HARLEY-DAVIDSON, INC. quarterly report, Q3 FY2016

Harley-Davidson, Inc. Form 10-Q Summary

Reporting period: Quarter and nine months ended September 25, 2016, compared with September 27, 2015. The filing was dated November 3, 2016. Harley-Davidson operates through Motorcycles & Related Products and Financial Services segments.

Financial Performance and Position

Metric	Q3 2016	Q3 2015	9M 2016	9M 2015
Total revenue	$1.275 billion	$1.317 billion	$4.886 billion	$4.815 billion
Operating income	$178.4 million	$215.8 million	$979.5 million	$1.088 billion
Net income	$114.1 million	$140.3 million	$645.0 million	$710.0 million
Diluted EPS	$0.64	$0.69	$3.55	$3.41
Operating margin	Approximately 14.0%	Approximately 16.4%	Approximately 20.0%	Approximately 22.6%
Operating cash flow	Not provided quarterly	Not provided quarterly	$927.8 million	$1.021 billion

Third-quarter revenue declined 3.2%, operating income declined 17.4%, and net income declined 18.7%. Nine-month revenue increased 1.5%, while operating income declined 10.0% and net income declined 9.2%.
Motorcycles segment revenue decreased 4.3% in the third quarter, and operating income declined 23.9% to $108.9 million. Nine-month segment revenue increased 0.9%, but operating income declined 12.1% to $764.1 million.
Financial Services revenue increased 3.4% in the third quarter and 6.7% for the nine months. Segment operating income decreased 4.6% and 1.8%, respectively, primarily due to higher credit-loss provisions and funding costs.
Third-quarter worldwide retail motorcycle sales decreased 4.5%; U.S. sales declined 7.1%, while international sales increased 1.0%. Nine-month worldwide retail sales declined 1.9%, with U.S. sales down 4.7% and international sales up 3.3%.
Third-quarter wholesale motorcycle shipments declined 9.1% to 48,611 units. Nine-month shipments increased 0.7% to 219,807 units.
At September 25, 2016, cash and cash equivalents were $790.3 million, current marketable securities were $5.0 million, and total liquidity including available credit facilities was approximately $1.848 billion.
Total debt was approximately $6.926 billion, consisting primarily of unsecured commercial paper, medium-term notes, senior unsecured notes, and asset-backed financing. Long-term debt was $5.171 billion and current debt totaled approximately $1.756 billion.
Finance receivables, net, totaled $7.150 billion, supported by an allowance for credit losses of $171.5 million. Annualized credit losses on on-balance-sheet retail loans were 1.59%, compared with 1.19% in the prior-year period; the 30-day delinquency rate was 3.61%, compared with 3.16%.
Capital expenditures were $162.7 million for the first nine months, compared with $139.1 million in 2015. The company expects 2016 capital expenditures of $255 million to $275 million.

Material Changes and Drivers

Motorcycle profitability was pressured by lower third-quarter shipments, unfavorable fixed-cost absorption, Kansas City ERP implementation costs, launch costs for the Milwaukee-Eight engine, and other manufacturing inefficiencies.
Pricing, product mix, lower raw-material costs, and foreign-currency effects partly offset the adverse volume and manufacturing-cost impacts.
Financial Services credit-loss provision increased 41.5% for the nine months to $97.1 million, driven by higher losses in oil-dependent areas, normalizing loan performance, lower used-motorcycle values, and a higher retail reserve rate.
The company sold finance receivables with a $301.8 million principal balance through an off-balance-sheet securitization, receiving $312.6 million and recognizing a $9.3 million gain.
Operating cash flow decreased 9.1% year over year, reflecting lower net income and a $25.0 million voluntary pension contribution. Financing cash flow was negative $487.5 million, including $374.2 million of share repurchases and $190.4 million of dividends.
Weighted-average diluted shares declined to 179.3 million in the third quarter and 181.6 million for the nine months, primarily because of share repurchases, helping offset lower net income in per-share results.
The effective tax rate was 32.9% for the first nine months, compared with 34.8% in 2015, including a $16.1 million discrete benefit related primarily to the closure of tax audits.

Guidance, Outlook, Risks and Unusual Items

Management continued to expect 2016 motorcycle shipments of 264,000 to 269,000 units, approximately down 1% to up 1% versus 2015, including 44,200 to 49,200 units in the fourth quarter.
Motorcycles segment operating margin guidance remained 15% to 16%, compared with 16.5% in 2015. Management expected fourth-quarter manufacturing costs to improve as operations returned to normal.
The company expected a fourth-quarter 2016 restructuring charge of approximately $20 million to $25 million, primarily for employee separation and reorganization costs, with expected 2017 savings of approximately $30 million to $35 million.
Financial Services operating income was expected to decline modestly for full-year 2016 because of higher credit-loss provisions and borrowing costs, partly offset by higher revenue. The expected full-year tax rate was approximately 33%.
The U.S. asset-backed commercial paper conduit facility, providing up to $600 million, was scheduled to expire on December 14, 2016; management anticipated renewal. The Canadian conduit facility expires June 30, 2017.
The company entered into an EPA consent decree involving emissions-related matters, including a fine, a three-year mitigation project, and restrictions on unapproved tuning products. The company had recorded a reserve and expected no material adverse effect if finalized, but court approval was pending.
NHTSA was investigating alleged brake failures on certain 2008–2011 ABS-equipped motorcycles. No reserve was recorded because management did not believe a loss was probable; potential future costs could not be reasonably estimated.
Other key risks include weak U.S. motorcycle demand, competitive pricing, dealer and consumer financial conditions, increasing retail credit losses, used-motorcycle values, foreign exchange, interest rates, commodity prices, product liability and recalls, environmental matters, supply-chain and ERP execution, and access to capital markets.

Investor Verification Checklist

Verify the trajectory of U.S. retail demand, dealer inventory, market share, and the response to model-year 2017 motorcycles and the Milwaukee-Eight engine.
Assess whether manufacturing inefficiencies and ERP launch costs normalize as projected and whether the 15%–16% segment margin outlook remains achievable.
Monitor HDFS delinquency rates, charge-offs, reserve adequacy, sub-prime originations, used-motorcycle values, and funding costs.
Confirm renewal of the $600 million U.S. conduit facility and continued access to commercial paper and other funding sources.
Track execution and costs of the announced restructuring, including the expected $30 million to $35 million of 2017 savings.
Review resolution of the EPA consent decree, NHTSA investigation, York environmental matters, product liability claims, and recall reserves.
Reconcile future cash deployment among debt repayment, dividends, share repurchases, pension obligations, capital expenditures, and Financial Services funding needs.