is not a number that we are prepared to guide this morning, Tim. As I said in my prepared remarks, we kind of give qualitative guidance in the third quarter and we will give the quantitative guidance in the fourth quarter call. So you can expect to hear something in that call. But I think you are right that things are going well with the KTM partnership overall. It is very, very early. We're a couple of months into this thing.

In terms of the types of projects that we would expect to see at least some benefit either on our side of the ledger or on the KTM side of the ledger, I think KTM will see some nice benefit and additions to their North American dealer network. They of course were at our dealer meeting. And they are going to make some targeted additions, not a widespread change in their distribution strategy, but in those markets where they really didn't have presence, there are a number of Polaris dealers that are good dealers that they think it is sensible to add those dealers.

For us from a distribution point of view, probably the thing that will have the quickest benefit will be in Germany. Obviously Germany is the largest economy in Europe. It is the largest motorcycle market in Europe by a bunch. And we have really a quite small presence there through a relatively small distributor who has been working hard and has been a good partner but doesn't have anywhere near the scale or resources that KTM has. So we expect in late first quarter that KTM will take over distribution of Polaris ATVs there and we should see some benefit from that. Again, we will see what those numbers look like.

You said late first or third, Tom?

Late first --.

Okay.

-- late first quarter. And so that any financial benefit would probably be in the second quarter I suspect, Tim.

The product development things will take some time obviously you've got to design and build the product. And the manufacturing investments and so forth will be something that would be a little bit further down the line. But conceptually the idea is that we're manufacturing a bunch of products that we build here and ship over there. And they are kind of doing the reverse. The containers are passing each other on the ocean which is not particularly smart from a spending point of view.

And we're trying to figure out what products makes sense to manufacture and the other parties -- that is a pretty detailed study. And something that we are undertaking right now and we will have the kind of results of those studies I suspect by the end of the fourth quarter. And then any investment decisions and so forth we would make following that.

Okay. And finally under the new agreement with HSBC, I think in the past they had done all the credit scoring and everything. It sounds like somewhat you are just going to receive an origination type fee -- or has the credit scoring and the approval process, is that still all -- are they handling all of that still?

Yes, that is exactly how it works, Tim. The process of the backroom work that HSBC does is really no different today than it was before. The difference is the risk for us is obviously significantly less and we structured it in a way that we're going to maintain the income potential from the business.

Okay. Thank you.

Ed Aaron with RBC Capital Markets.

Thanks. Good morning. I just wanted to ask a question on the kind of U.S. ATV market in terms of what we should expect to see -- where we should expect to see the inventory go. Last year you ended the factory authorized clearance in September and this year I think it has continued maybe into November. Can you talk about what October has looked like? Have you started to see the levels come down in the month of October with your clearance continuing?

Yes. You are right, Ed. The timing of the factory authorized clearance event is somewhat different this year than it was last year. Last year the program ended pretty much for almost all dealers at the end of September. This year most dealers it ends at the end of October with a few dealers that go into November. October, obviously it is early on a couple of weeks into it. I would say that we are seeing positive year-over-year comparisons in October as we would expect we would with the factory authorized clearance event continuing. So I would say so far so good. Not ahead of our plans, not behind our plans. I'd say right about on our plans for the first couple weeks of October.

With regard to the inventory situation, it's going to take some time to work through the dealer inventory and the factory inventory. That is not something that's going to happen in one quarter. I think that will take a couple of quarters to go forward. And that is something we're going to continue to monitor.

I think the thing that is probably the most difficult to predict, Ed, and I'm sure everybody on the call would like to know the answer to it is what is going to happen to the consumer and what is going to happen with the consumer confidence? We are not completely sure, Ed, to be candid with you. It reminds me a little bit of the situation following September 11th, about a month after September 11th, when we weren't completely sure how things were going to shake out in our business. We're not completely sure where the consumer is going to go with the energy crisis being the primary factor. You pick up the paper one day it's going to be $4 a gallon, the next day it's $5 a gallon and one day you're not going to get it. Now it looks like it will be something like $2.80 a gallon. Heating prices are going to be doubled -- no they are going to be up 30% -- they're going to be up 50%.

So the consumer is getting kind of whipsawed in terms of their expectations. And we are seeing that. And for the people walking in the door to buy our ATVs. So we are going to play things pretty cautious, be conservative and monitor the situation carefully and react to the changes that we see in the marketplace based on that.

Sure, that is fair. Can you also talk a little bit about what is happening in the retail level in Europe?

Things in Europe I think are good. We've had -- we had a very good quarter. We are gaining some marketshare. Of course the competitive environment in Europe is quite a bit different than the competitive environment in the U.S. The market, the ATV market specifically has a much higher concentration of Taiwanese and Chinese, Korean manufacturers, Kymko is actually the largest -- has the largest marketshare in Europe.

We've gone through over the last couple of year's kind of the Asian invasion, if you will, with lots and lots of Taiwanese and Chinese manufacturers entering the market. That seems to have subsided a little bit. Certainly for some of the smaller manufacturers, consumers have not been happy with the product quality necessarily and the support they've gotten from some of their dealers. So you are seeing some of the more established companies I think, ourselves included, kind of gain a little bit with regard to the market there.

One thing that we haven't seen a big impact on that frankly has surprised me a little bit is the gas prices. If we are paying roughly $3 a gallon here, they are paying between $6 and $7 a gallon over there. I wouldn't be surprised if we saw an impact from that but we haven't seen that so far.

Okay, thanks.

Greg Badishkanian with Citigroup.

Great, thanks. I just had a follow-up on Ed's question. You talk about the parallel of 9/11 and sales dropping off some. How long did it take for it to recover?

Well I think, I'm talking primarily about the consumer mindset, Greg. Just think back to a month after 9/11, right, we were all here. And people were scared; they weren't exactly sure where the country was going, they weren't exactly sure if there was going to be another terrorist attack. People kind of huddled (ph) to a certain extent in terms of focusing on their family and ultimately that turned out to be a pretty positive thing for our business. But there was a period of a month or six weeks or a couple of months where consumers weren't really sure, dealers weren't really sure, we weren't really sure.

I think this situation is somewhat similar economically, obviously not from a national security perspective, but over the last 30 days people have been concerned about how are the higher energy prices, the higher interest rates, is the Fed going to continue to raise rates even more rapidly or not. And for the average consumer, and that is who our customer is, it is not a Wall Street analyst, it is somebody that is working for a living. They are they are concerned -- that wasn't a shot by the way, it just kind of came out that way. They are concerned about are they going to be able to heat their house, are they going to be able to drive their pick-up to work? And so I think until we can get some predictability particularly in the energy market, I think that is the key driver. And I don't know how long that takes, Greg. Is that a month, six weeks, before these refineries get back online? And crude oil kind of settles down a little bit. But I think it is going to be uncertain until the energy markets settle down.

You are taking this inventory reduction in the fourth quarter, but I think you also mentioned that it may take you a few quarters to bring it down to levels that you want it to be at, is that right or?

That would be correct.

And if it takes a few quarters, does that assume that the retail sales continue to be weak?

It assumes that we hit our retail forecast which we have, which is implicit in the numbers and the way we run the business we have a retail forecast that drives a shipment forecast, that drives an earnings forecast. So implicit in that 324 to 329 is a set of assumptions for retail and shipments for all of our businesses which I think Mike kind of went through.

So I was thinking if US ATV retail sort of rebounds into early next year at the low mid single digit range positive, is that something, would that then mean that your inventories would be in good shape? Or are you already assuming that it rebounds like that?

We are being pretty conservative in terms of our retail forecast. We are not anticipating that the price of oil is going to go to $50 a barrel and people are going to -- everything gets back to kind of the way we would like it to be overnight. We are going to be conservative until we see signs that would indicate something different. But if the North American ATV business rebounds more quickly that of course would reduce inventory levels faster, and that would be a positive event for us. But the flipside is if things are if there is God forbid another hurricane or some other factor that causes things to drive consumer confidence lower we are prepared to make those adjustments too. Okay?

Right. When you do your production planning, what made you decide not to maybe cut a little bit deeper in the fourth quarter -- sort of you know similar to what Harley did just take a larger cut to get rid of the inventories quicker as opposed to having it sort of in the first and second quarter you know maybe linger on? Is it because you are not sure if retail is going to rebound and you want to be conservative having the product out there in case it does? Is that sort of why you are a little bit more cautious in that way in terms of cutting production?

We looked at a variety of scenarios including not cutting at all to cutting more aggressively. Probably can make arguments for all of those ranges of alternatives. I guess one of the factors that is very important is getting the 2006 model year product out there. We do have orders for these products from dealers. And the dealers are making plans, very significant plans to bring the good news to consumers. So what you want to do is kind of balance that inventory and also the opportunity to grow the business and to drive future retail. New products drive retail and we have some terrific new products that we want to get on the market. So that is kind of the balance I guess.

Have you discussed this with your dealers yet, the anticipated cut in production or is that something you will discuss later?

We will do that in the future. No, this is not something that we have discussed with our dealers at this point.

Okay. So I assume they will be probably pleased with it and maybe can report back to us how -- sort of how they view the production cut as well. I think it makes a lot of sense to do that. It is the prudent thing to do. So I am glad you did this quarter. So thank you.

Bob Evans with Craig-Hallum Capital.

Thank you and good morning everyone. Can you comment on kind of the cost structure flexibility -- where -- in terms of as we look into '06 and you're doing your planning on your unit production -- I mean, how much flexibility do you have on the cost side to be able to continue to grow earnings perhaps at a slower rate but still grow kind of given the uncertain environment? What are some of the levers and maybe magnitude of those levers?

I think if you compare us to maybe some of the other people in the market and Greg brought up Harley and Harley is a terrific company, a fine company. I think they had a terrific quarter yesterday which we congratulate them on. I guess one of the big differences between us and perhaps, some of the other alternatives that are out there is we are not just in one line of business, right. Harley has got a great company but obviously in motorcycles only. And that somewhat limits where you can go in terms of if the motorcycle market slows down you've kind of got to take the lumps with that.

It wasn't that many years ago around here we were 100% snowmobile company. And today we have obviously snowmobiles, ATVs, utility vehicles, motorcycles; we've got the global operation. We've got a very nice Parts, Garments and Accessories business. And so that diversity allows us to respond quite quickly. And we expect to use that diversity not just for this particular -- this issue but in our future.

We also have a low fixed cost structure. We have a high purchase content in the vehicles. We have, we don't have the types of fixed cost that perhaps some other business models have. So in an uncertain environment it allows us to move and change maybe more rapidly than some of our competitors. And that has been true for many years and I think it is part of the reason that we've been able to enjoy 24 years of record earnings with environments that do change.

I mean if you go back to the ATV collapse, as I mentioned, or the '91 Gulf war which really shocked consumer confidence or the second Gulf war or 9-11 or the Roseau flood or all the things -- meaningful things that have affected us. We figured out a way to use that high variable cost structure and low fixed cost structure to adapt to a changing market. And we will use that same basic recipe again. We think it is a good one.

So in '06, you know as I mentioned, I would expect positive sales comparisons but also to deliver some operating leverage and that the earnings per share growth will be higher than the sales growth.

Is it, let's say your positive sale comparison and we don't know yet, but let's say it's modest, you know, it's 3 to 5%. Do you have the operating expense flexibility to be able to still as a percentage of sales decrease that by 50, 60 basis points? And did you have that more controllable? I know you don't know commodity prices, but is that something that you have some overall control on?

Yes, I think, Bob, I will just kind of defer that question until the fourth quarter. I mean we just -- we simply don't know where the snowmobile business is going to be and we never do until we get between kind of Christmas and New Year's; that depends on snowfall and a variety of other factors. And as we said, the ATV situation we want to see a couple of months here of what the retail performance looks like and kind of re-establish where we think that business is going to be. And that will really drive -- those decisions will drive where we are from a variable cost perspective and a total cost perspective and overhead. So we think we can deliver operating leverage but beyond that, we are probably not going to provide any specific guidance there. I don't know, Mike, if you want to add to that?

No, I think that is the right way to approach it.

That's fair. On the ATV side, is there any particular segment that you are seeing particular weakness in or is more just across the board?

No, I would describe it as kind of across the board.

Okay. So it is more of a macro than a segment?

That is what our data shows, Bob.

Okay.

Obviously in parts of the country that were directly impacted by the hurricane, retail sales came almost to a halt in Houston and Southern Mississippi and Alabama and those type things as you would expect. That would be the only kind of outlier that I would say; it's just a general slowdown primarily driven by energy prices.

Okay, fair enough. And last question, on KTM, can you comment or give us any kind of directional color from accretiveness? This year's going to be a little bit more accretive. And then should we expect that momentum to build as the year progresses or how should we think about it?

I think the way that we want to handle that, Bob, is that we are off to a really good start in our relationship. The impact for the '05 period is a couple of pennies maybe better than what we thought it was. I'm not sure that that is real meaningfully different than what our expectation was before. We're off to a good start. We said it would be modestly accretive next year. We still believe that. And we are going to give specific guidance 90 days from now.

Okay.

I guess the only thing that I would add to that is we haven't, sometimes in these things, once you kind of get into it for a couple of months you find some holy smokes there is some big problem that you didn't know about. We haven't found any big problems. I mean things are going well.

Okay, thank you.

David Anders with Merrill Lynch.

Thank you and this is (indiscernible) thank you for David Anders. Two questions. The first one is, International sales growth seems significantly slower this quarter than the previous two quarters? Was there anything going on there? And the other question is in terms of interest expense, this quarter seemed around 1.6 million. Is this the rate we should anticipate going into next year? Thank you.

This is Tom. Let me take the International side and then I will let Mike take the interest expense piece. On the International side, as I mentioned in my prepared remarks, International sales -- they bounce around a little bit quarter to quarter. But let's say they have been growing 20 to 30% for several years. In the third quarter of 2004, the International sales growth was 60%, so very high comparable. This quarter they are plus 6. So if you kind of average those two, that is up roughly 33%. It doesn't feel to me like it is way out of whack. It feels fine based on what we are hearing from our teams on the ground over there. Interest, you want to take that?

Yes, you are right. The interest expense is up significantly in the third quarter of this year compared to last year. A couple of factors of that obviously the rates are higher which has had an impact on us. And the most significant impact is our KTM investment was made during the quarter; that is over $80 million. We have to pay the interest on that.

Our debt bounces around during the quarter. Usually at quarter end it is at a pretty low level, but it does bounce around during the quarter with seasonal borrowing needs. So I would expect higher interest expense levels to continue for the near term as we work off that significant cash investment for both KTM as well as our much higher share repurchases that we accomplished during 2005.

Okay, thank you.

Gary Cooper with Banc of America Securities.

Just a couple questions. Can you talk about who is the most aggressive on the ATV promotion side? And I guess what you have seen here in October. And then I've got one more.

Good morning, Gary. In terms of ATV promotions, let's say compared to the same time last year all in -- and we have some financial models that kind of aggregate rebates and consumer incentives and dealers incentives and all that sort of stuff -- not a big change, not a big change. Which surprises me a little bit. We are going to watch and see what happens in terms of going forward. Sometimes the individual companies that lead the pack changes. One guys loses share, the next guy gains share, whatever. I'd say right now Honda is probably as aggressive as anyone particularly with noncurrents. But I would say overall not a big change so far. That is something obviously we are watching.

Okay. And then I guess a series of questions on this motorcycle business. Can you talk about what the demographic is for this business? Maybe explain to us a little bit more about this new bike that you are introducing, how it is different from the other ones? And then do I have this right -- are you producing somewhere in the ballpark of 8 or 10,000 units per year and so maybe you could just kind of give us a ballpark of what the wholesale price is on this? Thank you.

This new bike I assume by that you mean the Jackpot as opposed to KTM?

Yes.

Okay. So the Jackpot is -- what we said we were going to do in Victory going back several years now when Mark Blackwell took over the business was we were going to introduce basically one impactful new model each year. And it started with Victory Vegas and then after that it was the Kingpin and then the Hammer and this year's model is the Jackpot. The Jackpot competes in a segment called the extreme custom segment. You know people that are familiar with motorcycles have seen this kind of explosion around a 35, $40,000 motorcycles -- where built around this kind of Orange County chopper type mentality. You've seen some of the smaller producers like American Iron Horse and Big Dog did quite well selling 30 to $50,000 motorcycles that people want. Not so much about the function of the motorcycle. It is about really the appearance of the motorcycles.

Harley has had a custom vehicle operation for quite some time that takes basically a base Harley model and up features it and maybe instead of selling it for 18 or $20,000, sells more in the high 20s. Again, going after lots of chrome and that type thing.

So this is an upper end model, it's depending on the particular features. It's in the 19 to 22, 23 type price point. And goes after a segment of that extreme custom motorcycle that has -- just a wicked paint job and every piece of chrome that you can put on it. It's for a little bit more affluent buyer. I think one of the key differences perhaps between our offering and maybe some of the customizers offering is product reliability.

The Victory Motorcycle is extremely reliable. I mean we get just phenomenal feedback from our customers regarding quality and that kind of thing. And so what we are trying to do is offer a value in that segment of a production quality motorcycle that has some of the appearance features that maybe they've been buying in the aftermarket.

Your other question, Gary, related to the unit volumes. As you know, we don't talk about specific unit volumes. But to help you out a little bit, our sales last year for Victory were 74 million; our guidance this year gets you to mid-90 million-ish range in terms of dollars. And our average selling price per unit has improved this year. As Tom mentioned, the Jackpot is a little bit higher end model. So our ASP, or average sales price per unit is up mid-single digits for this year.

Probably the big thing again for some of the longer-term people on the call -- I mean the big things that have been done in the motorcycle business over the last couple of years when we had the difficulty we had initially, basically we've increased the average retail selling price of that motorcycle dramatically from probably in the 10 to 12,000 range up in the 15 to 17,000 range. I mean we really repositioned that brand at retail. And we've also broadened the offerings.

We were in the say 12 to 14,000 kind of MSRP range and now we can offer motorcycles from around 12.5 up to the low 20s, you know 22,000. So we are appealing to a much broader cross-section of the buying public and offering people a great motorcycle and an alternative. And that seems to be working out quite well.

Okay, just two quick follow-ups to that. Let me try it this way. Do you think it is a fair statement that the wholesale ASP on your motorcycles is at least twice as high as that on your ATVs?

And then secondly if we are talking about these price points, I mean the demographic of your motorcycle buyer is roughly the same as the buyer of any other heavyweight bike, would that be fair?

Yes.

Okay.

I would say demographically similar, maybe psychographically a little different, Gary. It is a person that wants to kind of stand apart from the crowd a little bit as opposed to be part of the crowd. And that emotion is what we really play on with the new American motorcycle. It's somebody that wants to try something new and different. Not -- it's the new American motorcycle but the basic demographics are similar.

Thanks, guys.

Crystal, we have time for one more question.

Joe Hovorka with Raymond James.

My questions have been answered, thanks.

That is the easiest question you have ever given us, Joe.

Ladies and gentlemen, we have reached the end of the allotted time for questions and answers. Mr. Edwards, are there any closing remarks?

No, I just want to thank everyone for participating in this quarter's call and we look forward to talking to you next quarter. See you then. Goodbye.

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