10-Q 1 pii-09302018x10xq.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 September 30, 2018
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, if any, every Interactive Data File required to be submitted 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 such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
x
Accelerated filer
¨
Non-accelerated filer
¨
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 October 17, 2018, 61,780,602 shares of Common Stock, $.01 par value, of the registrant were outstanding. 
 

1


 
  POLARIS INDUSTRIES INC.
FORM 10-Q
For Quarterly Period Ended September 30, 2018
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2


Part I FINANCIAL INFORMATION
Item 1 – FINANCIAL STATEMENTS
POLARIS INDUSTRIES INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
 
September 30, 2018
 
December 31, 2017
 
(Unaudited)
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
183,411

 
$
138,345

Trade receivables, net
217,694

 
200,144

Inventories, net
1,019,517

 
783,961

Prepaid expenses and other
105,066

 
101,453

Income taxes receivable
5,865

 
29,601

Total current assets
1,531,553

 
1,253,504

Property and equipment, net
807,511

 
747,189

Investment in finance affiliate
88,790

 
88,764

Deferred tax assets
116,447

 
115,511

Goodwill and other intangible assets, net
1,515,431

 
780,586

Other long-term assets
88,299

 
104,039

Total assets
$
4,148,031

 
$
3,089,593

Liabilities and Shareholders’ Equity
 
 
 
Current liabilities:
 
 
 
Current portion of debt, capital lease obligations and notes payable
$
66,595

 
$
47,746

Accounts payable
436,401

 
317,377

Accrued expenses:
 
 
 
Compensation
160,033

 
168,014

Warranties
122,544

 
123,840

Sales promotions and incentives
187,307

 
162,298

Dealer holdback
124,259

 
114,196

Other
179,738

 
186,103

Income taxes payable
8,963

 
10,737

Total current liabilities
1,285,840

 
1,130,311

Long-term income taxes payable
26,805

 
20,114

Capital lease obligations
16,712

 
18,351

Long-term debt
1,781,020

 
846,915

Deferred tax liabilities
7,054

 
10,128

Other long-term liabilities
122,728

 
120,398

Total liabilities
$
3,240,159

 
$
2,146,217

Deferred compensation
$
9,620

 
$
11,717

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, 61,773 and 63,075 shares issued and outstanding, respectively
$
618

 
$
631

Additional paid-in capital
799,607

 
733,894

Retained earnings
152,561

 
242,763

Accumulated other comprehensive loss, net
(54,534
)
 
(45,629
)
Total shareholders’ equity
898,252

 
931,659

Total liabilities and shareholders’ equity
$
4,148,031

 
$
3,089,593

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 September 30,
 
Nine months ended September 30,
 
2018
 
2017
 
2018
 
2017
Sales
$
1,651,415

 
$
1,478,726

 
$
4,451,420

 
$
3,997,428

Cost of sales
1,250,145

 
1,114,764

 
3,341,493

 
3,040,589

Gross profit
401,270

 
363,962

 
1,109,927

 
956,839

Operating expenses:
 
 
 
 
 
 
 
Selling and marketing
128,929

 
122,642

 
369,495

 
355,486

Research and development
64,181

 
63,129

 
197,741

 
175,887

General and administrative
90,639

 
79,421

 
262,206

 
245,998

Total operating expenses
283,749

 
265,192

 
829,442

 
777,371

Income from financial services
21,348

 
18,138

 
64,117

 
57,711

Operating income
138,869

 
116,908

 
344,602

 
237,179

Non-operating expense:
 
 
 
 
 
 
 
Interest expense
19,823

 
8,492

 
37,087

 
24,438

Equity in loss of other affiliates
111

 
1,603

 
25,576

 
4,839

Other expense (income), net
(4,124
)
 
(2,368
)
 
(27,660
)
 
7,088

Income before income taxes
123,059

 
109,181

 
309,599

 
200,814

Provision for income taxes
27,530

 
27,293

 
65,816

 
59,796

Net income
$
95,529

 
$
81,888

 
$
243,783

 
$
141,018

Net income per share:
 
 
 
 
 
 
 
Basic
$
1.54

 
$
1.31

 
$
3.88

 
$
2.24

Diluted
$
1.50

 
$
1.28

 
$
3.78

 
$
2.21

Weighted average shares outstanding:
 
 
 
 
 
 
 
Basic
62,207

 
62,646

 
62,894

 
62,890

Diluted
63,546

 
63,885

 
64,550

 
63,942


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 September 30,
 
Nine months ended September 30,
 
2018
 
2017
 
2018
 
2017
Net income
$
95,529

 
$
81,888

 
$
243,783

 
$
141,018

Other comprehensive income, net of tax:

 

 

 

Foreign currency translation adjustments
1,804

 
10,606

 
(12,099
)
 
41,042

Unrealized gain (loss) on derivative instruments
(2,111
)
 
(167
)
 
2,998

 
(1,208
)
Retirement plan activity
66

 

 
196

 

Comprehensive income
$
95,288

 
$
92,327

 
$
234,878

 
$
180,852

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

5


POLARIS INDUSTRIES INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
Nine months ended September 30,
 
2018
 
2017
Operating Activities:
 
 
 
Net income
$
243,783


$
141,018

Adjustments to reconcile net income to net cash provided by operating activities:



Depreciation and amortization
155,910


138,105

Noncash compensation
43,219


34,249

Noncash income from financial services
(22,232
)

(20,131
)
Deferred income taxes
(4,171
)

(2,703
)
Impairment charges
21,716


25,395

Other, net
(9,618
)

4,839

Changes in operating assets and liabilities:



Trade receivables
(991
)

(447
)
Inventories
(201,229
)

(83,621
)
Accounts payable
90,842


108,198

Accrued expenses
1,620


80,949

Income taxes payable/receivable
28,715


62,336

Prepaid expenses and others, net
6,574


8,908

Net cash provided by operating activities
354,138


497,095

Investing Activities:



Purchase of property and equipment
(157,763
)

(126,647
)
Investment in finance affiliate, net
22,207


43,230

Investment in other affiliates, net
7,366


(7,110
)
Acquisition and disposal of businesses, net of cash acquired
(729,925
)

1,645

Net cash used for investing activities
(858,115
)

(88,882
)
Financing Activities:



Borrowings under debt arrangements / capital lease obligations
2,845,688


1,623,577

Repayments under debt arrangements / capital lease obligations
(1,970,701
)

(1,850,247
)
Repurchase and retirement of common shares
(246,931
)

(88,877
)
Cash dividends to shareholders
(112,748
)

(108,923
)
Proceeds from stock issuances under employee plans
47,158


14,226

Net cash provided by (used for) financing activities
562,466


(410,244
)
Impact of currency exchange rates on cash balances
(5,904
)

9,597

Net increase in cash, cash equivalents and restricted cash
52,585


7,566

Cash, cash equivalents and restricted cash at beginning of period
161,618


145,170

Cash, cash equivalents and restricted cash at end of period
$
214,203


$
152,736

 
 
 
 
Supplemental Cash Flow Information:
 
 
 
Interest paid on debt borrowings
$
33,218


$
21,968

Income taxes paid (refunded)
$
40,178


$
(582
)
 



The following presents cash, cash equivalents and restricted cash by category within the consolidated balance sheets:



Cash and cash equivalents
$
183,411


$
132,260

Other long-term assets
30,792


20,476

Total
$
214,203


$
152,736

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, 2017 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, interest rate 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, interest rate, and commodity transactions.
Assets and liabilities measured at fair value on a recurring basis are summarized below (in thousands):
 
Fair Value Measurements as of September 30, 2018
Asset (Liability)
Total
 
Level 1
 
Level 2
 
Level 3
Non-qualified deferred compensation assets
$
50,161

 
$
50,161

 
$

 
$

Foreign exchange contracts, net
3,010

 

 
3,010

 

Interest rate contracts, net
779

 

 
779

 

Total assets at fair value
$
53,950

 
$
50,161

 
$
3,789

 
$

Non-qualified deferred compensation liabilities
$
(50,161
)
 
$
(50,161
)
 
$

 
$

Total liabilities at fair value
$
(50,161
)
 
$
(50,161
)
 
$

 
$

 
 
 
 
 
 
 
 
 
Fair Value Measurements as of December 31, 2017
Asset (Liability)
Total
 
Level 1
 
Level 2
 
Level 3
Non-qualified deferred compensation assets
$
54,244

 
$
54,244

 
$

 
$

Total assets at fair value
$
54,244

 
$
54,244

 
$

 
$

Non-qualified deferred compensation liabilities
$
(54,244
)
 
$
(54,244
)
 
$

 
$

Foreign exchange contracts, net
(426
)
 

 
(426
)
 

Total liabilities at fair value
$
(54,670
)
 
$
(54,244
)
 
$
(426
)
 
$

 

 

 

 



7


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 September 30, 2018 and December 31, 2017, the fair value of the Company’s long-term debt, capital lease obligations and notes payable was approximately $1,901,307,000 and $922,123,000, 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 $1,864,327,000 and $913,012,000 as of September 30, 2018 and December 31, 2017, 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 net realizable value. The major components of inventories are as follows (in thousands):
 
September 30, 2018
 
December 31, 2017
Raw materials and purchased components
$
249,259

 
$
194,108

Service parts, garments and accessories
345,716

 
307,684

Finished goods
477,293

 
329,288

Less: reserves
(52,751
)
 
(47,119
)
Inventories
$
1,019,517

 
$
783,961

Product warranties. Polaris provides a limited warranty for its vehicles and boats for a period of six months to ten years, depending on the product. 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 September 30,
 
Nine months ended September 30,
 
2018
 
2017
 
2018
 
2017
Balance at beginning of period
$
106,155

 
$
108,403

 
$
123,840

 
$
119,274

Additions to warranty reserve through acquisitions
13,799

 

 
13,799

 

Additions charged to expense
37,741

 
42,039

 
79,913

 
103,855

Warranty claims paid, net
(35,151
)
 
(38,357
)
 
(95,008
)
 
(111,044
)
Balance at end of period
$
122,544

 
$
112,085

 
$
122,544

 
$
112,085


New accounting pronouncements.
Revenue from contracts with customers. Effective January 1, 2018, the Company adopted ASU No. 2014-09, Revenue from Contracts with Customers, 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 using the modified retrospective approach. The adoption of these ASUs did not have a material impact on the Company’s consolidated financial position, results of operations, equity or cash flows as of the adoption date or for the three or nine months ended September 30, 2018. The Company has included the disclosures required by ASU 2014-09 in Note 2.
Statement of cash flows. During the first quarter of 2018, the Company adopted ASU No. 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. Prior periods were retrospectively adjusted to conform to the current period’s presentation. As a result of the adoption of ASU 2016-18, the Company recorded an increase of $2,631,000 in net cash provided by operating activities for the nine months ended September 30, 2017 related to reclassifying the changes in our restricted cash balance from operating activities to the cash and cash equivalent balances within the Consolidated Statements of Cash Flows.

8


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 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. Early adoption is permitted. Entities are required to use a modified retrospective approach, with an option to apply the transition provisions of the new standard at its adoption date instead of at the earliest comparative period presented. The Company plans to use a modified retrospective approach and apply the transition provisions at the adoption date. The Company developed a project plan to guide the implementation of ASU 2016-02. The Company made progress on this plan including surveying the Company’s businesses, assessing the Company’s portfolio of leases, compiling information on active leases, and selecting a lease accounting software. The Company is currently identifying and implementing appropriate changes to its policies, business processes, systems and controls to support lease accounting and disclosures under Topic 842. The Company does not expect that its results of operations or cash flows will be materially impacted by this standard. The Company expects to record right of use assets and lease liabilities on its consolidated balance sheets upon adoption of this standard, which may be material.
Derivatives and hedging. In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. This ASU better aligns accounting rules with a company’s risk management activities; better reflects economic results of hedging in financial statements; and simplifies hedge accounting treatment. The 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, with early adoption permitted. The Company is evaluating the impact of this new standard on the financial statements.
Non-employee share-based payments. In June 2018, the FASB issued ASU No. 2018-07, Compensation - Stock Compensation (Topic 718): Improvements to Non-employee Share-based Payment Accounting. The amendments of this ASU apply to all share-based payment transactions to non-employees, in which a grantor acquires goods or services to be used or consumed in a grantor’s own operations, accounted for under ASC 505-50, Equity-Based Payments to Non-Employees. Under the amendments of ASU 2018-07, most of the guidance on compensation to nonemployees would be aligned with the requirements for shared based payments granted to employees in Topic 718. The 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, with early adoption permitted. The Company is evaluating the impact of this new standard on the financial statements.
Income Taxes. The Tax Cuts and Jobs Act (the “Act”) was enacted on December 22, 2017. The Act reduces the U.S. federal corporate tax rate from 35% to 21%, requires companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred and creates new taxes on certain foreign-sourced earnings.  
The Company has applied the guidance in ASU 2018-05, Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118, when accounting for the enactment-date effects of the Act. At September 30, 2018, the Company has not completed its accounting for the tax effects of the Act, as the Company is in the process of analyzing certain aspects of the Act, obtaining information, and refining its calculations of the Act’s impact. There have been no material measurement period adjustments made during the three and nine months ended September 30, 2018 related to the provisional amounts recorded and disclosed in the Company’s fiscal 2017 Annual Report filed on Form 10-K.  The Company expects to complete the accounting for the tax effects of the Act during 2018.
There are no other new accounting pronouncements that are expected to have a significant impact on the Company’s consolidated financial statements.


9


Note 2. Revenue Recognition
The following tables disaggregate the Company’s revenue by major product type and geography (in thousands):
 
Three months ended September 30, 2018
 
ORV / Snowmobiles
 
Motorcycles
 
Global Adj. Markets
 
Aftermarket
 
Boats
 
Consolidated
Revenue by product type
 
 
 
 
 
 
 
 
 
 
 
Wholegoods
$
851,733

 
$
134,410

 
$
78,312

 

 
$
134,321

 
$
1,198,776

PG&A
183,821

 
20,906

 
17,939

 
$
229,973

 

 
452,639

Total revenue
$
1,035,554

 
$
155,316

 
$
96,251

 
$
229,973

 
$
134,321

 
$
1,651,415

 
 
 
 
 
 
 
 
 
 
 
 
Revenue by geography
 
 
 
 
 
 
 
 
 
 
 
United States
$
866,289

 
$
116,072

 
$
51,363

 
$
217,816

 
$
132,139

 
$
1,383,679

Canada
70,765

 
9,712

 
837

 
12,157

 
2,182

 
95,653

EMEA
64,218

 
15,706

 
42,893

 

 

 
122,817

APLA
34,282

 
13,826

 
1,158

 

 

 
49,266

Total revenue
$
1,035,554

 
$
155,316

 
$
96,251

 
$
229,973

 
$
134,321

 
$
1,651,415


 
Nine months ended September 30, 2018
 
ORV / Snowmobiles
 
Motorcycles
 
Global Adj. Markets
 
Aftermarket
 
Boats
 
Consolidated
Revenue by product type
 
 
 
 
 
 
 
 
 
 
 
Wholegoods
$
2,356,086

 
$
395,189

 
$
263,874

 

 
$
134,321

 
$
3,149,470

PG&A
502,873

 
63,096

 
59,122

 
$
676,859

 

 
1,301,950

Total revenue
$
2,858,959

 
$
458,285

 
$
322,996

 
$
676,859

 
$
134,321

 
$
4,451,420

 
 
 
 
 
 
 
 
 
 
 
 
Revenue by geography
 
 
 
 
 
 
 
 
 
 
 
United States
$
2,347,202

 
$
313,530

 
$
151,157

 
$
644,382

 
$
132,139

 
$
3,588,410

Canada
197,096

 
27,421

 
16,422

 
32,477

 
2,182

 
275,598

EMEA
207,779

 
74,044

 
151,982

 

 

 
433,805

APLA
106,882

 
43,290

 
3,435

 

 

 
153,607

Total revenue
$
2,858,959

 
$
458,285

 
$
322,996

 
$
676,859

 
$
134,321

 
$
4,451,420

Revenue is recognized when obligations under the terms of a contract with the Company’s customer are satisfied which generally occurs with the transfer of control of the wholegood vehicles, parts, garments or accessories, and upon completion of the service or over the term of the agreement in proportion to the costs expected to be incurred in satisfying the obligations under the contract, for services. Revenue is measured as the amount of consideration the Company expects to receive in exchange for transferring goods or providing services. Sales, value add, and other taxes the Company collects concurrent with revenue-producing activities are excluded from revenue. Incidental items that are immaterial in the context of the contract are recognized as expense. The expected costs associated with the Company’s limited warranties and field service bulletin actions continue to be recognized as expense when the products are sold. The Company recognizes revenue for vehicle service contracts that extend mechanical and maintenance beyond the Company’s limited warranties over the life of the contract.
ORV/Snowmobiles, Motorcycles and Global Adjacent Markets segments
Wholegood vehicles and parts, garments and accessories. For the majority of wholegood vehicles, parts, garments and accessories (PG&A), the Company transfers control and recognizes a sale when it ships the product from its manufacturing facility, distribution center, or vehicle holding center to its customer (primarily dealers and distributors). The amount of consideration the Company receives and revenue it recognizes varies with changes in marketing incentives and returns it offers to its dealers and their customers. Sales returns are not material. The Company adjusts its estimate of revenue at the earlier of when the most likely amount of consideration it expects to receive changes or when the consideration becomes fixed.

10


Depending on the terms of the arrangement, the Company may also defer the recognition of a portion of the consideration received because it has to satisfy a future obligation (e.g., free extended service contracts). The Company uses an observable price to determine the stand-alone selling price for separate performance obligations. The Company has elected to recognize the cost for freight and shipping when control over vehicles, parts, garments or accessories has transferred to the customer as an expense in Cost of sales.
Extended Service Contracts. The Company sells separately-priced service contracts that extend mechanical and maintenance coverages beyond its base limited warranty agreements to vehicle owners. The separately priced service contracts range from 12 months to 84 months. The Company primarily receives payment at the inception of the contract and recognizes revenue over the term of the agreement in proportion to the costs expected to be incurred in satisfying the obligations under the contract.
Aftermarket segment
The Company’s Aftermarket products are sold through dealer, distributor, retail, and e-commerce channels. The Company transfers control and recognizes a sale when products are shipped or delivered to its customer. The amount of consideration the Company receives and revenue it recognizes varies with changes in marketing incentives and return rights it offers to its customers and their customers. When the Company gives its customers the right to return eligible parts and accessories, it estimates the expected returns based on an analysis of historical experience. The Company adjusts its estimate of revenue at the earlier of when the most likely amount of consideration it expects to receive changes or when the consideration becomes fixed.
Service revenue. At the Company’s Transamerican Auto Parts (“TAP”) retail stores (4 Wheel Parts), it offers installation services for parts that the retail store sells. Service revenues are recognized upon completion of the service.
Depending on the terms of the arrangement, the Company may also defer the recognition of a portion of the consideration received because it has to satisfy a future obligation (e.g., extended service contracts). The Company uses an observable price to determine the stand-alone selling price for separate performance obligations. The Company has elected to recognize the cost for freight and shipping when control over parts, garments or accessories has transferred to the customer as an expense in cost of sales.
Boats segment
Boats. For the majority of boats, the Company transfers control and recognizes a sale when it ships the product from its manufacturing facility or distribution center to its customer (primarily dealers). The amount of consideration the Company receives and revenue it recognizes varies with changes in marketing incentives and returns it offers to its dealers and their customers. Sales returns are not material. The Company adjusts its estimate of revenue at the earlier of when the most likely amount of consideration it expects to receive changes or when the consideration becomes fixed. The Company has elected to recognize the cost for freight and shipping when control over boats has transferred to the customer as an expense in cost of sales.
Deferred revenue
In 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. Warranty costs are recognized as incurred. Revenues related to sales of its extended warranty program 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. TAP recognizes revenues related to sales of its extended warranty programs for tires and other products over the term of the warranty period, which varies from two to five years.
At January 1, 2018, $45,760,000 of unearned revenue associated with outstanding contracts was reported in other current liabilities and other long-term liabilities. At September 30, 2018, the unearned amount was $55,586,000. The Company expects to recognize approximately $23,893,000 of the unearned amount over the next 12 months and $31,693,000 thereafter. The activity in the deferred revenue reserve during the periods presented was as follows (in thousands):
 
Three months ended September 30,
 
Nine months ended September 30,
 
2018
 
2017
 
2018
 
2017
Balance at beginning of period
$
52,620

 
$
36,188

 
$
45,760

 
$
26,157

New contracts sold
8,054

 
6,962

 
25,226

 
22,076

Less: reductions for revenue recognized
(5,088
)
 
(3,130
)
 
(15,400
)
 
(8,213
)
Balance at end of period (1)
$
55,586

 
$
40,020

 
$
55,586

 
$
40,020


11


(1) The unamortized ESC premiums (deferred revenue) recorded in other current liabilities totaled $23,893,000 and $16,045,000 at September 30, 2018 and 2017, respectively, while the amount recorded in other long-term liabilities totaled $31,693,000 and $23,975,000 at September 30, 2018 and 2017, respectively.

Note 3. Acquisitions
2018 Acquisitions.
Boat Holdings, LLC
On July 2, 2018, pursuant to the Agreement and Plan of Merger dated May 29, 2018, the Company completed the acquisition of Boat Holdings, LLC, a privately held Delaware limited liability company, headquartered in Elkhart, Indiana which manufactures boats (“Boat Holdings”).
The transaction was structured as an acquisition of 100% of the outstanding equity interests in Boat Holdings for aggregate consideration of $806,658,000, net of cash acquired, subject to customary adjustments based on, among other things, the amount of cash, debt and working capital in the business of Boat Holdings at the closing date. A portion of the aggregate consideration equal to $100,000,000 will be paid in the form of a series of deferred annual payments over 12 years following the closing date.
The Company funded the purchase price for the acquisition by amending, extending, and up-sizing the Credit Facility and with the proceeds of the issuance of 4.23% Senior Notes, Series 2018, due July 3, 2028, described in Note 5.
The consolidated statements of income for both the three and nine months ended September 30, 2018 include $134,321,000 of net sales and $20,253,000 of gross profit related to Boats.
The following table summarizes the preliminary fair values assigned to the Boat Holdings net assets acquired and the determination of net assets (in thousands):
Cash and cash equivalents
$
16,534

Trade receivables
17,602

Inventory
39,990

Other current assets
3,938

Property, plant and equipment
36,769

Customer relationships
341,080

Trademarks / trade names
210,680

Non-compete agreements
2,630

Goodwill
207,126

Accounts payable
(30,017
)
Other liabilities assumed
(23,140
)
Total fair value of net assets acquired
823,192

Less cash acquired
(16,534
)
Total consideration for acquisition, less cash acquired
$
806,658


On the acquisition date, amortizable intangible assets had a weighted-average useful life of approximately 19 years. The customer relationships were valued based on the Discounted Cash Flow Method and are amortized over 15-20 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 2018 acquisition of Boat Holdings had occurred at the beginning of fiscal 2017 (in thousands, except per share data).
 
Three months ended September 30,
 
Nine months ended September 30,
 
2018
 
2017
 
2018
 
2017
Net sales
$
1,651,415

 
$
1,593,659

 
$
4,802,580

 
$
4,410,691

Net income
99,224

 
81,473

 
268,660

 
149,517

 
 
 
 
 
 
 
 
Basic earnings per share
$
1.60

 
$
1.30

 
$
4.27

 
$
2.38

Diluted earnings per common share
$
1.56

 
$
1.28

 
$
4.16

 
$
2.34


12



The results for the quarter and year-to-date periods ended September 30, 2018 and 2017 have been adjusted to include the pro forma impact of amortization of intangible assets and the depreciation of property, plant, and equipment, based on purchase price allocations; the pro forma impact of additional interest expense relating to the acquisition; the pro forma impact of transaction related costs incurred by the Company directly attributable to the transaction; and the pro forma tax effect of both income before taxes and the pro forma adjustments. These performance results may not be indicative of the actual results that would have occurred under the ownership and management of the Company.
The results for the quarter and year-to-date periods ended September 30, 2018 have been adjusted to exclude the impact of approximately $4,849,000 and $8,918,000 of transaction related costs (pre-tax) incurred by the Company that are directly attributable to the transaction.
The pro forma financial information has been prepared for comparative purposes only and includes certain adjustments, as noted above. The adjustments are estimates based on currently available information and actual amounts may differ materially from these estimates. They do not reflect the effect of costs or synergies that would have been expected to result from the integration of the Boat Holdings acquisition.
2017 Acquisitions.
The Company did not complete any acquisitions in 2017.

Note 4. 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 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 September 30,
 
Nine months ended September 30,
 
2018
 
2017
 
2018
 
2017
Option plan
$
6,821

 
$
5,766

 
$
16,636

 
$
12,837

Other share-based awards
(748
)
 
(3,919
)
 
18,988

 
18,191

Total share-based compensation before tax
6,073

 
1,847

 
35,624

 
31,028

Tax benefit
1,446

 
686

 
8,479

 
11,524

Total share-based compensation expense included in net income
$
4,627

 
$
1,161

 
$
27,145

 
$
19,504

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 September 30, 2018, there was $113,879,000 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 1.49 years. Included in unrecognized share-based compensation expense is approximately $30,570,000 related to stock options and $83,309,000 for restricted stock.


13


Note 5. Financing Agreements
The carrying value of debt, capital lease obligations, and notes payable and the average related interest rates were as follows (in thousands):
 
Average interest rate at September 30, 2018
 
Maturity
 
September 30, 2018
 
December 31, 2017
Revolving loan facility
1.84%
 
July 2023
 
$
74,023

 
$
3,000

Term loan facility
3.77%
 
July 2023
 
1,165,000

 
680,000

Senior notes—fixed rate
3.81%
 
May 2018
 

 
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

Senior notes—fixed rate
4.23%
 
July 2028
 
350,000

 

Capital lease obligations
5.25%
 
Various through 2029
 
18,052

 
19,889

Notes payable and other
4.23%
 
Various through 2030
 
87,608

 
12,384

Debt issuance costs
 
 
 
 
(5,356
)
 
(2,261
)
Total debt, capital lease obligations, and notes payable
 
 
 
 
$
1,864,327

 
$
913,012

Less: current maturities
 
 
 
 
66,595

 
47,746

Total long-term debt, capital lease obligations, and notes payable
 
 
 
 
$
1,797,732

 
$
865,266

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.
In July 2018, Polaris amended the revolving loan facility to increase the facility to 700,000,000 and increase the term loan facility to $1,180,000,000, of which $1,165,000,000 is outstanding as of September 30, 2018. The expiration date of the facility was extended to July 2023, and interest will continue to be charged at rates based on a LIBOR or “prime” base rate. Under the facility, the Company is required to make principal payments totaling $59,000,000 over the next 12 months, which are classified as current maturities.
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. In July 2018, the Company entered into a Master Note Purchase Agreement to issue $350,000,000 of unsecured senior notes due July 2028.
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 at September 30, 2018.
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.
As a component of the Boat Holdings merger agreement, Polaris has committed to make a series of deferred payments to the former owners following the closing date of of the merger through July 2030. The original discounted payable was for $76,733,000, all of which is outstanding as of September 30, 2018. The outstanding balance is included in long-term debt.
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 $10,875,000 is outstanding as of September 30, 2018. The outstanding balance is included in Notes payable and other. The payment of principal and interest for the note payable is forgivable if the Company satisfies certain job commitments over the term of the

14


note. The Company has met the required commitments to date. Forgivable loans related to other Company facilities are also included within notes payable.

Note 6. Goodwill and Other Intangible Assets
Goodwill and other intangible assets, net of accumulated amortization, at September 30, 2018 and December 31, 2017 are as follows (in thousands):
 
September 30, 2018
 
December 31, 2017
Goodwill
$
637,486

 
$
433,374

Other intangible assets, net
877,945

 
347,212

Total goodwill and other intangible assets, net
$
1,515,431

 
$
780,586

Additions to goodwill and other intangible assets in 2018 relate to the acquisition of Boat Holdings in July 2018. The aggregate purchase price was allocated on a preliminary basis to the assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition. Boat Holding’s financial results are included in the Company’s consolidated results from the date of acquisition. As of September 30, 2018, the purchase price allocation remains preliminary. The pro forma financial results and the preliminary purchase price allocation are included in Note 3. There were no material additions to goodwill and other intangible assets for the three and nine months ended September 30, 2017.
The changes in the carrying amount of goodwill for the nine months ended September 30, 2018 were as follows (in thousands):
 
Nine months ended September 30, 2018
Goodwill, beginning of period
$
433,374

Goodwill from businesses acquired
207,126

Currency translation effect on foreign goodwill balances
(3,014
)
Goodwill, end of period
$
637,486

The components of other intangible assets were as follows (in thousands):
 
Total estimated life (years)
 
September 30, 2018
 
December 31, 2017
Non-amortizable—indefinite lived:
 
 
 
 
 
Brand names
 
 
$
440,976

 
$
230,709

Amortizable:
 
 
 
 
 
Non-compete agreements
4
 
2,370

 
540

Dealer/customer related
5-20
 
505,543

 
169,694

Developed technology
5-7
 
13,368

 
22,903

Total amortizable
 
 
521,281

 
193,137

Less: Accumulated amortization
 
 
(84,312
)
 
(76,634
)
Net amortized other intangible assets
 
 
436,969

 
116,503

Total other intangible assets, net
 
 
$
877,945

 
$
347,212

Amortization expense for intangible assets for the three and nine months ended September 30, 2018 was $10,403,000 and $22,586,000, respectively, compared to $6,344,000 and $18,792,000 for the comparable prior year periods. Estimated amortization expense for the remainder of 2018 through 2023 is as follows: 2018 (remainder), $10,500,000; 2019, $40,500,000; 2020, $35,500,000; 2021, $32,700,000; 2022, $27,700,000; 2023, $25,300,000; and after 2023, $264,800,000. 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 7. Shareholders’ Equity
During the nine months ended September 30, 2018, Polaris paid $246,931,000 to repurchase approximately 2,069,000 shares of its common stock. As of September 30, 2018, the Board of Directors has authorized the Company to repurchase up to an additional 4,367,000 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

15


cash dividend of $0.60 per share on September 17, 2018 to holders of record at the close of business on August 31, 2018. On October 24, 2018, the Polaris Board of Directors declared a regular cash dividend of $0.60 per share payable on December 17, 2018 to holders of record of such shares at the close of business on December 3, 2018.
Cash dividends declared and paid per common share for the three and nine months ended September 30, 2018 and 2017, were as follows: 
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Cash dividends declared and paid per common share
 
$
0.60

 
$
0.58

 
$
1.80

 
$
1.74

Net income per share
Basic income 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”) and the ESOP and deferred stock units under the 2007 Omnibus Incentive Plan (“Omnibus Plan”). Diluted income 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 September 30,
 
Nine months ended September 30,
 
2018
 
2017
 
2018
 
2017
Weighted average number of common shares outstanding
61,927
 
62,398

 
62,630
 
62,637

Director Plan and deferred stock units
181
 
161

 
175
 
154

ESOP
99
 
87

 
89
 
99

Common shares outstanding—basic
62,207
 
62,646

 
62,894
 
62,890

Dilutive effect of Omnibus Plan
1,339
 
1,239

 
1,656
 
1,052

Common and potential common shares outstanding—diluted
63,546
 
63,885

 
64,550
 
63,942

During the three and nine months ended September 30, 2018, the number of options that were not included in the computation of diluted income per share because the option exercise price was greater than the market price, and therefore, the effect would have been anti-dilutive, were 1,785,000 and 1,713,000, respectively, compared to 2,892,000 and 2,816,000 for the same periods in 2017.
Accumulated other comprehensive loss
Changes in the accumulated other comprehensive loss balance are as follows (in thousands):
 
Foreign
Currency
Items
 
Cash Flow
Hedging Derivatives
 
Retirement Plan Activity
 
Accumulated Other
Comprehensive Loss
Balance as of December 31, 2017
$
(42,442
)
 
$
(34
)
 
$
(3,153
)
 
$
(45,629
)
Reclassification to the statement of income

 
(7,141
)
 
196

 
(6,945
)
Change in fair value
(12,099
)
 
10,139

 

 
(1,960
)
Balance as of September 30, 2018
$
(54,541
)
 
$
2,964

 
$
(2,957
)
 
$
(54,534
)

16


The table below provides data about the amount of gains and losses, net of tax, reclassified from accumulated other comprehensive loss into the statements of income for cash flow derivatives designated as hedging instruments for the three and nine months ended September 30, 2018 and 2017 (in thousands): 
Derivatives in Cash
Flow Hedging Relationships
Location of (Gain) Loss Reclassified from Accumulated Other Comprehensive Loss into Income
 
Three months ended September 30,
 
Nine months ended September 30,
 
2018
 
2017
 
2018
 
2017
Foreign currency contracts
Other expense, net
 
$
4,587

 
$
(174
)
 
$
6,681

 
$
2,433

Foreign currency contracts
Cost of sales
 
(62
)
 
258

 
460

 
(178
)
Retirement benefit plan activity
Operating expenses
 
(66
)
 

 
(196
)
 

Total
 
 
$
4,459

 
$
84

 
$
6,945

 
$
2,255

The net amount of the existing gains or losses at September 30, 2018 that is expected to be reclassified into the statements of income within the next 12 months is not expected to be material. See Note 11 for further information regarding Polaris’ derivative activities.

Note 8. 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” 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 $88,790,000 at September 30, 2018 is accounted for under the equity method, and is recorded in investment in finance affiliate in the accompanying consolidated balance sheets. At September 30, 2018, the outstanding amount of net receivables financed for dealers under this arrangement was $1,237,689,000, which included $566,102,000 in the Polaris Acceptance portfolio and $671,587,000 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 2018, the potential 15 percent aggregate repurchase obligation is approximately $164,969,000. 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 9. Investment in Other Affiliates
The Company has certain investments in nonmarketable securities of strategic companies. As of December 31, 2017, the Company’s investment in Eicher-Polaris Private Limited (EPPL) represented the majority of these investments and is recorded as a component of other long-term assets in the accompanying consolidated balance sheets.

17


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.
During the first quarter of 2018, the Board of Directors of EPPL approved a shut down of the operations of the EPPL joint venture. As a result of the expected closure, the Company fully impaired its investment in EPPL by recognizing an impairment charge of $18,733,000 within Equity in loss of other affiliates in the consolidated statement of income. The Company has recognized $0 and $23,447,000 of costs, including impairment, associated with the wind-down of EPPL for the three and nine months ended September 30, 2018, respectively.
As of September 30, 2018 and December 31, 2017, the carrying value of the Company’s investment in EPPL was $0 and $18,616,000, respectively.
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® Motorcycles wind down, the Company recognized an impairment of substantially all of its cost-method investment in Brammo, Inc. in the first quarter of 2017. See Note 13 for additional discussion related to charges incurred related to the Victory Motorcycles wind down.
In October 2017, an agreement was signed to sell the assets of Brammo, Inc. to a third party. The sale was completed in the fourth quarter of 2017, and as a result of the sale, Polaris recognized a gain, which is included in Other expense (income), net on the 2017 consolidated statements of income. During the first quarter of 2018, Polaris received additional distributions from Brammo and recognized a gain of $13,478,000, which is included in Other expense (income) on the consolidated statements of income.

Note 10. Commitments and Contingencies
Polaris is subject to product liability claims in the normal course of business. The Company carries excess insurance coverage for catastrophic product liability claims. 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 estimable. 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 September 30, 2018, the Company had an accrual of $55,320,000 for the probable payment of pending claims related to continuing product liability litigation associated with Polaris products. This accrual is included as a component of other accrued expenses in the accompanying consolidated balance sheets.
Polaris is also a defendant in lawsuits and subject to other claims arising in the normal course of business, including matters related to intellectual property, commercial matters, product liability claims, and putative class action lawsuits. As of September 30, 2018, the Company is party to two putative class actions pending against Polaris in the United States, alleging that certain Polaris products caused personal injury, economic losses, and other damages resulting from unresolved fire hazards and excessive heat hazards. The Company is unable to provide an evaluation of the likelihood that a loss will be incurred or an estimate of the range of possible loss.
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, results of operations, or cash flows. However, in many of these matters, it is inherently difficult to determine whether a loss is probable or reasonably possible or to estimate the size or range of the possible loss given the variety and potential outcomes of actual and potential claims, the uncertainty of future rulings, the behavior or incentives of adverse parties, and other factors outside of the control of the Company. Accordingly, the Company’s loss reserve may change from time to time, and actual losses could exceed the amounts accrued by an amount that could be material to our consolidated financial position, results of operations, or cash flows in any particular reporting period.
In the normal course of business, the Company’s products are subject to extensive laws and regulations relating to safety, environmental and other regulations promulgated by the United States federal government and individual states, as well as international regulatory authorities. Failure to comply with applicable regulations could result in fines, penalties or other costs. 


18


Note 11. 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 occasionally 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 September 30, 2018, Polaris had the following open foreign currency contracts (in thousands):
Foreign Currency
 
Notional Amounts
(in U.S. Dollars)
 
Net Unrealized Gain
Australian Dollar
 
$
7,350

 
$
577

Canadian Dollar
 
104,486

 
1,451

Mexican Peso
 
20,023

 
982

Total
 
$
131,859

 
$
3,010

These contracts, with maturities through September 2019, met the criteria for cash flow hedges, and are recorded in other current assets or other current liabilities on the consolidated balance sheet. The unrealized gains or losses, after tax, are recorded as a component of accumulated other comprehensive loss in shareholders’ equity.
During the third quarter of 2018, the Company entered into interest rate swap transactions to hedge the variable interest rate payments for the Term Loan Facility. In connection with this transaction, the Company will pay interest based upon a fixed rate and receive variable rate interest payments based on the one-month LIBOR.
At September 30, 2018, Polaris had the following open interest rate swap contracts (in thousands):
Effective Date
 
Termination Date
 
Notional Amounts
 
Net Unrealized Gain (Loss)
May 2, 2018
 
May 4, 2021
 
$
25,000

 
$
682

September 28, 2018
 
September 30, 2019
 
250,000

 
(65
)
September 30, 2019
 
September 30, 2023
 
150,000

 
162

Total
 
 
 
$
425,000

 
$
779

These contracts, with maturities through September 2023, met the criteria for cash flow hedges, and are recorded in other current assets or other current liabilities on the consolidated balance sheet. The unrealized gains or losses, after tax, are recorded as a component of accumulated other comprehensive loss in shareholders’ equity.

19


The table below summarizes the carrying values of derivative instruments as of September 30, 2018 and December 31, 2017 (in thousands):
 
Carrying Values of Derivative Instruments as of September 30, 2018
 
Fair Value—
Assets
 
Fair Value—
(Liabilities)
 
Derivative Net
Carrying Value
Derivatives designated as hedging instruments
 
 
 
 
 
Foreign exchange contracts(1)
$
3,010

 
$

 
$
3,010

Interest rate contracts(1)
779

 

 
779

Total derivatives designated as hedging instruments
$
3,789

 
$

 
$
3,789

Total derivatives
$
3,789

 
$

 
$
3,789

 
Carrying Values of Derivative Instruments as of December 31, 2017
 
Fair Value—
Assets
 
Fair Value—
(Liabilities)
 
Derivative Net
Carrying Value
Derivatives designated as hedging instruments
 
 
 
 
 
Foreign exchange contracts(1)
$
621

 
$
(1,047
)
 
$
(426
)
Total derivatives designated as hedging instruments
$
621

 
$
(1,047
)
 
$
(426
)
Total derivatives
$
621

 
$
(1,047
)
 
$
(426
)
(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 statements of income in the same period or periods during which the hedged transaction affects the statements of income. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in the current statement of income.
The amount of gains (losses), net of tax, related to the effective portion of derivative instruments designated as cash flow hedges included in accumulated other comprehensive income (loss) for the three and nine months ended September 30, 2018 were $(2,111,000) and $2,998,000, respectively, compared to $(167,000) and $(1,208,000) for the same respective periods in 2017.
See Note 7 for information about the amount of gains and losses, net of tax, reclassified from accumulated other comprehensive loss into the statements of income for derivative instruments designated as hedging instruments. The ineffective portion of foreign currency contracts was not material for the three and nine month period ended September 30, 2018.

Note 12. 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 six operating segments: 1) ORV, 2) Snowmobiles, 3) Motorcycles, 4) Global Adjacent Markets, 5) Aftermarket, and 6) Boats, and five reportable segments: 1) ORV/Snowmobiles, 2) Motorcycles, 3) Global Adjacent Markets, 4) Aftermarket, and 5) Boats.
Through June 30, 2018, the Company reported under four segments for segment reporting. However, during the third quarter ended September 30, 2018, as a result of the Boat Holdings acquisition, the Company established a new reporting segment, Boats, which includes only the results of Boat Holdings. As such, the comparative 2017 results were not required to be reclassified as the new reporting segment structure did not impact historical segments.
The ORV/Snowmobiles segment includes the aggregated results of our ORV and Snowmobiles operating segments. The Motorcycles, Global Adjacent Markets, Aftermarket, and Boats 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):

20


 
Three months ended September 30,
 
Nine months ended September 30,
 
2018
 
2017
 
2018
 
2017
Sales
 
 
 
 
 
 
 
ORV/Snowmobiles
$
1,035,554

 
$
1,007,392

 
$
2,858,959

 
$
2,577,003

Motorcycles
155,316

 
155,059

 
458,285

 
473,345

Global Adjacent Markets
96,251

 
91,575

 
322,996

 
280,152

Aftermarket
229,973

 
224,700

 
676,859

 
666,928

Boats
134,321

 

 
134,321

 

Total sales
$
1,651,415

 
$
1,478,726

 
$
4,451,420

 
$
3,997,428

Gross profit
 
 
 
 
 
 
 
ORV/Snowmobiles
$
290,631

 
$
296,904

 
$
831,413

 
$
776,013

Motorcycles
19,577

 
10,354

 
60,817

 
11,589

Global Adjacent Markets
24,155

 
15,983

 
83,520

 
65,297

Aftermarket
66,092

 
63,239

 
182,291

 
164,721

Boats
20,253

 

 
20,253

 

Corporate
(19,438
)
 
(22,518
)
 
(68,367
)
 
(60,781
)
Total gross profit
$
401,270

 
$
363,962

 
$
1,109,927

 
$
956,839


Note 13. Victory Motorcycles Wind Down
In January 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 pretax charges of $1,281,000 and $3,911,000 for the three and nine month periods ended September 30, 2018, respectively, compared to $2,666,000 and $59,131,000 for the same respective periods in 2017, that are within the scope of ASC 420, Exit or Disposal Cost Obligations (ASC 420). These totals exclude the negative pretax impact of $233,000 and positive pretax impact of $2,154,000 incurred for other wind-down activities for the three and nine month periods ended September 30, 2018, respectively, and the negative pretax impact of $6,143,000 and $18,109,000 incurred for other wind-down activities for the three and nine month periods ended September 30, 2017, respectively. The Company estimates that the total impact of wind down activities in 2018 will be $5,000,000, inclusive of promotional activity. Substantially all costs related to wind down activities are expected to be recognized by the end of 2018.
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. The wind down expenses have been included as components of cost of sales, selling and marketing expenses, general and administrative expenses or other expense (income), net, in the consolidated statements of income. Charges related to the wind down plan for the three and nine months ended September 30, 2018 and 2017 within the scope of ASC 420 were as follows (in thousands):
 
Three months ended September 30,
 
Nine months ended September 30,
 
2018
 
2017
 
2018
 
2017
Contract termination charges
$
1,149

 
$
1,501

 
$
2,866

 
$
19,196

Asset impairment charges

 

 

 
18,760

Inventory charges

 

 

 
12,680

Other costs
132

 
1,165

 
1,045

 
8,495

Total
$
1,281

 
$
2,666

 
$
3,911

 
$
59,131


Total reserves related to the Victory Motorcycles wind down activities are $3,029,000 as of September 30, 2018. These reserves are included in other accrued expenses and inventory in the consolidated balance sheets. Changes to the reserves during the nine months ended September 30, 2018 were as follows (in thousands):

21


 
Contract termination charges
 
Inventory charges
 
Other costs
 
Total
Reserves balance as of December 31, 2017
$
3,187

 
$
777

 
$
1,681

 
$
5,645

Expenses
2,866

 

 
1,045

 
3,911

Cash payments / scrapped inventory
(4,907
)
 
(85
)
 
(1,535
)
 
(6,527
)
Reserves balance as of September 30, 2018
$
1,146

 
$
692

 
$
1,191

 
$
3,029


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 nine month periods ended September 30, 2018 compared to the three and nine month periods ended September 30, 2017. 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 Commercial, Government, and Defense vehicles; boats; 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 $95.5 million, or $1.50 per diluted share, compared to 2017 third quarter net income of $81.9 million, or $1.28 per diluted share. Third quarter sales totaled $1,651.4 million, an increase of 12 percent from last year’s third quarter sales of $1,478.7 million. The sales increase was driven primarily by the acquisition of Boat Holdings and strong ORV sales. Our unit retail sales to consumers in North America increased one percent in the third quarter of 2018, primarily driven by increased retail demand for side-by-sides. Our third quarter sales to North American customers increased 12 percent, driven by Boats and growth in ORV. Our sales to customers outside of North America increased 10 percent, primarily driven by strong sales in Snowmobiles and motorcycles, partially offset by foreign exchange movements.
Our gross profit of $401.3 million increased 10 percent from $364.0 million in the comparable prior year third quarter . The increase in gross profit dollars during the quarter was primarily driven by increased sales, primarily related to the Boat Holdings acquisition. The slight decrease in gross profit margins was driven by the impact of commodity, freight and tariff cost pressure, partially offset by lower promotional costs. Additionally, quarter gross profit was affected negatively as a result of $5.4 million and $13.8 million of wind-down, realignment and supply chain transformation costs, in 2018 and 2017, respectively. Our liquidity remained adequate with $183.4 million of cash on hand and $625.8 million of availability on the revolving loan facility at September 30, 2018.
As a result of our decision to wind down the Victory Motorcycles brand, total non-recurring wind down activities had a negative pretax impact of $1.5 million and $1.8 million for the three and nine month periods ended September 30, 2018, respectively. Total wind down activities had a negative pretax impact of $8.8 million and $77.2 million for the three and nine month periods ended September 30, 2017, respectively. We estimate the total pre-tax impact of non-recurring wind down activities in 2018 to be approximately $5.0 million. Substantially all costs related to wind down activities are expected to be recognized by the end of 2018.
During the third quarter, the Company completed the acquisition of Boat Holdings, LLC, headquartered in Elkhart, Indiana. The transaction was structured as an acquisition of 100% of the outstanding equity interests in Boat Holdings for aggregate consideration of $806.7 million, subject to customary adjustments based on, among other things, the amount of cash, debt and working capital in the business of Boat Holdings at the closing date. A portion of the aggregate consideration equal to $100.0 million will be paid in the form of a series of deferred annual payments over 12 years following the closing date. The Company funded the purchase price for the acquisition by amending, extending, and up-sizing the Credit Facility and with the proceeds of the issuance of 4.23% Senior Notes, Series 2018, due July 3, 2028.


22


Results of Operations
Unless otherwise noted, all “quarter” comparisons are from the third quarter 2018 to the third quarter 2017, and all “year-to-date” comparisons are from the nine month period ended September 30, 2018 to the nine month period ended September 30, 2017.
Sales:
Quarter sales were $1,651.4 million, a 12 percent increase from $1,478.7 million of quarter sales in the prior year. Year to date sales were $4,451.4 million, an 11 percent increase from $3,997.4 million of sales in the comparable prior year period. The consolidated statements of income for both the three and nine months ended September 30, 2018 include $134.3 million of net sales related to Boat Holdings. 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
 
Nine months ended
 
September 30, 2018
 
September 30, 2018
Volume
3
 %
 
6
%
Product mix and price
1

 
1

Acquisitions
9

 
3

Currency
(1
)
 
1

 
12
 %
 
11
%
The volume increase is primarily driven by strong ORV and Global Adjacent Market sales.
Our sales by reporting segment, which includes the respective PG&A, were as follows:
 
Three months ended September 30,
 
Nine months ended September 30,
($ in millions) 
2018
 
Percent
of Total
Sales 
 
2017
 
Percent
of Total
Sales 
 
Percent
Change
2018 vs.
2017
 
2018
 
Percent
of Total
Sales 
 
2017
 
Percent
of Total
Sales 
 
Percent
Change
2018 vs.
2017
ORV/Snowmobiles
$
1,035.5

 
63
%
 
$
1,007.4

 
68
%
 
3
%
 
$
2,858.9

 
64
%
 
$
2,577.0

 
64
%
 
11
 %
Motorcycles
155.3

 
9
%
 
155.1

 
11
%
 
0
%
 
458.3

 
10
%
 
473.3

 
12
%
 
(3
)%
Global Adjacent Markets
96.3

 
6
%
 
91.5

 
6
%
 
5
%
 
323.0

 
7
%
 
280.2

 
7
%
 
15
 %
Aftermarket
230.0

 
14
%
 
224.7

 
15
%
 
2
%
 
676.9

 
16
%
 
666.9

 
17
%
 
1
 %
Boats
134.3

 
8
%
 
0.0

 
0
%
 
100
%
 
134.3

 
3
%
 
0.0

 
0
%
 
100
 %
Total sales
$
1,651.4

 
100
%
 
$
1,478.7

 
100
%
 
12
%
 
$
4,451.4

 
100
%
 
$
3,997.4

 
100
%
 
11
 %
ORV/Snowmobiles
ORVs: Quarter and year-to-date sales, including PG&A, increased 12 and 15 percent, respectively, primarily due to strong RANGER®, RZR®, and ATV shipments. Sales outside North America increased five percent in the quarter, primarily due to increased side-by-side shipments. The quarter average per unit sales price increased five percent compared to the prior year.
Our North American ORV quarter unit retail sales to consumers increased low-single digit percent compared to the 2017 third quarter, with consumer purchases of side-by-side vehicles, which include RANGER, RZR, and Polaris GENERALincreasing low-single digit percent, and ATVs decreasing low-single digit percent over the prior year. The Company estimates that North American industry ORV retail sales were up low-single digit percent from the third quarter of 2017. Polaris’ North American dealer unit inventory was up mid-teens percent compared to the third quarter of 2017 and we believe are now at more normalized levels.
Snowmobiles: Quarter and year-to-date sales, including PG&A, were $80.4 million and $125.7 million, respectively, compared to $156.5 million and $199.3 million for the comparable prior year period. The changes are due to the timing of shipments of pre-season snowmobile orders year-over-year.
Motorcycles
Quarter sales, including PG&A, were flat compared to the prior year, while year-to-date sales were down three percent compared to the prior year due to a weak motorcycle industry. The quarter average per unit sales price decreased four percent, excluding Victory Motorcycles, driven by a shift in sales mix towards more mid-sized motorcycles.

23


North American consumer retail sales for Indian Motorcycle and Slingshot decreased high-single digits percent for the quarter. Indian Motorcycle retail sales increased low-single digit percent, in spite of an overall weak N.A. motorcycle market. Slingshot retail sales were down high-twenties percent during the quarter. Motorcycle industry retail sales, 900cc and above, decreased low-teens percent in the quarter. Indian Motorcycle gained market share for the 2018 third quarter on a year-over-year basis. North American Polaris dealer inventory was flat in the quarter compared to the same period last year.
Global Adjacent Markets
Quarter and year-to-date sales increased due primarily to strong Commercial, Government, Defense, and Polaris Adventures sales.
Aftermarket
Quarter and year-to-date sales, which include Transamerican Auto Parts (TAP), along with our other aftermarket brands of Klim, Kolpin, ProArmor, Trail Tech and 509, increased two and one percent, respectively. The growth was primarily driven by the aftermarket brands strong pre-season snow orders. TAP sales in the third quarter were down slightly, and impacted by delayed accessory development work and weakness in business-to-business sales in the South and Southwest United States.
Boats
Segment sales, which relate to the Boat Holdings acquisition which closed on July 2, 2018, were $134.3 million in the third quarter.
Sales by Geography
Sales by geographic region were as follows:
 
Three months ended September 30,
 
Nine months ended September 30,
($ in millions)
2018
 
Percent of Total Sales
 
2017
 
Percent of Total Sales 
 
Percent Change 2018 vs. 2017
 
2018
 
Percent of Total Sales
 
2017
 
Percent of Total Sales 
 
Percent Change 2018 vs. 2017
United States
$
1,383.7

 
84
%
 
$
1,202.0

 
81
%
 
15
 %
 
$
3,588.4

 
81
%
 
$
3,217.2

 
80
%
 
12
%
Canada
95.7

 
6
%
 
120.0

 
8
%
 
(20)
 %
 
275.6

 
6
%
 
266.1

 
7
%
 
4
%
Other foreign countries
172.0

 
10
%
 
156.7

 
11
%
 
10
 %
 
587.4

 
13
%
 
514.1

 
13
%
 
14
%
Total sales
$
1,651.4

 
100
%
 
$
1,478.7

 
100
%
 
12
 %
 
$
4,451.4

 
100
%
 
$
3,997.4

 
100
%
 
11
%
 
United States: Quarter and year-to-date sales in the U.S. increased primarily due to increased ORV shipments and the addition of Boat Holdings.
Canada: Quarter sales in Canada decreased primarily due to the timing of shipments of pre-season snowmobile orders year-over-year, while year-to-date sales in Canada increased due to increased ORV shipments. Currency rate movements had an unfavorable impact of four percent on quarter sales and a favorable impact of one percent on year-to-date sales.
Other foreign countries: Quarter and year-to-date sales in other foreign countries increased due to increased shipments of all segments. Currency rate movements had an unfavorable impact of three percent on quarter sales and a favorable impact of four percent on year-to-date sales.

24


Cost of Sales:  
 
Three months ended September 30,
 
Nine months ended September 30,
($ in millions)
2018
 
Percent of Total Cost of Sales
 
2017
 
Percent of Total Cost of Sales
 
Change
2018 vs. 2017
 
2018
 
Percent of Total Cost of Sales
 
2017
 
Percent of Total Cost of Sales
 
Change 2018 vs. 2017
Purchased materials and services
$
1,078.9

 
86
%
 
$
954.7

 
86
%
 
13
 %
 
$
2,894.7

 
87
%
 
$
2,610.9

 
86
%
 
11
 %
Labor and benefits
96.0

 
8
%
 
79.5

 
7
%
 
21
 %
 
267.1

 
8
%
 
220.7

 
7
%
 
21
 %
Depreciation and amortization
37.5

 
3
%
 
38.6

 
3
%