We Had a Clue: Harley Davidson Announces Diminished Q3 Results

We had clues Wednesday this might be the case. On average, analysts were expecting Harley Davidson (HOG) to record a 79 cents per share on revenue of $1.42 billion. HOG had exceeded analysts' profit estimates in three of the last four quarters. However, now shipments are down as credit has further tightened.

Today Harley Davidson confirmed the news:

Milwaukee, Wis., October 16, 2008 — Harley-Davidson, Inc. today announced its results for the third quarter ended September 28, 2008. Revenue for the quarter was $1.42 billion compared to $1.54 billion in the year ago quarter, a 7.7 percent decrease. Net income for the quarter was $166.5 million compared to $265.0 million in the third quarter 2007, a decrease of 37.1 percent. Third quarter diluted earnings per share were $0.71, a 33.6 percent decrease compared to last year’s $1.07.

“In the U.S., dealer retail sales of new Harley-Davidson motorcycles in the quarter were in line with our expectations,” said Jim Ziemer, Chief Executive Officer of Harley-Davidson, Inc. “Although Harley-Davidson retail motorcycle sales in international markets overall continued to grow double digits in the quarter, unit sales in several European countries slowed more than we anticipated during September as a result of deteriorating economic conditions. We continue to carefully monitor all markets in light of the potential impact of the current economic realities.”

For the full year 2008, the Company has narrowed its shipment expectations to 303,500 to 306,000 Harley-Davidson motorcycles. The Company has narrowed its expectations for diluted earnings per share for the full year to $3.00 to $3.10 from the prior range of $3.00 to $3.18.

“We also have been able to maintain Harley-Davidson Financial Services’ position as a stable, consistent source of financing for dealers and retail customers during these turbulent conditions in the credit markets,” Ziemer said. “Prudent management and customer access to credit will continue to be priorities at HDFS.”

“During the third quarter, we completed our acquisition of Italian motorcycle maker MV Agusta Group, expanding our opportunities in Europe. Our 105th Anniversary Celebration at the end of August drew tremendous, highly enthusiastic crowds. And we opened the Harley-Davidson MuseumTM, with its broad appeal to riders and non-riders alike. So even in the midst of economic uncertainty, we continue to broaden our appeal, plant seeds for the future and give people unparalleled experiences and reasons to ride,” Ziemer said.

“Going forward, we expect the global economy and consumer concerns to continue to create challenges for Harley-Davidson through the end of the year and in 2009. I remain confident about our future as we continue to manage and reinvest in the business,” said Ziemer.

Motorcycles and Related Products Segment – Third Quarter Results

Revenue from Harley-Davidson motorcycles was $1.05 billion, a decrease of $131.7 million or 11.1 percent versus the same period last year. Shipments of Harley-Davidson motorcycles totaled 74,704 units, a decrease of 11,831 units or 13.7 percent compared to last year’s third quarter.

Revenue from Parts and Accessories (P&A), which consists of Genuine Motor Parts and Genuine Motor Accessories, totaled $259.0 million, an increase of $7.5 million or 3.0 percent over the year-ago quarter. Revenue from General Merchandise, which consists of MotorClothes® apparel and collectibles, totaled $84.0 million, an increase of $0.8 million or 1.0 percent over the year-ago quarter.

Gross margin for the third quarter of 2008 was 34.0 percent of revenue compared to 38.4 percent for the third quarter last year. This decrease is primarily due to higher product costs and the allocation of fixed costs over fewer units than last year’s third quarter. Third quarter operating margin decreased to 16.4 percent from 23.2 percent in the third quarter of 2007. Operating margin for the third quarter of 2008 includes the impact of a one-time $16.6 million expense related to the value of acquired in-process research and development at MV Agusta Group.

Motorcycle Retail Sales Data

During the third quarter, worldwide retail sales of Harley-Davidson motorcycles decreased 9.6 percent compared to the third quarter of 2007. U.S. retail sales of Harley-Davidson motorcycles decreased 15.5 percent for the quarter. The heavyweight motorcycle market in the U.S. decreased 3.1 percent for the same period.

Retail sales of Harley-Davidson motorcycles grew 11.3 percent in the Company’s international markets during the third quarter of 2008 compared to the third quarter of 2007. Third quarter retail sales increased 12.4 percent in Canada; the Europe Region was up 2.9 percent; the Asia Pacific Region was up 17.5 percent; and the Latin America Region was up 41.6 percent.

During the first nine months of 2008, worldwide retail sales of Harley-Davidson motorcycles decreased 6.0 percent compared to the prior year. In the U.S., Harley-Davidson motorcycle retail sales decreased 11.9 percent for the first nine months of the year while the U.S. heavyweight market was down 4.0 percent for the same period. International retail sales increased by 12.6 percent for the first nine months of 2008.

Third quarter and year-to-date data are listed in the accompanying tables.

MV Agusta

On August 8, 2008, the Company completed the purchase of the privately-held Italian motorcycle maker MV Agusta Group. The Company acquired 100 percent of MV Agusta Group shares for total consideration of 68.3 million euros ($105.1 million), which includes the satisfaction of existing bank debt for 47.5 million euros ($73.2 million). As a result of the acquisition, the Company recorded $87.9 million of goodwill and the $16.6 million one-time expense related to the value of acquired in-process research and development. These results are included in the quarterly financial data.

Financial Services Segment

Harley-Davidson Financial Services [HDFS] operating income for the third quarter was $35.6 million, a decrease of $13.9 million or 28.0 percent compared to the year-ago quarter. The decrease is primarily due to a $9.4 million write-down of finance receivables held for sale to fair value. In addition, last year’s third quarter included a $3.5 million securitization gain compared to no securitization transaction during the third quarter of 2008.

Income Tax Rate

The Company’s third quarter effective income tax rate was 38.2 percent compared to 35.5 percent in the same quarter last year. The third quarter increase was due primarily to a non-deductible in-process research and development charge for MV Agusta Group and the expiration of the federal research and development tax credit as of December 31, 2007. In October 2008, the federal research and development tax credit was reinstated for two years retroactive to January 1, 2008 continuing through December 31, 2009. The Company expects its full year effective income tax rate in 2008 will be approximately 35.5 percent.

Harley-Davidson, Inc. — Nine Month Results

For the first nine months of 2008, revenue totaled $4.30 billion, a 0.9 percent decrease from the year-ago period. Diluted earnings per share were $2.45, a decrease of 16.9 percent compared to the same period last year.

Through the first nine months of this year, shipments of Harley-Davidson motorcycles were 226,898 units, a 9.0 percent decrease compared to last year’s 249,413 units. Harley-Davidson motorcycle revenue was $3.26 billion, which is down 2.2 percent compared to last year’s $3.33 billion. P&A revenue totaled $706.6 million, a 0.5 percent increase over last year’s $703.1 million. General Merchandise revenue totaled $244.8 million, a 5.5 percent increase compared to $232.0 million during the same period in 2007.

HDFS operating income was $107.7 million, a 38.0 percent decrease from last year’s $173.6 million.

Cash Flow

Cash and marketable securities totaled $504.9 million as of September 28, 2008. Cash used by operations was $221.2 million, and capital expenditures were $153.7 million during the first nine months of 2008. For the full year of 2008, capital expenditures are still expected to be between $235 million and $250 million.

Stock Repurchase

The Company repurchased 2.5 million shares of its common stock at a cost of $100.1 million during the third quarter of 2008. On September 28, 2008, the Company had 232.8 million shares of common stock outstanding.

As of September 28, 2008, there were 16.7 million shares remaining on a board-approved share repurchase authorization. An additional board-approved share repurchase authorization is in place to offset option exercises.

So, the bottom line is that if you are selling anything that requires credit to purchase it, things are going to be tough. The question then is, what is management doing to position the company for the inevitable improvement? CEO Zimmer is buying back shares at depressed prices, making international acquisitions at reduced prices and expanding the company's product line.

All these are great moves while the company remains solidly profitable. Merchandise and parts revenue continue to grow. International sales are growing double digits. The drag is U.S. domestic sales and HDFS. Eventually we get an improvement here. Even if 2009 just manages to be stagnant in the U.S., the other segments will propel EPS growth for the year.

Another point, at current levels ($24 and change), the shares carry with them a 5.38% yield that is very safe. The company will spend roughly $310 million next year on dividends and are buying back about $400 million a year of stock. The buybacks will be stopped before the dividend is threatened. Let's not forget they also trade at eight times earnings.

Disclosure ("none" means no position): Long HOG.

Comments

[Joseph Wagda:]

Hi Todd,

I am less bearish on HOG than I have been in responding to previous posts on SA regarding HOG. However, there are three points which must be addressed before I can get completely bullish.

1. HOG indicated during the earnings call that it wanted HDFS to access the unsecured debt markets for $300 - $500 million this quarter. Why would it attempt to access that market (if possible) and lock in high spreads in lieu of issuing 364 day commercial paper and taking out that commercial paper with proceeds from a portfolio securitization in 2009 (or an issuance of medium term notes at less onerous spreads)? It seems to me that, at the very least, HDFS should be able to roll that commercial paper forward until late 2010 if the securitization market remains shut down. The primary course of action chosen by HOG makes me wonder what is really going on with HDFS and its credit facilities.

2. The share buybacks done by HOG over the last 21 months have been a terrible use of capital – during 2007 it repurchased approximately $1 billion in shares at an average price of approximately $50 per share. I’d bet that the $500 million lost in that trade would be attractive to HOG management right now. Even the $100 million repurchased in the third quarter was bought for $40 per share. (At least Ziemer and Bergmann were not writing leveraged CDS on Lehman debt.) If HOG management really is serious about HOG being a value at these prices, then Ziemer and (former Chairman/CEO) Bleustein should make some large purchases of HOG stock with their own capital.

3. Lastly, indicating that the drags on HOG’s performance are domestic sales and HDFS is akin to stating that the only things wrong with the Cincinnati Bengals are their offense and their defense. At least the special teams (in this case international sales and P&A) have not fallen apart yet!

Notwithstanding the points made, at $26 per share, there is event driven risk priced into the shares which I believe is overblown. I’d buy these shares for a trade (maybe in conjunction with buying puts at $25 to limit event-driven risk exposure) with an eye on a $35 short term price target.

2008 Oct 16 05:47 PM

[http://www....:]

hog the last good american vehicle company

2008 Oct 17 03:20 AM

[mallarde:]

After being short all year, I bought a small amount of HOG looking for a short term trade. But I would not wait for the mid-$30s. I don't think it gets to that level anytime soon. Like not in the next 5 years.


On Oct 16 05:47 PM Joseph Wagda wrote:

> Hi Todd,
>
> I am less bearish on HOG than I have been in responding to previous
> posts on SA regarding HOG. However, there are three points which
> must be addressed before I can get completely bullish.
>
> 1. HOG indicated during the earnings call that it wanted HDFS to
> access the unsecured debt markets for $300 - $500 million this quarter.
> Why would it attempt to access that market (if possible) and lock
> in high spreads in lieu of issuing 364 day commercial paper and taking
> out that commercial paper with proceeds from a portfolio securitization
> in 2009 (or an issuance of medium term notes at less onerous spreads)?
> It seems to me that, at the very least, HDFS should be able to roll
> that commercial paper forward until late 2010 if the securitization
> market remains shut down. The primary course of action chosen by
> HOG makes me wonder what is really going on with HDFS and its credit
> facilities.
>
> 2. The share buybacks done by HOG over the last 21 months have been
> a terrible use of capital – during 2007 it repurchased approximately
> $1 billion in shares at an average price of approximately $50 per
> share. I’d bet that the $500 million lost in that trade would be
> attractive to HOG management right now. Even the $100 million repurchased
> in the third quarter was bought for $40 per share. (At least Ziemer
> and Bergmann were not writing leveraged CDS on Lehman debt.) If
> HOG management really is serious about HOG being a value at these
> prices, then Ziemer and (former Chairman/CEO) Bleustein should make
> some large purchases of HOG stock with their own capital.
>
> 3. Lastly, indicating that the drags on HOG’s performance are domestic
> sales and HDFS is akin to stating that the only things wrong with
> the Cincinnati Bengals are their offense and their defense. At least
> the special teams (in this case international sales and P&A) have
> not fallen apart yet!
>
> Notwithstanding the points made, at $26 per share, there is event
> driven risk priced into the shares which I believe is overblown.
> I’d buy these shares for a trade (maybe in conjunction with buying
> puts at $25 to limit event-driven risk exposure) with an eye on a
> $35 short term price target.

2008 Oct 17 01:46 PM

[mallarde:]

Todd, you are sounding like the spinners in Washington -- "This is old news. We knew about this already." C'mon, you have been pumping this stock for a year. I hate to pat myself on the back, but [pat, pat]. FUJIMO and I were dead on with respect to HOG. Everything, including the murky financing arm.

2008 Oct 17 01:51 PM

[Joseph Wagda:]

Mallarde

You were right about $35 - three weeks ago seems like such a distant memory. Good thing I mentioned covering the downside with puts otherwise my short-term long idea would have been wrong in an ugly way (as opposed to merely wrong).

The stock looked attractive at $26, but looks less attractive at $21. The company is being valued by the market at an absurdly cheap price, which in this case, when combined with the debt maturity due December, raises a HUGE red flag.

Investors having both capital and huevos grandes could make a nice profit between now and December 11 assuming HOG can issue new debt to retire this maturity or use free cash flow (Hey Ziemer, there is a concept!!) to retire the notes.

Any debt issuance, given spreads mentioned in other articles on SA, likely would be very expensive even if the company did not need the money. Given the circumstances under which HOG is seeking financing, things could get ugly.

2008 Oct 23 09:39 PM