Business Context and Reporting Period
Harley-Davidson, Inc. filed an unaudited Form 10-Q for the quarter ended September 26, 2010. The company operates through Motorcycles & Related Products and Financial Services, including Harley-Davidson Financial Services (HDFS). Results are presented for the three and nine months ended September 26, 2010, compared with September 27, 2009.
MV Agusta was classified as a discontinued operation for all periods and was sold on August 6, 2010 for nominal consideration, with Harley-Davidson contributing €20.0 million of operating capital.
Financial Performance and Key Metrics
| Metric | Three Months 2010 | Three Months 2009 | Nine Months 2010 | Nine Months 2009 |
|---|---|---|---|---|
| Total revenue | $1,260.0 million | $1,245.5 million | $3,775.9 million | $3,888.3 million |
| Operating income | $152.4 million | $99.1 million | $523.9 million | $425.0 million |
| Income from continuing operations | $93.7 million | $56.4 million | $301.7 million | $217.8 million |
| Net income | $88.8 million | $26.5 million | $193.3 million | $163.6 million |
| Diluted EPS | $0.38 | $0.11 | $0.82 | $0.70 |
| Operating margin | 12.1% | 8.0% | 13.9% | 10.9% |
- Motorcycles revenue declined 1.9% in the third quarter and 7.5% year to date. Motorcycle operating income declined 22.3% in the quarter and 28.1% year to date, pressured by lower shipments, higher selling and administrative costs, and restructuring charges.
- Financial Services revenue increased 26.2% in the quarter and 41.2% year to date. Segment operating income improved to $50.9 million from a $31.5 million loss in the prior-year quarter and to $138.4 million from a $110.8 million loss year to date.
- The provision for credit losses fell to $28.0 million in the quarter and $69.1 million year to date, compared with $56.4 million and $137.8 million, respectively, in the prior comparable periods.
- Motorcycle gross profit was $379.8 million in the quarter and $1,156.3 million year to date. The filing reports gross margin of 35.5% for the first nine months, slightly above the prior year.
- Worldwide Harley-Davidson retail sales declined 7.7% in the quarter and 9.8% year to date. Wholesale Harley-Davidson shipments declined 1.7% in the quarter and 11.3% year to date.
- Loss from discontinued operations was $4.9 million in the quarter and $108.4 million year to date, including $111.8 million of pre-tax MV impairment charges during the first nine months.
Cash Flow, Balance Sheet, Debt and Liquidity
- Cash provided by operating activities of continuing operations was $1,169.5 million for the first nine months, compared with $561.3 million in 2009. Management cautions that cash-flow comparisons were affected by the classification of retail finance receivable activity following the 2010 accounting adoption.
- Capital expenditures were $77.6 million, compared with $76.6 million in the prior-year period. Continuing-operations investing activities provided $109.1 million, while financing activities used $1,355.9 million.
- Cash and cash equivalents were $1,494.3 million at September 26, 2010, and marketable securities were $55.2 million. Total cash and marketable securities were $1,549.5 million.
- Total debt was $6,137.2 million, compared with $5,170.2 million at September 27, 2009. The increase primarily reflects consolidation of previously off-balance-sheet securitization entities, rather than solely new corporate borrowing.
- Debt included $3,603.8 million of global corporate debt and $2,533.4 million of finance-receivable securitization debt held by variable interest entities. Approximately $731.8 million of securitization obligations was classified as current.
- Liquidity included $445.3 million of availability under global credit facilities and a $600.0 million asset-backed conduit commitment, for total credit availability of $1,045.3 million and total cash, securities and availability of $2,594.8 million. No borrowings were outstanding under the conduit facility.
- HDFS and the company were in compliance with applicable debt covenants at September 26, 2010. The company maintained a support agreement for HDFS but had not provided funding under that agreement.
Material Changes and Unusual Items
- Effective January 1, 2010, the company adopted accounting guidance requiring consolidation of formerly unconsolidated securitization trusts and VIEs. This added restricted finance receivables and related debt to the balance sheet and made certain prior-period comparisons less comparable.
- HDFS no longer records securitization gains, retained-interest income, servicing fees, or related impairment charges. Instead, it records interest income, credit losses and interest expense on the consolidated receivables and debt.
- The 2010 restructuring plan generated a third-quarter charge of $40.7 million, including $28.2 million of noncash pension and postretirement curtailment losses. Total restructuring and impairment expense was $145.8 million for the first nine months.
- The company expects total costs for the 2009 and 2010 restructuring plans of approximately $505 million to $535 million through 2012 and anticipates ongoing annual savings of approximately $290 million to $310 million after completion.
- Wisconsin union employees ratified seven-year labor agreements effective April 2012. The company expects the agreements to reduce required full-time hourly positions by approximately 250 in Milwaukee and 75 in Tomahawk compared with the existing contracts.
- The effective tax rate was 28.2% in the third quarter and 34.0% for the first nine months, benefiting from a domestic manufacturing tax benefit and, year to date, a favorable IRS audit conclusion. The first-quarter tax rate also reflected a $13.3 million charge related to healthcare legislation.
Guidance, Outlook and Risks
- For 2010, management narrowed Harley-Davidson wholesale shipment guidance to 207,000 to 212,000 motorcycles and expects fourth-quarter shipments of 41,000 to 46,000 units.
- Full-year 2010 gross margin guidance was reiterated at 32.5% to 34.0%; management expects fourth-quarter gross margin to be lower than in the first three quarters because of lower shipments.
- Full-year effective tax rate guidance was revised to approximately 34.0%, and capital expenditure guidance was reduced to $190 million to $210 million, including $75 million to $90 million for restructuring activities. Management expects to fund capital expenditures with internally generated funds.
- Key risks include weak consumer demand, dealer financial capacity, access to capital markets, funding costs, HDFS credit performance and recovery rates, execution of restructuring and labor agreements, supply-chain and production disruptions, foreign exchange, interest rates, commodity costs, product recalls and regulatory matters.
- The EPA is investigating motorcycle emissions certificates, aftermarket parts and emissions-related warranty claims. The company cannot currently estimate potential fines or other remedies.
- The company has reserved approximately $5.9 million for its estimated share of future York, Pennsylvania environmental remediation costs. Soil remediation is expected to continue through approximately 2015, while groundwater remediation may continue longer.
- A consolidated state shareholder derivative lawsuit remained pending; the company stated that it could not predict or quantify the outcome or related potential losses.
Investor Verification Items
- Verify the effect of VIE consolidation on HDFS earnings, debt, restricted assets, cash-flow classification and comparability with 2009.
- Monitor motorcycle retail demand, dealer inventories, shipment levels and progress toward the 2010 shipment guidance.
- Assess whether restructuring savings materialize as projected and whether additional restructuring, pension or postretirement costs arise.
- Review HDFS delinquency, charge-off and allowance trends; managed retail-loan losses were 2.04% and 30-day delinquencies were 4.83% for the first nine months.
- Evaluate refinancing and liquidity needs, including the April 2011 maturity of the 364-day credit facility, the September 2011 conduit expiration and approximately $991.9 million of scheduled 2010 debt principal payments.
- Follow the EPA investigation, York environmental remediation and pending derivative litigation for potential financial or operational consequences.