Polaris Inc (PII) 2009 Q3 法說會逐字稿

Good morning. My name is Tanika and I will be your conference operator today. At this time I would like to welcome everyone to the Polaris third quarter earnings results conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question and answer session. (Operator Instructions)

I would now like to turn the call over to Mr. Edwards. You may begin.

Thank you, Tanika, and good morning and thank you for joining us for our third quarter 2009 earnings conference call. As in the past quarters, we will be showing a slide presentation that is accessible at our web site at www.polarisindustries.com/irhome which has additional information for this morning's call. The speakers today are Scott Wine, our Chief Executive Officer, Bennett Morgan, our President and Chief Operating Officer, and Mike Malone, our Chief Financial Officer.

During the call today we will be discussing certain topics including product demand and shipments, sales and margin trends, income and profitability levels and other matters including more specific guidance on our expectations for future periods which should be considered forward-looking for the purposes of the Private Securities Litigation Reform Act of 1995. Additional information regarding these factors may be found in Polaris' 2008 annual report and in the 2008 Form 10-K which are on file with the SEC.

Now I'll turn it over to Scott.

Thanks, Richard. Good morning, everyone, and thank you for joining us. It was almost exactly a year ago I was conducting my first earnings call for Polaris. At that time we reported record sales and earnings per share for the third quarter of 2008 and also discussed a very uncertain economic outlook. We've been through a great deal in the past 12 months and this team has accomplished quite a lot. I'm proud of the fact that once again we exceeded our expectations for the recently ended third quarter.

Net income of $31.2 million for the quarter equates to earnings per share of $0.94, both down 17% from the prior year period. Sales for the quarter were $436.2 million, down 25% from the third quarter of 2008. Retail demand remained weak cross almost all regions and markets although we continue to see trends moving in the right direction, especially for our industry leading side-by-side products.

We do not ever plan to get comfortable with large sales declines but I do like the way we've managed through this downturn. Volume was again lower in all product lines but overall we cut production and shipments more than the retail sales decline which enabled to us bring down dealer inventory and also gain share in our largest product line, the off-road vehicle division. Our smallest business units, Victory Motorcycles, had another difficult quarter with revenue down 56% on a slightly smaller drop in retail sales. We made significant changes and progress in the Victory business during the quarter and managed to achieve a small share gain in September providing better traction going into the fourth quarter.

Outside the US we saw sales and shipments in Canada outperform the US market for the sixth quarter in a row. Europe was down only slightly less than the 28% drop we saw in North America. We continue to benefit from positive pricing and mix from our strong product lineup but took a small hit from currency which we expect to turn around and be favorable in the fourth quarter.

We made solid progress with our gross margin expansion efforts in the quarter. Despite a 25% top line sales decrease, we improved gross margin by 160 basis points enabling to us deliver $31.2 million net income, a 17% decline. One of my major initiatives to ensure that our gross margin improvements actually drive an increase in our bottom line. We demonstrated our ability to do that in the third quarter as our control of expenses and all other aspects of the P&L drove a 60 basis points net margin improvement from the same period a year ago. Our teams have developed tools and processes to ensure our margin expansion is sustainable and we expect to have another strong performance in the fourth quarter. Lower product and commodity cost and better pricing will continue and we expect to have currency turn from a headwind to a tailwind to finish the year.

I like to use the quarter look at retail sales to dispel any thoughts that this will be a V shaped recovery. While we have seen improvements in all product lines except Victory in the third quarter the 17% decline in North American retail sales was a stark reminder that this remains a difficult time for consumers. We are operating under the premise that we must make growth happen and we continue to find ways to outperform the market. With solid programs in place and a very strong model year (inaudible) lineup we did see demand improve as the third quarter progressed. Side-by-side continues to lead the way with retail sales down mid single-digit percent in the quarter and even a smaller drop in September. While still down significantly core ATVs had their smallest percentage retail drop since the spring of 2008. As we progress into the fourth quarter we will benefit from easier comparables but it is worth noting that retail sales grew 3% in October of last year so we really only have two months of easier comps. Our expectation is that North American retail sales will be down about 10% in the fourth quarter.

One reason we have confidence in our fourth quarter outlook is due to the strong reception of our expansive model year 2010 product launches. This summer we unveiled more than 25 new models across our product lines. Our order solicitation has slightly exceeded our expectations and provided welcome momentum as we work to close out a challenging year. The interest in and orders for our new electric RANGER exceeded expectations and we remain excited about the potential for that product and that technology. We gained access to another 30% of the side by side market with the launch of the value oriented RANGER 400. And the Victory team was not about to be outdone and impressed our dealers, customers and industry press with two exciting new touring bikes. Innovation remains a strength and a competitive advantage for Polaris.

Partly because of our strong new product lineup and certainly because we continue to assist our dealers in reducing inventory, we are seeing surprising strength and stability from our dealer network. Our Max Velocity Program roll-out continues to go well which helped drive dealer inventory down 18% in the quarter. Our joint venture relationship with GE via Polaris Acceptance continues to provide access to wholesale credit for our dealers, which is certainly an advantage in the industry. We have seen a decline in the number of repossessions throughout the year and still expect to maintain dealer terminations below 5% which is in line with our historical annual turnover.

With that I will turn it over to Chief Operating Officer Bennett Morgan who will provide additional insights into our operations and business unit performance.

Thanks, Scott. Let's start with off-road vehicles. Our off-road vehicle business performed to our expectations in the third quarter with wholesale sales down 30% off of stout third quarter '08 comparables. ORV markets appear to have stabilized, we have not seen signs of significant improvement in the markets yet. North American ATV industry retail sales are down high 20% year to date, and while we don't have clear industry data for side-by-sides we believe it is down mid-teens percent year to date. We have seen sequential improvement from both the industry and Polaris in the third quarter versus the previous quarters.

Polaris continues to gain solid amounts of market share in both ATVs and in particular side-by-sides. With our strong RANGER and RZR line-ups we saw our side-by-side retail sales improve down mid single digits in the third quarter. Our model year '10 July dealer meeting was a resounding success in our home state of Minnesota as we entertained our dealers at our Wyoming Worldwide Product Development Center. We once again are the most aggressive OEM for introducing innovative new products for both side-by-sides and ATVs. Our entire RANGER lineup received more horsepower and we introduced an all new mid-sized RANGER 400 at a value price of $7999 which has received fantastic reviews. In addition, we introduced our first off-road low-emission vehicle, the electric powered RANGER EV, which Scott mentioned.

In ATVs we introduced a full lineup of value-priced products for most key ATV segments as well as expanding our award-winning Sportsman XP chassis in the two all-new 2-up touring models. ATV dealer inventories are down over 30% in North America versus a year ago at this time and down double digits percent versus just 90 days ago. With a strong new model lineup and well managed dealer inventories, orders from dealers exceeded our expectations for both ATVs and side-by-side products at the show and we are well-positioned for the upcoming quarters from both a business and competitive standpoint.

Our military business had a strong quarter with sales up well over 50%. More importantly, we secured a number of future orders with a growing number of new customers including a large order for RANGER Crews for the National Guard.

Snowmobiles. Third quarter wholesale sales were down 13%, and as we expected, Polaris and the industry have gotten off to a slow start for the season. Early season industry retail sales are down double digits, with Polaris down more. This was expected with the lower snow check sales and the planned late fall shipment of the award-winning new Polaris Rush snowmobile. Consumer attendance has increased at the fall shows and there is a ton of excitement in particular for the new Rush model which was recently named Snowmobile of the Year by SnowGoer Magazine, the industry's largest publication. Less than 10% of the season's retailers occurred so the next 120 days, as they do every year, will be the critical retail months for the industry and Polaris. Dealer inventory levels for the industry and Polaris are in solid shape and based on these factors we remain cautiously optimistic about the upcoming snowmobile season.

On-road vehicles and Victory Motorcycles. The overall motorcycle industry and Victory continue to disappoint in the third quarter. Total North American motorcycle industry retail sales improved versus the second quarter but were still down mid 30%. In the segments Victory competes in, heavyweight cruiser and touring segments the industry performed slightly better. Victory retail sales declined a little bit more than the industry and we lost a little bit of share in the third quarter due primarily to competitive discounting activity.

Third quarter sales to dealers declined 56% as we continue to aggressively reduce shipments to assist dealers in reducing inventories. Dealer inventories continue to come down. They are down 22% from a year ago. But remain higher than we and our dealers would prefer. We are not satisfied with our progress on the retail and inventory fronts and we've made additional investments including increased promotions, personnel additions, product lineup streamlining, adding new value priced model options and international market expansion to ensure that we are more competitive in this challenging motorcycle environment.

The summer dealer meeting was a significant success for Victory as all of our new model year '10 Cross Country and Cross Road touring bikes received rave reviews from the press, our dealers and consumers. We expect these new models will greatly increase our reach in the large and lucrative touring segment and drive market share expansion in the upcoming quarters. Model year '10 Victory orders slightly exceeded expectations, which is encouraging, but we will continue to actively monitor retail sales to ensure that we maintain appropriate inventory levels in the field.

During the third quarter we began our first shipments and actually had our first retail transactions in our newest adjacency, our low-emission electric vehicle for master plan communities. We are currently in five communities with a plan to be established in nine communities by year end. The early consumer traffic and response has exceeded our expectations and we continue to learn more about this new market. Our dealer business model is based on a variant of our MVP program and early dealer feedback has been positive.

Parts, garments and accessories. PG&A had a decent quarter with sales declining by 11% which once again outperformed our overall Polaris business. Gross margins expanded impressively and we are seeing outstanding productivity gains from our Vermillion operation despite the lower volume environment. Innovation remains strong with over 200 new accessory products introduced for model year '10. Third quarter program orders from dealers exceeded our expectations and our daily order volume appears to have stabilized and is showing modest directional improvement.

International. International sales were down 24% in the third quarter, a modest improvement versus the first half of the year. As in North America, we are seeing markets stabilize with some beginning to show modest signs of directional improvement. The overall European off-road vehicle market continues to be down mid 20s percent with Polaris gaining a nice amount of market share thanks to our innovative products and our strong distribution. Victory has achieved a 5% market share position in the UK heavyweight cruiser market and we are poised for an excellent start in Germany based on our dealer additions and our presold model year '10 product retail sales.

Operational excellence. Our focus on quality, costs and speed continue to pay big dividends. Inventories at both the factory level and dealer levels continue to be significantly lower than a year ago, both down 18%. Our cost position continues to improve significantly as we see the rewards of our value engineering, low cost country sourcing efforts, and benefits from favorable commodity costs. Together these activities drove gross margin improvement of 160 basis points in the third quarter. We expect to continue and accelerate this momentum in the fourth quarter.

We increased our MVP roll-out to about 50% of our North American dealer retail volume in the third quarter. We've been able to manage the additional dealers and handle the more rapid order cycles effectively. MVP dealer orders and retail performance has performed within our range of expectations. And while we and our dealers continue to learn and improve this new business process, we are growing increasingly confident in our ability to execute this model successfully and that it will lead to competitive advantage for Polaris and our dealers in the long-term. MVP should allow both our dealers and Polaris to be more nimble and better positioned to weather the current environment, while being able to more quickly respond to the emerging market opportunities as conditions improve. Our operational excellence progress has Polaris in a stronger, healthier position than when we entered the recession. It is enhancing our product innovation and is the fuel behind much of our success.

With that I will turn it over to Mike Malone, our Chief Financial Officer.

Thanks, Bennett, and good morning to everyone. As Scott and Bennett mentioned, we are very pleased with our third quarter results in this difficult economic environment. Our cost reduction initiatives are producing positive results and the momentum we have drives our expectation of continued benefit going forward. As before, my comments this morning will be related to updating our 2009 guidance with some reference to actual third quarter results to highlight a few specific points.

I'll begin with Financial Services. Income from Financial Services for the third quarter 2009 declined 12%, largely due to a decline in income from retail financing as our sales volumes and penetration rate has declined compared to last year. Income from financial services for the full year 2009 is expected to decline about 20% from the full year last year which guidance has narrowed from previously issued guidance. For the third quarter, we financed through our retail credit programs HSBC, GE and Sheffield combined, about 35% of Polaris products sold to consumers in the United States, which improved sequentially over the penetration rate we experienced in the first half of the year. The approval rate in the third quarter increased to 52% compared to 46% for the first half of '09.

Sheffield, our newest retail credit provider, continued to gain share of the installment financing provided to our consumers during the third quarter. During the third quarter the wholesale portfolio related to the floor plan financing for dealers in the United States was approximately $563 million, a decrease of 16% from a year ago third quarter, reflecting the decline in the dollar amount of dealer inventories. This 16% decline is in dollars. The units outstanding in the portfolio in the United States are down 24% compared to last year due to the mix change to higher priced side-by-side inventory. Credit losses in the dealer wholesale portfolio remain very reasonable averaging well less than 1% of the portfolio. During the third quarter we continued to see a modest number of dealer failures, repossessions of inventory and credit losses as expected, but these issues were well within our expectations, as Scott mentioned earlier.

The actual gross profit margin percentage generated for the third quarter was 24.1% compared to 22.5% in the third quarter a year ago. A 160 basis point improvement. The primary driver of the improvement in gross margins was a focused attention on taking costs out of our products, both from an engineering perspective, and adjusting our manufacturing capacity and cost structures to help minimize the fixed cost absorption impact of the lower production volumes resulting from the lower sales. The gross margin percentage in the third quarter continued to benefit from commodity and transportation costs decreases, higher selling prices, and a positive mix change. These gross margin benefits in the third quarter '09 were somewhat offset by higher Victory promotional costs and by the negative currency movements in Canada, Europe and Japan compared to last year. However, in the fourth quarter of '09 currencies are expected to turn positive for sales and gross margins given the dramatic move in currencies in the fourth quarter of a year ago.

Taking into account the year to date improvement in gross margins and the benefit of the cost reductions initiatives in place and changes in currency rates, we now expect the gross profit margin percentage for the full year 2009 to improve in the range of 150 basis points to 180 basis points over what was generated a year ago. This implies a significant improvement in our gross margin percentage for the fourth quarter of '09, upwards of 230 to 320 basis point improvement. We are confident in these projections given the success we have experienced in taking costs out of our model year 2010 products in addition to ongoing benefits from higher selling prices, lower commodity costs and the lower ATV promotional cost environment.

Moving now to our balance sheet and liquidity profile. Our debt position finished at $200 million at the end of the third quarter which is $20 million lower than a year ago. We continue to have ample borrowing capacity under our attractively priced long-term $450 million banking arrangement. As Bennett mentioned, factory inventories at the end of the quarter were $220.8 million, an 18% decrease from a year ago. We expect factory inventory levels to continue to decline during the fourth quarter to below $200 million at year end.

Accounts receivables of $88.1 million at the end of September 2009 is up 14% from a year ago. Entirely due to a delay in the timing of collection of the floor plan receivables from GE in Canada. We now collect those receivables in 30 days rather than just a few days as we did in the past. For the year to date period we have made appropriate and more efficient investments in the business through capital expenditures and new product development tooling totaling $35 million which is 40% lower than a year ago. For the full year '09 we expect our appetite for capital expenditure spending to be in the range of $50 million to $55 million which is significantly lower than last year. We will continue to invest in tooling for innovative new products, and targeted investments in capital projects to reduce our production costs and improve efficiencies to continue to improve our product margins.

We expect depreciation for the full year 2009 to be in the range of $60 million to $65 million, unchanged from previous guidance. Operating cash flow provided by operating activities was $111 million for the third quarter of '09 and actually increased slightly over the third quarter a year ago. For the nine months year to date we've generated $102.5 million of operating cash flow, down 23% from last year. The decreases in net income and the decrease in accrued expenses for the year to date period compared to last year are the primary reasons for the decline in our year to date operating cash flow. We continue to expect cash flow provided to decrease for the full year 2009 in line with the percentage decline in net income. But well above the net income level in dollar terms.

During the first nine months of the year we repurchased only a minimal number of shares under our share repurchase program. We still have approximately 3.8 million shares authorized from our Board of Directors to repurchase but as I have stated in the most recent past calls we have taken a different approach this year and are being more conservative in share repurchases for the foreseeable future. During the third quarter we once again paid a cash dividend of $0.39 per share which represents a 3% increase over a year ago and we expect to continue to pay the dividend at that rate for the balance of 2009.

Guidance for the full year 2009 has been raised and narrowed to reflect the actual results generated from the first nine months and our current outlook for the remainder of the year. Total Company sales guidance has been narrowed and is now expected to decline 20% to 22% for the full year with the individual businesses as follows. Off-road vehicles is now narrowed to down 22% to 24%. Snowmobiles have improved to down 12% to 14%. On-road and Victory Motorcycles has narrowed to down mid 40% range. And PG&A has improved to down 11% to 12%. Gross margins for the full year are expected to expand in the range of 150 to 180 basis points for the reasons I explained earlier.

Operating expenses are expected to decrease significantly in dollar terms for 2009, down in the mid-teens percent or around $40 million as we continue to aggressively deal with the reality of a lower volume environment. Operating expenses will increased as a percentage of sales for the full year 2009 due to the lower sales.

The income tax provision was recorded at a rate of approximately 32.1% of pretax income for the third quarter of '09 which is higher than last year due to a lower amount of favorable tax events compared to last year. For the full year '09 our expectation is that the income tax provision rate will be in the range of 33.5% to 34% of pretax income, slightly better than the previously issued guidance. Earnings per share for the full year 2009 are now expected to be in the range of $2.92 to $2.98 per diluted share, which is a decrease of 15% to 17% compared to the full year last year.

Guidance for the fourth quarter 2009 is as follows. Total company sales are expected to decrease in the range of 12% to 17% from the fourth quarter of last year due primarily to an expected continued decline in the total company retail sales in the fourth quarter. Earnings are expected to be in the range of $1.19 to $1.25 per diluted share for the fourth quarter, an increase of 7% to 13% over the fourth quarter a year ago.

In conclusion, we are very pleased with our results given the economic environment and are confident in our ability to finish the year strong. Assuming we achieve our fourth quarter guidance range, the result will be the highest net income and earnings per share quarter in the company's history. Evidence of our ability not only to weather, but actually thrive in this current economic storm.

At this time, I will turn it back over to Scott for some concluding comments.

Thanks, Mike. Overall we had a solid third quarter. As you can tell from our comments we feel good about how we are positioned to finish the year. Our commitment to staying on strategy while also aggressively reducing cost has put us in a position of strength to prepare for the challenges of 2010. We are still in the early stages of our official planning for next year but I will offer a few initial thoughts. As I mentioned earlier we do not expect a V shaped recovery and are not planning on any tailwinds from the US or our key international markets. While it is possible that GDP will grow 2% or even 3% next year we expect consumer demand to remain muted by high unemployment and an overdue period of increased personal savings.

We have proven that we can manage through tough times and still improve our business fundamentals. We are committed to being the best in power sports and will continue in 2010 to invest wisely in our business and products to prepare us for the strong economic growth that will ultimately come. We will continue to diversify and seek growth outside of North America as we add more investment to our business in Europe, the Middle East and Africa, as well as South America and most recently China. Our new general manager has been in China for several months now and we are encouraged by his progress to help us establish strong distribution and a foothold in that important and growing market.

We will likely make at least one acquisition in 2010 and are pleased to have Todd Balan on board as our Corporate Development Officer to ensure we execute on only the best opportunities to accelerate growth and profitability and to enhance shareholder value. We will stay on the gas with operational excellence which will be a key part of our ongoing margin expansion efforts. The opportunities for to us improve quality, cost and speed are real and we are committed to capturing the benefits for all player stakeholders.

2010 will be an important year for our newly formed on-road business as we drive much needed improvements in our Victory business to help both margins and our top line and accelerate the growth of our new low-emission vehicle product line. We anticipate continued growth in our military business and expect our Bobcat relationship to begin generating revenue and profit in the second half of 2010.

In summary we are preparing for a challenging year but feel confident that we have stayed on strategy and made progress in 2009 that will enable Polaris to return to limited top line growth and continued margin expansion in the year ahead. Our primary focus right now is closing out 2009 on a strong and positive note and I am confident in our ability to do that. I look forward to speaking with you again next year to talk about our full year results.

With that I will turn it over to Tanika to open up the lines for questions.

(Operator Instructions) Your first question comes from the line of Greg.

First of all, good quarter obviously, and a few questions. First just with respect to retail sales I think that you mentioned it was going to be down around 10% in the fourth quarter, did I hear you right on that one?

Yes, that's about right.

Good. I'm just wondering did you notice any change throughout in terms of trend throughout the quarter? And also, if I'm not mistaken, I think compares get easier in November because that's when I believe trends fell off for you last year.

That's exactly right. It did -- in most of our product lines we did see improvements in September, could be the end of programs and just regular seasonality but September was better than the previous months in the quarter. October, as I said, was still up 3% last year so, you're right, Greg, it was November where we started to see a real decline so we have a little bit easier comparables in November and December.

Good, good. And also just in terms of financing, maybe a little bit more color on that, the last 60 days I believe things have eased up for you, and would you expect it to maybe continue to ease up a little bit or what are you seeing out there?

I assume you are talking retail financing, Greg?

Yes.

As the metrics showed in the speech and on the charts the metrics are a little better in the third quarter than earlier in the year both from an approval rate and a penetration rate perspective. It's still tough out there. The credit score requirements are higher, certainly the down payment requirements are higher than they were a year ago. This business is probably not going back to where it was a year or two ago. That's the reality of the situation. But our providers and our dealers are working their way through it and we are relatively pleased with the stability that we've seen in our retail credit business, and customers that have decent credit can still find credit to purchase our products which is our ultimate goal.

Finally, just on inventory levels, obviously down pretty substantially at the retail level, your dealer level. With retail sales starting to stabilize when would you expect them to start adding to their inventories?

Greg, this is Bennett. I would tell you based on what we've seen from what's going on in the markets we expect to continue to work inventories down additionally in the fourth quarter, and I would expect that we will continue to make efforts through the MVP program to take inventories down even further in 2010. I think a lot of the more heavy lifting has been done over the last couple of years but we would expect to continue to drive inventory levels down for both frankly the dealer as well as us in the upcoming quarters.

And in terms of your competitors, in terms of their inventory level at the retail level, how would you characterize that?

We don't get perfect visibility to that, Greg, but I would tell you based on at least what we think the Japanese have done they've made progress on their inventory levels in the first nine months of the year. I think they cut back production maybe more aggressively than we even anticipated and inventory levels are coming down out there. So again it's a tough environment out there for the dealers but I'm encouraged by that, frankly. I think that competitors have made more progress, at least most of them have made more progress than I might have anticipated three months ago.

Thank you very much.

Next question?

Your next question comes from the line of James Hardiman.

Good morning. Congratulations on a great quarter. A couple of questions for you guys. Just first I think you said year to date core ATVs are down high 20s. What was that number in the third quarter for the industry and for you guys?

We gained -- we were down low 20s and the industry, we were better than the industry. It was, like I said, we've seen difficult core ATV retail numbers for quite some time so it was the best quarter in five quarters in terms of less bad year-over-year declines. But we were down in the low 20s.

And on the side-by-sides, obviously you know what you are, you said you were down mid singles and you think that's meaningfully better than the industry as well. Even though you don't have the industry numbers you think you are gaining shares on side-by-sides as well.

Yes, we are still fairly confident of that.

In terms of MVP, you've said that you've rolled that out to 50% of your dealer base or at least dealers represent 50% of your sales. Where should we expect that number to get to over the next couple of quarters? And are there any sort of metrics you can share, or at least qualitatively share, how the inventory management is going, MVP versus non MVP dealers at this point?

James, this is Bennett. I think from the standpoint of expectations you guys should have going forward on MVP we are trying to be aggressive about this, it is about 50% of our volume currently. Based on how it's going so far, not a commitment but our expectation would be no later than sometime in 2010 we would expand that more broadly, perhaps up to as much as 70%, 80% of our volume. Again, we continue to learn on this so there is some scale that is advantageous to run this program for our dealers. From a metrics or some qualitative standpoint, as I said, the orders and the retail activity is meeting our expectations right now. I can't remember where I was at on that.

Part of it, the other part of his question was the inventory levels on the MVP versus non MVP.

Thank you. What we are seeing, as you would expect, is inventory levels in the MVP dealers are lower than our non MVP dealers, and just based on the model I think you should continue to expect that. As we expand MVP, that will tend to drive lower levels of dealer inventory levels because that's almost what that model is based on.

One point we ought to just address, we've heard some noise, we had a couple of dealers that didn't have product that they thought they'd want and we ought to dispel that that's directly related to MVP. I think it's just the type of thing that we could find in our business overall. And overall I think the team has done a really good job of rolling this out. As Bennett said, you should expect good things from the program going forward.

Great. Just one last question on the snowmobile segment, you mentioned that it's off to a little bit of a slow start. Is that basically through September and has any of the unseasonably cold weather, some of the snowfall we've been getting in the last couple of weeks, I know it's a little bit early but does it seem like that's helping? And do you have any thoughts on where -- obviously your guess is as good as anybody's in terms of where snowfall is going to be this year -- and how that might impact your business?

I'm not going to touch the snowfall prediction with a 10-foot pole.

Fair enough.

If it was I would be smarter and I wouldn't be sitting here. I don't think that the weather probably in the snow belt, it might get people thinking about it. It's way too early to see any kind of appreciable increase in retail activity. I think there's some positive signs as I said in the remarks that we are encouraged by, the interest at the shows has actually been up year-over-year which is fantastic and a real pleasant surprise. And so the state of the snowmobile enthusiast is strong but it's only 7% of the seasonality has gone and so again as I said, James, we are just going to have to wait and see. With this economy and what's going on we are cautiously optimistic but it will come down to weather and when the snow falls. We feel good where we are right now, though.

Great. Fair enough. Thanks, guys.

Next question?

Your next question comes from the line of Tim Conder.

Thank you and, gentlemen, let me also add congratulations on the fabulous execution you continue to perform with. Scott, you used the plural form of the word acquisitions, acquisition, I should say. Could you elaborate on that and, again, it would appear that Mike, Scott, whoever, Bennett, wants to take this part that you are letting the cash build in anticipation of at least one if not multiple acquisitions in 2010?

Tim, we will have to review the transcript to see who heard and what was said. I think it was "at least one" was the way it was referred to. I've said for a year now that we think it's an important part of our longer term growth strategy. We like what we see in terms of acquisition possibilities aligned with our strategy. We will continue to be disciplined. The fact that we generate a lot of cash and aren't buying back shares, obviously it's going to build up on the balance sheet. And our commitment is to continue to maintain a very shareholder friendly capital allocation model. If that means a small acquisition that's going to add to the business performance over time, we will do that. But I don't think you should read anything into my comments or our cash position to change what we've been saying all along about acquisitions.

Okay. Okay. And in relation to your comments on China, and then the additional expansion in the EU, any type of quantification, directional commentary that you can give us as far as how you're thinking about that in driving the top line in 2010 versus, let's just call it your existing organic businesses elsewhere?

I wouldn't anticipate meaningful impact on top line sales in China in 2010. We are very encouraged by the potential in that market. Interestingly, a lot of the ATV manufacturers there are starting to lobby the Chinese government for access to trails to create the market there which ultimately will play to our advantage as they've lost opportunities to sell into the US market. So we believe we'll sign up a strong distribution partner here in the next few months and we think we'll have the opportunity for retail sales in China in 2010 but we don't expect it to be a number. It will grow over time but not meaningful next year.

Europe, we've got a strong team and a strong business in Europe. They've had a difficult year, as we have here. But we do think with their industry leading share position and where we are positioned that we can do good things in Europe and have a long way to grow and expand in across the Europe, Middle East and Africa region.

You said distributor in China. So maybe just talk about that, your broad thoughts, where you are looking to expand? If you put into buckets the EU, Asia, Latin America, your thoughts over '10 and '11, where you are looking to expand via distributors versus actual dealers?

I meant to say distribution not distributors. And obviously in China we can't -- we just don't have the patience, quite honestly, to go over there and organically set up a factory and set up distribution. So we'll try to do that with very selective partners, somebody that can help us get established in the marketplace there.

Tim, this is Mike. I think the right way to look at this is that we have an established business in Europe. We make -- we have a pretty good market share position there, number one market share position, but it's actually quite a bit lower on a percentage basis than it is here in North America. We think there's significant growth that we can get with the strength of our team and our operation in Europe, and that in the near term should help our top line sales growth very well. Other markets like Asia and India and Brazil, we sell almost zero today. And our desire there is to learn and grow over time but that's not going to happen next week or next quarter or probably not even next year. Those are investments we are making for the long-term to allow our international business to grow significantly over time. And we just don't expect that to materialize in significant dollar terms and sales in the short term.

But again there you are evaluating whether more of a distributor versus a dealer direct type of model as you roll-out those expansions in the rest of Asia and Latin America?

Yes, we are learning. So we are in the markets. We are talking to companies, manufacturers, distributors in the markets, learning, and we'll figure out how we are going to do that going forward.

Thank you again, gentlemen, appreciate it.

Next question?

Your next question comes from the line of Bob Evans.

Good morning and I want to also reiterate congratulations on a great execution this quarter. First, again, clarification on something that was said early on on the retail sales being down 10%. Did you say that was for core ATVs?

No, we said we expect the entire North American retail to be down about 10% in the fourth quarter, Bob.

Entire, okay. But you're saying ATVs, not side-by-side and everything else?

No, if you take the cumulative Polaris business, we expect overall retail, so that's everything in our portfolio, North America. We can't predict what's going to happen, especially with the difficult comparables throughout the quarter, but we expect it to be down about 10% in the fourth quarter.

That's relative to the minus 17% in Q3 and the minus 22% in Q2 of this year.

So sequentially the trend is showing nice improvement. And you had made the comment, Scott, that you are not looking for a V shaped recovery but how should we take that in terms of are you expecting a recovery? And can you just give us a little bit more color as you maybe, obviously you can't -- don't have a crystal ball but give us some sense of what you're thinking?

I would call it as a poorly written U. It's going to be a very slow slope to the curve, I believe. We've started the early cycles of planning next year and if you factor in the weak GDP growth and the fact that consumers are going to have to rebuild their personal balance sheets, consumer demand is going to remain low. We'll get back to organic growth, that's what we projected next year. We will get limited growth, but we just don't see a strong return to demand in 2010.

Margins, you've done a great job this year on margins, I think there was a general comment of continued margin improvement. Can you give us some sense of maybe thoughts on margin trends?

I think that's about all we are going to say. It's going to get better.

Get better but not magnitude, okay. I believe a comment was made, PG&A margins were up nicely this quarter. Can you give us color as to why?

Bob, this is Bennett. Some of it is mix with markets the way it is. Our parts piece of the portfolio PG&A is probably the most stable part of the line. It doesn't go up as much, it doesn't go down, and that's the highest margin piece of the PG&A piece. And that's really good execution by the team and some innovative new products. They have increased margins essentially in every one of the pieces and parts in garments and accessories. They're doing a nice job on reducing costs and bringing innovative products that have higher margins. So I'm thrilled with how that team is performing on the margin standpoint.

And that's a trend that we should see continue in the future?

We would like to believe that.

Okay. Great. Thank you.

Your next question comes from the line of Edward Aaron.

Thanks, good morning, great quarter. I know you're not ready to talk about next year in a whole lot of detail but I was hoping you could maybe share some thoughts just about mix in 2010. It's more of a wholesale shipment question than a retail sales question, and the reason I bring it up is side-by-side trends at retailers is so much better than core ATVs. But you've under shipped retail by such a greater magnitude than core ATVs this year that I wonder if the mix will continue to shift in your wholesale shipments towards side-by-sides in 2010 like it did in 2009?

Ed, I wouldn't expect that to change. Remember, the reason we under shipped much more on core ATVs was because we started with a much higher inventory level than we did on side-by-sides. I think the positive mix is likely to maintain, as you heard Bennett talk about. We introduced some very strong new models in the side-by-side range and we expect that to be helpful in the fourth quarter and throughout next year.

Last quarter I think you might have shared some side-by-side inventory trend with us. I might have missed it this quarter but if not can I ask you for some similar commentary as what you made last quarter.

Ed, this is Bennett. We didn't put it in the remarks because it just generally isn't an issue. Inventories are essentially about flat there and again I would characterize the dealer inventory levels as very, very healthy. We actually, in a couple of key products in side-by-sides, we are actually in shortage positions which is never fun to have but those are the good kind of problems you like to have.

Fair enough. Lastly just on the promotional environment, is it fair to say do you think that in aggregate it's somewhat less promotional than perhaps it was? I know you cited Victory as a negative for gross margins on promotions but if I look at the accrual on your balance sheet, which was down, and some of the anecdotes that we hear from the channel, it seems a bit more benign than what we've seen recently.

This is Bennett again. I think on the ORV side the competitive environment remains I think what I would characterize as aggressive. We did see it stabilize in the third quarter. We continue to see efficiencies in our portfolio because of the operational excellence model we have. Our inventory levels are in general lower. Our age of our products is newer. We have a lot more innovative new products. And that's certainly helping drive some short term and in longer term more promotional efficiencies. In Victory and in the motorcycle industry, you just saw the numbers, they just have been weak across the industry and people, and particularly dealers have had to step up to try to move non-current products. So for that reason that's why you've seen us make some adjustments there, is to be more aggressive because, again, we just want to manage those inventory levels as effectively as we can.

Great. Thanks for taking my questions.

We have a follow-up question from the line of Tim Conder.

Bennett, one question. How do you -- where do you guys stand on your engine mix internal versus external? And then in relation to that, for Mike, Mike, a traditional question I've asked you along the way here, how do you look on currency hedges looking into 2010?

This is Bennett. On the engine mix, it's fairly similar to what we've quoted you in the past. It's fairly close on a percent of revenue, right around 50/50. That's something again longer term we would continue to like to grow that into our control and our portfolio.

Tim, I would have been disappointed if I had gotten off the call without the currency question, so I'm pleased. Seriously, though, we have done more currency hedging lately given the strength of the currencies most recently. We have hedged a relatively high portion of our exposure for the first half of 2010, upwards of 50% for the Canadian dollar. We've also hedged between a third and half of our exposure for the Australian dollar and the Norwegian and Swedish currencies, as well. So our view is that we'd like to take some of that positive movement and lock it in. So we've done probably a little bit more aggressive hedging on currencies than we typically do. On the yen that's unfavorable currently to us and as of today we have no hedges on the yen for 2010.

And, Mike, you said those percentages that you were citing, was that of your expected exposure only in the first half or for the full year, just to clarify that?

Yes, you're correct, it's the expected -- an estimated expected exposure for the first half of 2010.

And so really you don't have much for anything in the back half of the year at this point.

Correct.

Okay. Great. I just didn't want to disappoint so thank you for indulging.

Your next question comes from the line of [Alexander Fodor].

Good morning. Thanks for taking my question. Just curious, the third quarter can you talk a little about sequential improvement, if there's some way you can quantify it, just overall demand in your sales?

If you can get online, and we do have a chart in the deck that we used that talks about where retail sales have trended for the last five quarters. So if you think about going back to the third quarter of 2008 it was down 12. This is for the overall --

Sorry to interrupt but I meant the question sort of intra quarter not quarter on quarter.

Within the quarter we saw it get better, and as we've seen throughout the year. It's not only been through other quarters but with rare exceptions this year we've seen it get better month over month. September was a better month than July and August.

That's great. In terms of the fourth quarter and the full year, I know you give gross margin outlooks, where does the operating margin fall for the year in the fourth quarter?

It will expand. Obviously with the guidance we've issued on the gross margin line and the EPS guidance we've issued, if you work your way down the model, it's going to expand significantly. But I'm not going to give any more.

I get a fourth quarter of something like 13, over 13%. Does that make sense?

I'm not going to do the math for you.

Okay. Just looking at what sort of -- the run rate coming out of the full year '09 which could be under 10, 9.5, is the fourth quarter typically, from a seasonal perspective, a higher margin quarter versus the other three?

Typically the second half of the year is significantly higher sales, higher profitability than the first half of the year. Oftentimes it bounces around between third and fourth quarter. Which one is better based on the timing of our new products and when they're produced and when they are shipped and retail sales patterns and those kinds of things. So sometimes it's third quarter, sometimes it's fourth quarter that's better, but the seasonality works so that the second half of the year is always significantly better than the first half.

Got it. So is the third quarter -- because I'm just trying to think of next year what sort of a normalized operating margin assuming comparable sales for this year, no sales growth, given all the improvements that you've made. What's really an annual run rate?

We are not giving guidance for 2010 yet. It's (multiple speakers) so I'm not --.

Sure, I'm just trying to get a sense of what's more permanent. So, if this year looks like it'll be below 10 but obviously it's progressed throughout the year. Just wondering, if we are at 12% for the year, we are at a 12% run rate, just what the run rate would be.

It would be wrong to extrapolate our fourth quarter or third quarter results for the full year. I think what our -- my comments were that we are going to have margin expansion in 2010 and that's probably the extent of what we are going to communicate today.

Okay. All right. Thanks for taking my question again and congratulations.

We have time for one more question, Tanika.

Our final question comes from the line of Bob Evans.

Hello again. And just so you know, I leave all currency questions to Tim. But my question is inventory related as it relates to MVP. I think you said you expect to be $200 million or lower by the end of the year. Is that right?

Yes, factory.

Can you give us any sense of how low you think you can drive it given more fully implementing MVP maybe as a percentage of sales? I'm just trying to get some sense of the target of where you think you can drive it.

Bob, I'm going to be careful with that one. We are trying to be reasonably prescriptive saying that we believe we will drive inventory levels above 200 in the fourth quarter. We feel very confident we will be able to do that. As I made the remarks in MVP, we are learning and we are lowering the water levels for ourselves and our dealers, and as we lower the water level on inventory we learn. And we've gotten a lot faster with what we've done in our operations and with our supply chain so we are able to react to the more frequent ordering and the shifts in demand much, much more effectively, but that's an unknown for us. We believe we will be able to drive it lower but I'm not going to quantify that at this point because we are just not far enough down the learning curve right now to make any bold claims on that.

Okay. Fair enough. Thank you.

All right. Thank you all.

Thanks, everyone, that's all the time we have this morning. We will look forward to speaking to you again next quarter. Thanks again, goodbye.

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