Harley-Davidson, Inc. 2015 Third-Quarter Form 10-Q Summary
Business context and reporting period
Harley-Davidson operates through two segments: Motorcycles & Related Products, which designs, manufactures and sells motorcycles, parts, accessories and merchandise, and Financial Services, which provides retail and wholesale financing. This unaudited Form 10-Q covers the quarter and nine months ended September 27, 2015, compared primarily with the periods ended September 28, 2014.
Key financial metrics
| Metric | Q3 2015 | Q3 2014 | 9M 2015 | 9M 2014 |
|---|---|---|---|---|
| Total revenue | $1.317 billion | $1.302 billion | $4.815 billion | $5.028 billion |
| Operating income | $215.8 million | $224.1 million | $1.088 billion | $1.183 billion |
| Net income | $140.3 million | $150.1 million | $710.0 million | $770.1 million |
| Diluted EPS | $0.69 | $0.69 | $3.41 | $3.52 |
| Operating margin | 16.4% | 17.2% | 22.6% | 23.5% |
| Net margin | 10.7% | 11.5% | 14.7% | 15.3% |
| Operating cash flow | Not separately provided for the quarter | Not separately provided for the quarter | $1.021 billion | $966.9 million |
Motorcycles revenue increased 0.9% in the third quarter but declined 5.2% for the first nine months. Motorcycles operating income declined 2.2% in the quarter and 10.1% year to date. Financial Services revenue increased 3.5% in the quarter and 4.3% year to date, while segment operating income declined 6.4% in the quarter but increased 1.8% year to date.
At September 27, 2015, cash and cash equivalents were $1.369 billion, current marketable securities were $47.4 million, and total liquidity including available credit facilities was approximately $2.396 billion. Total debt was $6.936 billion, compared with $5.444 billion at September 28, 2014. Shareholders’ equity was $2.560 billion.
Finance receivables totaled $7.223 billion before the $145.4 million allowance for credit losses. Retail receivables represented $6.194 billion and wholesale receivables represented $1.029 billion. The annualized loss rate on retail motorcycle loans was 1.19%, compared with 1.08% in the prior-year period; the 30-day delinquency rate was 3.16%, compared with 3.00%.
For the first nine months, operating cash flow was $1.021 billion, capital expenditures were $139.1 million, cash used for investing was $903.8 million, dividends paid were $191.5 million and share repurchases totaled $894.6 million. Cash increased by $461.9 million during the period.
Material changes versus the prior comparable period
- Third-quarter net income declined 6.5% and operating income declined 3.7%; year-to-date net income declined 7.8% and operating income declined 8.0%.
- Worldwide retail motorcycle sales declined 1.4% in the third quarter and in the first nine months. U.S. third-quarter retail sales declined 2.5%, while international sales increased 0.9%.
- Worldwide motorcycle shipments increased 5.5% in the third quarter to 53,472 units, but declined 2.4% year to date to 218,233 units.
- Motorcycles gross profit was pressured by unfavorable foreign currency movements, shipment mix and higher manufacturing and pension costs. Pricing, productivity and lower raw-material costs provided partial offsets.
- Financial Services provision for credit losses increased 26.7% in the quarter and 18.8% year to date, primarily due to higher retail losses, increased receivables and increased sub-prime originations.
- The company issued $750 million of senior unsecured notes in July 2015, consisting of $450 million due in 2025 at 3.50% and $300 million due in 2045 at 4.625%. Proceeds were intended to fund share repurchases.
- The company repurchased $894.6 million of common stock during the first nine months, contributing to a decline in diluted weighted-average shares from 218.8 million to 208.3 million year to date.
- On August 4, 2015, the company acquired Canadian distribution rights and related assets and liabilities from Fred Deeley Imports for $59.9 million. The transaction added $28.6 million of goodwill and $20.8 million of intangible assets and included $3.3 million of third-quarter severance expense.
Guidance, outlook, commentary and risks
- 2015 motorcycle shipment guidance was reduced from 276,000–281,000 units to 265,000–270,000 units, approximately flat to down 2% from 2014.
- 2015 Motorcycles segment operating margin guidance was reduced to 16%–17%, from the prior 18%–19% expectation. The company continued to expect modestly higher gross margin and Financial Services operating income modestly above 2014.
- The company expects fourth-quarter 2015 expenses of approximately $30 million–$35 million for employee separation and reorganization activities related to reallocating spending toward demand generation. It expects approximately $10 million of fourth-quarter Canadian distributor operating expenses.
- For 2016, the company expects motorcycle shipments to increase approximately 3%–5% from 2015 and plans to increase customer-facing marketing spending by approximately 65% and new-product-development spending by approximately 35% from 2015 levels. More definitive 2016 guidance was expected in January 2016.
- Foreign currency was a significant headwind. The company estimated that, if October 19, 2015 exchange rates persisted, currency would reduce 2015 Motorcycles revenue by approximately 4.25% and reduce gross margin by approximately 0.75 percentage points. It estimated an additional approximately $45 million adverse gross-margin impact in 2016 under the stated hypothetical assumptions.
- The company estimates the Canadian distributor transaction will reduce 2015 EPS by approximately $0.04, including approximately $0.02 incurred in the third quarter.
- Key risks include intense competition and market-share pressure, weak consumer demand in certain regions, foreign exchange volatility, increasing credit losses and sub-prime exposure, funding costs and capital-market access, product recalls and warranty claims, environmental matters, dealer financial capacity, supply-chain disruptions, cybersecurity and regulatory changes.
- The EPA investigation concerning emissions certifications, aftermarket parts and emissions-related warranty claims may result in fines or other relief. The company has a reserve but cannot estimate potential losses beyond the current reserve.
- The company has reserves for environmental remediation at its York, Pennsylvania facility but cannot reasonably estimate additional costs that may arise from the ongoing investigation. Product-liability accruals and insurance coverage were considered adequate by management.
- The U.S. asset-backed commercial paper conduit facility, with a $600 million commitment, was extended in October 2015 from October 30, 2015 to December 14, 2015. The company reported compliance with applicable debt covenants.
Important facts for investors to verify
- Whether the reduced 2015 shipment and operating-margin guidance was achieved and whether the planned 2016 marketing and product investments improved retail demand.
- Trends in U.S. and international market share, dealer inventory, motorcycle shipments and retail sales, particularly following the model-year transition.
- Subsequent changes in HDFS credit losses, delinquencies, charge-offs, allowance coverage and sub-prime loan originations.
- Debt maturities, refinancing needs, commercial-paper availability and the expiration or renewal of asset-backed funding facilities.
- The cash-flow impact and long-term returns from share repurchases funded partly with new senior unsecured debt.
- Final purchase accounting and operating costs associated with the Canadian distribution transaction.
- Developments in the EPA investigation, York environmental remediation, product recalls and other litigation or contingencies.
- The effect of foreign exchange rates, hedging results and pension costs on future gross and operating margins.