10-Q 1 pii-06302017x10xq.htm 10-Q Document

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark one)
 
 
x
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2017
OR
 
 
 
¨
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 1-11411
 
POLARIS INDUSTRIES INC.
(Exact name of registrant as specified in its charter)
 
Minnesota
 
41-1790959
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
2100 Highway 55, Medina MN
 
55340
(Address of principal executive offices)
 
(Zip Code)
 
(763) 542-0500
(Registrant’s telephone number, including area code)
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
x
Accelerated filer
¨
Non-accelerated filer
¨  (Do not check if a smaller reporting company)
Smaller reporting company
¨
 
 
Emerging growth company
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨ 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No   x
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
As of July 17, 2017, 62,558,720 shares of Common Stock, $.01 par value, of the registrant were outstanding. 
 

1


 
  POLARIS INDUSTRIES INC.
FORM 10-Q
For Quarterly Period Ended June 30, 2017
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2


Part I FINANCIAL INFORMATION
Item 1 – FINANCIAL STATEMENTS
POLARIS INDUSTRIES INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
 
June 30, 2017
 
December 31, 2016
 
(Unaudited)
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
127,378

 
$
127,325

Trade receivables, net
169,314

 
174,832

Inventories, net
815,990

 
746,534

Prepaid expenses and other
85,221

 
91,636

Income taxes receivable
18,976

 
50,662

Total current assets
1,216,879

 
1,190,989

Property and equipment, net
736,866

 
727,596

Investment in finance affiliate
86,552

 
94,009

Deferred tax assets
192,167

 
188,471

Goodwill and other intangible assets, net
786,935

 
792,979

Other long-term assets
95,573

 
105,553

Total assets
$
3,114,972

 
$
3,099,597

Liabilities and Shareholders’ Equity
 
 
 
Current liabilities:
 
 
 
Current portion of debt, capital lease obligations and notes payable
$
2,831

 
$
3,847

Accounts payable
352,538

 
273,742

Accrued expenses:
 
 
 
Compensation
116,341

 
122,214

Warranties
108,403

 
119,274

Sales promotions and incentives
176,978

 
158,562

Dealer holdback
116,804

 
117,574

Other
164,486

 
162,432

Income taxes payable
9,725

 
2,106

Total current liabilities
1,048,106

 
959,751

Long-term income taxes payable
27,764

 
26,391

Capital lease obligations
18,245

 
17,538

Long-term debt
1,046,721

 
1,120,525

Deferred tax liabilities
9,009

 
9,127

Other long-term liabilities
100,625

 
90,497

Total liabilities
$
2,250,470

 
$
2,223,829

Deferred compensation
$
10,725

 
$
8,728

Shareholders’ equity:
 
 
 
Preferred stock $0.01 par value, 20,000 shares authorized, no shares issued and outstanding

 

Common stock $0.01 par value, 160,000 shares authorized, 62,557 and 63,109 shares issued and outstanding, respectively
$
626

 
$
631

Additional paid-in capital
679,689

 
650,162

Retained earnings
227,904

 
300,084

Accumulated other comprehensive loss, net
(54,442
)
 
(83,837
)
Total shareholders’ equity
853,777

 
867,040

Total liabilities and shareholders’ equity
$
3,114,972

 
$
3,099,597

The accompanying footnotes are an integral part of these consolidated statements.

3


POLARIS INDUSTRIES INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)
 
Three months ended June 30,
 
Six months ended June 30,
 
2017
 
2016
 
2017
 
2016
Sales
$
1,364,920

 
$
1,130,777

 
$
2,518,702

 
$
2,113,773

Cost of sales
1,014,534

 
846,274

 
1,925,825

 
1,581,692

Gross profit
350,386

 
284,503

 
592,877

 
532,081

Operating expenses:
 
 
 
 
 
 
 
Selling and marketing
118,531

 
77,820

 
232,844

 
155,061

Research and development
60,753

 
45,579

 
112,758

 
88,688

General and administrative
91,063

 
64,566

 
166,577

 
134,146

Total operating expenses
270,347

 
187,965

 
512,179

 
377,895

Income from financial services
19,143

 
20,464

 
39,573

 
39,960

Operating income
99,182

 
117,002

 
120,271

 
194,146

Non-operating expense:
 
 
 
 
 
 
 
Interest expense
8,032

 
3,802

 
15,946

 
6,667

Equity in loss of other affiliates
1,336

 
1,583

 
3,236

 
3,641

Other expense (income), net
(2,152
)
 
1,805

 
9,456

 
1,886

Income before income taxes
91,966

 
109,812

 
91,633

 
181,952

Provision for income taxes
29,925

 
38,646

 
32,503

 
63,897

Net income
$
62,041

 
$
71,166

 
$
59,130

 
$
118,055

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.99

 
$
1.10

 
$
0.94

 
$
1.82

Diluted
$
0.97

 
$
1.09

 
$
0.92

 
$
1.80

Weighted average shares outstanding:
 
 
 
 
 
 
 
Basic
62,895

 
64,406

 
63,012

 
64,726

Diluted
63,807

 
65,297

 
63,970

 
65,639


The accompanying footnotes are an integral part of these consolidated statements.

4


POLARIS INDUSTRIES INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)
 
 
Three months ended June 30,
 
Six months ended June 30,
 
2017
 
2016
 
2017
 
2016
Net income
$
62,041

 
$
71,166

 
$
59,130

 
$
118,055

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustments, net of tax benefit (expense) of ($265) and ($435) in 2017 and ($172) and $28 in 2016
17,020

 
(10,904
)
 
30,436

 
(1,038
)
Unrealized loss on derivative instruments, net of tax benefit of $860 and $649 in 2017 and $44 and $4,318 in 2016
(1,397
)
 
(74
)
 
(1,041
)
 
(7,259
)
Comprehensive income
$
77,664

 
$
60,188

 
$
88,525

 
$
109,758

The accompanying footnotes are an integral part of these consolidated statements.

5


POLARIS INDUSTRIES INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
Six months ended June 30,
 
2017
 
2016
Operating Activities:
 
 
 
Net income
$
59,130

 
$
118,055

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
91,124

 
78,109

Noncash compensation
31,416

 
38,382

Noncash income from financial services
(13,328
)
 
(14,828
)
Deferred income taxes
(4,083
)
 
(4,876
)
Impairment charges
18,760

 

Other, net
3,236

 
3,641

Changes in operating assets and liabilities:
 
 
 
Trade receivables
12,370

 
14,744

Inventories
(59,421
)
 
27,605

Accounts payable
75,576

 
45,598

Accrued expenses
6,406

 
4,910

Income taxes payable/receivable
40,727

 
28,527

Prepaid expenses and others, net
2,136

 
8,416

Net cash provided by operating activities
264,049

 
348,283

Investing Activities:
 
 
 
Purchase of property and equipment
(81,803
)
 
(117,628
)
Investment in finance affiliate, net
20,785

 
20,030

Investment in other affiliates
(1,814
)
 
(6,861
)
Acquisition and disposal of businesses, net of cash acquired
1,645

 
(54,830
)
Net cash used for investing activities
(61,187
)
 
(159,289
)
Financing Activities:
 
 
 
Borrowings under debt arrangements / capital lease obligations
932,317

 
1,202,652

Repayments under debt arrangements / capital lease obligations
(1,010,870
)
 
(1,198,337
)
Repurchase and retirement of common shares
(65,622
)
 
(143,876
)
Cash dividends to shareholders
(72,612
)
 
(70,583
)
Proceeds from stock issuances under employee plans
7,027

 
11,758

Net cash used for financing activities
(209,760
)
 
(198,386
)
Impact of currency exchange rates on cash balances
6,951

 
676

Net increase (decrease) in cash and cash equivalents
53

 
(8,716
)
Cash and cash equivalents at beginning of period
127,325

 
155,349

Cash and cash equivalents at end of period
$
127,378

 
$
146,633

 
 
 
 
Supplemental Cash Flow Information:
 
 
 
Interest paid on debt borrowings
$
15,466

 
$
6,537

Income taxes paid (refunded)
$
(4,735
)
 
$
34,966

The accompanying footnotes are an integral part of these consolidated statements.

6


POLARIS INDUSTRIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Significant Accounting Policies
Basis of presentation. The accompanying unaudited consolidated financial statements of Polaris Industries Inc. (“Polaris” or the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States for interim financial statements and, therefore, do not include all information and disclosures of results of operations, financial position and changes in cash flow in conformity with accounting principles generally accepted in the United States for complete financial statements. Accordingly, such statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 previously filed with the Securities and Exchange Commission (“SEC”). In the opinion of management, such statements reflect all adjustments (which include only normal recurring adjustments) necessary for a fair presentation of the financial position, results of operations, and cash flows for the periods presented. Due to the seasonality trends for certain products and to certain changes in production and shipping cycles, results of such periods are not necessarily indicative of the results to be expected for the complete year.
Fair value measurements. Fair value is the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Assets and liabilities measured at fair value are classified using the following hierarchy, which is based upon the transparency of inputs to the valuation as of the measurement date:
Level  1 — Quoted prices in active markets for identical assets or liabilities.
Level  2 — Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
In making fair value measurements, observable market data must be used when available. When inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement. The Company utilizes the market approach to measure fair value for its non-qualified deferred compensation assets and liabilities, and the income approach for foreign currency contracts and commodity contracts. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities, and for the income approach the Company uses significant other observable inputs to value its derivative instruments used to hedge foreign currency and commodity transactions.
Assets and liabilities measured at fair value on a recurring basis are summarized below (in thousands):
 
Fair Value Measurements as of June 30, 2017
Asset (Liability)
Total
 
Level 1
 
Level 2
 
Level 3
Non-qualified deferred compensation assets
$
50,556

 
$
50,556

 

 

Total assets at fair value
$
50,556

 
$
50,556

 

 

Non-qualified deferred compensation liabilities
(50,556
)
 
$
(50,556
)
 

 

Foreign exchange contracts, net
(1,428
)
 

 
$
(1,428
)
 

Total liabilities at fair value
$
(51,984
)
 
$
(50,556
)
 
$
(1,428
)
 

 
 
 
 
 
 
 
 
 
Fair Value Measurements as of December 31, 2016
Asset (Liability)
Total
 
Level 1
 
Level 2
 
Level 3
Non-qualified deferred compensation assets
$
49,330

 
$
49,330

 

 

Foreign exchange contracts, net
298

 

 
$
298

 

Total assets at fair value
$
49,628

 
$
49,330

 
$
298

 

Non-qualified deferred compensation liabilities
(49,330
)
 
$
(49,330
)
 

 

Total liabilities at fair value
$
(49,330
)
 
$
(49,330
)
 
$

 

Fair value of other financial instruments. The carrying values of the Company’s short-term financial instruments, including cash and cash equivalents, trade receivables and short-term debt, including current maturities of long-term debt, capital lease obligations and notes payable, approximate their fair values. At June 30, 2017 and December 31, 2016, the fair value of the Company’s long-term debt, capital lease obligations and notes payable was approximately $1,080,788,000 and

7


$1,156,181,000, respectively, and was determined using Level 2 inputs, including quoted market prices or discounted cash flows based on quoted market rates for similar types of debt. The carrying value of long-term debt, capital lease obligations and notes payable including current maturities was $1,067,797,000 and $1,141,910,000 as of June 30, 2017 and December 31, 2016, respectively.
Inventories. Inventory costs include material, labor and manufacturing overhead costs, including depreciation expense associated with the manufacture and distribution of the Company’s products. Inventories are stated at the lower of cost (first-in, first-out method) or market. The major components of inventories are as follows (in thousands):
 
June 30, 2017
 
December 31, 2016
Raw materials and purchased components
$
147,673

 
$
141,566

Service parts, garments and accessories
318,378

 
316,383

Finished goods
411,383

 
333,760

Less: reserves
(61,444
)
 
(45,175
)
Inventories
$
815,990

 
$
746,534

Product warranties. Polaris provides a limited warranty for its Off-road vehicles (ORVs) for a period of six months, for a period of one year for its snowmobiles, for a period of two years for its motorcycles, for a period of one year for its Taylor-Dunn vehicles and for a two-year period for its GEM, Goupil and Aixam vehicles. Polaris provides longer warranties in certain geographical markets as determined by local regulations and market conditions and may also provide longer warranties related to certain promotional programs. Polaris’ standard warranties require the Company or its dealers to repair or replace defective products during such warranty periods at no cost to the consumer. The warranty reserve is established at the time of sale to the dealer or distributor based on management’s best estimate using historical rates and trends. Adjustments to the warranty reserve are made from time to time as actual claims become known in order to properly estimate the amounts necessary to settle future and existing claims on products sold as of the balance sheet date. Factors that could have an impact on the warranty accrual in any given period include the following: change in manufacturing quality, shifts in product mix, changes in warranty coverage periods, snowfall and its impact on snowmobile usage, product recalls and any significant changes in sales volume. The activity in the warranty reserve during the periods presented was as follows (in thousands):
 
Three months ended June 30,
 
Six months ended June 30,
 
2017
 
2016
 
2017
 
2016
Balance at beginning of period
$
109,852

 
$
67,207

 
$
119,274

 
$
56,474

Additions to warranty reserve through acquisitions

 
42

 

 
147

Additions charged to expense
30,122

 
38,358

 
61,816

 
67,531

Warranty claims paid, net
(31,571
)
 
(28,734
)
 
(72,687
)
 
(47,279
)
Balance at end of period
$
108,403

 
$
76,873

 
$
108,403

 
$
76,873

During 2016, the Company incurred significant additions to the warranty reserve, primarily associated with recall activity for certain RZR ORVs. In April 2016, the Company issued a voluntary recall for certain RZR 900 and 1000 ORVs manufactured since model year 2013 due to reports of thermal-related incidents, including fire, and in September 2016, the Company issued a voluntary recall for certain RZR XP Turbo off-road vehicles due to similar thermal-related incidents.
Deferred revenue. In the second quarter of 2016, Polaris began financing its self-insured risks related to extended service contracts (“ESCs”). The premiums for ESCs are primarily recognized in income in proportion to the costs expected to be incurred over the contract period. Additionally, in the fourth quarter of 2016, the Company acquired Transamerican Auto Parts (“TAP”), which recognizes revenues related to sales of its extended warranty programs for tires and other products over the term of the warranty period which vary from two to five years. Warranty costs are recognized as incurred. Revenues related to sales of its extended warranty program for powertrains and related accrued costs for claims are deferred and amortized over the warranty period, generally five years, while warranty administrative costs are recognized as incurred. The activity in the deferred revenue reserve during the periods presented was as follows (in thousands):
 
Three months ended June 30,
 
Six months ended June 30,
 
2017
 
2016
 
2017
 
2016
Balance at beginning of period
$
30,445

 

 
$
26,157

 

New contracts sold
8,772

 
8,276

 
15,114

 
8,276

Less: reductions for revenue recognized
(3,029
)
 
(176
)
 
(5,083
)
 
(176
)
Balance at end of period (1)
$
36,188

 
$
8,100

 
$
36,188

 
$
8,100


8


(1) Unamortized extended service contract premiums (deferred revenue) of $14,678,000 and $21,510,000 were recorded in other current liabilities, and other long-term liabilities, respectively, as of June 30, 2017.
New accounting pronouncements.
Share-based payment accounting. During the first quarter of 2017, the Company adopted Accounting Standards Update (ASU) No. 2016-09, Improvements to Employee Share-Based Payment Accounting. As a result of the adoption, the Company recognized a tax benefit of $1,225,000 and $3,149,000 of excess tax benefits related to share-based payments in our provision for income taxes for the three and six months ended June 30, 2017. These items were historically recorded in additional paid-in capital. In addition, for each period presented, cash flows related to excess tax benefits are now classified as an operating activity along with other income tax related cash flows. The Company elected to apply the change in presentation of excess tax benefits in the statements of cash flows on a prospective basis. The Company’s compensation expense each period continues to reflect estimated forfeitures.
Revenue from contracts with customers. In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers. This ASU is a comprehensive new revenue recognition model that requires a company to recognize revenue from the transfer of goods or services to customers in an amount that reflects the consideration that the entity expects to receive in exchange for those goods or services. The new standard is effective for fiscal years and interim periods beginning after December 15, 2017 and is effective for the Company’s fiscal year beginning January 1, 2018. Subsequent to the issuance of ASU 2014-09, the FASB has issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net), and ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients. These ASUs do not change the core principle of the guidance stated in ASU 2014-09, instead these amendments are intended to clarify and improve operability of certain topics included within the revenue standard. These ASUs will have the same effective date and transition requirements as ASU 2014-09.
The Company has completed a preliminary assessment of the impact of ASU No. 2014-09 and other related ASUs, and does not anticipate the impact will be significant to the Company’s financial statements, accounting policies or processes. The Company expects to adopt ASU No. 2014-09 for the Company’s fiscal year beginning January 1, 2018, and expects to adopt the guidance using the modified retrospective approach.
Statement of cash flows. In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which requires that restricted cash be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The provisions of ASU 2016-18 are effective for years beginning after December 15, 2017, with early adoption permitted. The Company expects to adopt the requirements of the new standard for the Company’s fiscal year beginning January 1, 2018, using the retrospective transition method, as required by the new standard. The adoption of this ASU is not expected to have a material impact to the consolidated statements of cash flows.
Leases. In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). This ASU requires most lessees to recognize right of use assets and lease liabilities, but recognize expenses in a manner similar with current accounting standards. The new standard is effective for fiscal years and interim periods beginning after December 15, 2018 and is effective for the Company’s fiscal year beginning January 1, 2019. Entities are required to use a modified retrospective approach, with early adoption permitted. The Company is evaluating the impact of this new standard on the financial statements.
There are no other new accounting pronouncements that are expected to have a significant impact on Polaris’ consolidated financial statements.

Note 2. Acquisitions
Transamerican Auto Parts
On October 11, 2016, the Company entered into a definitive agreement with TAP Automotive Holdings, LLC
(“Transamerican Auto Parts” or “TAP”), to acquire the outstanding equity interests in Transamerican Auto Parts, a privately held, vertically integrated manufacturer, distributor, retailer and installer of off-road Jeep® and truck accessories, for an aggregate consideration of $668,348,000, net of cash acquired. TAP’s products and services for customers in the off-road four-wheel-drive market correspond closely to our ORV business. The transaction closed on November 10, 2016. The Company funded the purchase price with borrowings under its existing credit facilities.
As of June 30, 2017, the purchase price allocation for the acquisition is preliminary. The following table summarizes the preliminary fair values assigned to the TAP net assets acquired and the determination of final net assets (in thousands):

9


Cash and cash equivalents
$
3,017

Trade receivables
18,214

Inventory
145,612

Property, plant and equipment
32,814

Customer relationships
87,000

Trademarks / trade names
175,500

Goodwill
264,324

Other assets
18,578

Deferred revenue
(7,944
)
Other liabilities assumed
(65,750
)
Total fair value of net assets acquired
671,365

Less cash acquired
(3,017
)
Total consideration for acquisition, less cash acquired
$
668,348


On the acquisition date, amortizable intangible assets had a weighted-average useful life of 8.9 years. The customer relationships were valued based on the Discounted Cash Flow Method and are amortized over 5-10 years, depending on the customer class. The trademarks and trade names were valued on the Relief from Royalty Method and have indefinite remaining useful lives. Goodwill is deductible for tax purposes.
The following unaudited pro forma information represents the Company’s results of operations as if the fiscal 2016 acquisition of TAP had occurred at the beginning of fiscal 2015 (in thousands, except per share data). These performance results may not be indicative of the actual results that would have occurred under the ownership and management of the Company.
 
Three months ended June 30, 2016
 
Six months ended June 30, 2016
Net sales
$
1,328,647

 
$
2,499,277

Net income
$
78,018

 
$
129,067

Basic earnings per share
$
1.21

 
$
1.99

Diluted earnings per common share
$
1.19

 
$
1.97


Note 3. Share-Based Compensation
The amount of compensation cost for share-based awards to be recognized during a period is based on the portion of the awards that are ultimately expected to vest. The Company estimates stock option forfeitures at the time of grant and revises those estimates in subsequent periods if actual forfeitures differ from those estimates. The Company analyzes historical data to estimate pre-vesting forfeitures and records share-based compensation expense for those awards expected to vest.
Total share-based compensation expenses were comprised as follows (in thousands):
 
Three months ended June 30,
 
Six months ended June 30,
 
2017
 
2016
 
2017
 
2016
Option plan
$
5,649

 
$
6,158

 
$
7,071

 
$
11,562

Other share-based awards
13,018

 
9,362

 
22,110

 
18,819

Total share-based compensation before tax
18,667

 
15,520

 
29,181

 
30,381

Tax benefit
6,933

 
5,789

 
10,838

 
11,332

Total share-based compensation expense included in net income
$
11,734

 
$
9,731

 
$
18,343

 
$
19,049

In addition to the above share-based compensation expenses, Polaris sponsors a qualified non-leveraged employee stock ownership plan (ESOP). Shares allocated to eligible participants’ accounts vest at various percentage rates based on years of service and require no cash payments from the recipient.
At June 30, 2017, there was $125,826,000 of total unrecognized share-based compensation expense related to unvested share-based equity awards. Unrecognized share-based compensation expense is expected to be recognized over a weighted-average period of 1.89 years. Included in unrecognized share-based compensation is approximately $42,458,000 related to stock options and $83,368,000 for restricted stock.

10



Note 4. Financing Agreements
The carrying value of debt, capital lease obligations, notes payable and the average related interest rates were as follows (in thousands):
 
Average interest rate at June 30, 2017
 
Maturity
 
June 30, 2017
 
December 31, 2016
Revolving loan facility
2.15%
 
May 2021
 
$
118,268

 
$
172,142

Term loan facility
2.44%
 
May 2021
 
720,000

 
740,000

Senior notes—fixed rate
3.81%
 
May 2018
 
25,000

 
25,000

Senior notes—fixed rate
4.60%
 
May 2021
 
75,000

 
75,000

Senior notes—fixed rate
3.13%
 
December 2020
 
100,000

 
100,000

Capital lease obligations
5.03%
 
Various through 2029
 
19,868

 
19,306

Notes payable and other
3.50%
 
June 2027
 
12,383

 
13,618

Debt issuance costs
 
 
 
 
(2,722
)
 
(3,156
)
Total debt, capital lease obligations, and notes payable
 
 
 
 
$
1,067,797

 
$
1,141,910

Less: current maturities
 
 
 
 
2,831

 
3,847

Total long-term debt, capital lease obligations, and notes payable
 
 
 
 
$
1,064,966

 
$
1,138,063

In August 2011, Polaris entered into a $350,000,000 unsecured revolving loan facility. In March 2015, Polaris amended the loan facility to increase the facility to $500,000,000 and to provide more beneficial covenant and interest rate terms. The amended terms also extended the expiration date to March 2020. Interest is charged at rates based on a LIBOR or “prime” base rate. In May 2016, Polaris amended the revolving loan facility to increase the facility to $600,000,000 and extend the expiration date to May 2021. The amended terms also established a $500,000,000 term loan facility. In November 2016, Polaris amended the revolving loan facility to increase the term loan facility to $750,000,000, of which $720,000,000 is outstanding as of June 30, 2017.
In December 2010, the Company entered into a Master Note Purchase Agreement to issue $25,000,000 of unsecured senior notes due May 2018 and $75,000,000 of unsecured senior notes due May 2021 (collectively, the “Senior Notes”). The Senior Notes were issued in May 2011. In December 2013, the Company entered into a First Supplement to Master Note Purchase Agreement, under which the Company issued $100,000,000 of unsecured senior notes due December 2020.
The unsecured revolving loan facility and the Master Note Purchase Agreement contain covenants that require Polaris to maintain certain financial ratios, including minimum interest coverage and maximum leverage ratios. Polaris was in compliance with all such covenants as of June 30, 2017.
The debt issuance costs are recognized as a reduction in the carrying value of the related long-term debt in the consolidated balance sheets and are being amortized to interest expense in our consolidated statements of income over the expected remaining terms of the related debt.
A property lease agreement for a manufacturing facility which Polaris began occupying in Opole, Poland commenced in February 2014. The Poland property lease is accounted for as a capital lease.
The Company has a mortgage note payable agreement for land, on which Polaris built the Huntsville, Alabama manufacturing facility in 2016. The original mortgage note payable was for $14,500,000, of which $12,083,000 is outstanding as of June 30, 2017. The payment of principal and interest for the note payable is forgivable if the Company satisfies certain job commitments over the term of the note. The Company has met the required commitments to date. Forgivable loans related to other Company facilities are also included within notes payable.

Note 5. Goodwill and Other Intangible Assets
Goodwill and other intangible assets, net of accumulated amortization, as of June 30, 2017 and December 31, 2016 are as follows (in thousands):

11


 
June 30, 2017
 
December 31, 2016
Goodwill
$
427,790

 
$
421,563

Other intangible assets, net
359,145

 
371,416

Total goodwill and other intangible assets, net
$
786,935

 
$
792,979

There have been no material additions to goodwill and other intangible assets in 2017. In March 2016, the Company acquired Taylor-Dunn Manufacturing Company (“Taylor-Dunn”), a leading provider of industrial vehicles serving a broad range of commercial, manufacturing, warehouse and ground-support customers. Taylor-Dunn is based in Anaheim, California, and is included in the Global Adjacent Markets reporting segment.
In November 2016, the Company acquired TAP, a vertically integrated manufacturer, distributor, retailer and installer of off-road Jeep and truck accessories. TAP is based in Compton, California, and is included in the Aftermarket reporting segment. As of June 30, 2017, the purchase price allocation for the TAP acquisition remains preliminary.
The changes in the carrying amount of goodwill for the six months ended June 30, 2017 were as follows (in thousands):
 
Six months ended June 30, 2017
Goodwill, beginning of period
$
421,563

Goodwill from businesses acquired

Currency translation effect on foreign goodwill balances
6,227

Goodwill, end of period
$
427,790

The components of other intangible assets were as follows (in thousands):
 
Total estimated life (years)
 
June 30, 2017
 
December 31, 2016
Non-amortizable—indefinite lived:
 
 
 
 
 
Brand names
 
 
$
230,082

 
$
229,121

Amortizable:
 
 
 
 
 
Non-compete agreements
5
 
540

 
540

Dealer/customer related
5-10
 
167,537

 
164,837

Developed technology
5-7
 
22,755

 
26,048

Total amortizable
 
 
190,832

 
191,425

Less: Accumulated amortization
 
 
(61,769
)
 
(49,130
)
Net amortized other intangible assets
 
 
129,063

 
142,295

Total other intangible assets, net
 
 
$
359,145

 
$
371,416

Amortization expense for intangible assets for the three months ended June 30, 2017 and 2016 was $6,238,000 and $3,774,000, respectively. Estimated amortization expense for the remainder of 2017 through 2022 is as follows: 2017 (remainder), $14,000,000; 2018, $25,900,000; 2019, $24,400,000; 2020, $19,500,000; 2021, $17,100,000; 2022, $15,900,000; and after 2022, $12,300,000. The preceding expected amortization expense is an estimate and actual amounts could differ due to additional intangible asset acquisitions, changes in foreign currency rates or impairment of intangible assets.

Note 6. Shareholders’ Equity
During the six months ended June 30, 2017, Polaris paid $65,622,000 to repurchase and retire approximately 758,000 shares of its common stock. As of June 30, 2017, the Board of Directors has authorized the Company to repurchase up to an additional 6,705,000 shares of Polaris stock. The repurchase of any or all such shares authorized for repurchase will be governed by applicable SEC rules and dependent on management’s assessment of market conditions. Polaris paid a regular cash dividend of $0.58 per share on June 15, 2017 to holders of record at the close of business on June 1, 2017. Cash dividends declared per common share for the three and six months ended June 30, 2017 and 2016, were as follows: 
 
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2017
 
2016
 
2017
 
2016
Cash dividends declared and paid per common share
 
$
0.58

 
$
0.55

 
$
1.16

 
$
1.10


12


Net income per share
Basic earnings per share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding during each period, including shares earned under the Deferred Compensation Plan for Directors (“Director Plan”), the ESOP and deferred stock units under the 2007 Omnibus Incentive Plan (“Omnibus Plan”). Diluted earnings per share is computed under the treasury stock method and is calculated to compute the dilutive effect of outstanding stock options and certain shares issued under the Omnibus Plan. A reconciliation of these amounts is as follows (in thousands):
 
Three months ended June 30,
 
Six months ended June 30,
 
2017
 
2016
 
2017
 
2016
Weighted average number of common shares outstanding
62,638
 
64,130

 
62,756
 
64,444

Director Plan and deferred stock units
157
 
166

 
151
 
181

ESOP
100
 
110

 
105
 
101

Common shares outstanding—basic
62,895
 
64,406

 
63,012
 
64,726

Dilutive effect of Omnibus Plan
912
 
891

 
958
 
913

Common and potential common shares outstanding—diluted
63,807
 
65,297

 
63,970
 
65,639

During the three and six months ended June 30, 2017, the number of options that could potentially dilute earnings per share on a fully diluted basis that were not included in the computation of diluted earnings per share (because to do so would have been anti-dilutive) were 3,626,000 and 3,398,000, respectively, compared to 1,809,000 and 1,672,000 for the same periods in 2016.
Accumulated other comprehensive loss
Changes in the accumulated other comprehensive loss balance is as follows (in thousands):
 
Foreign
Currency
Items
 
Cash Flow
Hedging Derivatives
 
Accumulated Other
Comprehensive Loss
Balance as of December 31, 2016
$
(84,133
)
 
$
296

 
$
(83,837
)
Reclassification to the income statement

 
(2,171
)
 
(2,171
)
Change in fair value
30,436

 
1,130

 
31,566

Balance as of June 30, 2017
$
(53,697
)
 
$
(745
)
 
$
(54,442
)
The table below provides data about the amount of gains and losses, net of tax, reclassified from accumulated other comprehensive loss into the income statement for cash flow derivatives designated as hedging instruments for the three and six months ended June 30, 2017 and 2016 (in thousands): 
Derivatives in Cash
Flow Hedging Relationships
Location of (Gain) Loss
Reclassified from
Accumulated OCI
into Income
 
Three months ended June 30,
 
Six months ended June 30,
 
2017
 
2016
 
2017
 
2016
Foreign currency contracts
Other expense, net
 
$
1,380

 
$
493

 
$
2,607

 
$
2,423

Foreign currency contracts
Cost of sales
 
(32
)
 
(278
)
 
(436
)
 
(849
)
Total
 
 
$
1,348

 
$
215

 
$
2,171

 
$
1,574

The net amount of the existing gains or losses at June 30, 2017 that is expected to be reclassified into the income statement within the next 12 months is not expected to be material. See Note 10 for further information regarding Polaris’ derivative activities.

Note 7. Financial Services Arrangements
Polaris Acceptance, a joint venture between Polaris and Wells Fargo Commercial Distribution Finance, a direct subsidiary of Wells Fargo Bank, N.A. (“Wells Fargo”), which is supported by a partnership agreement between their respective wholly owned subsidiaries, finances substantially all of Polaris’ United States sales whereby Polaris receives payment within a few days of shipment of the product.
Polaris’ subsidiary has a 50 percent equity interest in Polaris Acceptance. Polaris Acceptance sells a majority of its receivable portfolio to a securitization facility (the “Securitization Facility”) arranged by Wells Fargo. The sale of receivables from Polaris Acceptance to the Securitization Facility is accounted for in Polaris Acceptance’s financial statements as a “true-sale”

13


under Accounting Standards Codification (“ASC”) Topic 860. Polaris’ allocable share of the income of Polaris Acceptance has been included as a component of income from financial services in the accompanying consolidated statements of income. The partnership agreement is effective through February 2022.
Polaris’ total investment in Polaris Acceptance of $86,552,000 at June 30, 2017 is accounted for under the equity method, and is recorded in investment in finance affiliate in the accompanying consolidated balance sheets. At June 30, 2017, the outstanding amount of net receivables financed for dealers under this arrangement was $1,078,043,000, which included $467,531,000 in the Polaris Acceptance portfolio and $610,512,000 of receivables within the Securitization Facility (“Securitized Receivables”).
Polaris has agreed to repurchase products repossessed by Polaris Acceptance up to an annual maximum of 15 percent of the aggregate average month-end outstanding Polaris Acceptance receivables and Securitized Receivables during the prior calendar year. For calendar year 2017, the potential 15 percent aggregate repurchase obligation is approximately $183,951,000. Polaris’ financial exposure under this arrangement is limited to the difference between the amounts unpaid by the dealer with respect to the repossessed product plus costs of repossession and the amount received on the resale of the repossessed product. No material losses have been incurred under this agreement during the periods presented.
Polaris has agreements with Performance Finance, Sheffield Financial and Synchrony Bank, under which these financial institutions provide financing to end consumers of Polaris products. Polaris’ income generated from these agreements has been included as a component of income from financial services in the accompanying consolidated statements of income.
Polaris also administers and provides extended service contracts to consumers and certain insurance contracts to dealers and consumers through various third-party suppliers. Polaris finances its self-insured risks related to extended service contracts, but does not retain any insurance or financial risk under any of the other arrangements. Polaris’ service fee income generated from these arrangements has been included as a component of income from financial services in the accompanying consolidated statements of income.

Note 8. Investment in Other Affiliates
The Company has certain investments in nonmarketable securities of strategic companies. As of June 30, 2017 and December 31, 2016, the Company’s investment in Eicher-Polaris Private Limited (EPPL) represents the majority of these investments and is recorded as a component of other long-term assets in the accompanying consolidated balance sheets.
EPPL is a joint venture established in 2012 with Eicher Motors Limited (“Eicher”). Polaris and Eicher each control 50 percent of the joint venture, which is intended to design, develop and manufacture a full range of new vehicles for India and other emerging markets. The investment in EPPL is accounted for under the equity method, with Polaris’ proportionate share of income or loss recorded within the consolidated financial statements on a one month lag due to financial information not being available timely. As of June 30, 2017 and December 31, 2016, the carrying value of the Company’s investment in EPPL was $19,930,000 and $20,182,000, respectively. Through June 30, 2017, Polaris has invested $45,016,000 in the joint venture. Polaris’ share of EPPL loss for the three and six months ended June 30, 2017 was $1,336,000 and $3,236,000, respectively, compared to $1,583,000 and $3,641,000, for the same respective periods in 2016. The loss is included in equity in loss of other affiliates on the consolidated statements of income.
Polaris will impair or write off an investment and recognize a loss if and when events or circumstances indicate there is impairment in the investment that is other-than-temporary. When necessary, Polaris evaluates investments in nonmarketable securities for impairment, utilizing level 3 fair value inputs. As a result of the Victory Motorcycle wind down, the Company
recorded an impairment of a cost-method investment in Brammo, Inc. during the first quarter of 2017. See Note 12 for additional discussion related to charges incurred related to the Victory wind down.
Note 9. Commitments and Contingencies
Polaris is subject to product liability claims in the normal course of business. In late 2012, Polaris purchased excess insurance coverage for catastrophic product liability claims for incidents occurring after the policy date. Polaris self-insures product liability claims before the policy date and up to the purchased catastrophic insurance coverage after the policy date. The estimated costs resulting from any losses are charged to operating expenses when it is probable a loss has been incurred and the amount of the loss is reasonably determinable. The Company utilizes historical trends and actuarial analysis tools, along with an analysis of current claims, to assist in determining the appropriate loss reserve levels. At June 30, 2017, the Company had an accrual of $38,165,000 for the probable payment of pending claims related to product liability litigation associated with Polaris products. This accrual is included as a component of other accrued expenses in the accompanying consolidated balance sheets.

14


Polaris is a defendant in lawsuits and subject to other claims arising in the normal course of business. In the opinion of management, it is unlikely that any legal proceedings pending against or involving Polaris will have a material adverse effect on Polaris’ financial position or results of operations.
As a component of certain past acquisition agreements, Polaris has committed to make additional payments to certain sellers contingent upon either the passage of time or certain financial performance criteria. Polaris initially records the fair value of each commitment as of the respective opening balance sheet, and each reporting period the fair value is evaluated, using level 3 inputs, with the change in value reflected in the consolidated statements of income. As of June 30, 2017 and December 31, 2016, the fair values of contingent purchase price commitments are immaterial.

Note 10. Derivative Instruments and Hedging Activities
The Company is exposed to certain risks relating to its ongoing business operations. From time to time, the primary risks managed by using derivative instruments are foreign currency risk, interest rate risk and commodity price fluctuations. Derivative contracts on various currencies are entered into in order to manage foreign currency exposures associated with certain product sourcing activities and intercompany cash flows. Interest rate swaps are occasionally entered into in order to maintain a balanced risk of fixed and floating interest rates associated with the Company’s long-term debt. Commodity hedging contracts are entered into in order to manage fluctuating market prices of certain purchased commodities and raw materials that are integrated into the Company’s end products.
The Company’s foreign currency management objective is to mitigate the potential impact of currency fluctuations on the value of its U.S. dollar cash flows and to reduce the variability of certain cash flows at the subsidiary level. The Company actively manages certain forecasted foreign currency exposures and uses a centralized currency management operation to take advantage of potential opportunities to naturally offset foreign currency exposures against each other. The decision of whether and when to execute derivative instruments, along with the duration of the instrument, can vary from period to period depending on market conditions, the relative costs of the instruments and capacity to hedge. The duration is linked to the timing of the underlying exposure, with the connection between the two being regularly monitored. Polaris does not use any financial contracts for trading purposes.
At June 30, 2017, Polaris had the following open foreign currency contracts (in thousands):
Foreign Currency
 
Notional Amounts
(in U.S. Dollars)
 
Net Unrealized Gain (Loss)
Australian Dollar
 
$
25,653

 
$
(307
)
Canadian Dollar
 
129,555

 
(1,644
)
Japanese Yen
 
2,533

 
(35
)
Mexican Peso
 
8,040

 
558

Total
 
$
165,781

 
$
(1,428
)
These contracts, with maturities through June 2018, met the criteria for cash flow hedges and the unrealized gains or losses, after tax, are recorded as a component of accumulated other comprehensive loss in shareholders’ equity.

15


The table below summarizes the carrying values of derivative instruments as of June 30, 2017 and December 31, 2016 (in thousands):
 
Carrying Values of Derivative Instruments as of June 30, 2017
 
Fair Value—
Assets
 
Fair Value—
(Liabilities)
 
Derivative Net
Carrying Value
Derivatives designated as hedging instruments
 
 
 
 
 
Foreign exchange contracts(1)
$
583

 
$
(2,011
)
 
$
(1,428
)
Total derivatives designated as hedging instruments
$
583

 
$
(2,011
)
 
$
(1,428
)
Total derivatives
$
583

 
$
(2,011
)
 
$
(1,428
)
 
Carrying Values of Derivative Instruments as of December 31, 2016
 
Fair Value—
Assets
 
Fair Value—
(Liabilities)
 
Derivative Net
Carrying Value
Derivatives designated as hedging instruments
 
 
 
 
 
Foreign exchange contracts(1)
$
2,128

 
$
(1,830
)
 
$
298

Total derivatives designated as hedging instruments
$
2,128

 
$
(1,830
)
 
$
298

Total derivatives
$
2,128

 
$
(1,830
)
 
$
298

(1)
Assets are included in prepaid expenses and other and liabilities are included in other accrued expenses on the accompanying consolidated balance sheets.
For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative is reported as a component of accumulated other comprehensive loss and reclassified into the income statement in the same period or periods during which the hedged transaction affects the income statement. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in the current income statement.
The amount of losses, net of tax, related to the effective portion of derivative instruments designated as cash flow hedges included in accumulated other comprehensive loss for the three and six months ended June 30, 2017 was $1,397,000 and $1,041,000, respectively, compared to $74,000 and $7,259,000 for the same respective periods in 2016.
See Note 6 for information about the amount of gains and losses, net of tax, reclassified from accumulated other comprehensive loss into the income statement for derivative instruments designated as hedging instruments. The ineffective portion of foreign currency contracts was not material for the three and six month periods ended June 30, 2017.

Note 11. Segment Reporting
The Company’s reportable segments are based on the Company’s method of internal reporting, which generally segregates the operating segments by product line, inclusive of wholegoods and PG&A. The internal reporting of these operating segments is defined based, in part, on the reporting and review process used by the Company’s Chief Executive Officer. The Company has five operating segments: 1) ORV, 2) Snowmobiles, 3) Motorcycles, 4) Global Adjacent Markets and 5) Aftermarket, and four reportable segments: 1) ORV/Snowmobiles, 2) Motorcycles, 3) Global Adjacent Markets, and 4) Aftermarket.
Through December 31, 2016, the Company reported under three segments for segment reporting. However, during the first quarter ended March 31, 2017, as a result of the acquisition of TAP, the Company established a new reporting segment, Aftermarket, which includes the results of TAP as well as the other aftermarket brands. The comparative 2016 results were reclassified to reflect the new reporting segment structure.
The ORV/Snowmobiles segment includes the aggregated results of our ORV and Snowmobiles operating segments. The Motorcycles, Global Adjacent Markets and Aftermarket segments include the results for those respective operating segments. The Corporate amounts include costs that are not allocated to individual segments, which include incentive-based compensation and other unallocated manufacturing costs. Additionally, given the commonality of customers, manufacturing and asset management, the Company does not maintain separate balance sheets for each segment. Accordingly, the segment information presented below is limited to sales and gross profit data (in thousands):

16


 
Three months ended June 30,
 
Six months ended June 30,
 
2017
 
2016
 
2017
 
2016
Sales
 
 
 
 
 
 
 
ORV/Snowmobiles
$
845,508

 
$
799,332

 
$
1,569,611

 
$
1,507,435

Motorcycles
197,997

 
228,392

 
318,286

 
413,659

Global Adjacent Markets
97,022

 
90,959

 
188,577

 
165,068

Aftermarket
224,393

 
12,094

 
442,228

 
27,611

Total sales
$
1,364,920

 
$
1,130,777

 
$
2,518,702

 
$
2,113,773

Gross profit
 
 
 
 
 
 
 
ORV/Snowmobiles
$
266,150

 
$
228,494

 
$
479,109

 
$
434,481

Motorcycles
21,116

 
38,915

 
1,235

 
66,174

Global Adjacent Markets
21,216

 
23,952

 
49,314

 
44,335

Aftermarket
59,918

 
2,982

 
101,482

 
7,681

Corporate
(18,014
)
 
(9,840
)
 
(38,263
)
 
(20,590
)
Total gross profit
$
350,386

 
$
284,503

 
$
592,877

 
$
532,081

Note 12. Victory Motorcycles Wind Down
On January 9, 2017, the Company’s Board of Directors approved a strategic plan to wind down the Victory® Motorcycles brand. The Company began wind down activities during the first quarter of 2017. As a result of the activities, the Company recognized total charges of $10,683,000 and $56,465,000, respectively, for the three and six month periods ended June 30, 2017 that are within the scope of ASC 420, Exit or Disposal Cost Obligations. These totals exclude the promotional impacts of $168,000 and $11,966,000, respectively, incurred for the three and six month periods ended June 30, 2017. The Company estimates that the total impact of wind down activities in 2017 will be in the range of $80,000,000 to $90,000,000, inclusive of promotional activity. Substantially all costs related to wind down activities are expected to be recognized by the end of 2017.
As a result of the wind down activities, the Company has incurred expenses within the scope of ASC 420 consisting of dealer termination, supplier termination, dealer litigation, employee separation, asset impairment charges, including the impairment of a cost method investment, inventory write-down charges and other costs. There were no wind down expenses related to this initiative during the three and six month periods ended June 30, 2016. The wind down expenses have been included as components of cost of sales, selling and administrative, general and administrative expenses or other expense, net, in the consolidated income statements. Charges related to the wind down plan for the three and six months ended June 30, 2017 within the scope of ASC 420 were as follows (in thousands):
 
Three months ended June 30,
 
Six months ended June 30,
 
2017
 
2017
Contract termination charges
$
3,388

 
$
17,695

Asset impairment charges

 
18,760

Inventory charges
5,229

 
12,680

Other costs
2,066

 
7,330

Total
$
10,683

 
$
56,465


Total reserves related to the Victory Motorcycles wind down activities are $15,764,000 as of June 30, 2017. These reserves are included in other accrued expenses and inventory in the consolidated balance sheets. Changes to the reserves during the six months ended June 30, 2017 were as follows (in thousands):
 
Contract termination charges
 
Inventory charges
 
Other costs
 
Total
Reserves balance as of January 1, 2017

 

 

 

Expenses
$
17,695

 
$
12,680

 
$
7,330

 
$
37,705

Cash payments / scrapped inventory
(11,860
)
 
(4,516
)
 
(5,565
)
 
(21,941
)
Reserves balance as of June 30, 2017
$
5,835

 
$
8,164

 
$
1,765

 
$
15,764



17



Item 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
The following discussion pertains to the results of operations and financial position of Polaris Industries Inc., a Minnesota corporation, for the three and six month periods ended June 30, 2017 compared to the three and six month periods ended June 30, 2016. The terms “Polaris,” the “Company,” “we,” “us,” and “our” as used herein refer to the business and operations of Polaris Industries Inc., its subsidiaries and its predecessors, which began doing business in 1954. We design, engineer and manufacture powersports vehicles which include Off-Road Vehicles (ORV), including all-terrain vehicles (ATV) and side-by-side vehicles; motorcycles; Global Adjacent Markets vehicles, including Work & Transportation and Government and Defense vehicles; and related Parts, Garments and Accessories (PG&A), as well as Aftermarket accessories and apparel. Due to the seasonality of certain products and to certain changes in production and shipping cycles, results of such periods are not necessarily indicative of the results to be expected for the complete year.
We reported net income of $62.0 million, or $0.97 per diluted share, compared to 2016 second quarter net income of $71.2 million, or $1.09 per diluted share. Sales totaled $1,364.9 million, an increase of 21 percent from last year’s second quarter sales of $1,130.8 million. The sales increase was driven primarily by the acquisition of TAP, as well as strong international and PG&A sales. Our unit retail sales to consumers in North America decreased three percent in the second quarter of 2017, primarily driven by decreased retail demand for ATVs and Slingshot. Our second quarter sales to North American customers increased 22 percent, due primarily to the TAP acquisition. Our sales to customers outside of North America increased twelve percent, driven by a 19 percent increase in sales in the Asia/Pacific region, an 11 percent increase in sales in Europe, Middle East and Africa (“EMEA”) and an 11 percent increase in the Latin American region. Our gross profit of $350.4 million increased 23 percent from $284.5 million in the comparable prior year period. The increase in gross profit dollars was primarily driven by the TAP acquisition. Our liquidity remained healthy with $127.4 million of cash on hand and $481.3 million of availability on the revolving loan facility at June 30, 2017.
As a result of our decision to wind down the Victory Motorcycles brand, total non-recurring wind down activities had a pre-tax impact of $10.9 million and $68.4 million for the three and six month periods ended June 30, 2017, respectively. We estimate the total pre-tax impact of non-recurring wind down activities in 2017 to be in the range of $80.0 million to $90.0 million. Substantially all costs related to wind down activities are expected to be recognized by the end of 2017.


Results of Operations
Unless otherwise noted, all “quarter” comparisons are from the second quarter 2017 to the second quarter 2016, and all “year-to-date” comparisons are from the six month period ended June 30, 2017 to the six month period ended June 30, 2016.
Sales:
Quarter sales were $1,364.9 million, a 21 percent increase from $1,130.8 million of quarter sales in the prior year. Year to date sales were $2,518.7 million, a 19 percent increase from $2,113.8 million of sales in the comparable prior year period. The following table is an analysis of the percentage change in total Company sales:
 
 
Percent change in total Company sales compared to corresponding period of the prior year
 
Three months ended
 
Six months ended
 
June 30, 2017
 
June 30, 2017
Volume
1
 %
 

Product mix and price
1

 
(1
)%
Acquisitions
20

 
21

Currency
(1
)
 
(1
)
 
21
 %
 
19
 %
The quarter and year-to-date acquisition impact is primarily driven by the TAP acquisition in 2016.

18


Our sales by reporting segment, which includes the respective PG&A, were as follows:
 
Three months ended June 30,
 
Six months ended June 30,
($ in millions) 
2017
 
Percent
of Total
Sales 
 
2016
 
Percent
of Total
Sales 
 
Percent
Change
2017 vs.
2016
 
2017
 
Percent
of Total
Sales 
 
2016
 
Percent
of Total
Sales 
 
Percent
Change
2017 vs.
2016
ORV/Snowmobiles
$
845.5

 
62
%
 
$
799.3

 
71
%
 
6
 %
 
$
1,569.6

 
62
%
 
$
1,507.4

 
71
%
 
4
 %
Motorcycles
198.0

 
15
%
 
228.4

 
20
%
 
(13
)%
 
318.3

 
13
%
 
413.7

 
20
%
 
(23
)%
Global Adjacent Markets
97.0

 
7
%
 
91.0

 
8
%
 
7
 %
 
188.6

 
7
%
 
165.1

 
8
%
 
14
 %
Aftermarket
224.4

 
16
%
 
12.1

 
1
%
 
1,755
 %
 
442.2

 
18
%
 
27.6

 
1
%
 
1502
 %
Total sales
$
1,364.9

 
100
%
 
$
1,130.8

 
100
%
 
21
 %
 
$
2,518.7

 
100
%
 
$
2,113.8

 
100
%
 
19
 %
ORV/Snowmobiles
ORVs: Quarter and year-to-date sales increased primarily due to increased ORV shipments of side-by-side vehicles as we began shipping RZR vehicles at a more normalized rate. Sales outside North America increased eight percent in the quarter, primarily due to increased shipments. The quarter average per unit sales price increased three percent.
Our North American ORV quarter unit retail sales to consumers were down low-single digits percent compared to the 2016 second quarter, with consumer purchases of side-by-side vehicles, which include RANGER®, RZR, and Polaris GENERAL, up low-single digits percent, and ATV retail sales down high-single digits percent over the prior year. The Company estimates that North American industry ORV retail sales were up mid-single digits percent from the second quarter of 2016. Polaris’ North American dealer unit inventory decreased six percent from the second quarter of 2016.
Snowmobiles: Historically, the first half of the year are slow quarters for shipments to dealers due to the seasonality of the business. Quarter and year-to-date sales decreased due to the timing of shipments year-over-year.
Motorcycles
Quarter and year-to-date sales decreased due to the wind down of Victory® Motorcycles, as well as decreased shipments of Slingshot®, partially offset by increased shipments of Indian Motorcycle®. Indian Motorcycle sales increased in the second quarter driven by new product introductions and increased awareness of the brand. Quarter sales to customers outside of North America increased 11 percent due primarily to increased shipments of Indian Motorcycles. The quarter average per unit sales price decreased one percent, excluding Victory Motorcycles.
Consumer North American retail sales for Indian Motorcycle and Slingshot decreased low-single digits percent for the quarter. Indian Motorcycle retail sales increased 17 percent and gained market share. Slingshot retail sales decreased significantly due to tough comparables driven by increased shipments in the second quarter of 2016 ahead of our production move from Spirit Lake, Iowa to Huntsville, Alabama and the cadence of several limited edition models introduced in the second quarter last year. North American industry retail sales, 900cc and above, were down mid-single digits percent in the quarter. North American Polaris dealer inventory increased low-double digits percent.
Global Adjacent Markets
Quarter and year-to-date sales increased due primarily to increased Work and Transportation wholegood sales, including our Aixam quadricycle business and our Goupil light-utility business in France. The quarter average per unit sales price decreased one percent.
Aftermarket
Quarter and year-to-date sales, which includes Transamerican Auto Parts (TAP), along with our other aftermarket brands of Klim, Kolpin, ProArmor, Trail Tech and 509, increased due to the acquisition of TAP in November 2016. TAP contributed sales of $209.1 million and $411.1 million for the quarter and year-to-date periods, respectively.
Sales by Geography
Sales by geographic region were as follows:

19


 
Three months ended June 30,
 
Six months ended June 30,
($ in millions)
2017
 
Percent of Total Sales
 
2016
 
Percent of Total Sales 
 
Percent Change 2017 vs. 2016
 
2017
 
Percent of Total Sales
 
2016
 
Percent of Total Sales 
 
Percent Change 2017 vs. 2016
United States
$
1,084.6

 
79
%
 
$
879.8

 
78
%
 
23
%
 
$
2,015.2

 
80
%
 
$
1,646.1

 
78
%
 
22
%
Canada
89.1

 
7
%
 
80.5

 
7
%
 
11
%
 
146.1

 
6
%
 
134.6

 
6
%
 
9
%
Other foreign countries
191.2

 
14
%
 
170.5

 
15
%
 
12
%
 
357.4

 
14
%
 
333.1

 
16
%
 
7
%
Total sales
$
1,364.9

 
100
%
 
$
1,130.8

 
100
%
 
21
%
 
$
2,518.7

 
100
%
 
$
2,113.8

 
100
%
 
19
%
 
United States: Quarter and year-to-date sales in the U.S. increased due primarily to our acquisition of TAP in November 2016.
Canada: Quarter and year-to-date sales in Canada increased due to the acquisition of TAP and increased ORV shipments, partially offset by lower shipments of motorcycles. Currency rate movement had an unfavorable four and one percent impact on quarter and year-to-date sales, respectively.
Other foreign countries: Quarter and year-to-date sales in other foreign countries increased due to increased Indian Motorcycle shipments and ORV shipments.
Cost of Sales:  
 
Three months ended June 30,
 
Six months ended June 30,
($ in millions)
2017
 
Percent of Total Cost of Sales
 
2016
 
Percent of Total Cost of Sales
 
Change
2017 vs. 2016
 
2017
 
Percent of Total Cost of Sales
 
2016
 
Percent of Total Cost of Sales
 
Change 2017 vs. 2016
Purchased materials and services
$
876.6

 
86
%
 
$
708.3

 
84
%
 
24
 %
 
$
1,656.2

 
86
%
 
$
1,327.2

 
84
%
 
25
 %
Labor and benefits
75.7

 
8
%
 
69.3

 
8
%
 
9
 %
 
141.2

 
7
%
 
128.3

 
8
%
 
10
 %
Depreciation and amortization
32.1

 
3
%
 
30.3

 
4
%
 
6
 %
 
66.6

 
4
%
 
58.7

 
4
%
 
13
 %
Warranty costs
30.1

 
3
%
 
38.4

 
4
%
 
(22
)%
 
61.8

 
3
%
 
67.5

 
4
%
 
(8
)%
Total cost of sales
$
1,014.5

 
100
%
 
$
846.3

 
100
%
 
20
 %
 
$
1,925.8

 
100
%
 
$
1,581.7

 
100
%
 
22
 %
Percentage of sales
74.3
%
 
 
 
74.8
%
 
-51 basis points
 
 
76.5
%
 
 
 
74.8
%
 
+163 basis points
 
The increase in quarter and year-to-date cost of sales dollars resulted primarily from the acquisition of TAP and Victory wind down costs.
 Gross Profit:
 
Three months ended June 30,
 
Six months ended June 30,
($ in millions)
2017
 
Percent of Sales
 
2016
 
Percent of Sales
 
Change
2017 vs. 
2016 
 
2017
 
Percent of Sales
 
2016
 
Percent of Sales
 
Change
2017 vs. 
2016 
ORV/Snowmobiles
$
266.2

 
31.5
%
 
$
228.5

 
28.6
%
 
16
 %
 
$
479.1

 
30.5
%
 
$
434.5

 
28.8
%
 
10
 %
Motorcycles
21.1

 
10.7
%
 
38.9

 
17.0
%
 
(46
)%
 
1.2

 
0.4
%
 
66.2

 
16.0
%
 
-98
 %
Global Adjacent Markets
21.2

 
21.9
%
 
23.9

 
26.3
%
 
(11
)%
 
49.3

 
26.2
%
 
44.3

 
26.9
%
 
11
 %
Aftermarket
59.9

 
26.7
%
 
3.0

 
24.7
%
 
1,899
 %
 
101.5

 
22.9
%
 
7.7

 
27.8
%
 
1,218
 %
Corporate
(18.0
)
 
 
 
(9.8
)
 
 
 

 
(38.3
)
 
 
 
(20.6
)
 
 
 

Total gross profit dollars
$
350.4

 
 
 
$
284.5

 
 
 
23
 %
 
$
592.8

 
 
 
$
532.1

 
 
 
11
 %
Percentage of sales
25.7
%
 
 
 
25.2
%
 
+51 basis points
 
 
23.5
%
 
 
 
25.2
%
 
-163 basis points
 
Consolidated. Quarter gross profit, as a percentage of sales, increased due to significant gross VIP cost savings and positive product mix, partially offset by higher promotions. Gross profit for the quarter includes the negative impact of $8.9 million of Victory wind down costs and $4.3 million of manufacturing network realignment costs. Year-to-date gross profit includes the negative impact of $47.4 million of costs related to the wind down of Victory Motorcycles, $13.0 million of inventory step-up accounting adjustments related to the TAP acquisition, and increased promotional costs. These year-to-date costs were partially offset by product cost reduction efforts generated through lean initiatives.
ORV/Snowmobiles. Gross profit, as a percentage of sales, increased for the quarter and year-to-date periods, primarily due to favorable changes in product mix.

20


Motorcycles. Gross profit, as a percentage of sales, decreased significantly for the quarter and year-to-date periods, primarily due to higher costs associated with the wind down of Victory motorcycles, including increased promotions and inventory charges, and unfavorable product mix.
Global Adjacent Markets. Gross profit, as a percentage of sales, decreased for the quarter and year-to-date periods, primarily due to the $4.3 million of costs incurred related to the manufacturing network realignment.
Aftermarket. Gross profit, as a percentage of sales, increased for the quarter, due the acquisition of TAP. Year-to-date gross profit, as a percentage of sales, decreased due to the negative impact of $13.0 million of inventory step-up adjustments related to the TAP acquisition.
Operating Expenses:
 
Three months ended June 30,
 
Six months ended June 30,
($ in millions) 
2017
 
2016
 
Change
2017 vs. 2016
 
2017
 
2016
 
Change
2017 vs. 2016
Selling and marketing
$
118.5

 
$
77.8

 
52
%
 
$
232.8

 
$
155.1

 
50
%
Research and development
60.8

 
45.6

 
33
%
 
112.8

 
88.7

 
27
%
General and administrative
91.1

 
64.6

 
41
%
 
166.6

 
134.1

 
24
%
Total operating expenses
$
270.4

 
$
188.0

 
44
%
 
$
512.2

 
$
377.9

 
36
%
Percentage of sales
19.8
%
 
16.6
%
 
+319 basis points

 
20.3
%
 
17.9
%
 
+246 basis points

Operating expenses, as a percentage of sales and in absolute dollars, for the quarter and year-to-date periods increased primarily due to the TAP acquisition. For the quarter, operating expenses included $2.0 million of Victory wind down costs and $3.7 million of TAP integration expenses. For the year-to-date period, operating expenses included $8.0 million of Victory wind down costs and $7.0 million of TAP integration expenses. In addition to these costs, research and development expenses increased for ongoing product refinement and innovation, and general and administrative costs have increased due to increased legal related expenses.
Income from Financial Services:
 
Three months ended June 30,
 
Six months ended June 30,
($ in millions)
2017
 
2016
 
Change
2017 vs. 2016
 
2017
 
2016
 
Change
2017 vs. 2016
Income from financial services
$
19.1

 
$
20.5

 
(6
)%
 
$
39.6

 
$
40.0

 
(1
)%
Percentage of sales
1.4
%
 
1.8
%
 
-41 basis points

 
1.6
%
 
1.9
%
 
-32 basis points

The decrease for the quarter and year-to-date periods in income from financial services is directly related to lower income generated from both the wholesale and retail portfolio, partially offset by increased income from the sale of extended service contracts. Further discussion can be found in the “Liquidity and Capital Resources” section below.

21


Remainder of the Income Statement:
 
Three months ended June 30,
 
Six months ended June 30,
($ in millions except per share data)
2017
 
2016
 
Change
2017 vs. 2016
 
2017
 
2016
 
Change
2017 vs. 2016
Interest expense
$
8.0

 
$
3.8

 
111
 %
 
$
15.9

 
$
6.7

 
139
 %
Equity in loss of other affiliates
$
1.3

 
$
1.6

 
(16
)%
 
$
3.2

 
$
3.6

 
(11
)%
Other expense (income), net
$
(2.2
)
 
$
1.8

 
(222
)%
 
$
9.5

 
$
1.9

 
401
 %
 
 
 
 
 
 
 
 
 
 
 
 
Income before taxes
$
92.0

 
$
109.8

 
(16
)%
 
$
91.6

 
$
182.0

 
(50
)%
Provision for income taxes
$
29.9

 
$
38.6

 
(23
)%
 
$
32.5

 
$
63.9

 
(49
)%
Percentage of income before taxes
32.5
%
 
35.2
%
 
-265 basis

 
35.5
%
 
35.1
%
 
+35 basis

 
 
 
 
 
points

 
 
 
 
 
points

Net income
$
62.0

 
$
71.2

 
(13
)%
 
$
59.1

 
$
118.1

 
(50
)%
Diluted net income per share:
$
0.97

 
$
1.09

 
(11
)%
 
$
0.92

 
$
1.80

 
(49
)%
Weighted average diluted shares outstanding
63.8

 
65.3

 
(2
)%
 
64.0

 
65.6

 
(2
)%
Interest expense: The quarter and year-to-date increase is primarily due to increases in debt levels related to the acquisition of TAP in November 2016 through borrowings on our term loan facility during the comparative periods.
Equity in loss of other affiliates: Quarter and year-to-date losses relate to continued operating activities at Eicher-Polaris Private Limited (EPPL). During the quarter, EPPL continued production of the jointly-developed Multix personal vehicle, which is specifically designed to satisfy the varied transportation needs of consumers in India. We have recorded our proportionate 50 percent share of EPPL losses.
Other expense (income), net: The quarter change primarily relates to foreign currency exchange rate movements and the corresponding effects on foreign currency transactions and balance sheet positions related to our foreign subsidiaries from period to period. The year-to-date change primarily relates to an impairment of a cost method investment recorded due to the wind down of Victory Motorcycles.
Provision for income taxes: The quarter tax rate decrease is partially due to a benefit recognized related to the adoption of the new employee share-based accounting standard adopted in the first quarter of 2017, and due to the impact of discrete tax events in the quarter.
Weighted average shares outstanding: Over the time period within and between the comparable quarter, weighted average shares outstanding decreased approximately two percent due primarily to share repurchases under our stock repurchase program.
Cash Dividends:
We paid a regular cash dividend of $0.58 per share on June 15, 2017 to holders of record at the close of business on June 1, 2017.

Liquidity and Capital Resources
Our primary source of funds has been cash provided by operating and financing activities. Our primary uses of funds have been for acquisitions, repurchase and retirement of common stock, capital investment, new product development and cash dividends to shareholders.
We believe that existing cash balances and cash flow to be generated from operating activities and borrowing capacity under the credit facility arrangement will be sufficient to fund operations, new product development, cash dividends, share repurchases and capital requirements for the foreseeable future. At this time, management is not aware of any factors that would have a material adverse impact on cash flow.

22


Cash Flows
The following table summarizes the cash flows from operating, investing and financing activities:
($ in millions)
Six months ended June 30,
2017
 
2016
 
Change
Total cash provided by (used for):
 
 
 
 
 
Operating activities
$
264.1

 
$
348.3

 
$
(84.2
)
Investing activities
(61.2
)
 
(159.3
)
 
98.1

Financing activities
(209.8
)
 
(198.4
)
 
(11.4
)
Impact of currency exchange rates on cash balances
7.0

 
0.7

 
6.3

Increase (decrease) in cash and cash equivalents
$
0.1

 
$
(8.7
)
 
$
8.8

Operating activities: The $84.2 million decrease in net cash provided by operating activities in 2017 is primarily the result of decreased net income, and increased working capital required. The increase in working capital for the six months ended June 30, 2017 was $52.0 million. Changes in working capital (as reflected in our statements of cash flows) was a decrease of $77.8 million, compared to an decrease of $129.8 million for the same period in 2016. This was primarily due to an increase in net cash used of $87.0 million related to inventory purchases, partially offset by a decrease in net cash used of $30.0 million related to payments made for accounts payable.
Investing activities: The primary use of cash was for the purchase of property and equipment, for continued capacity and capability at our manufacturing facilities. Investing activities for the comparative 2016 period includes the acquisition of Taylor-Dunn.
Financing activities: Cash used for financing activities changed primarily due to net repayments under debt arrangements, capital lease obligations and notes payable of $78.6 million compared to net borrowings of $4.3 million in the 2016 comparable period, and common stock repurchases of $65.6 million compared to $143.9 million in the 2016 comparable period. Additionally, we paid cash dividends of $72.6 million and $70.6 million for the six months ended June 30, 2017 and 2016, respectively. Proceeds from the issuance of stock under employee plans were $7.0 million and $11.8 million for the six months ended June 30, 2017 and 2016, respectively.
The seasonality of production and shipments cause working capital requirements to fluctuate during the year.
Debt and Capital
We are party to a $600 million variable interest rate bank lending agreement and a Master Note Purchase Agreement, as amended and supplemented, under which we have unsecured borrowings. We are also party to a $750 million term loan facility, of which $720 million is outstanding as of June 30, 2017.
We enter into leasing arrangements to finance the use of certain property and equipment.
We have a mortgage note payable agreement for land, on which Polaris built our Huntsville, Alabama manufacturing facility in 2016. The original mortgage note payable was for $14.5 million, of which $12.1 million is outstanding as of June 30, 2017