POLARIS INC. The following discussion pertains to the results of operations and financial position of the Company and should be read in conjunction with the Consolidated Financial Statements and the Notes thereto included elsewhere in this report. This section of this Form 10-K generally discusses 2019 and 2018 items and year-to-year comparisons between 2019 and 2018. Discussions of 2017 items and year-to-year comparisons between 2018 and 2017 that are not included in this Form 10-K can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of Polaris' Annual Report on Form 10-K for the fiscal year endedDecember 31, 2018 .
Overview
2019 was a record year, with sales of$6.8 billion , a 12 percent increase from 2018, primarily due to strong Off-Road Vehicles (ORV) sales and a full year of results related toBoat Holdings, LLC ("Boat Holdings "), which was acquired onJuly 2, 2018 .Boat Holdings added$621.4 million and$279.7 million of sales in 2019 and 2018, respectively. Our annual sales to North American customers increased 13 percent and our annual sales to customers outside ofNorth America increased four percent in 2019. Our unit retail sales of ORVs, snowmobiles, and motorcycles to consumers inNorth America decreased low single-digits percent for the full year, driven by the increasingly competitive ORV and motorcycle markets. Polaris North American dealer inventory was up approximately five percent, driven by higher model year 2020 ORV shipments, as well as higher motorcycle shipments. Full year net income attributable toPolaris Inc. of$324.0 million was a three percent decrease from 2018, with diluted earnings per share decreasing one percent to$5.20 per share. The decrease was driven by higher tariff costs, negative foreign currency impacts, and investments in strategic projects. Additionally, the Company recorded a$13 million gain on the sale of the Company's investment inBrammo Inc. in the 2018 comparative period. The decrease was partially offset by increased volume, higher average selling prices, and a full year of Boats operations. OnJanuary 31, 2020 , we announced that our Board of Directors approved a two percent increase in the regular quarterly cash dividend to$0.62 per share for the first quarter of 2020, representing the 25th consecutive year of increased dividends to shareholders effective with the 2020 first quarter dividend. 25
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Consolidated Results of Operations
The consolidated results of operations were as follows:
For the Years Ended December 31,
($ in millions except per share Change Change
data) 2019 2018 2019 vs. 2018 2017 2018 vs. 2017
Sales $ 6,782.5 $ 6,078.5 12 % $ 5,428.5 12 %
Cost of sales $ 5,133.7 $ 4,577.3 12 % $ 4,103.8 12 %
Gross profit $ 1,648.8 $ 1,501.2 10 % $ 1,324.7 13 %
Percentage of sales 24.3% 24.7% -39 basis 24.4% +29 basis
points points
Operating expenses:
Selling and marketing $ 559.1 $ 491.8 14 % $ 471.8 4 %
Research and development 292.9 259.7 13 % 238.3 9 %
General and administrative 393.9 349.8 13 % 331.2 6 %
Total operating expenses $ 1,246.0 $ 1,101.2 13 % $ 1,041.3 6 %
Percentage of sales 18.4 % 18.1 % +25 basis 19.2 % -107 basis
points points
Income from financial services $ 80.9 $ 87.4 (7 )% $ 76.3 15 %
Operating income $ 483.7 $ 487.4 (1 )% $ 359.7 36 %
Non-operating expense:
Interest expense $ 77.6 $ 57.0 36 % $ 32.2 77 %
Equity in loss of other $ 5.1 $ 29.3 (83 )% $ 6.8 331 %
affiliates
Other (income) expense, net
$ 2.0 NM Income before income taxes$ 407.8 $ 429.2 (5 )%$ 318.8 35 % Provision for income taxes$ 83.9 $ 94.0 (11 )%$ 146.3 (36 )% Effective income tax rate 20.6% 21.9% -132 basis 45.9% NM points Net income$ 323.9 $ 335.3 (3 )%$ 172.5 94 % Net loss attributable to 0.1 - NM - NM noncontrolling interest Net income attributable to$ 324.0 $ 335.3 (3 )%$ 172.5 94 %
Diluted net income per share$ 5.20 $ 5.24 (1 )%$ 2.69 95 % attributable toPolaris Inc. shareholders Weighted average diluted shares 62.3 63.9 (3 )% 64.2 0 % outstanding NM = not meaningful Sales: Sales were$6,782.5 million in 2019, a 12 percent increase from$6,078.5 million in 2018.Boat Holdings added$621.3 million and$279.7 million of sales in 2019 and 2018, respectively. The components of the consolidated sales change were as follows: Percent change in
total Company sales compared to the
prior year
2019 2018
Volume 1 % 4 %
Product mix and price 6 3
Acquisitions 6 5
Currency (1 ) -
12 % 12 %
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The volume increase in 2019 was primarily the result of increased side-by-side, snowmobile, and Indian Motorcycle shipments. Product mix and price contributed a six percent increase in 2019, primarily due to higher average selling prices for ORVs, partially offset by increased promotions. Acquisitions contributed a six percent increase for 2019, primarily due to theBoat Holdings acquisition inJuly 2018 . Sales by geographic region were as follows: For the Years Ended December 31, Percent Percent Change Change Percent of Percent of 2019 vs. Percent of 2018 vs.
($ in millions) 2019 Total Sales 2018 Total Sales 2018 2017 Total Sales 2017 United States$ 5,551.7 82 %$ 4,883.8 80 % 14 %$ 4,327.6 80 % 13 % Canada 394.9 6 % 390.2 7 % 1 % 375.6 7 % 4 % Other foreign countries 835.9 12 % 804.5 13 % 4 % 725.3 13 % 11 % Total sales$ 6,782.5 100 %$ 6,078.5 100 % 12 %$ 5,428.5 100 % 12 % Sales inthe United States for 2019 increased 14 percent compared to 2018, primarily resulting from the acquisition ofBoat Holdings inJuly 2018 and increased ORV shipments.The United States represented 82 percent of total company sales in 2019. Canadian sales for 2019 increased one percent compared to 2018, driven by increased snowmobile shipments. Currency rate movement had an unfavorable two percent impact on sales for 2019 compared to 2018. Sales inCanada represented six percent of total company sales in 2019. Sales in other foreign countries, primarily inEurope , increased four percent in 2019 compared to 2018. This increase was primarily driven by higher sales of Indian motorcycles. Currency rate movements had an unfavorable five percent impact on sales for 2019 compared to 2018. Sales in other foreign countries represented 12 percent of total company sales in 2019. Cost of sales: The following table reflects our cost of sales in dollars and as a percentage of sales: For the Years Ended December 31, Percent Percent Percent of Total of Total of Total Cost of Cost of Change 2019 Cost of Change 2018 ($ in millions) 2019 Sales 2018 Sales vs. 2018 2017 Sales vs. 2017 Purchased materials and services$ 4,418.5 86 %$ 3,978.1 87 % 11 %$ 3,526.0 86 % 13 % Labor and benefits 433.3 9 % 358.5 8 % 21 % 292.6 7 % 23 % Depreciation and amortization 159.0 3 % 135.7 3 % 17 % 139.5 3 % (3 )% Warranty costs 122.9 2 % 105.0 2 % 17 % 145.7 4 % (28 )% Total cost of sales$ 5,133.7 100 %$ 4,577.3 100 % 12 %$ 4,103.8 100 % 12 % Percentage of 75.7 % 75.3 % +39 basis 75.6 % -29 basis sales points points For 2019, cost of sales increased 12 percent to$5,133.7 million compared to$4,577.3 million in 2018. The increase in cost of sales in 2019 is primarily attributed to the acquisition ofBoat Holdings which closed onJuly 2, 2018 , as well as increased purchased materials and services related to higher sales volumes and tariff costs. Gross profit: Consolidated gross profit, as a percentage of sales, decreased in 2019 due to higher tariff costs, the negative impact of foreign currency rates, and the addition of Boats, which has lower gross profit margins, partially offset by increased productivity and higher average selling prices. 27
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Operating expenses: Operating expenses for 2019, in absolute dollars, increased primarily due to theBoat Holdings acquisition, which closed onJuly 2, 2018 , ongoing investments in research and development, and investments in strategic projects. Operating expenses, as a percentage of sales, increased primarily due to ongoing investments in research and development and investments in strategic projects, partially offset byBoat Holdings , which has a lower operating expense to sales ratio. Income from financial services: The following table reflects our income from financial services: For the Years Ended December 31, Change Change ($ in millions) 2019 2018 2019 vs. 2018 2017 2018 vs. 2017 Income from Polaris Acceptance joint$ 32.5 $ 30.4 7 %$ 27.3 11 %
venture
Income from retail credit agreements 45.6 46.3 (2 )% 37.5 23 % Income from other financial services 2.8 10.7 (74 )% 11.5 (7 )%
activities
Total income from financial services$ 80.9 $ 87.4 (7 )%$ 76.3 15 % Percentage of sales 1.2 % 1.4 % -25 basis
1.4 % +3 basis points
points
Income from financial services decreased 7 percent to $80.9 million in 2019
compared to $87.4 million in 2018. The decrease in 2019 was primarily due to
lower retail sales and lower penetration rates, partially offset by higher
wholesale credit income due to higher dealer inventory levels.
Interest expense:
The increase in 2019 compared to 2018, was primarily due to increased debt
levels to finance the Boat Holdings acquisition.
Equity in loss of other affiliates:
As a result of the decision by the Eicher-Polaris Private Limited (EPPL) Board
of Directors to shut down the operations of the EPPL joint venture, we impaired
our investment in EPPL and incurred additional wind-down related costs in 2018.
Such costs did not occur in 2019.
Other (income) expense, net:
The change in Other (income) expense, net primarily relates to foreign currency
exchange rate movements and the corresponding effects on foreign currency
transactions, currency hedging positions and balance sheet positions related to
our foreign subsidiaries from period to period. 2018 includes a $13.5 million
gain on the Company's investment in Brammo Inc.
Provision for income taxes:
The income tax rate for 2019 was 20.6% as compared with 21.9% in 2018. The lower
income tax rate for 2019, compared with 2018 was primarily due to additional
domestic manufacturing benefits realized from the filing of amended returns and
favorable adjustments in 2019 for prior year tax filings related to
international tax provisions, as well as, favorable adjustments related to state
attributes, partially offset by a decrease in excess tax benefits related to
share based compensation as compared to 2018.
Weighted average shares outstanding:
The change in the weighted average diluted shares outstanding from 2018 to 2019
was primarily due to share repurchases under our stock repurchase program at the
end of 2018.
Segment Results of Operations
The summary that follows provides a discussion of the results of operations of
each of our five reportable segments. Each of these segments is comprised of
various product offerings that serve multiple end markets. We evaluate
performance based on sales and gross profit.
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UntilJuly 2018 , the Company reported under four segments, however, as a result of theBoat Holdings acquisition, the Company established a fifth reporting segment, Boats, which includes the results ofBoat Holdings . The comparative 2018 and 2017 results were not required to be reclassified as the new reporting segment structure did not impact historical segments. Our sales and gross profit by reporting segment, which includes the respective PG&A, were as follows: For the
Years Ended
Percent Percent
Change Change
Percent of Percent 2019 vs. Percent 2018 vs.($ in millions) 2019 Sales 2018 of Sales 2018 2017 of Sales 2017 Sales ORV/Snowmobiles$ 4,209.1 62 %$ 3,919.4 64 % 7 %$ 3,570.8 66 % 10 % Motorcycles 584.1 9 % 545.6 9 % 7 % 576.0 11 % (5 )% Global Adjacent Markets 461.3 7 % 444.6 7 % 4 % 396.8 7 % 12 % Aftermarket 906.7 13 % 889.2 15 % 2 % 884.9 16 % 0 % Boats 621.3 9 % 279.7 5 % NM 0.0 - % NM Total sales$ 6,782.5 100 %$ 6,078.5 100 % 12 %$ 5,428.5 100 % 12 % For the Years Ended December 31, Percent Percent Change Change Percent of Percent of 2019 vs. Percent of 2018 vs. ($ in millions) 2019 Sales 2018 Sales 2018 2017 Sales 2017 Gross profit ORV/Snowmobiles$ 1,204.3 28.6 %$ 1,113.9 28.4 % 8 %$ 1,054.6 29.5 % 6 % Motorcycles 44.1 7.5 % 63.0 11.6 % (30 )% 16.7 2.9 % 277 % Global Adjacent Markets 129.9 28.2 % 116.6 26.2 % 11 % 94.9 23.9 % 23 % Aftermarket 222.7 24.6 % 234.4 26.4 % (5 )% 225.5 25.5 % 4 % Boats 124.6 20.1 % 46.3 16.5 % NM - - % NM Corporate (76.8 ) (73.0 ) 5 % (67.0 ) 9 % Total gross profit$ 1,648.8 $ 1,501.2 10 %$ 1,324.7 13 % NM = not meaningful ORV/Snowmobiles: ORV sales, inclusive of PG&A, of$3,825.5 million in 2019, which includes ATV, Polaris GENERAL, RANGER, and RZR vehicles, increased seven percent compared to 2018. This increase was driven by RZR and RANGER shipments. Polaris' North American ORV unit retail sales to consumers decreased low-single digits percent for 2019 compared to 2018, with ATV unit retail sales down mid-single digits percent and side-by-side vehicles unit retail sales increasing low-single digits percent over the prior year, as consumers continue to shift from ATVs to side-by-sides. The Company estimates that North American industry ORV retail sales were up mid single-digits percent over the prior year. North American dealer inventories of ORVs increased high-single digits percent from 2018. ORV sales outside ofNorth America was approximately flat in 2019 compared to 2018. For 2019, the average ORV per unit sales price increased approximately 10 percent compared to 2018's per unit sales price. Snowmobiles sales, inclusive of PG&A sales, increased 12 percent to$383.5 million for 2019 compared to 2018. Retail sales to consumers for the 2019-2020 season-to-date period throughDecember 31, 2019 , increased mid-single digits percent. Sales of snowmobiles to customers outside ofNorth America , principally within the Scandinavian region andRussia , decreased approximately 19 percent in 2019 as compared to 2018. North American dealer inventories of snowmobiles decreased mid-single digits percent from 2018. The average unit sales price in 2019 increased approximately one percent over 2018's per unit sales price. For the ORV/Snowmobiles segment, gross profit, as a percentage of sales, increased from 2018 to 2019, primarily due to higher average selling prices partially offset by higher tariff costs. 29
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Motorcycles:
Sales of Motorcycles, inclusive of PG&A sales, increased seven percent to$584.1 million for 2019 compared to 2018. The increase in 2019 sales was primarily due to increased sales of Indian motorcycles of 14 percent, partially offset by a decrease in sales of Slingshot of approximately 22 percent. The Company estimates North American industry retail sales, 900cc and above cruiser, touring, and standard market segments (including Slingshot), decreased mid-single digits percent in 2019 compared to 2018. Over the same period, Polaris North American unit retail sales to consumers decreased approximately 10 percent. North American Polaris motorcycle dealer inventory increased mid-teens percent in 2019 versus 2018 levels. Sales of motorcycles to customers outside ofNorth America increased approximately 24 percent in 2019 compared to 2018, due primarily to an increase in Indian motorcycle shipments. The average per unit sales price for the Motorcycles segment in 2019 was approximately flat compared to 2018's per unit sales price. Gross profit, as a percentage of sales, decreased from 2018 to 2019, primarily due to higher tariffs, higher warranty expense, and the negative impact of foreign currency rates. Global Adjacent Markets: Global Adjacent Markets sales, inclusive of PG&A sales, increased four percent to$461.3 million for 2019 compared to 2018. The increase in sales was primarily due to growth in Polaris Adventures as well as the government and defense business. Sales to customers outside ofNorth America increased approximately five percent in 2019 compared to 2018 primarily due to higher sales in the commercial, government and defense business. Gross profit, as a percentage of sales, increased from 2018 to 2019, primarily due to improved sales mix, increased productivity and lower warranty expense. Aftermarket: Aftermarket sales, which includesTransamerican Auto Parts (TAP), along with our other aftermarket brands of Klim, Kolpin, ProArmor, Trail Tech and 509, of$906.7 million for 2019 were up two percent compared to 2018, primarily due to growth in the other aftermarket brands, which increased 14%. TAP's sales were approximately flat. Gross profit, as a percentage of sales, decreased from 2018 to 2019, primarily due to tariffs and sales mix. Boats: Boat sales, which primarily relate to theBoat Holdings acquisition which closed onJuly 2, 2018 , were$621.3 million in 2019 compared to$279.7 million in 2018. We estimate thatU.S. pontoon industry unit sales decreased low single-digits percent during 2019. PolarisU.S. pontoon unit retail sales to consumers outperformed the market, and is estimated to be down slightly compared to 2018. Gross profit, as a percentage of sales, increased from 2018 to 2019, primarily due to purchase accounting adjustments in 2018, as well as increased pricing and improved productivity. Liquidity and Capital Resources Our primary source of funds has been cash provided by operating and financing activities. Our primary uses of funds have been for acquisitions, repurchase and retirement of common stock, capital investment, new product development and cash dividends to shareholders. The seasonality of production and shipments cause working capital requirements to fluctuate during the year. We believe that existing cash balances, cash flow to be generated from operating activities and available borrowing capacity under the line of credit arrangement will be sufficient to fund operations, new product development, cash dividends, share repurchases, acquisitions and capital requirements for the foreseeable future. At this time, we are not aware of any factors that would have a material adverse impact on cash flow. 30
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The following table summarizes the cash flows from operating, investing and
financing activities for the years ended
For the Years Ended December 31,
Change Change
($ in millions) 2019 2018 2019 vs. 2018 2017 2018 vs. 2017
Total cash provided by (used
for):
Operating activities $ 655.0 $ 477.1 $ 177.9 $ 585.4 $ (108.3 )
Investing activities (239.3 ) (959.5 ) 720.2 (151.1 ) (808.4 )
Financing activities (411.8 ) 523.4 (935.2 ) (427.7 ) 951.1
Impact of currency exchange rates
on cash balances (0.7 ) (9.5 ) 8.8 9.8 (19.3 )
Increase (decrease) in cash and
cash equivalents $ 3.2 $ 31.5 $ (28.3 ) $ 16.4 $ 15.1
Operating Activities:
Net cash provided by operating activities totaled $655.0 million and $477.1
million in 2019 and 2018, respectively. The $177.9 million increase is primarily
the result of a decrease in net working capital, partially offset by lower net
income. The primary driver of lower net working capital is the result of timing
of payments for accounts payable and higher accrued expenses, including sales
promotions and incentives and dealer holdback. Higher accrued expenses is driven
largely by higher dealer inventory.
Investing Activities:
Net cash used for investing activities was $239.3 million in 2019 compared to
$959.5 million in 2018. The primary uses of cash in 2019 were for the purchase
of property and equipment and tooling for continued capacity and capability at
our manufacturing and distribution facilities and for product development. The
primary use of cash in the prior year comparable period was for the acquisition
of Boat Holdings .
Financing Activities:
Net cash used for financing activities was $411.8 million in 2019 compared to
net cash provided by financing activities of $523.4 million in 2018. We paid
cash dividends of $149.1 million and $149.0 million in 2019 and 2018,
respectively. Total common stock repurchased in 2019 and 2018 totaled $8.4
million and $348.7 million , respectively. In 2019, we had net repayments under
debt arrangements, finance lease obligations and notes payable of $270.0
million , compared to net borrowings of $973.7 million in 2018 to fund the Boat
Holdings acquisition. Proceeds from the issuance of stock under employee plans
were $15.7 million and $47.4 million in 2019 and 2018, respectively.
Financing Arrangements:
We are party to an unsecured $700.0 million variable interest rate revolving
loan facility that expires in July 2023 , under which we have unsecured
borrowings. At December 31, 2019 , there were borrowings of $75.2 million
outstanding under this arrangement. We are also party to a $1,180.0 million term
loan facility, of which $1,000.0 million is outstanding as of December 31, 2019 .
Interest is charged at rates based on LIBOR or "prime."
In December 2010 , the Company entered into a Master Note Purchase Agreement to
issue $25.0 million of unsecured senior notes due May 2018 and $75.0 million 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 $100.0 million of unsecured senior notes due December 2020 . In July 2018 ,
the Company entered into a Master Note Purchase Agreement to issue $350.0
million of unsecured senior notes due July 2028 . At December 31, 2019 and 2018,
outstanding borrowings under the amended Master Note Purchase Agreement totaled
$525.0 million and $525.0 million , respectively.
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
$76.7 million , of which $71.7 million is outstanding as of December 31, 2019 .
The outstanding balance is included in long-term debt and current portion of
long-term debt in the consolidated balance sheets.
At December 31, 2019 and 2018, we were in compliance with all debt covenants.
Our debt to total capital ratio was 60 percent and 69 percent at December 31,
2019 and 2018, respectively.
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Contractual Obligations: The following table summarizes our significant future contractual obligations atDecember 31, 2019 : (In millions): Total <1 Year 1-3 Years 4-5 Years >5 Years Senior notes$ 525.0 $ 100.0 $ 75.0 -$ 350.0 Borrowings under our credit facility 75.2 - -$ 75.2 - Term loan facility 1,000.0 59.0 118.0 823.0 - Notes payable and other 81.3 6.4 13.6 14.5 46.8 Interest expense 192.8 53.0 94.2 45.6 - Finance leases 20.4 2.1 4.2 4.2 9.9 Operating leases 121.3 38.1 47.3 22.9 13.0 Total$ 2,016.0 $ 258.6 $ 352.3 $ 985.4 $ 419.7 In the table above, we assumed ourDecember 31, 2019 , outstanding borrowings under the Senior Notes will be paid at their respective due dates. Interest expense has not been estimated beyond year five. Additionally, atDecember 31, 2019 , we had letters of credit outstanding of$21.6 million related to purchase obligations for raw materials. Not included in the above table are unrecognized tax benefits of$28.1 million , including interest, as the timing of payment is uncertain. We administer and provide extended service contracts to consumers and certain insurance contracts to dealers and consumers through various third-party suppliers. We finance our self-insured risks related to extended service contracts, but do not retain any insurance or financial risk under any of the other arrangements. The balance of restricted cash as ofDecember 31, 2019 , 2018, and 2017 was$39.2 million ,$32.0 million , and$23.3 million , respectively. Restricted cash represents cash equivalents held in trust, as well as amounts held on deposit with regulatory agencies in the various jurisdictions in which our insurance entity does business. Share Repurchases: Our Board of Directors has authorized the cumulative repurchase of up to 90.5 million shares of our common stock through an authorized stock repurchase program. Of that total, approximately 87.3 million shares have been repurchased cumulatively from 1996 throughDecember 31, 2019 . We repurchased a total of 0.1 million shares of our common stock for$8.4 million during 2019, which had an immaterial impact on earnings per share. We have authorization from our Board of Directors to repurchase up to an additional 3.2 million shares of our common stock as ofDecember 31, 2019 . The repurchase of any or all such shares authorized remaining for repurchase will be governed by applicableSEC rules. Wholesale Customer Financing Arrangements: We have arrangements with certain finance companies to provide secured floor plan financing for our dealers. These arrangements provide liquidity by financing dealer purchases of our products without the use of our working capital. A majority of the worldwide sales of snowmobiles, ORVs, motorcycles, boats and related PG&A are financed under similar arrangements whereby we receive payment within a few days of shipment of the product. The amount financed by worldwide dealers under these arrangements related to snowmobiles, ORVs, motorcycles, boats and related PG&A as ofDecember 31, 2019 and 2018, was approximately$1,884.1 million and$1,643.8 million , respectively. We participate in the cost of dealer financing up to certain limits. Polaris Acceptance, a joint venture betweenPolaris andWells Fargo Commercial Distribution Finance Corporation ("WFCDF"), a direct subsidiary ofWells Fargo Bank, N.A . ("Wells Fargo"), which is supported by a partnership agreement between their respective wholly owned subsidiaries, finances substantially all of ourU.S. sales of snowmobiles, ORVs, motorcycles, and related PG&A, whereby we receive payment within a few days of shipment of the product. The partnership agreement is effective throughFebruary 2027 . Polaris Acceptance sells a majority of its receivables portfolio (the "Securitized Receivables") to a securitization facility ("Securitization Facility") arranged by Wells Fargo, a WFCDF affiliate. 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 ASC Topic 860. Polaris Acceptance is not responsible for any continuing servicing costs or obligations with respect to the Securitized Receivables. The remaining portion of the receivable portfolio is recorded on Polaris Acceptance's books, and is funded through a loan from an affiliate of WFCDF and through equity contributions from both partners. At 32
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December 31, 2019 , the outstanding amount of net receivables financed for dealers under this arrangement, including Securitized Receivables, was$1,423.4 million , a 16 percent increase from$1,226.4 million atDecember 31, 2018 . We account for our investment in Polaris Acceptance under the equity method. Polaris Acceptance is funded through equal equity cash investments from the partners and a loan from an affiliate of WFCDF. We do not guarantee the outstanding indebtedness of Polaris Acceptance. The partnership agreement provides that all income and losses of Polaris Acceptance are shared 50 percent by our wholly owned subsidiary and 50 percent by WFCDF's subsidiary. Our total investment in Polaris Acceptance atDecember 31, 2019 was$110.6 million . Our exposure to losses of Polaris Acceptance is limited to our equity in Polaris Acceptance. Credit losses in the Polaris Acceptance portfolio have been modest, averaging less than one percent of the portfolio. We have 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 2019, the potential 15 percent aggregate repurchase obligation was approximately$180.6 million . For calendar year 2020, the potential 15 percent aggregate repurchase obligation is approximately$198.3 million . Our financial exposure under this arrangement is limited to the difference between the amount paid to the finance company for repurchases and the amount received on the resale of the repossessed product. No material losses have been incurred under this agreement. However, an adverse change in retail sales could cause this situation to change and thereby require us to repurchase repossessed units subject to the annual limitation referred to above. We have not guaranteed the outstanding indebtedness of Polaris Acceptance. A subsidiary of TCF Financial Corporation ("TCF") finances a portion of ourUnited States sales of boats whereby we receive payment within a few days of shipment of the product. We have agreed to repurchase products repossessed by TCF up to a maximum of 100 percent of the aggregate outstanding TCF receivables balance. AtDecember 31, 2019 , the potential aggregate repurchase obligation was approximately$221.5 million . Our 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. Retail Customer Financing Arrangements: We have agreements with Performance Finance,Sheffield Financial andSynchrony Bank , under which these financial institutions provide financing to end consumers of our products. The income generated from these agreements has been included as a component of income from financial services in the accompanying consolidated statements of income. AtDecember 31, 2019 , the agreements in place were as follows: Financial institution Agreement expiration date Performance FinanceDecember 2026 Sheffield FinancialDecember 2024 Synchrony Bank December 2025 During 2019, consumers financed 32 percent of our vehicles sold inthe United States through the Performance Finance,Sheffield Financial andSynchrony Bank installment retail credit arrangements. The volume of installment credit contracts written in calendar year 2019 with these institutions was$1,249.0 million , a six percent decrease from 2018. Critical Accounting Policies We have adopted various accounting policies to prepare the consolidated financial statements in accordance withU.S. GAAP. Our significant accounting policies are described in Note 1 of the Notes to Consolidated Financial Statements. Some of those significant accounting policies require us to make difficult, subjective, or complex judgments or estimates. An accounting estimate is considered to be critical if it meets both of the following criteria: (i) the estimate requires assumptions about matters that are highly uncertain at the time the accounting estimate is made, and (ii) different estimates reasonably could have been used, or changes in the estimate that are reasonably likely to occur may have a material impact on our financial condition or results of operations. The significant accounting policies that management believes are the most critical to aid in fully understanding and evaluating our reported financial results include the following: revenue recognition, sales promotions and incentives, product warranties, product liability, and goodwill and indefinite-lived intangibles. 33
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Revenue recognition. With respect to wholegood vehicles, boats, parts, garments and accessories, revenue is recognized when we transfer control of the product to the customer. With respect to services provided by us, revenue is recognized 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 over the term of the service period. Revenue is measured as the amount of consideration we expect to receive in exchange for transferring goods or providing services. Sales, value add, and other taxes we collect 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 our limited warranties and field service bulletin actions are recognized as expense when the products are sold. We recognize revenue for vehicle service contracts that extend mechanical and maintenance coverage beyond our limited warranties over the life of the contract. Historically, product returns, whether in the normal course of business or resulting from repurchases made under the floorplan financing program, have not been material. However, we have agreed to repurchase products repossessed by the finance companies up to certain limits. Our financial exposure is limited to the difference between the amount paid to the finance companies and the amount received on the resale of the repossessed product. No material losses have been incurred under these agreements. We have not historically recorded any significant sales return allowances because we have not been required to repurchase a significant number of units. However, an adverse change in retail sales could cause this situation to change. Revenue from goods and services transferred to customers at a point-in-time accounts for the majority of our revenue. Sales promotions and incentives. We provide for estimated sales promotion and incentive expenses, which are recognized as a component of sales in measuring the amount of consideration we expect to receive in exchange for transferring goods or providing services. Examples of sales promotion and incentive programs include dealer and consumer rebates, volume incentives, retail financing programs and sales associate incentives. Sales promotion and incentive expenses are estimated based on current programs and historical rates for each product line. We record these amounts as a liability in the consolidated balance sheet until they are ultimately paid. AtDecember 31, 2019 and 2018, accrued sales promotions and incentives were$189.9 million and$167.6 million , respectively. Actual results may differ from these estimates if market conditions dictate the need to enhance or reduce sales promotion and incentive programs or if the customer usage rate varies from historical trends. Adjustments to sales promotions and incentives accruals are made as actual usage becomes known in order to properly estimate the amounts necessary to generate consumer demand based on market conditions as of the balance sheet date. Product warranties. We provide a limited warranty for our vehicles and boats for a period of six months to ten years, depending on the product. We provide longer warranties in certain geographical markets as determined by local regulations and customary practice and may provide longer warranties related to certain promotional programs. Our standard warranties require us, through our dealer network, to repair or replace defective products during such warranty periods. 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. We record these amounts as a liability in the consolidated balance sheet until they are ultimately paid. AtDecember 31, 2019 and 2018, the accrued warranty liability was$136.2 million and$121.8 million , respectively. Adjustments to the warranty reserve are made based on actual claims experience in order to properly estimate the amounts necessary to settle future and existing claims on products sold as of the balance sheet date. The warranty reserve includes the estimated costs related to recalls, which are accrued when probable and estimable. Factors that could have an impact on the warranty accrual include the following: changes in manufacturing quality, shifts in product mix, changes in warranty coverage periods, weather and its impact on product usage, product recalls and changes in sales volume. While management believes that the warranty reserve is adequate and that the judgment applied is appropriate, such amounts estimated to be due and payable could differ materially from what will ultimately transpire in the future, and have a material adverse effect on our financial condition. Product liability. We are subject to product liability claims in the normal course of business. We carry excess insurance coverage for product liability claims. We self-insure product liability claims before the policy date and up to the purchased insurance coverage after the policy date. The estimated costs resulting from any uninsured losses are charged to operating expenses when it is probable a loss has been incurred and the amount of the loss is reasonably estimable. There is significant judgment and estimation required in evaluating the possible outcomes and potential losses of product liability matters. We utilize historical trends and actuarial analysis, along with an analysis of current claims, to assist in determining the appropriate loss reserve levels. AtDecember 31, 2019 and 2018, we had accruals of$57.0 million and$52.8 million , respectively, for the probable payment of pending and expected claims related to product liability matters associated with our products. This accrual is included as a component of other accrued expenses in the consolidated balance sheets. While management believes the product liability reserves are adequate, adverse determination of material product liability claims made against us could have a material adverse effect on our financial condition. 34
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Goodwill .Goodwill represents the excess of the cost of acquired businesses over the net of the fair value of identifiable tangible net assets and identifiable intangible assets purchased and liabilities assumed.Goodwill is tested at least annually for impairment and is tested for impairment more frequently when events or changes in circumstances indicate that the asset might be impaired. The Company completes its annual goodwill impairment test as of the first day of the fourth quarter. The Company may first perform a qualitative assessment to determine whether it is more likely than not that the fair value of each reporting unit is less than its carrying amount. A qualitative assessment requires that we consider events or circumstances including macroeconomic conditions, industry and market considerations, cost factors, overall financial performance, changes in management or key personnel, changes in strategy, changes in customers, changes in the composition or carrying amount of a reporting unit's net assets, and changes in our stock price. If, after assessing the totality of events or circumstances, it is determined that it is more likely than not that the fair value of the reporting unit is less than its carrying amount, or if the Company elects to bypass the qualitative test and proceed to a quantitative test, then the quantitative goodwill impairment test is performed. A quantitative test includes comparing the fair value of each reporting unit to the carrying amount of the reporting unit, including goodwill. The fair value of each reporting unit is determined using a discounted cash flow analysis and a market approach. If the estimated fair value is less than the carrying amount of the reporting unit, an impairment is recognized in an amount equal to the difference, limited to the total amount of goodwill allocated to that reporting unit. Under the quantitative goodwill impairment test, the fair value of each reporting unit is determined using a discounted cash flow analysis and market approach. In developing our discounted cash flow analysis, assumptions about future revenues and expenses, capital expenditures and changes in working capital are based on our annual operating plan and long-term business plan for each of our reporting units. These plans take into consideration numerous factors including historical experience, anticipated future economic conditions, changes in raw material prices and growth expectations for the industries and end markets we participate in. These assumptions are determined over a five year long-term planning period. The five year growth rates for revenues and earnings before interest, taxes, depreciation and amortization ("EBITDA") vary for each reporting unit being evaluated. Revenues and EBITDA beyond five years are projected to grow at a terminal growth rate consistent with industry expectations. Actual results may significantly differ from those used in our valuations. The forecasted future cash flows are discounted using a weighted-average cost of capital developed for each reporting unit. The discount rates were developed using market observable inputs, as well as our assessment of risks inherent in the future cash flows of the respective reporting unit. In estimating fair value using the market approach, we identify a group of comparable publicly traded companies for each reporting unit that are similar in terms of size and product offering. These groups of comparable companies are used to develop multiples based on total market-based invested capital as a multiple of EBITDA. We determine our estimated values by applying these comparable EBITDA multiples to the operating results of our reporting units. The ultimate fair value of each reporting unit is determined considering the results of both valuation methods. In the fourth quarter of 2019, we completed the annual impairment test. It was determined that goodwill was not impaired as each reporting unit's fair value exceeded its carrying value. We completed a qualitative assessment for the ORV, Snow, Motorcycles and Global Adjacent Markets reporting units and a quantitative goodwill test for the Aftermarket and Boats reporting units. No reporting units had a difference between their fair value and carrying value that is lower than 10%. However, the results of the Aftermarket reporting unit test are sensitive to certain key inputs and assumptions. While management believes the current projections, discount rate, and other assumptions are reasonable, the estimated fair value of the reporting unit is particularly dependent on Aftermarket's ability to execute the planned actions underlying the forecasted improvement in its performance, including sales growth, gross profit expansion, and cash flow growth. The Boats reporting unit was tested on a quantitative basis for the first time following our acquisition ofBoat Holdings, LLC inJuly 2018 . As such, the results of the Boats reporting unit test are inherently sensitive due to the close proximity to the acquisition date. While management believes the current projections, discount rate, and other assumptions are reasonable, the estimated fair value of the reporting unit is particularly dependent on the continued strength of the pontoon industry. Fair value determinations require considerable judgment and are sensitive to changes in underlying assumptions and factors. As a result, there can be no assurance that the estimates and assumptions made for purposes of the impairment test will prove to be an accurate prediction of the future. To the extent future operating results differ from those in our current forecast, or if the assumptions underlying the discount rate change significantly, it is possible that an impairment 35
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charge could be recorded. As ofDecember 31, 2019 , the goodwill balances for the Aftermarket and Boats reporting units were approximately$270.4 million and$227.1 million , respectively. Identifiable intangible assets. Our primary identifiable intangible assets include: dealer/customer relationships, brand/trade names, developed technology, and non-compete agreements. Identifiable intangibles with finite lives are amortized and those identifiable intangibles with indefinite lives are not amortized. Identifiable intangible assets that are subject to amortization are evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Identifiable intangible assets with indefinite lives are tested for impairment annually or more frequently when events or changes in circumstances indicate that the asset might be impaired. We complete our annual impairment test as of the first day of the fourth quarter each year for those identifiable assets not subject to amortization. Our identifiable intangible assets with indefinite lives include brand/trade names. The impairment test consists of a comparison of the fair value of the brand/trade name with its carrying value. The fair value is determined using the relief-from-royalty method. This method assumes the trade name has value to the extent that the owner is relieved of the obligation to pay royalties for the benefits received from them. This method requires us to estimate the future revenue for the related brands, the appropriate royalty rate and the weighted average cost of capital. Forecasted revenues were derived from our annual budget and long-term business plan and royalty rates were based on brand profitability. The discount rates were developed using the market observable inputs used in the development of the reporting unit discount rates, as well as our assessment of risks inherent in the future cash flows of the respective trade name.
New Accounting Pronouncements See Item 8 of Part II, "Financial Statements and Supplementary Data-Note 1-Organization and Significant Accounting Policies-New accounting pronouncements."
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