Harley-Davidson, Inc. 2017 Q2 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 report covers the quarter and six months ended June 25, 2017, compared with the periods ended June 26, 2016.
Financial Performance and Position
| Metric | Three Months 2017 | Three Months 2016 | Six Months 2017 | Six Months 2016 |
|---|---|---|---|---|
| Total revenue | $1.765 billion | $1.861 billion | $3.267 billion | $3.611 billion |
| Operating income | $401.6 million | $412.3 million | $693.1 million | $801.2 million |
| Net income | $258.9 million | $280.4 million | $445.2 million | $530.9 million |
| Diluted EPS | $1.48 | $1.55 | $2.53 | $2.91 |
| Operating margin | 22.7% | 22.2% | 21.2% | 22.2% |
Second-quarter revenue declined 5.2%, operating income declined 2.6% and net income declined 7.7%. For the first half, revenue declined 9.5%, operating income declined 13.5% and net income declined 16.1%. The reported net margin was approximately 14.7% in the second quarter and 13.6% for the first half.
- Motorcycles revenue was $1.577 billion in the second quarter, down 5.6%, and $2.906 billion for the first half, down 10.5%. Motorcycles operating income declined 1.0% in the quarter and 14.8% year to date.
- Financial Services revenue was $188.0 million in the quarter, down 1.5%, and $361.3 million for the first half, down 0.8%. Segment operating income declined 8.5% in the quarter and 7.8% year to date.
- Worldwide retail motorcycle sales declined 6.7% in the second quarter and 5.7% for the first half. U.S. retail sales declined 9.3% in the quarter and 7.9% year to date; international sales declined 2.3% and 2.1%, respectively.
- Wholesale motorcycle shipments declined 7.2% in the quarter and 10.8% for the first half. Touring motorcycles represented a larger share of shipments, while Cruiser shipments declined materially.
- Net cash provided by operating activities was $627.1 million for the first half, compared with $456.3 million in the prior-year period. Net cash used in investing activities was $392.8 million, and net cash used in financing activities was $18.2 million. Cash increased $228.5 million to $988.5 million.
- Capital expenditures were $69.8 million, compared with $107.5 million in the prior-year period. The company paid $128.5 million in dividends and used $243.1 million to repurchase shares.
- Total debt was $7.172 billion at June 25, 2017, compared with $7.061 billion at June 26, 2016. Current debt included $928.4 million of unsecured commercial paper and $1.566 billion of current maturities of long-term debt.
- Finance receivables, net, were $7.333 billion, with an allowance for credit losses of $193.5 million. Annualized retail loan credit losses were 1.71%, compared with 1.50% in the prior-year period, and the on-balance-sheet retail 30-day delinquency rate was 3.25%, compared with 3.16%.
Material Changes Versus the Prior Comparable Period
- The principal driver of the Motorcycles segment decline was lower shipment volume, resulting from weak U.S. industry conditions and lower retail demand. Lower volume reduced first-half gross profit by an estimated $151.8 million.
- Price increases and a higher Touring mix partly offset the volume pressure, while weaker foreign exchange rates, higher steel and aluminum costs, lower fixed-cost absorption and higher depreciation reduced gross profit.
- Financial Services results benefited from higher average retail receivables and increased licensing and insurance commission revenue, but were pressured by higher credit losses and funding costs.
- The prior-year period included a $9.3 million gain on an off-balance-sheet asset-backed securitization; no comparable transaction occurred in 2017.
- The effective tax rate increased to 34.4% in both the second quarter and first half, versus 30.9% and 32.7%, respectively, primarily because the prior-year periods included discrete tax benefits from tax-audit closures.
- Lower diluted share counts from repurchases partially offset the earnings decline. Weighted-average diluted shares declined to 175.3 million in the quarter and 176.2 million for the first half.
Guidance, Outlook, Risks and Unusual Items
- Management reduced 2017 worldwide shipment guidance to 241,000–246,000 motorcycles, approximately 6%–8% below 2016. Third-quarter shipments were expected to be 39,000–44,000 units.
- Management expects 2017 Motorcycles gross margin to decline modestly and operating margin to decline approximately one percentage point from 2016. Third-quarter gross margin was expected to decline approximately 2.5 percentage points because of lower fixed-cost absorption, with substantial recovery anticipated in the fourth quarter.
- Financial Services operating income was expected to decline in 2017, primarily because the prior-year securitization gain will not recur. Capital expenditures were expected to be $200 million–$220 million, funded by operating cash flow, and the full-year effective tax rate was expected to be approximately 34.5%.
- Liquidity included $988.5 million of cash and $1.287 billion of availability under credit and conduit facilities, for total reported liquidity of $2.275 billion. U.S. conduit facilities were scheduled to expire December 13, 2017; management expected renewal. The Canadian conduit was renewed June 30, 2017 through June 30, 2018 with a reduced borrowing amount of up to C$220 million.
- Management cited risks from weak U.S. demand, used-motorcycle pricing, dealer inventory, competition, credit losses, funding costs, foreign exchange, commodity prices, regulatory matters, product liability, recalls, supply-chain disruption and access to capital markets.
- The EPA settlement concerning emissions-related matters remained subject to court approval; the company had reserved its estimated obligation. Additional York, Pennsylvania environmental costs could not be reasonably estimated.
- NHTSA was investigating alleged brake failures involving certain ABS-equipped motorcycles. The company considered a loss not probable, had established no reserve and could not estimate potential future costs.
- At June 25, 2017, the company and HDFS were in compliance with applicable financial covenants, and disclosure controls were assessed as effective.
Important Facts for Investors to Verify
- Whether U.S. motorcycle demand, market share and dealer inventories improve as expected in the second half of 2017.
- Whether reduced production and lower fixed-cost absorption cause the projected margin pressure.
- Trends in HDFS retail credit losses, delinquencies, subprime exposure and the allowance for credit losses.
- Renewal and availability of the U.S. conduit facilities and the company’s ability to refinance or repay significant debt maturities.
- The effect of the EPA settlement, York environmental remediation and the NHTSA brake investigation, none of which has a fully determinable ultimate cost in the filing.
- Whether expected model-year 2018 launches, increased marketing and international expansion improve retail sales without materially increasing operating expenses.