Derivative Instruments and Hedging Activities

9 Months Ended

Sep. 30, 2012

Derivative Instruments and Hedging Activities

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 sales. Interest rate swaps are entered into in order to manage interest rate risk associated with the Company’s variable-rate borrowings. 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 September 30, 2012, Polaris had the following open foreign currency contracts (in thousands):

Foreign Currency	Notional Amounts (in US Dollars)		Net Unrealized Gain (Loss)
Australian Dollar	$	9,714	$	(14	)
Canadian Dollar		136,211		(2,098	)
Swedish Krona		11,301		(159	)
Japanese Yen		10,986		77
Mexican Peso		10,483		818
Euro		8,243		(479	)
Total	$	186,938	$	(1,855	)

These contracts, with maturities through December 31, 2013, met the criteria for cash flow hedges and the unrealized gains or losses, after tax, are recorded as a component of Accumulated other comprehensive income in Shareholders’ Equity.

Polaris has entered into derivative contracts to hedge a portion of the exposure related to diesel fuel and aluminum for 2011 and 2012. These diesel fuel and aluminum derivative contracts did not meet the criteria for hedge accounting.

The table below summarizes the carrying values of derivative instruments as of September 30, 2012 and December 31, 2011 (in thousands):

	Carrying Values of Derivative Instruments as of September 30, 2012
	Fair Value— Assets		Fair Value— (Liabilities)			Derivative Net Carrying Value
Derivatives designated as hedging instruments
Foreign exchange contracts(1)	$	1,427	$	(3,282	)	$	(1,855	)
Total derivatives designated as hedging instruments	$	1,427	$	(3,282	)	$	(1,855	)
Commodity contracts(1)	$	1,452	$	(914	)	$	538
Total derivatives not designated as hedging instruments	$	1,452	$	(914	)	$	538
Total Derivatives	$	2,879	$	(4,196	)	$	(1,317	)

	Carrying Values of Derivative Instruments as of December 31, 2011
	Fair Value— Assets		Fair Value— (Liabilities)			Derivative Net Carrying Value
Derivatives designated as hedging instruments
Foreign exchange contracts(1)	$	4,738	$	(1,160	)	$	3,578
Total derivatives designated as hedging instruments	$	4,738	$	(1,160	)	$	3,578
Commodity contracts(1)	$	193	$	(1,530	)	$	(1,337	)
Total derivatives not designated as hedging instruments	$	193	$	(1,530	)	$	(1,337	)
Total Derivatives	$	4,931	$	(2,690	)	$	2,241

(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 a cash flow hedge, the effective portion of the gain or loss on the derivative is reported as a component of Accumulated other comprehensive income 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 table below provides data about the amount of gains and losses, net of tax, related to derivative instruments designated as cash flow hedges included in Accumulated other comprehensive income for the three and nine month periods ended September 30, 2012 and 2011 (in thousands):

Derivatives in Cash Flow Hedging Relationships	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2012			2011			2012			2011
Interest rate contracts	$	(6	)	$	(6	)	$	(18	)	$	68
Foreign currency contracts		(1,744	)		11,884			(3,378	)		8,520
Total	$	(1,750	)	$	11,878		$	(3,396	)	$	8,588

The table below provides data about the amount of gains and losses, net of tax, reclassified from Accumulated other comprehensive income into income (loss) on derivative instruments designated as hedging instruments for the three and nine month periods ended September 30, 2012 and 2011 (in thousands):

Derivatives in Cash	Location of Gain (Loss) Reclassified from Accumulated OCI	For the Three Months Ended September 30,					For the Nine Months Ended September 30,
Flow Hedging Relationships	Into Income	2012			2011		2012			2011
Interest rate contracts	Interest expense	$	—		$	—	$	—		$	(152	)
Foreign currency contracts	Other (income) expense, net		(2,028	)		1,328		(5,644	)		3,350
Foreign currency contracts	Cost of sales		(465	)		—		(352	)		—
Total		$	(2,493	)	$	1,328	$	(5,996	)	$	3,198

The net amount of the existing gains or losses at September 30, 2012, that is expected to be reclassified into the income statement within the next 12 months is expected to not be material. The ineffective portion of foreign currency contracts was not material for the three months ended September 30, 2012.

The Company recognized a gain of $2,778,000 and a loss of $240,000 in Cost of sales on commodity contracts not designated as hedging instruments for the three and nine month periods ended September 30, 2012, versus a loss of $1,342,000 and $681,000 for the three and nine month periods ended September 30, 2011.