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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.