Harley-Davidson, Inc. — 2016 First-Quarter Form 10-Q
Reporting period: Three months ended March 27, 2016; filed May 5, 2016. The company operates through Motorcycles & Related Products and Financial Services, principally Harley-Davidson Motor Company and Harley-Davidson Financial Services.
Financial performance and position
- Revenue: $1.750 billion, up 4.6% from $1.673 billion in the prior-year quarter. Motorcycles revenue was $1.577 billion, up 4.4%; Financial Services revenue was $173.4 million, up 6.8%.
- Profitability: Operating income was $388.8 million, down 5.2%. Net income was $250.5 million, down 7.2%. Diluted EPS increased to $1.36 from $1.27 because diluted weighted-average shares declined to 184.2 million from 211.8 million following share repurchases.
- Margins: Consolidated operating margin was approximately 22.2%, compared with 24.5% in the prior-year quarter. Net margin was approximately 14.3%, compared with 16.1%. Motorcycles gross profit was essentially unchanged at $590.3 million despite revenue growth.
- Cash flow: Operating cash flow was $41.1 million versus $174.7 million. Investing cash use was $82.7 million, including $39.0 million of capital expenditures and $21.0 million of net finance-receivable originations. Financing cash flow was $10.3 million. Cash and cash equivalents ended at $694.0 million, down from $722.2 million at year-end 2015 and $1.169 billion a year earlier.
- Liquidity: Cash and current marketable securities totaled $739.1 million. Available credit facilities totaled $1.111 billion, for reported liquidity of $1.850 billion. Management targets liquidity covering at least 12 months of projected needs.
- Debt: Total debt was $7.113 billion, compared with $5.913 billion at March 29, 2015. Debt included $870.1 million of unsecured commercial paper, $4.062 billion of medium-term notes, $740.8 million of senior unsecured notes, and $1.287 billion of term asset-backed securitization debt.
- Shareholder returns: The quarterly dividend was $0.35 per share versus $0.31. The company repurchased 3.5 million shares for $150.4 million and had 25.6 million shares remaining under repurchase authorizations at quarter-end.
- Financial Services credit: Net finance receivables were $7.377 billion, up from $6.849 billion a year earlier. The allowance for credit losses rose to $156.2 million from $132.8 million. Annualized retail loan losses were 1.98% versus 1.56%, and retail loans 30 days or more delinquent were 2.88% versus 2.64%.
Material changes versus the prior comparable period
- Motorcycle shipments increased 4.3% to 83,036 units, while worldwide dealer retail sales increased 1.4% to 57,458 units. International shipments represented 30.6% of total shipments versus 28.8%.
- Motorcycles operating income declined 3.8% to $332.5 million. Higher volume and pricing were offset by unfavorable product mix, foreign-exchange effects, higher manufacturing costs, ERP implementation start-up costs, and increased marketing and product-development spending.
- Financial Services operating income declined 12.8% to $56.4 million. Higher revenue was more than offset by a 19.2% increase in interest expense and a 41.4% increase in the provision for credit losses.
- Operating cash flow decreased primarily because of increased wholesale lending, higher working capital, a $25.0 million voluntary pension contribution, and higher inventory to support the selling season and expected ERP-related production disruption.
- Debt increased materially as the company issued $1.2 billion of medium-term notes, while repaying $450.0 million of maturing notes and reducing commercial paper and other credit-facility borrowings.
- Adopted accounting updates concerning consolidation, debt issuance-cost presentation, cloud-computing arrangements, and business-combination measurement-period adjustments. The filing states that these adoptions had no material impact, except for debt issuance-cost reclassification.
Guidance, outlook, risks and unusual items
- Management maintained 2016 shipment guidance of 269,000 to 274,000 motorcycles, representing approximately 1% to 3% growth, including second-quarter shipments of 82,500 to 87,500 units.
- Motorcycles segment operating margin guidance remained 16% to 17%, compared with 16.5% in 2015. Gross margin is expected to decline because of foreign exchange, unfavorable mix, higher manufacturing costs, and ERP implementation costs.
- The company expects approximately $70 million of additional 2016 demand-driving investment, including approximately 65% higher customer-facing marketing investment and 35% higher new-product-development investment versus 2015.
- Financial Services operating income is expected to decline modestly because of higher borrowing costs and credit losses, partially offset by higher revenue. Capital expenditures are expected to be $255 million to $275 million, funded by operating cash flow, and the effective tax rate is expected to be approximately 34.5%.
- The Kansas City ERP implementation is expected to be completed by the end of the third quarter of 2016 and may cause start-up costs, lost production, and higher inventory levels.
- The company faces intense competition, macroeconomic weakness, foreign-exchange volatility, challenging conditions in oil-dependent markets and Brazil, and potential pressure from used-motorcycle values and dealer inventory.
- Material contingencies include a probable EPA enforcement action concerning emissions-related matters and ongoing environmental remediation at the York, Pennsylvania facility. The company has reserves but cannot reasonably estimate potential additional losses beyond those reserves.
- The Canadian asset-backed commercial-paper facility was scheduled to expire June 30, 2016, and the U.S. conduit facility December 14, 2016; management expected to renew both. On April 7, 2016, the company entered into a new $765.0 million five-year global credit facility maturing in April 2021.
- The company remained in compliance with applicable debt covenants, and management reported effective disclosure controls with no material change in internal control over financial reporting.
Investor verification points
- Verify whether motorcycle shipments converted into sustained retail demand without excessive dealer inventory or discounting.
- Monitor gross-margin recovery, foreign-exchange effects, product mix, ERP implementation costs, and the timing of demand-driving expenditures.
- Track HDFS retail delinquency, charge-off, reserve-rate, sub-prime, and used-motorcycle-auction trends.
- Assess refinancing and renewal of the Canadian and U.S. conduit facilities, commercial-paper reliance, debt maturities, and funding costs.
- Review the eventual scope and cost of the EPA matter and York environmental remediation, which the filing states may differ materially from current reserves.
- Reconcile reported EPS growth with the substantial reduction in share count and continued share repurchases.