HARLEY-DAVIDSON, INC. quarterly report, Q1 FY2019

Harley-Davidson, Inc. — Form 10-Q Summary

Reporting period: Three months ended March 31, 2019, compared with the three months ended April 1, 2018. The filing is unaudited and reports two segments: Motorcycles and Related Products and Financial Services.

Financial performance and liquidity

Metric	Q1 2019	Q1 2018	Change
Total revenue	$1.384 billion	$1.542 billion	Down 10.2%
Motorcycles revenue	$1.196 billion	$1.364 billion	Down 12.3%
Financial Services revenue	$188.7 million	$178.2 million	Up 5.9%
Operating income	$167.1 million	$236.4 million	Down 29.3%
Operating margin	12.1%	15.3%	Down 3.2 points
Net income	$127.9 million	$174.8 million	Down 26.8%
Diluted EPS	$0.80	$1.03	Down 22.3%
Operating cash flow	$32.7 million	$191.6 million	Down $158.9 million
Capital expenditures	$35.3 million	$28.4 million	Up $6.8 million

Motorcycles gross profit was $347.4 million, producing a 29.1% segment gross margin versus 34.7% in the prior-year quarter. Motorcycles operating income fell 37.3% to $108.4 million. Financial Services operating income declined 7.6% to $58.7 million despite higher revenue, primarily because of higher funding costs, credit-loss provisions and operating expenses.

Cash, cash equivalents and marketable securities totaled $759.6 million at March 31, 2019. Including available credit and conduit facilities, reported liquidity totaled approximately $1.734 billion. Cash, cash equivalents and restricted cash decreased $460.6 million during the quarter, ending at $799.1 million.

Total debt was $7.310 billion at March 31, 2019, compared with $7.018 billion at April 1, 2018. Current debt included $1.193 billion of unsecured commercial paper and $1.372 billion of current long-term debt. Shareholders’ equity was $1.798 billion. The company paid $60.9 million of dividends and repurchased $61.7 million of common stock during the quarter.

Material changes versus the prior comparable period

Worldwide dealer retail sales declined 3.8%, including a 4.2% decline in the United States and a 3.3% decline internationally. Wholesale motorcycle shipments fell 7.9% to 58,891 units.
Motorcycles revenue was negatively affected by lower shipment volume, unfavorable product mix, foreign exchange and increased sales support. Incremental tariffs reduced first-quarter gross profit; tariff costs were $21.0 million in the quarter.
Lower restructuring expense and favorable net warranty and recall costs partially offset the pressure on Motorcycles earnings. Restructuring expense declined to $13.6 million from $46.8 million.
Financial Services interest income increased 3.7%, but interest expense rose 8.0%, the provision for credit losses rose 14.8% to $34.5 million, and operating expenses rose 19.7%.
Retail motorcycle annualized credit losses increased to 2.22% from 2.15%, while the 30-day delinquency rate increased to 3.73% from 3.31%. Management attributed part of the delinquency increase to temporary implementation inefficiencies related to a new loan-management system.
Operating cash flow was substantially lower because of lower sales and unfavorable working-capital changes. Financing cash flow included $750.0 million of medium-term-note repayments, $546.7 million of new note issuance, dividends and share repurchases.
The company adopted the new lease standard on January 1, 2019, initially recognizing approximately $60 million of right-of-use assets and lease liabilities. The filing states that the adoption did not materially affect ongoing net income or cash flow.
On March 4, 2019, the company acquired certain StaCyc assets and liabilities for total consideration of $14.9 million, including $7.0 million of cash, to expand its electric two-wheeler portfolio.

Guidance, outlook and management commentary

For full-year 2019, management expected to ship 217,000 to 222,000 motorcycles, approximately 3% to 5% below 2018 levels, with international retail sales growth but continued U.S. industry pressure.
Motorcycles segment operating margin was expected to be 8.0% to 9.0%. Gross margin was expected to decline because of tariffs, lower volume and unfavorable mix, partly offset by cost reductions.
Management expected incremental tariff costs of approximately $100 million to $120 million for 2019, excluding the effect of higher steel and aluminum costs.
The company planned to mitigate European Union and China tariffs by supplying those markets from Thailand by year-end, subject to regulatory approval. Management identified a material risk that approval might not be granted.
Second-quarter 2019 motorcycle shipments were expected to be 65,500 to 70,500 units, down approximately 3% to 10% year over year, with segment operating margin expected to decline approximately four percentage points.
Financial Services operating income was expected to decline in 2019 because of higher debt costs and depreciation associated with the new loan-management system.
2019 capital expenditures were expected to be $225 million to $245 million, including approximately $20 million for the Manufacturing Optimization Plan. Management expected operating cash flow to fund capital expenditures.
The 2019 effective tax rate was expected to be approximately 24% to 25%.
The Manufacturing Optimization Plan was expected to generate $25 million to $30 million of savings in 2019 and $45 million to $50 million in 2020, with ongoing annual savings projected at $65 million to $75 million. The plan includes the Kansas City plant closure, expanded York operations and closure of Adelaide wheel operations.

Risks, contingencies and unusual items

Demand remains exposed to a declining U.S. motorcycle industry, low used-motorcycle prices, competitive promotions, weather, dealer financial health and changing consumer preferences.
Tariff exposure, foreign exchange, steel and aluminum prices, product mix and the execution of Thailand production materially affect margins and the outlook.
The company is executing a manufacturing restructuring program expected to incur total costs of $152 million to $162 million through 2019, approximately 70% of which is expected to be cash costs.
The company has warranty and recall liabilities of $122.4 million at March 31, 2019, including $64.1 million related to recall campaigns. A Street motorcycle recall contributed to limited product availability during the quarter.
An EPA consent decree remains subject to court approval. The company has an accrual and expects no material adverse effect if finalized, but it cannot reasonably estimate potential remedies beyond the reserve if approval is denied.
Environmental remediation at the York, Pennsylvania facility remains subject to an unapproved final remedy, and the company cannot reasonably estimate any additional costs that may result.
HDFS depends on continued access to unsecured debt, commercial paper, conduit facilities and asset-backed financing. The Canadian conduit facility was scheduled to expire June 28, 2019, and U.S. conduit facilities were scheduled to expire November 29, 2019; management expected renewal.
The company remained in compliance with applicable debt covenants at March 31, 2019. It also maintains a support agreement for HDFS, although no support has historically been provided.

Important facts for investors to verify

Whether motorcycle retail demand, U.S. industry trends and wholesale shipments improve during the 2019 selling season.
Actual 2019 tariff costs and whether Thailand production and regulatory approvals sufficiently mitigate European Union and China tariffs.
Progress, final costs, timing and savings from the Manufacturing Optimization Plan and related workforce changes.
HDFS credit performance, delinquency trends, charge-offs, allowance adequacy and funding costs.
Renewal and availability of the Canadian and U.S. asset-backed conduit facilities and continued access to commercial-paper markets.
Resolution of the EPA consent decree and the scope and cost of York environmental remediation.
Whether cash generation can support planned capital expenditures, dividends, share repurchases and Financial Services funding while debt remains elevated.