Harley-Davidson, Inc. Q1 FY2022 Earnings Call

Thank you. Good morning, everyone. This is Shawn Collins, the Director of Investor Relations at Harley-Davidson. Welcome to our Q1 2022 earnings call. You can access the slides supporting today's call on the Internet at investor.harley-davidson.com. Our comments will include forward-looking statements that are subject to risks that could cause actual results to be materially different. Those risks include, among others, matters we have noted in our latest earnings release and filings with the SEC. Harley-Davidson disclaims any obligation to update information in this call. Joining me this morning are CEO, Jochen Zeitz; and CFO, Gina Goetter. In addition, Chief Commercial Officer, Edel O’Sullivan, will join for the Q&A. Jochen, let's get started.

Thank you, Shawn, and good morning, everyone. Thank you for joining us today. Before we get into the quarter's results, I want to take a moment to recognize the devastating war that continues to unfold in Ukraine. On March 1, following the invasion of Ukraine, Harley-Davidson announced that we were suspending our business in Russia. This remains unchanged. At Harley-Davidson, our response to the humanitarian crisis has been driven by the core element of our mission as a brand, Freedom. Whether through the philanthropic donations we've made to organizations like United Way or through the efforts of our employees and the wider community donating time, money, and resources to provide aid to those in need. It is that spirit of freedom underpinned by community that has driven our efforts. A key initiative pioneered by the company has been a fundraising t-shirt designed by our employees. We've partnered with two charities delivering aid to those in need, United Way and Open Mind. And we're committed to support these organizations and their incredible work as long as needed. With that, I'll move on to our results from the quarter. We started the fiscal year with good momentum across the business, underpinned by strong global consumer demand for our products. First quarter consolidated revenue was up 5% to $1.495 billion, driven primarily by HDMC revenue growth. And while we are pleased with our start to 2022 and anticipate the momentum to improve during the year, it's important to acknowledge the significant supply challenges that we had to work through in Q1 and that we expect to continue to impact the industry. We are cautiously optimistic on improvements to the supply chain environment in the second half of the year. However, this remains difficult to predict with certainty. That said, the brand is getting stronger and more desirable as we continue to deliver our Hardwire milestones as part of the huge transformational journey the company is on. At the last quarter, we provided a comprehensive recap of our delivery against both the Rewire and the Hardwire, including the important realignment of our organization, creating a culture of performance, efficiency, focus, and speed. In unlocking this potential, we set the company's foundation for long-term success. In May, we will be presenting a comprehensive update to our Hardwire strategy. So today, I will only briefly address some highlights from the quarter aligned to our strategic pillars and our delivery against them. Profit focus. As you know, we are committed to strengthening and growing our position in our strongest motorcycle segments; in Touring, Large Cruiser, and Trike. Not only are these segments the most profitable in the market globally, but we also believe these segments have untapped potential to inspire more engagement, while compelling new customers and riders to choose Harley-Davidson. With Hardwire, we made a commitment to introduce a series of motorcycles that align with our strategy to increase desirability and to drive and build on the incredible legacy of Harley-Davidson. In this context, in January at our Further Faster model year launch, we added extra performance in factory custom style to our 22 motorcycle lineup with the reveal of eight new models, each powered with the Milwaukee-Eight 117, the most powerful factory installed engine ever offered by Harley-Davidson for those riders who want nothing but the biggest and the best, building on our position as the most desirable motorcycle brand in the world. New models included the Street Glide ST, the Road Glide ST, and the Grand American Touring Line, the more powerful Low Rider S and the new Low Rider ST cruiser models and four super premium models from Harley-Davidson Custom Vehicle Operations, CVO. Since launch, the response to this performance-driven lineup has been very strong. And as the market leader, we look forward to building on our performance-driven legacy in these segments. We believe the demand we are seeing is a good indicator of the desirability that we've been able to build for our brand and product. Lead in electric. Electric motorcycles are important to Harley-Davidson's future and we're committed to staying at the forefront of electric motorcycle technology. LiveWire continues on its mission to be the most desirable electric motorcycle company and brand in the world. Building on our announcement from last year, the LiveWire transaction remains on track as we work towards the listing in Q2. We recently opened the first LiveWire Experience Center in Malibu with one of our first in-person events since the pandemic began. The consumer awareness of the brand is building and the interest in EV continues to grow. Growth beyond bikes. Harley-Davidson Financial Services, H-D1 marketplace, parts and accessories, apparel, and licensing are important drivers of the company's future success as a global sport and lifestyle brand, providing untapped potential to grow our customer base. HDFS is an important asset to Harley-Davidson from both a brand and revenue point of view. And as we look ahead, we look forward to widening our HDFS offering to new markets. This quarter, we've seen retail credit losses begin to normalize resulting in a higher provision for credit losses, partially offset by lower interest expense. This quarter saw particularly strong performance from parts and accessories, especially in North America. With personalization at the heart of motor culture and the Harley-Davidson brand, we believe parts and accessories is a long-term growth area for the business and that there is strong potential to continue growth trajectory as more riders look to make Harley-Davidson uniquely theirs. This quarter is the first time we are reporting apparel and licensing as a separate business unit. The quarter saw modest growth in apparel against a challenging supply backdrop and strong growth in our licensing business. Looking ahead, we're excited about the potential to grow both apparel and licensing, leveraging the power of the Harley-Davidson brand across the globe. And lastly, this quarter saw the publication of our annual Inclusive Stakeholder Management Report, highlighting some of the key achievements by the company through inclusive stakeholder management in the context of people, planet, and profit. We continue to redefine and evolve our brand and company with inclusive stakeholder management as one of our six strategic priorities. The report highlights include prioritizing people through the implementation of the Hardwire brand, preserving our planet through our commitment to reduce carbon emissions and creating a path to achieving net zero carbon emissions for Harley-Davidson by 2050 and for LiveWire by 2035, and promoting social profit through the Harley-Davidson Foundation's investment into our home neighborhood in Milwaukee, making it not only a great place to work but a great place to live and visit. We have much to be proud of and much to look forward to in the years ahead. And before I hand over to Gina, I want to reiterate that we're looking forward to welcoming many of you to Milwaukee on the 10th of May for Harley-Davidson's Inaugural LiveWire investor sessions. But now I'll hand over to Gina to run through the numbers.

Thank you, Jochen. First quarter results reflect year-over-year revenue growth but operating profit decline as we continue to operate in a volatile and inflationary supply chain environment, and we begin lapping last year's record performance within HDFS as a result of the lower loss rates and reserve allowance release. We continue to deal with the constraints resulting from the global semiconductor shortage, higher raw material prices, and broad supplier volatility, with cost inflation at levels consistent with what we experienced in the back half of 2021. Looking more closely at our financial results in the quarter, total consolidated revenue of $1.5 billion was 5% ahead of last year. This increase was largely driven by revenue growth of 6% within HDMC. Despite wholesale motorcycle units being flat year-over-year, revenue growth was attributed to strong global pricing and 11% growth across our parts and accessories business and 2% growth in the apparel business. Within the Financial Services segment, revenue was up 1% due to higher retail lending. Total operating income of $289 million was down 16% compared to last year, in line with our expectations. For HDMC, operating income was $203 million, down 11% versus last year. The profit decline is attributed to cost inflation and production limitations preventing us from achieving an optimal unit mix. At HDFS, operating income was $86 million, down 27% versus the prior year, as the loss performance continues to normalize in line with expectations. First quarter GAAP earnings per share of $1.45 compares to $1.68 last year, with the decline driven by the factors already noted. Global retail sales of new motorcycles were up 2% in the quarter, with significant growth in our international markets offsetting a decline in North America. North America Q1 retail sales were down 5% versus last year as production challenges resulted in lower dealer inventories. We continue to build out our reservation system with the new model year launch with 92% of the U.S. dealer network participating in the program which is up from 78% in 2021. Reservations have increased 48% in 2022 compared to total 2021 reservations. Recent new model introductions continue to show high demand in our leading reservation requests, including Low Rider ST, Pan America Special, and Sportster. In markets outside of North America, Q1 retail sales were up 21% versus last year driven by growth in India, which was up 28%, and Asia Pacific, which was up 16%. EMEA and APAC retail sales were positively impacted by greater product availability and moving past the majority of the unit declines associated with the market exits and model pruning actions taken as part of the Rewire. Worldwide retail inventory of new motorcycles was down 24% versus last year and roughly flat to the previous quarter. Given the challenges with production, there was limited pipeline fill. On average, a bike is sitting on the showroom floor in the U.S. for less than two weeks, which is an extraordinary reduction from Q1 2019 when this was more like 10 weeks. Overall, we continue to see strong pricing dynamics for both new and used motorcycles in Q1 as we did throughout 2021, with transaction prices staying within two points of MSRP. The used market also held steady with prices continuing to trend significantly above historical levels and within narrow gaps of new motorcycle pricing. Looking at revenue, total HDMC Q1 revenue was up 6% versus last year. Focusing on the key drivers in the quarter, two points of growth came from volume, which is a combination of flat motorcycle units and growth in the parts and accessories and the apparel business. Seven points of growth from pricing and incentives driven by global MSRP price increases, coupled with pricing surcharges in select markets. Two points of negative impact from unfavorable mix due to supply limitations, which predominantly impacted our North America touring business. And finally, one point of negative impact from foreign exchange. Focusing in on margins, Q1 gross margin of 31.3% was down 280 basis points versus last year. The margin benefit from pricing was offset by the negative cost inflation across the supply chain and an unfavorable impact for the motorcycle mix. Recall that in 2021, inflation really started accelerating in Q2 and continued ramping as we moved throughout the year. The cost inflation we saw come through in Q1 is consistent with the level seen in the back half of last year. Q1 operating margin finished at 15.6% compared to 18.5% last year. Besides the drivers already noted, we had higher operating expenses in the quarter primarily driven by LiveWire. The Financial Services segment operating income in Q1 was $86 million, down $32 million compared to last year and slightly better than internal expectations. The decline versus last year is largely driven by the unfavorable year-over-year comparison in 2021 where we experienced both low loss rates and a significant release of the loss allowance. Setting aside the tough comps to 2021 and looking at the HDFS base business, retail originations in Q1 were up 13% versus last year, behind strong new and used motorcycle origination volume. Ending finance receivables in Q1 were $6.8 billion, which is up 1% from last year. HDFS's retail credit loss ratio of 1.8% is a 60 basis point increase versus 2021, as credit performance continues to revert back to historical norms and we move past the benefits provided to individuals under the federal stimulus package of last year. This increase in Q1 is in line with expectations. In addition, the retail allowance for credit losses at the end of Q1 was 5%, which was unchanged from Q4. Wrapping up with Harley-Davidson, Inc. financial results, we delivered $139 million of operating cash flow, down from $163 million in Q1 2021. The decrease in operating cash flow is driven by a change in working capital. Total cash and cash equivalents ended at $1.4 billion, which is down $927 million compared to the end of the prior year Q1. And during the quarter, we restarted share repurchases and bought back approximately 6.2 million shares. As we look to the rest of 2022, we reaffirm our full-year outlook where we continue to expect HDMC revenue growth of 5% to 10%. This revenue growth forecast incorporates what we know today in terms of the impact from the semiconductor and supplier challenges impacting our business. We expect revenue to continue to be positively impacted by our global pricing actions as we work to offset the cost headwinds across the supply chain. Furthermore, we expect annual growth for the parts and accessories and apparel and licensing businesses. We continue to expect HDMC operating income margin of 11% to 12%. We believe the anticipated positive impact from volume leverage, unit mix, and pricing combined with growth across our margin-accreted businesses of P&A and apparel will more than offset the expected cost inflation across the supply chain. Also, the suspension of the additional EU tariffs realized in 2021 contributes over a point in margin growth. We continue to expect HDFS operating income to decline by 20% to 25%. This decline is largely a result of the favorable allowance releases and lower credit losses in 2021. We believe that favorability is not likely to repeat itself in 2022. And lastly, we continue to expect capital investments of $190 million to $220 million as we invest behind product development and capability enhancement in support of our Hardwire strategy. Embedded within our guidance for 2022 is LiveWire. At this time, we remain committed to the outlook issued as part of our December 13 announcement. And finally, as we look to the 2022 capital allocation, our priorities remain to fund the growth of the Hardwire initiative, which includes the capital expenditures previously mentioned, pay dividends, and we plan to continue to execute discretionary share repurchases. We have 12 million shares remaining at the end of Q1 on our Board approved share repurchase plan. This financial guidance is reflective of the supply chain outlook that we have at this time. This updated forecast assumes that logistics and manufacturing will improve as we move through the back half of the year, as we get beyond the peak levels of inflation experienced in 2021 and the semiconductor supply stabilizes. Given the macro global factors influencing raw materials, we now believe that raw materials and supply component inflation will continue through the balance of 2022 at inflation rates similar to Q1. As we think about phasing for the year, we believe our back half revenue growth is going to be stronger than our front half. Additionally, due to the timing of anticipated supply chain stabilization, we expect our operating income margin to be in the mid-teens in the front half and to be in the mid to high single digits in the back half. At this point, I'll turn it back to the operator to take your questions.

Good morning, and thank you for taking my question. I have two questions. First, Gina, could you provide some insight into the trend of this shipment during the first quarter? Was there a shortfall in March in the U.S.? Additionally, you've mentioned some details about the supply chain, but Polaris indicated they might be seeing some positive developments. Can you share any further information on that? Lastly, regarding the guidance for the year, could you elaborate on the timing of gross margin offsets and what factors might improve gross margin in the second half related to term changes and the possibility of more surcharges? Thank you.

Good morning, Robbie. Thank you for your questions. Let's begin with the shipments and their movement throughout the quarter. March was definitely more challenging than earlier in the quarter, primarily due to our chip supply and its impact on production as we progressed through the first quarter. Production rates did not slow down as we moved forward. Regarding supply chain issues, the first quarter was quite similar to the second half of last year. Q4 mirrored the trends we are observing in Q1. Looking ahead, we anticipate improvements in chip availability during the latter part of the year, although we do expect some supplier volatility to persist. This reflects what we experienced in Q1 and will likely continue as the year progresses. We see promising signs of improvement in logistics and our manufacturing environment. As chip supply stabilizes, our production becomes more efficient. Our manufacturing inflation rate for the first half of the year is worse than what we expect for the second half, largely due to our ability to operate more efficiently as the chip issue resolves. We also anticipate logistics will improve in the latter half of the year. While costs may not decrease, we expect them not to rise as significantly as they did in Q1. Last year, Q1 experienced low inflation, but Q2 saw an increase that continued through Q3 and Q4. This quarter continues to reflect the rising inflation trends of the previous four quarters. In terms of our guidance, improved visibility on chip supply and the resulting production capabilities give us confidence in a margin increase for the latter half of the year. Additionally, we have consistent global pricing and other cost management strategies in place to help maintain our overall margins.

Thanks. Good morning. A couple of quick questions. I guess, first, the dichotomy between retail trends in the U.S. and internationally in Q1, was that all due to the difference in base period compares? You mentioned in terms of EMEA better availability, et cetera. But it just seemed like it was a big difference this quarter. So I'm curious what you saw from a demand standpoint internationally that maybe you didn't see in the U.S.?

Joe, demand is equally strong throughout the regions. You need to consider that especially in the first quarter of last year in the EMEA region, we had a drop that we were compensating with the first quarter of this year, but there is no demand difference. Demand is equally strong in all regions. Also, what you need to bear in mind is maybe as an additional comment is we serve as a market from our manufacturing plant and Thailand serves the EMEA region as well. So there's also differences in timing in terms of when we were manufacturing, particularly in March.

Hi. Good morning. Thanks for taking my question. It's on the economy. Obviously, there's a lot of focus on your supply chain challenges, and rightly so. But we do get a lot more questions on the economy and demand trends as the Fed looks to fight inflation and the potential for a recession as they try to get ahead of it. I guess in your mind, what can you do to prepare for a recession? And how likely is that as you see your current demand trends today?

Thanks, Craig. Demand trends and signals are strong, as Gina pointed out. Currently, 92% of our dealer network is utilizing our reservation system, with reservations up 48% compared to last year. Both the quantitative and qualitative feedback from our dealers confirm that demand for our product remains very strong. I also mentioned that inventory levels are down 24% compared to the end of last week, which reflects the ongoing strong demand. Our market share in our most profitable categories is increasing, with more riders participating in our Riding Academy than ever before. Additionally, the gap between used and new bike prices is the smallest it has ever been, and transaction prices are at or above MSRP. All of this suggests that while we can't predict a recession, if one does occur, our extremely low inventory levels will help us navigate any potential negative impacts on our wholesales. Furthermore, in terms of HDFS, they are starting from a very solid position. The cost of funds is currently half what it was back in 2009, and rates are more competitive. While we are preparing for any challenges, we see no signs of weakening demand for our products. Demand is strong, and that is what we are planning for.

Good morning. This is Joe Nolan on for David MacGregor. I was just wondering if you could talk about within the 5% to 10% motorcycle revenue growth guidance for the year, could you just talk about how you're thinking about volume versus price within that guidance?

Sure. Good morning, Joe. This is Gina. So in that 5% to 10%, how we've talked about it at the low end of the range of that 5%, it's basically all price. At the high end of the range at 10%, that is both a combination of volume and price.

Hi. Good morning. Thank you for taking my questions. First, I'm curious if you would be willing to discuss what your composition of dealer inventory looks like right now and maybe where your optimal time on the show floor would be? It's obviously somewhere between two weeks and 10 weeks, but I'm guessing we may not be at that level yet. And then as you think about the mix of units for the rest of the year, if you have any insight as to how you expect that to play out that would be really helpful from a gross margin perspective? Thank you.

Good morning, Jamie. Thank you for your questions. Let me first address your inquiry about the optimal inventory level. As you pointed out, we are currently experiencing a lighter inventory in our dealer network than we would like. This is something we've noted, both from qualitative feedback from our dealers and the speed at which our units are being sold. We are implementing several short-term measures, including our reservations and preorder systems, to support this lean inventory position in both domestic and international markets. Our dealers would definitely appreciate an increase in inventory to make it more robust over time. However, regarding your mention of the upper limit of a 10-week inventory, we do not foresee returning to that level. We, along with our dealers, have learned to operate more efficiently and have found alternative ways to meet customer demand for specific models, especially the new ones, without needing excessive inventory on the dealer floor. We are continuously learning and evolving, gaining a better understanding of consumer behavior over the past few years, and we will consider that as we plan inventory levels moving forward. As for your second question about units, in Q1, we were anticipating higher demand for shipments, particularly for our touring product in North America. It's important to note that our manufacturing footprint was impacted differently during the quarter. We expect to see some recovery in this aspect in the latter half of the year. We have strong demand in North America for some core products, which are among our most profitable lines, and we aim to fulfill that demand throughout the year. Therefore, there is definitely an opportunity for mix and how these core segments will represent for the rest of the year.

Hi. Good morning. Sorry about that earlier. Gina, you helped us with the phasing of the motorcycle. Is there any way you can help us with HDFS phasing for the rest of the year? And maybe how some of these CECL provisions might play into that?

Yes, good question. I would say it's going to be relatively constant with what you saw play through here in Q1. There's not any big spike up or down. When you think about the reserve release and what happened last year, it was a pretty kind of steady decline as we moved quarter-by-quarter. When you look at where our reserve rate is in Q1, relatively unchanged from what we saw in Q4. So we're not at this point expecting any big swings up or down in that reserve rate as we move through the balance of the year. And that was what was really creating, I would say, the lumpiness in last year's results.

Great, thank you. Good morning. I was hoping we could talk a little bit more about pricing, particularly surcharges. I think in international, maybe you did not have some surcharges last year, and if you're implementing those in international markets this year? And then also the contribution from the reduction in dealer margin and how you came to that decision to go forward with a lower margin for dealers? Thank you.

Good morning. Thank you for your questions. So as your reference, we have taken several pricing actions starting last year and into the first part of this year on an ongoing basis across all regions and all family lines, so both motorcycles as well as parts and accessories and apparel and licensing. Those actions have largely offset the cost inflation that we are seeing this year. However, we continue to monitor that very closely to ensure that we are preserving our margin as much as possible through pricing actions. We also, of course, are monitoring price realization and understanding of where some of those metrics may be landing both domestically and internationally. As you say, we have used a mixture of MSRP as well as surcharges. We believe that this provides us flexibility. You will see that play out differently in different markets. But certainly the combination of those two factors is something that we think provides, again, that flexibility to monitor the situation as we go throughout the year. To your second question around the dealer margin, I wouldn't like to comment on the specifics of sort of the economic terms between ourselves and our key partners that are dealers in North America. I will say that for us a strong and healthy dealer network is an incredibly important part of the Hardwire strategy and what we intend to do over the next few years. Dealer profitability is at near record levels, which to us is great to see and we intend to continue to partner with our dealers to continue to evolve the model of how we work together to best serve our customers over the course of Hardwire and beyond.

Hi. Good morning. Thanks for the question. Gina, thanks for the color there on what the production schedule looked like as we moved through the quarter. Could you flip that around maybe and talk about what the demand trends have looked like during the quarter, because particularly as we've seen gas prices move higher here in the last couple of months?

In short, no. We have not experienced any current acute inflation issues affecting consumers or our demand. So, we are not seeing that. The main factor impacting our shipments in Q1 was our ability to produce according to demand. There was no slowdown at all, and Edel can provide additional insights from a dealer perspective. Everything observed in Q1 was related to our production capabilities.

Gina, maybe let me add to that and reiterate some of the points you also made earlier. Every dimension that we look at in terms of the data, preorders, price realization, the growth in demand and some of those key categories, Touring, Trike, Large Cruiser, as well as the relative speed of the inventory turning out sort of unprecedented rates at more or less two weeks, and that includes those shipments, all of those we find to be positive. Some of the other metrics that we look at to monitor demand, the used price gap versus new as well as even how many students are coming through Riding Academy are also very positive. And then to the third factor that Gina referenced, the qualitative feedback that we get from our dealers, I think the consistent message both in the U.S. and Canada and in other international markets is really around, if we had more bikes, you could sell them. So I think that all of those factors contribute to giving us confidence in what we are seeing in terms of demand.

Hi, guys. Good morning. Thanks for the question. I just wanted to follow up on the comment about just that gap between new and used pricing. It's not something that you guys have been working on for a really long time. But as we think about whether it's later this year or into next year, how do you see that gap trending? Should we expect it to expand a little bit? Could there be a little bit more seasonality?

I would not expect that gap to widen too dramatically as we move through the remainder of this year and into next fiscal year, considering the current situation on the supply side. The production levels in 2020, 2021, and 2022 will positively impact the economics in the used market.

Great. Well, thanks everyone for joining today's call and we hope you have a great day and obviously check in with us with any questions. Thanks.

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.