Harley-Davidson, Inc. — 2018 Q2 Form 10-Q Summary
Business context and reporting period
Harley-Davidson operates through two reportable segments: Motorcycles & Related Products and Financial Services. The filing covers the quarter and six months ended July 1, 2018, compared with the periods ended June 25, 2017. The interim financial statements are unaudited.
Financial performance and key metrics
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenue | $1.713 billion | $1.765 billion | $3.255 billion | $3.267 billion |
| Operating income | $323.9 million | $399.3 million | $560.4 million | $688.5 million |
| Net income | $242.3 million | $258.9 million | $417.1 million | $445.2 million |
| Diluted EPS | $1.45 | $1.48 | $2.48 | $2.53 |
| Cash dividends per share | $0.370 | $0.365 | $0.740 | $0.730 |
- Q2 operating margin was approximately 18.9%, versus 22.6% in the prior-year quarter; net margin was approximately 14.1%, versus 14.7%.
- Six-month operating margin was approximately 17.2%, versus 21.1% in the prior-year period; net margin was approximately 12.8%, versus 13.6%.
- Motorcycles segment revenue declined 3.3% in Q2 and 0.6% for the first half. Segment operating income declined 23.3% in Q2 to $243.4 million and 24.9% for the first half to $416.2 million.
- Financial Services revenue was essentially flat in Q2 at $188.1 million and increased 1.4% for the first half. Segment operating income declined 1.7% in Q2 to $80.5 million but increased 7.1% for the first half to $144.1 million.
- Worldwide retail motorcycle sales declined 3.6% in Q2 and 5.1% for the first half. U.S. retail sales declined 6.4% in Q2 and 8.7% for the first half, while international retail sales increased 0.7% and 0.5%, respectively.
- Wholesale motorcycle shipments declined 11.3% in Q2 and 10.5% for the first half.
- Cash and cash equivalents were $978.7 million at July 1, 2018. Cash, cash equivalents and restricted cash totaled $1.030 billion.
- Operating cash flow for the first half was $735.9 million, compared with $627.1 million in the prior-year period. Capital expenditures were $69.3 million.
- Total debt was $7.141 billion, including $1.327 billion of unsecured commercial paper, compared with $7.172 billion at June 25, 2017. Debt principal payments totaled $7.164 billion through maturities and other contractual payments, with estimated interest payments of $858.9 million.
- Total finance receivables, net, were $7.313 billion, supported by an allowance for credit losses of $193.9 million. Retail annualized credit losses were 1.56% through June 2018 versus 1.71% in the prior-year period; retail 30-day delinquency was 3.09% versus 3.25%.
- The Company reported $842.7 million of availability under credit and conduit facilities, for total cash and availability of approximately $1.821 billion.
Material changes versus the prior comparable period
- Lower motorcycle shipments and volume reduced revenue and gross profit. Q2 motorcycle gross profit declined 7.1% to $532.1 million.
- Motorcycle profitability was pressured by restructuring and manufacturing optimization costs, lower fixed-cost absorption, higher depreciation, temporary inefficiencies, higher steel and aluminum costs, and increased selling, administrative and engineering spending.
- The Company recorded $12.4 million of restructuring expense in Q2 and $59.2 million for the first half. It also recorded $3.1 million of temporary inefficiency costs in the first half.
- Financial Services benefited from lower credit-loss provisions, which declined 28.0% in Q2 and 29.9% for the first half, but this benefit was largely offset in Q2 by higher borrowing costs.
- The effective tax rate fell to 24.1% from 34.4%, primarily due to the 2017 Tax Cuts and Jobs Act.
- Diluted weighted-average shares declined to 167.2 million in Q2 from 175.3 million, reflecting share repurchases. The Company repurchased $111.2 million of common stock during the first half and had 23.2 million shares remaining under repurchase authorizations at quarter-end.
- The Company adopted revenue recognition guidance, recording a $6.0 million after-tax increase to opening retained earnings. It also adopted pension-cost presentation and restricted-cash cash-flow guidance.
Guidance, outlook, commentary and risks
- Management continued to expect 2018 worldwide dealer shipments of 231,000 to 236,000 motorcycles, approximately 2% to 4% below 2017.
- 2018 Motorcycles segment operating margin guidance was reduced to approximately 9% to 10% from 9.5% to 10.5%, primarily because of approximately $45 million to $55 million of expected tariff costs.
- Management expected 2018 Financial Services operating income to be flat to slightly higher than 2017, an improvement from prior guidance of flat to modestly down.
- Expected 2018 capital expenditures remained $250 million to $270 million, including approximately $50 million for manufacturing optimization. Management expected operating cash flow to fund capital expenditures.
- The manufacturing optimization plan consolidates Kansas City assembly operations into York and closes wheel operations in Adelaide. Expected total costs through 2019 are $170 million to $200 million, approximately 70% cash, with completion expected by mid-2019. The plan is expected to generate annual ongoing cash savings of $65 million to $75 million beginning in 2020.
- The More Roads to Harley-Davidson strategy targets, by 2022 versus 2017, $1.0 billion to $1.5 billion of incremental annual revenue, $200 million to $250 million of incremental annual operating income and 0.75 to 1.25 percentage points of operating-margin improvement. The plan includes cumulative operating costs and expenses of $450 million to $550 million and capital expenditures of $225 million to $275 million through 2022.
- Key risks include weak U.S. motorcycle demand, tariffs, execution of the manufacturing optimization and growth plans, product acceptance, used-motorcycle values, foreign exchange, interest rates and funding costs, dealer financial health, credit losses at HDFS, regulatory and environmental matters, recalls, product liability, supply-chain disruptions, cybersecurity and access to capital markets.
- The EPA consent decree remained subject to court approval. The Company has accrued for the matter and expects no material adverse effect if finalized, but cannot reasonably estimate potential remedies beyond the reserve if approval is not obtained.
- Additional environmental remediation costs at the York facility cannot currently be reasonably estimated. Product-liability accruals and insurance coverage were considered adequate by management.
Important facts for investors to verify
- Whether U.S. retail demand and worldwide shipments stabilize relative to management’s 2018 shipment outlook.
- The realized impact of tariffs and whether cost reductions offset the expected $45 million to $55 million of 2018 incremental costs.
- Actual restructuring, temporary inefficiency and capital costs, timing of plant closures, and achievement of projected savings.
- HDFS credit-loss trends, delinquencies, allowance adequacy and the effect of higher funding costs.
- Debt maturities, commercial-paper refinancing capacity and the renewal of conduit facilities, including the U.S. facilities expiring December 12, 2018.
- Execution, funding and returns from the More Roads to Harley-Davidson strategy.
- Resolution of the EPA settlement and the scope and cost of York environmental remediation.