Harley-Davidson, Inc. — 2018 Q3 Form 10-Q Summary
Business context and reporting period
Harley-Davidson operates through two reportable segments: Motorcycles and Related Products, which designs, manufactures and sells motorcycles, parts, accessories and merchandise, and Financial Services, which finances motorcycle purchases and dealer inventory. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2018, compared with the comparable periods ended September 24, 2017.
Key financial metrics
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Total revenue | $1.316 billion | $1.151 billion | $4.571 billion | $4.418 billion |
| Operating income | $149.4 million | $94.4 million | $709.8 million | $782.9 million |
| Operating margin | 11.4% | 8.2% | 15.5% | 17.7% |
| Net income | $113.9 million | $68.2 million | $531.0 million | $513.4 million |
| Net margin | 8.7% | 5.9% | 11.6% | 11.6% |
| Diluted EPS | $0.68 | $0.40 | $3.17 | $2.95 |
| Cash dividends per share | $0.370 | $0.365 | $1.110 | $1.095 |
Motorcycles revenue increased 16.8% in Q3 and 3.7% for the first nine months. Financial Services revenue increased 1.4% in both periods. Motorcycles operating income was $65.7 million in Q3, versus $17.4 million a year earlier, but declined to $481.9 million for the first nine months from $571.3 million. Financial Services operating income increased 8.7% in Q3 and 7.7% year to date, primarily because of lower credit-loss provisions.
Net cash provided by operating activities was $1.123 billion for the first nine months, compared with $949.1 million in 2017. Capital expenditures were $119.8 million, and net cash used for finance-receivable activity was $474.5 million. Ending cash, cash equivalents and restricted cash totaled $970.0 million, including $927.0 million of cash and cash equivalents.
Total debt was $7.097 billion at September 30, 2018, compared with $6.973 billion at September 24, 2017. Current debt consisted of $1.374 billion of commercial paper and $1.526 billion of current maturities of long-term debt. The company reported $937.0 million of cash and marketable securities and $852.1 million of availability under credit and conduit facilities, for total stated liquidity of $1.789 billion.
Finance receivables, net, were $7.304 billion, up from $7.101 billion at the prior-year comparable date. The allowance for credit losses was $193.4 million. Retail annualized credit losses were 1.55% through September 30, 2018, compared with 1.73% in the prior-year period, and the retail 30-day delinquency rate was 3.60%, compared with 3.72%.
Material changes versus the prior comparable period
- Q3 revenue increased 14.3%, operating income increased 58.3%, net income increased 66.9% and diluted EPS increased 70.0%.
- Q3 wholesale motorcycle shipments increased 16.7% to 48,639 units, helped by a 51.3% increase in Touring shipments. Nine-month shipments decreased 4.7% to 185,176 units.
- Worldwide retail motorcycle sales declined 7.8% in Q3 and 5.9% for the first nine months. U.S. retail sales declined 13.3% in Q3 and 10.2% year to date, while international retail sales increased 2.6% and 1.1%, respectively.
- Year-to-date Motorcycles operating income declined 15.6%, reflecting lower shipment volume, higher marketing and product-development spending, restructuring expense, tariffs, higher raw-material costs, higher depreciation and manufacturing inefficiencies.
- Financial Services’ provision for credit losses declined 19.6% in Q3 and 26.8% year to date.
- The effective tax rate declined to 19.4% in Q3 from 24.1% and to 23.1% for the first nine months from 33.2%, primarily reflecting the 2017 Tax Cuts and Jobs Act and discrete tax benefits.
- Share repurchases totaled $196.0 million during the first nine months, versus $465.2 million in the prior-year period; 21.3 million shares remained authorized for repurchase at quarter-end.
Guidance, outlook, commentary and unusual items
Management continued to expect 2018 motorcycle shipments of 231,000 to 236,000 units, toward the low end of the range and approximately 2% to 4% below 2017. Full-year Motorcycles operating margin was expected at approximately 9% to 10%, likely at the low end because of an estimated $35 million fourth-quarter safety-recall cost. The recall covers approximately 238,300 motorcycles and relates to a hydraulic clutch assembly.
Management expected 2018 incremental tariff costs of approximately $43 million to $48 million, including U.S. steel and aluminum tariffs, European Union tariffs and China-related tariffs. Full-year capital expenditures were reduced to $230 million to $250 million, including approximately $50 million for the manufacturing optimization plan. The company expected its full-year effective tax rate to be approximately 22.5% to 24.0%.
The manufacturing optimization plan consolidates the Kansas City assembly plant into York, Pennsylvania, and closes wheel operations in Adelaide, Australia. Through 2019, the plan is expected to eliminate approximately 800 Kansas City jobs and 90 Adelaide jobs while adding approximately 450 York jobs. Total costs are estimated at $155 million to $185 million through 2019, with approximately 70% expected to be cash costs. The company expects ongoing annual cash savings of $65 million to $75 million beginning in 2020.
The company recorded $74.0 million of restructuring expense during the first nine months and $14.8 million in Q3, plus $9.3 million of temporary manufacturing inefficiency costs year to date. It also recorded a $96.4 million pretax pension and postretirement benefit remeasurement gain in other comprehensive income.
Key risks include weak U.S. motorcycle demand, used-motorcycle pricing, tariffs and foreign exchange, execution of the manufacturing plan and More Roads to Harley-Davidson strategy, product quality and recalls, dealer financial condition, HDFS credit losses, funding costs and capital-market access, environmental remediation, litigation, cybersecurity and regulatory changes. The EPA settlement remained subject to court approval, and the final scope and cost of York environmental remediation could not be reasonably estimated.
The company adopted the new revenue-recognition standard in 2018, increasing opening retained earnings by $6.0 million after tax. It also adopted new pension-cost and restricted-cash presentation requirements. It expected the forthcoming lease standard to increase recognized assets and liabilities; the expected quantitative effect was not yet clear.
Important facts for investors to verify
- Whether U.S. retail demand and the broader U.S. motorcycle industry stabilize, and whether international growth offsets domestic weakness.
- Actual fourth-quarter and full-year impact of the $35 million recall, tariffs and manufacturing inefficiencies on margins.
- Progress, final costs, timing and realized savings from the Kansas City, York and Adelaide manufacturing optimization plan.
- Whether the company achieves the 231,000-to-236,000 shipment target and the 9%-to-10% Motorcycles operating-margin guidance.
- HDFS retail credit losses, delinquencies, allowance adequacy and the effect of potentially higher sub-prime lending.
- Refinancing requirements, particularly the $1.415 billion of scheduled 2018 debt principal payments and the December 12, 2018 expiration of the U.S. conduit facilities.
- Final court treatment of the EPA settlement and the eventual scope and cost of York environmental remediation.
- Impact of the 2017 Tax Act provisional accounting, future tax guidance and the company’s final effective tax rate.