Polaris Inc (PII) 2005 Q4 法說會逐字稿

Good morning. My name is Mike and I will be your conference facilitator. At this time I'd like to welcome everyone to the Polaris fourth quarter earnings release conference call.

[OPERATOR INSTRUCTIONS]

Thank you Mr. Edward you may begin your conference.

Thank you Mike. Good morning and thank you for joining us for our fourth quarter and year-end 2005 earnings conference call. Michael Malone, our Chief Financial Officer and Tom Tiller, our Chief Executive Officer, will be participating in the call. Also present here this morning is Bennett Morgan, our President and Chief Operating Officer.

During this presentation, as before, 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 period,s 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 statement, which by their nature involve risks and uncertainties. There are a number of important factors that could cause results to differ materially from those anticipated. Additional information concerning the number of these factors can be found Polaris' 2004 annual report and in the 2004 Form 10-K, which are on file with the SEC.

Now I will turn it over to Tom. Tom?

Thank you Richard and good morning everyone. And thank you for your interest in Polaris. Earlier this morning, we reported both fourth quarter and first full year 2005 results for Polaris.

For the quarter, the operating results met our expectations. Sales were $526 million, down 2% from last year and earnings per share were $1.03, also down 2% from last year. These results are near the high end of the range that we discussed in the third quarter call. The full year results were earnings per share up $3.29 per share, up 8% on 5% sales growth, which also met our expectations.

2005 was a relatively good year for the company. From a positive perspective, the company grew, and for the 24th year in a row, earnings per share increased. We produced the record sales and earnings results in a challenging environment and made progress on a number long-term initiatives, which should benefit the Company for a number of years. Each of our growth businesses performed well, including our Victory motorcycle division, our Ranger utility vehicle business, and our international business. We delivered a number of outstanding new products which are critical for future growth.

We formed a strategic partnership with KTM, the Austrian motorcycle company, which should help us build a bigger, stronger motorcycle business and substantially strengthen our position globally. We opened a new state of the art technology center in Wyoming, Minnesota and we did a better job of controlling our overhead costs in 2005 than we did in 2004.

2005 also had some disappointments. We did not do a good job of managing our inventory, either at the factory or the dealer level. We continue to face a tough challenge in the snowmobile business, and our gross margin percentage after several years of expansion was down on a year-over-year basis.

Some of these challenges were a direct result of the external environment, which was pretty tough. '05 saw a continuation of the Fed's policy of raising interest rates, which has dampened consumer confidence and led to a modest decline in the core North America ATV industry. At the same time we experienced rapid increases in commodity costs, especially energy related items which pressured our margins.

Some of these same challenges will continue into 2006, but I expect the company to perform well and deliver our 25th consecutive record year. '06 will be about executing the fundamentals well. In the first half we expect to get the inventory situation back in line and for the full year we expect the margins to be better. We will grow, but it will be modest growth. We expect to deliver operating leverage and to strengthen our competitive position. We will continue to invest in the business and drive the same strategic initiatives that we laid out in 2004, specifically a steady flow of new products, building a successful Victory motorcycle brand, globalizing, driving for class leading cost and quality and expecting the very best from the Polaris team.

With that overview, let's turn to the individual business segments, starting with all terrain vehicles. The ATV division representing about 65% of the revenue of the Company, had a solid fourth quarter to cap a good year. ATV shipments were up 1% for the quarter and up 7% for the year with very strong growth in both Ranger utility vehicles and in international sales.

Many of you are aware that the core North American ATV industry has slowed its rate of growth over the last few years. For 2005, in the United States, retail sales of ATVs were 780,000 units, down 4% from '04. You may recall that in '04 the industry grew by about 2% and in '03 the ATV industry grew by about 4%.

As a reminder, we continue to enjoy high growth in two categories outside the reported core North American ATV business. Specifically, with Ranger utility vehicles and international sales. Rangers make up about 20% of our ATV business and grew well in excess of 20% during 2005. Sales of ATVs outside of North America now are more than 12% of the total ATV business and grew by almost 30%.

Neither of these two categories, utility vehicles or international sales are included in the industry data that I referenced earlier, nor are traditional ATVs designed for two riders, so called two-up ATVs. When you combine these unreported segments with the reported industry data, the growth rate for the global ATV Industry is significantly higher than down 4%. Our estimates are that the total global ATV Industry grew at a rate of between mid to high-single digits during 2005.

My point is despite the economy, there are opportunities to grow in the global ATV business. Certainly the days of 20% industry growth are behind us, but we remain bullish about ATVs.

A great deal has been written and said about North American ATV dealer inventories. As we discussed in the third quarter call, our inventory is higher than we would like and we're taking steps to gradually reduce the level of dealer and factory inventory.

We made some positive progress in the fourth quarter. The strategy to do this is simple, produce and ship less and sell more. From a production side, as we anticipated, we trimmed up production rates and we expect to continue to reduce production and shipments of ATVs in North America during Q1 and Q2 of 2006.

From a retail sales perspective, we had a solid fourth quarter. Retail sales of core North American Polaris ATVs increased by 8% over the previous year. The combination of increased retail sales and reduced production rates should bring inventory back in line, which we expect to be largely completed by the end of the second quarter 2006.

Promotions in ATVs continue to be at a high level, but are relatively stable for the most part. This is an area that we are monitoring closely as most of our competitors are all dealing with basically the same issues that we are.

Part of what will drive our growth is new products. The new products that we introduced to our dealers last summer, including the improved Sportsman 500 EFI, the all new Outlaw, which is the industry's first sport Quad with independent rear suspension, the all new midsize Hawkeye and our first two-up ATV, the Sportsman X2 have all now recently entered production. These new two models began arriving at dealerships either late in the fourth quarter or early in the first quarter of '06, and retail sales to date have been limited. We should see the benefit of these innovations accelerating in the first half of 2006.

In terms of '06, we expect to see more of the same macro trends. We anticipate a core North American ATV industry that may be down slightly in terms of units but is likely to be about flat in terms of dollars. We expect retail sales of Polaris ATVs to outperform the industry in North America and we expect the fast growth in Rangers and international to continue.

Snowmobiles. The snowmobile division had a generally disappointing 2005. As expected, shipments were down 29% for the fourth quarter and 11% for the year. During 2005, we saw some significant margin compression, as some of our new models were more expensive to produce than we expected. And our warranty costs were also higher than they were a year ago.

For the industry, the 2005, 2006 riding and selling season has been mixed so far. Snowfall was good early, particularly in the Midwest, until about the holidays. But since then, warm weather has melted away much of the rideable snow, particularly in the East and the Midwest. January 2006 is expected to be the warmest January in the last 160 years.

Snowfall throughout the West has been excellent for most of the season. In total, retail sales for the snowmobile industry through the end of December were down mid-single digits from a year-ago and our market share is down slightly. I would anticipate that for the full season, the industry sales to be down as well. Dealer floor traffic has been reported lighter than normal for all brands in January as a result of the warm weather. Compared to the prior year, dealer inventory at the end of the December was up slightly, single digits, from the same time a year ago but the inventory situation could get worse given the current snow conditions. We will be meeting with our dealers in early March to unveil our new model 2007 lineup and solicit orders.

At this point, we expect double-digit declines in snowmobile shipments, but also anticipate improvements in cost, quality, and margins. In the next quarterly conference call following the end of the riding season and after our annual dealer meeting, we will be more specific about the new products and our future guidance.

Victory Motorcycles. An excellent fourth quarter closed what was another strong year for the Victory motorcycle division. Victory shipments were up 56% for the quarter and were 34% higher for the full year. Consumer and dealer interest in Victory motorcycles continues to grow rapidly as we have seen throughout the fall and winter motorcycle shows.

The overall motorcycle market had another record year in 2005, with a 4.5% increase in US retail registrations to just over 1 million units. Victory's retail sales pace dramatically outperformed the industry in 2005 and we expect that trend to continue for several more years.

Compared to just a couple of years ago, we've made real progress in the motorcycle division. The bikes are better looking, more reliable, and cover a broader range of price points. The Victory brand is starting to become fairly well known among motorcyclists. Victory dealerships are improving and the quality of dealers expressing interest in carrying the Victory brand is much stronger than when we first started. Perhaps most importantly, the feedback we've been getting from Victory customers in our annual buyer's survey is very, very positive and improving.

Our customer satisfaction has increased dramatically in recent years, and is now at or near the top of the motorcycle industry in virtually every key area, styling, performance, comfort, reliability and so forth. This customer satisfaction translates into very valuable word-of-mouth referrals, which are critical to any growing business but are especially important in a high-ticket discretionary category like heavyweight cruisers.

All this feel-good stuff has translated and all this feel-good stuff as translated into tangible benefits for our shareholders as well. During the fourth quarter of 2005, for the first time, the Victory motorcycle business made money and we expect that progress to continue during 2006 and beyond. So we've not only turned the corner from a brand, quality, and product appeal perspective, the gross margins are expanding and we're now making money in the motorcycle business.

This is a substantial achievement for the Victory team and marks the first time in over 60 years that a major motorcycle manufacturer has successfully entered the US market. Going into the motorcycle business was a good decision for Polaris, and Victory will be a key platform for growth for the next 10 years.

That growth will continue in 2006. The new Victory models that we introduced for '06 appear to have generated strong consumer interest. The all new Victory Jackpot has graced the cover of a number of key motorcycle publications and has drawn strong interest at the winter motorcycle shows and early retail results have been very positive for the Jackpot. '06 should bring more good news for Victory, will build on a strong momentum and help grow this business into a solid part of Polaris.

Parts, garments and accessories. We had a good close to the year in PG&A, with solid 12% growth for the fourth quarter and 9% for the year. This business is operating well and we expect more of the same in '06. We've seen good balance across the product categories and modest margin expansion. Innovation is driving much of the growth. For example, we saw over a 30% revenue growth in the innovative Lock-and-Ride accessory category.

We are seeing the fastest growth in the Victory and Ranger related products, both of which have a high dollar per unit mix of accessories and in Victory's case, clothing as well. So as Ranger and Victory continue to grow rapidly, that helps our PG&A results.

International. International had a solid year in '05 and delivered 14% growth for the fourth quarter and was up 20% for the year driven by strong increases in ATVs. We continue to be helped by three major factors; volume and share gains driven by our new products, better dealer direct distribution model and more recently our partnership with KTM.

We grew market share in almost every international market in 2005. We improved our dealer network across the board and are carefully adding or upgrading a select number of distributors, including in Germany. We anticipate that our international business will continue to grow throughout the decade.

KTM. One of the biggest changes at Polaris in 2005, was the formation of a strategic partnership with the Austrian motorcycle manufacturer KTM. In July, we purchased 25% of KTM and began Phase I of a relationship that's designed to strengthen both companies. As we discussed in our prior announcements, this first phase of the relationship, which will last through the fall of 2007, is designed to determine how successfully the two companies can work together and whether the potential benefits of cooperation are real. We have begun seven projects, including European and North American distribution, product development, sourcing, production, dealer financing, and engine technology sharing.

So far the projects are proceeding well. The teams are making good progress and the benefits that we expected to see are materializing. In 2005, we saw $2.3 million of after-tax benefit from the KTM investment. In 2006, we expect that benefit to about double. So I think we're off to a good start with Phase I of the KTM relationship and expect to continue to work on the seven cooperation projects throughout 2006.

Before I turn it over to Mike, let me summarize our expectations for 2006. '06 will be stronger than 2005. For the full year, we expect revenues to grow but modestly, flat to up low single-digits. We anticipate that the revenue will be down in the first half of the year as we adjust inventory levels, and improve in the second half. The environment will remain tough with a flattish North American ATV industry and a down snowmobile business.

I expect us to outperform our competitors at retail. Gross margins are expected to improve in excess of 100 basis points. Earnings per share should grow 3% to 7% or in a range of $3.23 to $3.38 per share after adjusting both the 2005 and 2006 numbers for the new SFAS 123 directive, regarding the expensing of stock based compensation, which Mike will discuss in more detail in his section. I'm confident with the plans we have in place, 2006 should be another record year, our 25th in a row.

And at this time, I'd like to turn it over to our Chief Financial Officer, Mike Malone. Mike?

Thanks, Tom. As Tom mentioned the industry and economic environment throughout 2005 was challenging. However, we made several adjustments during the year and we were able to generate another record year for the company, our 24th consecutive year of growth in earnings per share.

Moving into 2006, we continue to face some challenges as Tom described earlier. Our guidance for 2006 takes into account our current viewpoint of the industry, current inventory levels, and the overall economic conditions for 2006. As before, my comments and guidance today relate only to the results from continuing operations of the company unless otherwise noted.

The exit of the personal autograph business that we announced over a year ago is substantially complete. In 2006, we will have some minor charges related to the watercraft exit to finish cleaning up a few remaining open items. Our current expectation is that the loss from continued discontinued operations, which was only $0.02 per diluted share in 2005, will be about $0.01 per share in 2006.

The other item to note is that starting in the first quarter of 2006 we will begin expensing stock options in accordance with the Statement of Financial Accounting Standards 123R. The adoption of this standard is expected to result in a charge to the full year 2006 earnings of approximately $0.12 to $0.14 per diluted share with approximately $0.03 per diluted share coming in the first quarter of 2006.

Assuming that the company had adopted this standard for fiscal 2005, pro forma diluted earnings per share from continuing operations would have been reduced by $0.14 per share from the reported $3.29 to $3.15. The pro forma diluted earnings per share of $3.15 for calendar 2005 forms the basis from which we derive our 2006 earnings expectationa. For the first quarter of 2005, pro forma diluted earnings per share would have been reduced by $0.02 per share to $0.40 per diluted share. The remainder of my comments will include the impact of the new accounting standard for both years.

In addition to the expensing of stock options, certain other stock based compensation expenses will be treated differently. Beginning with the first quarter of 2006, we will reclassify our other stock based compensation expenses, which have previously been reported in general and administrative expenses, into cost of goods sold and the other operating expense lines on the P&L, consistent with the methodology prescribed by the new accounting standard.

Earlier this morning, we filed a Form 8-K that includes the 2005 income statements adjusted for the impacts of the new accounting standard as low as the allocation of our other stock based expenses into the appropriate line items for each quarter of 2005. You can use that Form 8-K for reference in adjusting your historical modeling.

For the full year 2006, taking into the account the overall economic, inventory and industry environment, we're expecting total sales to be in the flat to a 2% increase range, with sales growth expected in each product line with the exception of snowmobiles. We expect earnings from continuing operations to grow and be in the range of $3.23 to $3.38 per diluted share, an increase of 3% to 7% when compared to the pro forma $3.15 per share in 2005, which would result in what would be our 25th consecutive year of EPS growth.

As we did in the fourth quarter of 2005, during the first quarter of 2006 we expect to once again reduce ATV shipments to further balance North American dealer inventories. As a result, we expect first quarter 2006 sales to be lower than the first quarter of '05, in the range of minus 6% to minus 9%. First quarter earnings per share from continuing operations is expected to be in the range of $0.25 per share to $0.27 per diluted share. By mid-year, we anticipate that ATV dealer inventory will be more in line with retail expectations, and we would expect to see stronger, more normalized sales and earnings growth in the second half of 2006.

Now, let me give you some additional details on results for the fourth quarter of '05 and the expectations for the full year '06. Sales of Polaris ATVs in 2006 are expected to grow modestly driven by the growth in sales from our new products introduces last year that Tom talked about. Additionally, we expect to continue to realize strong growth from the Ranger utility vehicles and our international business.

During 2006, we expect to reduce shipments of our base North American full-size ATVs in order to adjust for the heavier dealer inventory situation, particularly in the first quarter. For the full year 2006, Polaris ATV wholesale sales to dealers are expected to increase in the 1% to 3% range, while retail sales to consumers are expected to increase at a faster pace.

Victory motorcycles are expected to grow significantly and have another strong year as the Hammer and Vegas Jackpot models gain share along with increasing sales for the improved Kingpin and Vegas models, which feature the more powerful 100 cubic inch engine and a six-speed transmission. Additionally, our dealer network will continue to expand and gain strength and we expect the overall heavyweight cruiser and touring market to continue to grow. Sales for Victory are expected to grow in the high teens percent for the full year 2006.

As always at this point in a year it's really too early to tell what the dealer orders for snowmobiles will look like for the next season, but given what we know today we're expecting double-digit percent lower snowmobile sales in calendar 2006, given the current snowfall levels, retail sales patterns, and continued high dealer inventories.

Although the expected decline is disappointing, it is important to remember that snowmobiles are less than 14% of total company sales in 2005. As we normally do, we will give you more specifics during our next quarterly call after our spring snowmobile dealer meeting.

Parts, garments, and accessory sales are expected to increase at a slightly faster pace than the overall company for 2006, in the range of low to mid single-digit percent growth with growth coming primarily from PG&A sales of ATVs, Victory motorcycles, and utility vehicles.

Moving down the income statement now. As expected, our gross profit on a percentage of sales basis was lower in the fourth quarter than in the fourth quarter a year ago. The gross margin erosion in the fourth quarter was primarily due to lower snowmobile margins, particularly, with the new four stroke models, higher floor plan financing cost caused by the higher interest rates and higher inventory levels, as well as higher sales promotion cost causef by the heavier ATV dealer inventories.

However, gross profit of the full year 2006 year is expected to improve over the 2005 gross profit on a percentage of sales basis. Although they have been very volatile, given what we now today, we expect commodity costs to abate somewhat when compared to the full year 2005, contributing somewhat to the improvement in gross margins.

In addition, we expect our benefits from our increased cost reduction and efficiency improvement efforts, sourcing of component parts from lower-cost suppliers plus new product introductions and lower warranty costs will all positively impact gross margins in 2006. Currency movements are expected to have a slight positive impact on gross margins for the full year 2006.

Given all these anticipated factors, our expectation is that gross margin percentage will expand for full 2006 in excess of 100 basis points from our current year -- sorry, from our full year 2005 gross margin of 22.0%, which is the number after adjusting for the expensing of stock options and reclassification of the other stock based compensation expenses.

Moving down to operating expenses. Operating expenses for the fourth quarter of '05 were 10% lower than the fourth quarter last year. This decrease is primarily due to an 86 point -- 86 basis point benefit from the lower stock based compensation expenses, driven in large part by the lower Polaris stock price.

Operating expenses are expected to be slightly higher as a percentage of sales for the full year 2006 as we will continue to invest in research and development efforts, to drive future growth through new products, including a full year expense related to the new R&D facility opened up in mid year '05.

In addition, our expectation is for higher stock based compensation expense in 2006 compared to a relatively lower expense in '05 in a more normalized Polaris stock price environment.

Income from financial-services for the fourth quarter increased 27% compared to the fourth quarter a year ago, resulting from improved profitability of both the wholesale and the retail credit arrangements. The income from financial services for the full year '06 is expected to grow at about the same percentage base as overall company sales growth, due to a more moderate growth and income from wholesale financing as the dealer inventories are reduced over time.

At year end 2005, the wholesale portfolio related to floor plan financing for dealers in the United States was approximately $797 million, up from 669 million at the end of last year. Credit losses in the dealer portfolio continue to be very reasonable, averaging less than 1% of the portfolio over the life of the partnership.

I want to remind you that during the third quarter this year, we modified our retail revolving credit financing relationship with HSBC 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' risk. You will recall that the previous agreement provided for equal sharing of all income and losses with respect to the portfolio. This new structure allows Polaris to substantially reduce the risk associated with the credit program while maintaining the current income potential of the business. The income reported by Polaris is no longer directly impacted by interest rate movements or credit lines, rather it is determined solely from the volume of retail sales financed.

For the full year 2005, consumers financed about 37% of our products in the United States through this HSBC arrangement compared to 34% for 2004 while the volume of revolving credit contracts written in calendar '05 was $527 million, an 8% increase over last year.

As Tom mentioned, during 2005 we made an investment in Austrian motorcycle manufacturer KTM by purchasing a 25% interest for approximately $84 million. Income from the investment in KTM is recorded on an after-tax basis on the income statement as a component of equity in income of manufacturing affiliates and totaled $2.3 million for the full year 2005. For the full year 2006, we expect the financial benefit to the Polaris income statement of the KTM investment to approximately double given that we will have our ownership position for the entire calendar year.

The income tax provision was recorded at a rate of approximately 31.1% of Polaris' pre-tax income for the fourth quarter of '05, and 31.2% of Polaris' pre-tax income for the full year 2005, which is a reduction from 33% recorded in each of the 2004 periods. These reductions are due to favorable income tax events recorded in the second half of this year.

For the full year 2006 the income tax provision rate is expected to be in the range of 33% to 34% of Polaris' pretax income. When we talk about taxes, it's important to note that the KTM income is reported on our income statement net of tax. So for modeling purposes you need the -- the KTM income needs to be removed from Polaris' pre-tax income before you apply the Polaris income tax provision rate.

Let me take a moment to talk about the impact of currency fluctuations on our operating results. For the full year 2005, our currency hedging strategy performed well for us. For '05, currency fluctuation of the Canadian dollar had a positive impact on sales and gross margins, while the Japanese yen and euro had negligible impacts on gross margins.

The gains and losses from our hedging activity are recorded in other non-operating expense. The weak US dollar and the resulting impact on our Canadian dollar hedging transactions has generated the majority of the 1.3 million expense in the fourth quarter of 2005. We currently have foreign currency hedges in place for the first half of 2006 for the Canadian dollar at an average exchange rate of about $0.84 and through the first three quarters of 2006 for the Japanese yen at an average rate of about 1.12.

We do not have any hedges in place for the euro, since we currently have a natural hedge situation. For the full year 2006, based on the hedge contracts 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 from the currencies compared to 2005.

Now, let's take a look at some cash flow and balance sheet information for the 2005 year. We ended the year with about 20 million in cash on the balance sheet, down from 138 million of cash a year ago. The decrease in cash position at the end of '05 is primarily the result of our KTM investment, increased share repurchases and the higher Polaris inventory levels.

During the year we repurchased shares of Polaris stock totaling 2.4 million shares at a cost of $132 million. We paid cash dividends of 47 million and invested the 84 million for the ownership stake in KTM, as well as making investments in the business through capital expenditures and tooling, totaling $90 million, including 17 million for the new research and development center.

For the full year 2006, capital expenditures are expected to be less than they were in '05, in the range of 70 million to $80 million, as we continue to invest in new product tooling and engine and technology projects. We expect depreciation for the full year 2006 to also increase, to be in the range of $70 million to $75 million. Net cash flow provided by continuing operating activities was $177.6 million for the year 2005, a 28% decrease compared to $245 million in the prior year.

The significant decrease in cash flow relates primarily to higher factory inventory levels in 2005, and more normalized levels of accounts payable growth in 2005. Our factory inventory situation improved somewhat during the fourth quarter of '05, but ending inventories remain higher than what we would like, particularly, ATV finished goods inventory.

Inventories at the end of December were 202 million, a 16% increase from a year ago, but a significant decrease from the 250 million of inventory at the end of the third quarter of '05. The production reductions we announced on our last call, have had a positive effect in bringing down our factory inventory. In the first half of '06, we will continue to moderate our production levels in an attempt to reduce factory inventories.

Receivables on our books at the end of the year were 78.4 million, up 10% from last year, primarily, due to the higher sales from our rapidly growing international business, which grew 20% during 2005. We expect to continue to repurchase shares during 2006 under our existing board authorization, which has approximately 4.7 million shares remaining, particularly, if the stock price continues to be undervalued.

Debt to total capital was just 5% at the end of the year, about the same level as it was a year ago. EBITDA from continuing operations was $281 million for the full year 2005, up 6% from a year ago level. And just to remind you, a week ago we announced the increase of our regular quarterly dividend by 11% to $0.31 per share per quarter, effective with the 2006 first quarter dividend. This increase represents our 11th consecutive year of increasing the dividend.

Let me conclude by recapping our full year 2006 guidance. Total sales for the year are expected to be in the flat to 2% increase range with EPS growing to $3.23 to $3.38 for the full year of 2006, an increase of 3 to 7% over the pro forma $3.15 per share earned in 2005. First quarter 2006 sales are expected to be down 6 to 9%, with earnings per share expected to be in the $0.25 to $0.27 per share range, compared to the pro forma $0.40 in the first quarter of '05. Remember, all earnings per share amounts for each period have been adjusted for the impact of the new accounting rule 123R.

At this time, we would like to take any questions that the analysts may have. Mike, would you please open the line for question?

[OPERATOR INSTRUCTIONS]

Hi, Mike, we're ready to go.

Okay. Your first question comes from the line of Gary Cooper from Bank of America. Go on.

Actually, this is [Steven Watts] with [Luxor Research]. A couple of questions, Tom. Given the climate around materials and the pressure around material costs that you're facing right now, what strategies have you guys already in place to manage material costs across your extended supply chain?

Well, I think the significant increases in material costs we think will be on a comparable year-over-year basis, reasonable. I think the places that we're seeing the most significant inflation is around the energy related expenses, so plastics, heating, transportation costs, some processing costs, but primarily energy being the big year-over-year pressure.

We are working hard to reduce the material content of our vehicles. That's one way we can drive productivity. We also are on a gradual basis working with our suppliers to -- certain types of commodities, move them to lower-cost countries. As you may know, if you look at Polaris' variable costs, most of our cost is not in our own assembly plants, it's actually in the supply base.

So working closely with our suppliers to reduce both material content and to reduce the cost of the particular components is very important. We also are working hard on part simplification, trying to drive design simplicity, although that tends to come primarily in platform redesigns. So those are our primary strategies.

When you talk about working more closely with suppliers, are they open to that? I mean how are you guys extending that partnership so it's a win-win for both parties?

Well, we have, I think, long-term very good relationship with our suppliers. If you look at what's driven the success of Polaris over the years, to a very large extent it's been our relationship with our key suppliers. We do have a program called Strategies Toward Annual Reduction where we have essentially a cost-sharing type arrangement with our suppliers, so that as we drive productivity in the supply base, we share the savings with them. It's not as adversarial perhaps as some of the traditional automotive models.

When you look at where the innovation comes for our product, in many cases, it comes out of our supply base. So it's more than just buying commodities. We also have long-term partnerships that fuel the innovation and growth of the Company.

Okay. And final question. A year from now, what would you like to say to everyone in the community that you would like to have accomplished for 2006 in terms of reducing material costs. And then when challenged, you said you focused and faced and were able to solve.

I think if we can see the gross margin expansion that we anticipate, a good bit of that comes out of material costs. So if we can see gross margin expansion well in excess of 100 basis points, I think we will have demonstrated our ability to manage the cost side of the business well in hopefully a less volatile environment than we saw in 2005.

Your next question will come from the line of Tom Conder.

Thank you. It's Tim Conder. A couple of questions, gentlemen. Tom, just wanted to clarify -- you did say that the Ranger was 20% of your total ATV sales?

Yes, a little in excess of that, Tim. Yes.

Okay. And the International, Tom? As far as, it was 12% of your total ATV sales?

Yes, again, a little in excess of that.

Okay. That international component, does that include Ranger and does it include Canada?

That does not include Canada and it's primarily - the vast majority of it is traditional ATVs and the international sales of Ranger because of the size of product, the volume of product is not a big part of the International ATVs. So technically they're in there. But Ranger is much smaller internationally than it is domestically on a percentage basis.

Okay, okay. And then what type of expectations do you have built into your guidance regarding the contribution from KTM? I think year-to-date, since you did the transaction, roughly $0.03 after you net out the cost of your interest and all that type of thing, what type of expectations at this point do you have looking into '06?

Well, for the full year '06 in my prepared comments, Tim, I said that it would be roughly double for the full year, given that we'll have full year of ownership.

Okay. And was that roughly the $0.03 on a net basis? Mike, is that - I apologize. Just to clarify there, was that correct for '05?

Yes, that's in the neighborhood, when you net out the financing cost of the transaction.

Okay, okay. And then, Tom, how are things progressing there as far as getting things set up with the plant where they're going to be contract manufacturing for you and then maybe changing some of your streamlining a few things where there is overlap between the two companies? And granted, you only own 25% at this point, I understand.

Yes. I think -- again, as I mentioned in my prepared remarks, Tim, I think that overall we're off to a good start. We have seven projects, one of which, as you mentioned, does include manufacturing. And we also have sourcing and product development and distribution projects and financing, really across the whole spectrum.

And really, I think what we're trying to figure out in Phase I of this thing is, can we work effectively with the KTM team, not just at the senior level but at the engineer-to-engineer level and at the buyer-to-buyer level in purchasing and so forth. And also are the benefits that we anticipate to be pretty significant in a Phase II type of world -- are those real? So we're doing test projects in several different parts of the enterprise and -- at least so far and we are six months into this thing, we are not six years into it. So far, I would say, in total, there have been no major surprises. I think the benefits appear to be very much in line with what we expected them to be on these pilot projects and things are progressing well.

So we will announce the specific progress of each of these projects as they sort of naturally come to that point. For example, just like we wouldn't announce a new product at Polaris before the product was completed, we wouldn't announce any kind of product development effort at KTM before that is completed. So -- but I think generally, things are going well. The teams are getting along just fine. Benefits look good. And I think six months into it, I'm pleased with the progress.

And one last question related to KTM and international on ATVs. They have become your distributor in Germany her for ATVs. How much of that is going to account for your growth in international ATVs? I mean just percentage-wise, I mean is that going to be the primary driver, equal driver to your core new products, which by the way looked pretty decent, what you are going to have over there?

Yes, it's a small part in 2006. I suspect it will be a significant part as we go forward. Just to clarify, they will become the German distributor, they're not technically the German distributor yet. That will be in March of 2006.

Okay.

And I would -- like any new distributor, it takes some time to build a dealer network to establish the brand, to train the people and all that sort of stuff. But Germany is the largest market for a ATVs in Europe and we have a very small share. So, over time over the next two to three years we expect that KTM with its strength in distribution there should help us. But I don't anticipate a big contribution from that in 2006. I think that will be down the road a little bit,Tim. But we're very pleased with how that is going so far.

Okay, thank you.

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

Great, thank you. I guess my question relates first to inventory levels at the dealer level. How do you, how will you characterize them by the end of the first quarter or second quarter and what's your -- what will your comfort level be and sort of what would of your expectation be for retail sales for the next quarter or two?

I think, as we mentioned, Greg, in the prepared remarks, I think we made some progress in reducing inventory in the fourth quarter. I expect that, that progress will continue in the first quarter and in the second quarter, and if things go according to plan in terms of our retail plans and the industry and sell-through and all that sort of stuff, I think we will be in a sort of more normalized inventory position by the end of the second quarter.

We may have a model or two that will be too high or too low, but in aggregate I think we will be in pretty good shape by then and if the market performs the way we expect it to, if our share performs the way we expect it to and dealers perform in the way we expect it to. So, I expect things will be lower, year-over-year basis on a relative basis, each quarter for the next couple and we will continue to monitor retail and inventory and adjust the production plans as appropriate to try to drive to make that happen. But I am pleased with the progress so far.

Just to your comment on the global industry being mid to high single digits in '05 -- is that all [tier] products and would that include like the Ranger and what was yours globally from a retail perspective?

That would include all elements of what we define as in the ATV segment, okay. So, that would include utility vehicles, international, two-ups, one-ups, all that sort of stuff. And I think you can get some of the flavor for that from the motorcycle industry Greg. If you look historically over the years, the two industries tend to move pretty much together.

I mean you may see one year that one is a percent or two higher or lower, but I mean you got basically the same fundamentals that drive the two industries and you saw in the North America that the motorcycle industry was up 4.5%. I think it is not crazy to think that that ATV industry -- again, when you take out the fact that utility vehicles have cannibalized some traditional ATVs, two-ups aren't reported, when you put those factors back in I think you are seeing an ATV industry that's growing at a rate similar to where the motorcycle industry will. And I think those two as you go forward will probably move together some -- the drivers are similar, the demographics are similar, distribution is similar. It is kind of logical I think, absent some tremendous new product or those type things, that you expect the two do wildly different things.

And just a follow-up you mentioned North American ATV -- for your company up 8%, I may have misheard that. Could you sort of just clarify, could you just clarify that, and what segments would that include? Does that all include utility et cetera?

Yes. No, that includes that 8%, which is generally not a number you've heard from us, generally we don't talk too much about that but because of the inventory situation we wanted to give people a general feel of not just what is going on at the production level but also what's happening at the retail level. So, what I said was that for the fourth quarter, core North American ATVs, the same segment that you guys generally see for the industry trends --

All right.

-- for us in the fourth quarter our retail sales for traditional North American ATVs was up 8% in the fourth quarter of 2005 versus the fourth quarter of 2004.

Okay, great. You outpaced the industry. In terms of the promotional environment then, how would you characterize that, right now?

We did not do anything in the fourth quarter from a promotional perspective that I would say was unusual. As I said, I think promotions are high but relatively stable, but as we look to our - what's happening in the industry, there is really a couple of ways people can play this thing. As the growth rate comes down, people can ratchet up promotions, which is one way of solving the problem.

The other way of solving the problem is innovation and production cuts and you can kind of see where we are going with the innovation with the X2, and the Outlaw and the Hawkeye and the 500 EFI and also the production cuts that we talked about. But there is no guarantee that all of the other competitors are going to behave that way. If you have that memo I would be interested in seeing it but they don't send that to me. So, we're watching to see how they perform and, of course, each company will react a little bit differently depending on their own individual circumstance, but I do think that at this point we haven't seen anybody lose their mind. But we will watch it.

Great. Thank you very much.

Your next question will come from the line of Ed Aaron from RBC Capital Markets.

Thanks. Good morning.

Hey, Ed.

Couple of questions on the core ATVs. Could you just give us a sense as to what your underlying expectations are for 2006, both for the full-year retail and then the wholesale shipments, because obviously there are a number of moving parts in your ATV sales number?

Yes. I think what we said on the retail side Ed was, we expect the industry to be down a little bit in terms of unit shipment -- unit sales, unit retail sales, but maybe flattish in terms of dollars. So maybe something that would be similar in 2005. '05 was down 4%, but the dollars, probably when you look at the mix of ATVs with a higher number of relatively more expensive ATVs sold, Sportsmen 800 type products. For the industry, we think the dollars were flattish to maybe even up just a little bit.

And I think for '06 that would be a reasonable expectation in terms of the industry retail performance. As I mentioned a couple of times, I expect us to outperform the industry based on the strengths of our new products, and our overall program, I expect us to outperform the industry for the full year 2006 at retail. And shipments, do you want to go back over the shipment guidance again, Mike?

Yes. In fact, again I didn't give specific guidance for core, but the total ATV category will be up 1% to 3%. So that translates to down for the core ATVs.

Okay. And then on your comments on the promotions side, being kind of fairly stable in Q4 and normal -- I think you extended the factory-authorized clearance to a good chunk of the fourth quarter, which wasn't in place a year ago. So would it be fair to say that for Polaris specifically on a year-over-year basis in the fourth quarter, there was a significant increase in promotions or --

No, I didn't think that's not necessarily fair and we also had a hurricane in the fourth quarter of 2006, if you look at it on a dollars per unit basis, with some kind of rolling average, the promotion environment can fluctuate a little bit, but I don't see a major change from us certainly which we have -- obviously we have the data. And not a major change from any of our competitors. Of course, at some point you can walk into any dealer across the country and you'll find that, oh, Honda lost their mind, or Suzuki lost their mind, Polaris has lost their mind.

But in aggregate as we see the data across the country, across the model lines, currents, non-currents and factor that in to sort of on a dollars per unit basis, we don't see major changes. We see normal fluctuations up and down. I think we've told you in the past when we see major changes because it has a dramatic impact on the business. I don't think that it is fair to characterize that our promotions were significantly higher in '04 -- in '05 than they were in '04.

Okay. And just last question on ATVs. There are just three competitors, one yourself included, that are very well entrenched in that market from just the share perspective. Then there are number of competitors that are more kind of fringe competitors. And to the extent that the market is kind of flat to down going forward, do you think that there at the end of the day will be as many competitors in this space as there are today?

Well, I'm not sure I can really predict the future in that area accurately Ed. But my guess is that just about everybody is making money in the ATV business. It's a profitable business, obviously a very profitable business for us. I suspect that every one of the major 7 MIC reporters, the major 7 is making money in ATVs, and continues to see it as a opportunity to continue to make money. I would be surprised if any of the major 7 decided to leave the ATV business.

In terms of the Taiwanese, the Koreans, the Chinese, what we see in Europe, I suspect for sure that we'll see some shakeout there. You know, you've got companies that have much smaller financial strength. They don't have a strong brand, they don't have technology. So we'll see shakeout there. But in terms of North America, I'd be pretty surprised if any of the big guys decide to leave.

Okay.

Although necessarily disappointed if that would have happen.

Can I ask you about the youth segment of the ATV market and as it relates to the lower cost Chinese or Taiwanese manufacturers, did you see much impact there from those competitors relative to what we saw, maybe, a couple of years ago?

Our youth business continues to be good, Ed. Certainly, there are more options available for consumers. You see -- where you see the Chinese, Taiwanese and Koreans in the U.S., North America, primarily is in that say less than 150 cc segment. In Europe, it's a little different story. But in North America, that's where you see them. They may have taken business from others, but from us we're very happy with our youth business. It continues to grow a little bit. We're very pleased with it.

I think that, you know, for a -- there's a number of reasons why a Polaris youth product is superior, not the least of which is the quality, the product, the brand, the reputation, the ability to get parts and service, and I think product liability is also an important differentiator. We're really seeing the Asian imports, the non big four Japanese motorcycle company, the Chinese, Taiwanese and Koreans, we're really seeing them make hay, I think, is in alternative distribution. You know, people in the automotive stores, for example, in sort of non-dealer outlets. That's where they're making some hay. But we're very happy with our youth business, and expect to continue be happy with our youth business. We haven't seen any major impact from that.

Thank you.

Your next question will come from the line of Bob Evans from Craig-Hallum Capital.

Good morning, everyone.

Good morning, Bob.

Mike Malone Hi, Bob.

Can you comment a little bit more on the gross margin side of things? You're saying you're looking for over 100 basis points of improvement. If you're going to segment it a little bit, where are the couple largest chunks, where are you going to get that? It sounds like product sourcing was one, I just want to clarify that.

Yes, Bob. I preface everything by saying that we had a fair amount of erosion in 2005. So we're kind of starting from a historically low base. And we would expect to get some from better sourcing, and some of the activities that Tom talked about with our supply base. We had significantly higher warranty costs in 2005 with some of the quality issues that we experienced that we certainly expect to turnaround and be beneficial for us in 2006.

We've got a number of the efficiency improvement projects and cost reduction efforts going on. As I said in my comments, we have experienced some erosion in our snowmobile margins. We expect that to turnaround as we get more experienced in some of the newer technologies in our snowmobile business. So those are a few of the buckets. And then currencies also will help. It will help a little a bit to rebound the margins.

The only thing I would add to that Bob, just on the quality stuff. As you know, we've had a multi-year effort here, to improve quality. And in general, I'm pretty happy with the results that we have demonstrated. I think, in the motorcycle world we've gone from last to kind of a leadership position in quality, which is pretty amazing given relatively short time we've been in the motorcycle business.

I'm very pleased with the quality of the Ranger product, it's bulletproof. We've made good improvements in ATV product quality. Where we've had some difficulties is the snowmobile side. And we had a number of bulletins and recalls and that kind of thing in 2005. I think we can do better than that, we should do better than that and you can expect to see some of that in 2006.

So most of that gross margin improvement by and large is under your control, is that a fair statement?

Yes. I think so. If we have another hurricane and oil goes to $120 a barrel, we'll probably be singing the blues.

Right. In a normal world.

Assuming the economy as we look it and commodity prices and those type things, I think we've got a very good shot at getting the margins back to on the trajectory that we were on before 2005, which was nice steady expansion.

Okay. And then on the motorcycle business, you had said profitable Q4 first time. Can you give us any sense of the swing factor in terms of magnitude of change, maybe '05 versus '04 or even better '06 versus '05, in terms of -- not exact but just trying to get a sense of what the level of change you're seeing?

I'll let Mike dodge the short-term question, and then I'll take the long-term side of it.

Well, as you know, Bob we don't disclose profitability by product line. We are extremely happy to have made money in the fourth quarter. This was a long time coming. We've been working really hard to improve our motorcycle business and we are thrilled that we're into the positive in the fourth quarter, and we'll continue to see that.

As I've said for quite a while, the motorcycle business is accretive. Our margins are improving every year. We expect them to continue to improve going forward. We said a long time ago that we think that our motorcycles can be our highest margin product that we sell, and we still think that. It's -- the margins are improving significantly and we expect that to continue.

Okay. So he dodged that, let me give you the long-term side of it, Bob. Being in the motorcycle business is a very key strategic goal for the company, and I think we are through the difficult phase of it, we're in that really exciting phase now, very rapid growth of building a brand and building the distribution.

I think, -- if you think about this business at the end of the decade, I think, in 2005 it was roughly $100 million, 99.4 or whatever -- $100 million business. And we ought to think about this business somewhere in the 250 million or 300 million type range by the end of the decade. And maybe, 10 years from now, you could dream about this business to be in something like a $1 billion business, a real business. You know on ATV size type business for us.

That's the way we're thinking about it. And when you couple that with the opportunity to work with KTM and potentially, if we can get through a Phase II discussion, we can have a real motorcycle business in this company. And that is very important from a diversification point of view, from a margin point of view, from a distribution point of view in terms of building the strength of our dealer network.

So it's very, very important. And we're excited with the early progress. We've got a lot of work in front of us and you know, we're going to take it kind of a year at a time, but we did want to, celebrate the fact that we're making money. We expect to make more in 2006 and we did in '05 and we're going to keep that trend go on here for a number of years. But there is a lot's of room to grow for us, I think, in motorcycles.

Europe, Asia, other segments of the business, it's a big field. And again, just for that -- for the people that aren't quite as familiar with it, you know, if we sold every snowmobile on the planet, that's a number like $1 billion, okay. It's a $1 billion industry. For us to grow the business structurally we've got to be successful in larger markets. And if you look at all segments of the motorcycle business, it's on the order of $25 billion. Okay, a much, much larger growth opportunity.

So if we can that -- and that includes scooters and dirt bikes and Asia and Europe and lots of other segments that we're not currently in, but the point is there is lot's a room to explore. And we're pleased to how it's going here in the beginning in heavyweight cruisers.

Okay. And last question, on the Q1 guidance that you gave on the revenue side, how should we think about the ATV part of that guidance comment, kind of, a down 10 or I'm just kind of looking -- trying to think from a segment standpoint.

Well, again, we generally don't give specific guidance by product line in the quarter. But I think you can assume that Victory is going to be up, that PG&A is going to be up, that our snowmobile business like -- doesn't matter in the first quarter, that wholesale shipments are almost next to zero, which would means ATVs are going to be down.

Fair enough. Thank you.

Next question, we have time for one more question.

Your next question will come from the line of Craig Kennison from Robert W. Baird.

Good morning.

Good morning.

Mike, quick question to you. Did you walk through the warranty reserve expense and claims paid?

I did not, but I will.

Thanks.

For the full year 2005, our warranty expense is 36.3 million, compared to 26.3 million for the prior year. Our claims paid for the full year 2005 were 35.4 million, compared to 27.1 million a year ago. And then remember we had this 900 and some thousand dollar settlement that we paid earlier this year. So the reconciliation is that the beginning balance this year was about 28 million, and the ending balance at the end of the year in warrantee reserve is about 28 million.

Okay. Thank you. And then finally, Tom, to you, I love to hear you talk about the long-term and given your outlook for 2006 could you just comment on your confidence in your five-year plan that you laid out about a year ago, and what gives you confidence in that outlook today? Thanks.

We remain confident, and committed to the goals that we laid out in 2004, which were 3 billion of sales by 2009, expanding margins to 9%, building a dominant brand. To achieve those goals, it's going to require us to continue to execute well in the fundamental part of our business, our core business, and to expand the KTM partnership through Phase II.

If we can do that, if we can grow the Victory motorcycle business, maintain or grow our market share in a slower growth, but still growing ATV business, with the utility vehicle business continuing to grow, and leverage the KTM partnership that we talked about, I think those numbers continue to be very good. The basic strategic direction isn't going to change for the company. It's continuing to drive innovation through our technology team, controlling more of our own destiny with power trains as we have.

It's building this bigger stronger Victory motorcycle business, globalizing and driving productivity. Cost and productivity will be very, very important in this slower growth environment, and I think we have all the tools to do that. The first half of '06 is going to be a little bit of a correction to get the inventory situation in line, but I think that the future of the company -- we have a very clean balance sheet, we've made some good investments, we have some good relationships. If we can leverage those, I think we've got a very good chance at delivering on those goals for '09 and beyond.

Thank you.

Thanks everyone. We are out of time. So I want to thank you all for participating in today's call. Please remember that our presentation and responses to your questions contain certain statements that could be considered forward-looking for purposes of the Private Securities Reform Act of 1995, and that actual results could differ materially from those projected in any forward-looking statements. Thanks again for listening, and we'll talk to you next quarter. Goodbye.

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