Harley-Davidson Inc (HOG) 2006 Q2 法說會逐字稿

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  • Operator

  • At this time I would like to welcome everyone to the Harley-Davidson second quarter 2006 earnings conference call. [OPERATOR INSTRUCTIONS] Thank you.

  • It is now my pleasure to turn the floor over to your host, Mark Van Genderen, Director of Investor Relations.

  • Sir you may begin your conference.

  • - Director, IR

  • Thank you.

  • Good morning and welcome to Harley-Davidson's second quarter 2006 conference call.

  • Over the course of the next hour we will provide comments on our second quarter performance, on Harley-Davidson retail sales at our dealership, and the 2007 model lineup introduced this past weekend to our dealers in San Diego.

  • With the time remaining we will answer questions.

  • Harley-Davidson's CEO, Jim Ziemer, will speak to you in a moment; followed by CFO, Tom Bergmann, who will share the financial and retail highlights of the quarter.

  • Tom will be followed by Donna Zarcone, the President and Chief Operating Officer of Harley-Davidson Financial Services who will talk about the performance of that business unit;

  • Jim Ziemer will wrap up our prepared comments sharing his thoughts on the quarter, the 2007 model year motorcycles and the impact these motorcycles will have in the marketplace.

  • We will then open up the phone lines for questions.

  • Before we begin I would like to remind you that this call is being recorded and a replay will be available after 11:00 a.m.

  • Central time this morning.

  • Please dial 973-341-3080, and enter pin number 7433466 followed by the pound sign.

  • The recording will be available through July 24.

  • It is also being webcast live on Harley-Davidson.com.

  • The webcast will be available for replay throughout the next several weeks before being archived on the Investor Relations portion of the Harley-Davidson website.

  • This call 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.

  • Now, I'd like to turn the call over to CEO and President of Harley-Davidson, Inc., Jim Ziemer.

  • - CEO

  • Good morning and welcome to our second quarter conference call.

  • Tom and I are still in San Diego this morning, after having spent the last four days at our summer dealer meeting with over 5,000 representatives from our worldwide dealer network.

  • There's no doubt they are fired up about our new 2007 model year motorcycles that we just introduced to the marketplace on Friday.

  • But before I get ahead of myself, to tell you about the additions and the enhancements to our motorcycle lineup I'd like to turn the call over to Tom who will share in more detail the financial and retail performance of the quarter.

  • - CFO

  • Thanks, Jim.

  • Good morning, everyone.

  • As we look at the second quarter, we are very pleased with the financial results of the quarter and the retail performance posted by the Harley-Davidson dealer network worldwide.

  • Here are some of the highlights compared to the second quarter of 2005.

  • Revenue for the quarter was $1.4 billion, up 3.3%.

  • Net income for the quarter was $243.4 million, up 2.5%.

  • Earnings per share were $0.91, up 8.3%.

  • Worldwide retail sales of Harley-Davidson motorcycles totaled 125,455 units, up 10% from the year-ago period.

  • And we bought back 7.8 million shares of our common stock at a cost of $392.5 million.

  • Turning specifically to our motorcycles and related products segment, wholesale Harley-Davidson motorcycle shipments in the quarter grew 3.5% to 79,796 units while revenue from motorcycles was up 2.2% to $1.03 billion.

  • Average revenue per unit declined approximately $165 during the quarter, primarily due to mix changes within our custom motorcycle families.

  • In support of our international dealers continued strong retail growth international shipments of Harley-Davidson motorcycles in the second quarter of 2006 were 21,744 units, up 19.9% compared to the same period in 2005.

  • Wholesale shipments to our domestic dealers in the second quarter of 2006 were 58,052 units compared to 58,997 units in the same period of 2005.

  • So for the second quarter, international shipments represented 27.2% of total wholesale shipments.

  • Looking at overall mix, the motorcycle mix among Touring, Custom, and Sportster models were stable compared to the second quarter of 2005.

  • The percentage of Touring motorcycles shipped in the quarter was 34.3% this year compared to 34% in last year's second quarter.

  • Sportsters represented 19.7% of motorcycle shipments for the quarter, identical to last year's second quarter.

  • Custom shipments for the quarter were 46% compared to 45.9% in last year's second quarter.

  • However, as I mentioned, there were some mix changes between two of our custom motorcycle families.

  • More specifically, we shipped a higher percentage of Dyna motorcycles compared to Softails this year versus last year.

  • Parts and accessories and general merchandise delivered positive results in the quarter as well.

  • General merchandise, with quarterly sales of $67.1 million, was up 5.8%, or 3.7 million over last year's second quarter.

  • Parts and accessory's revenue was $251.7 million, up 5.9%, or $13.9 million compared to the same quarter last year.

  • Now, let's turn to margins for the quarter.

  • You will notice that gross margins are 37.5%, equal to the margin for the same period in 2005.

  • During the quarter, currency favorability and model year pricing was offset by continued raw material surcharges and mix changes within the custom motorcycle families.

  • As we've previously stated, the Company expected continued raw material surcharges, given the current price of steel, aluminum, and other materials.

  • In the second quarter of 2006, these surcharges totaled approximately $12 million, compared to approximately $9 million in the second quarter of 2005.

  • So, for the first half of the year, we incurred just over $20 million in material surcharges compared to 17 million for the same period in 2005.

  • Provided raw material prices remain at their current levels, we anticipate that increases in material surcharges during the second half of the year will be consistent with the increases experienced in the first half of 2006.

  • Operating margins in the second quarter of 2006 decreased from 24.0% to 23.6% compared to the year-ago quarter.

  • Among the factors that impacted operating margins this quarter were additional motorcycle warranty expense, primarily related to higher than anticipated second-year experience on two-year warranties and higher product development costs.

  • While quarter to quarter variances can and do occur, we believe that margin improvement will continue on an annual basis.

  • Turning to the tax rate, you will notice that the Company's second quarter effective income tax rate is 36.0% compared to 35.5% in the same quarter last year.

  • This increase was due to the expiration of the federal research and development tax credit as of December 31, 2005.

  • The Company expects its full-year 2006 effective tax rate to be 35.5%, assuming the retroactive reinstatement of this tax credit.

  • Net income for the second quarter was $243.4 million, an increase of $6 million, or 2.5% compared to the second quarter of 2005.

  • Diluted earnings per share for the second quarter were $0.91, an 8.3% increase calculated on a weighted average share base of 268.131 million compared to 281.181 in the year-ago quarter.

  • The Company experienced strong operating cash flow for the first six months of 2006 of $828.8 million.

  • For the same period, depreciation was $108 million, and capital expenditures were $89 million.

  • For the full year, we expect capital expenditures in the range of 250 to $275 million.

  • During the quarter, we repurchased 7.8 million shares for a total of $392.5 million. 2006 year to date we have repurchased just under 10 million shares of stock for $500 million.

  • The Company continues to feel that share repurchases are a good use of cash and an efficient way to return value to shareholders.

  • There are approximately 10 million shares left on a 20 million share repurchase authorization granted by the Board in 2005.

  • You may have noticed in our press release this morning that we have condensed the operating activity section of our cash flow statement.

  • This new presentation is consistent with generally accepted accounting principles and additional disclosure will be provided in our second quarter 10-Q.

  • With that, now I'd like to turn to the current retail environment.

  • Over the past several months, concerns have been raised about the strength of the economy and the impact on leisure industries.

  • Despite this continued uncertainty, for the past 12 months Harley-Davidson dealers have delivered worldwide retail sales growth of 8.6%.

  • We continue to be pleased with this performance and, as you will hear from Jim Ziemer in a moment, we believe we are in a great position to continue this retail momentum.

  • Second quarter is traditionally Harley-Davidson dealers largest quarter of the year for new motorcycle unit sales.

  • Our worldwide dealer network retailed a record 125,455 new motorcycles in the second quarter of 2006, which is a 10% increase compared to the second quarter of 2005.

  • In the U.S., Harley-Davidson motorcycle retail sales increased 8.1% during the second quarter of 2006 compared to the same period in 2005.

  • In general, our information indicates that dealers are selling new motorcycles at MSRP.

  • And, retail sales of Harley-Davidson motorcycles in our international markets continued their momentum.

  • Total international growth for the second quarter of 2006 was 17.3%.

  • Europe experienced 15.6% growth in the second quarter.

  • Japan experienced growth of 15.8%.

  • And the Canadian market increased 13.4%.

  • All other international markets grew at a combined rate of 33.5%.

  • We are excited about our international growth.

  • It is evident that a number of foundational strategies we have been implementing over the last several years are really starting to take hold.

  • These include improvements within our dealer base, enhanced marketing programs, and more effective and efficient distribution of our motorcycles worldwide.

  • Looking forward, we anticipate that our international growth will outpace domestic growth.

  • With that, let's look at our third quarter shipment plan.

  • We are planning on shipping 97,000 Harley-Davidson motorcycles in the third quarter.

  • As a reminder, this third quarter shipment number includes approximately 12,500 2007 models that were produced but not shipped in the second quarter as we prepared for the 2007 model launch.

  • This third quarter shipment plan is an increase of 10.7% compared to the third quarter of 2005.

  • When combined with the shipments from the first six months of the year, this represents a year to date shipment growth rate of 6.2%.

  • For the full year 2006, the Company's wholesale motorcycle shipment target remains between 348,000 and 352,000 units.

  • Now that we have covered the motorcycle segment, retail sales, and our third quarter shipment plans, I'd like to turn it over to Donna Zarcone to discuss the Harley-Davidson financial services results for the second quarter.

  • - President, COO, Financial Services

  • Thanks, Tom.

  • Harley-Davidson Financial Services delivered second quarter operating income of $56.3 million, an increase of $5.2 million, or 10.3%, compared to last year's second quarter.

  • This performance was primarily driven by higher net interest income and insurance revenues compared to the second quarter last year.

  • Retail market share for HDFS in the United States related to new Harley-Davidson motorcycles grew to approximately 48% in the first half of 2006 compared to 43% for the first half of 2005, and roughly 45% for the full year 2005.

  • This growth in market share contributed to the increase in net interest income.

  • Our $800 million second quarter securitization resulted in income of $10.9 million.

  • This compares to a $14 million second quarter 2005 securitization gain.

  • This lower securitization gain for the second quarter of 2006 can be attributed to the rising interest rate environment and competitive market pressures.

  • Losses on managed retail motorcycle loans for the first half of 2006 totaled 1.2% on an annualized basis compared to 1.13% for the same period in 2005.

  • This increase is driven by a higher incidence of loss and a slightly higher average write-off per loss account.

  • Managed retail loans include both those which we keep and those which we sell through securitization transactions.

  • The 30-day delinquency rate for managed retail motorcycle loans at the end of the second quarter was 3.61% down from 3.66% for the second quarter of 2005.

  • Looking forward over the long term, the HDFS operating income growth rate is expected to be slightly higher than the Company's wholesale motorcycle shipment growth rate.

  • With that I will turn it over to Jim Ziemer, President and CEO of Harley-Davidson, Inc.

  • - CEO

  • Thank you, Donna.

  • As some of you know, Donna has made the decision to pursue a different career path as of the end of this month, so this will be the last time she will participate in our quarterly conference calls with you.

  • Despite my efforts to keep her in the Harley-Davidson family, she's determined to exercise her entrepreneurial nature and make her mark in a yet to be determined business venture.

  • I would like to take this opportunity to thank Donna for her dedication and contribution to Harley-Davidson over the past 12 years.

  • She has truly made a difference.

  • Now, I'd like to spend a few minutes giving you my perspective on the second quarter and highlighting the major product announcements that we've just completed here in San Diego.

  • To summarize the second quarter, we delivered on our planned shipments in the second quarter.

  • At the same time, our retail sales climbed 10% worldwide.

  • The strong retail sales at our dealers around the world have reduced dealer inventories by nearly 46,000 units in advance of the 2007 model year launch.

  • In my estimation, our second quarter retail sales results demonstrate that our ongoing strategy of balancing supply and demand is working.

  • I believe that the sales success of our dealers are having is based in large part on having great product and having that product available to customers when they want it.

  • We know that exciting product news helps drive retail sales. 2006 was a great model year in terms of product news.

  • And as Tom mentioned, looking at the last 12 months, which roughly matches the 2006 model year, retail sales grew 8.6% compared to the prior year.

  • Many of you have heard me say over the past few months that I have been fired up about our 2007 model year lineup, so I'm glad that I can finally talk about it to you in detail.

  • As you've probably heard by now, the major news was the introduction of a new engine.

  • The Twin Cam 96.

  • I can tell you firsthand, it was a huge hit with the dealers.

  • Just as I'm sure it will be with our customers, given that the look, sound, and feel of our Harley-Davidson starts with the V twin engine, the bigger, more powerful Twin Cam 96 is a major milestone.

  • This is the first new air-cooled engine since the introduction of the Twin Cam 88 in 1999.

  • Twin Cam 96 along with our recently introduced six-speed cruise drive transmission will power all of our motorcycles in the Dyna, Softail, and Touring families for 2007.

  • This new engine and transmission were designed simultaneously to maximize their integrated performance.

  • The gear ratios were engineered to an exact match with the torque curve, with much smoother shifting and acceleration improvement in all gears.

  • There are dozens of new technological breakthroughs, uncompromising precision at every level, and displacement, torque, and hoist bar have all increased as well.

  • Harley-Davidsons are known for their rumble and we took the opportunity to improve the sound quality of the exhaust with the Twin Cam 96 engine.

  • New mufflers have been tuned to enhance the lower sound frequencies for a deeper, more commanding exhaust tone that preserves the legendary Harley-Davidson sound.

  • Our international models also benefit from the engineering advancements of the Twin Cam 96 with significant power and quality improvements.

  • This will enhance our product offering for the growing markets like Europe and Asia.

  • In Europe, for example, torque output from the big twin motors -- excuse me, models, will increase significantly.

  • A change we believe our European customers will really respond to.

  • In addition to the new engine, the six-speed transmission, we introduced a number of new models as well.

  • There are two new V-rods, which as a family that tends to appeal to a younger demographic and are particularly popular in Europe.

  • This is the first 120-horsepower -- excuse me, the first is the 120-horsepower Night Rod Special with lower rear suspension and lower profile 240-millimeter-wide rear tires.

  • The seat height on the sinister looking bike is only 25.2 inches.

  • The second model is a limited edition street legal tribute to our National Hot Rod Association championship V-rods.

  • Its drag bake inspired paint scheme complements the standard 123-horsepower engine.

  • The Softail family will benefit from the Twin Cam 96 engine and the six-speed transmission and also adds a new model, the Softail Custom.

  • This chopper-inspired model has a chromed out, laid-back look with a 200-millimeter rear tire and ape hanger handlebars.

  • In addition, all Sportster model motorcycles now come standard with electronic fuel injection.

  • This improvement will be a major feature on the entire line of Sportster models. 2007 also marks the 50th anniversary of the Sportster family.

  • With that milestone comes an anniversary model offered in appropriate commemorative colors.

  • Mirage orange and vivid black.

  • Of course, there are numerous other product highlights that have been made to the 2007 lineup of motorcycles.

  • We've been able to accomplish all of these great product changes with an average increase to worldwide MSRP of approximately 1%.

  • Consider for a moment what we are bringing to market this year for Harley-Davidson.

  • There's a new engine for the big twin families, a six-speed transmission for all our Touring and Softail motorcycles, fuel-injected Sportsters, a number of new models, and a host of great features.

  • To get a full handle on the magnitude of these changes I would encourage you to check out our website, stop by a Harley-Davidson dealership, or attend one of our numerous events that our demo fleet is supporting this summer.

  • As I think about the impact of these changes in the marketplace, I believe the 2007 motorcycle lineup makes a new prospective customer out of every single existing Harley owner out there, giving him a reason to trade up to a 2007 model.

  • Of course the power of these changes will extend well beyond the current customers.

  • Competitive brand riders as well as people who are buying a motorcycle for the first time will sit up and take notice.

  • The 2007 model year is our strongest product year ever.

  • And as a result, I expect new interest in our motorcycles for a sustained period.

  • That said, the incredible products we have for this year don't stand alone.

  • As I've described to you before, Harley-Davidson has a lot going for us.

  • For example, we developed new target marketing programs to attract minorities, enter adults, and women.

  • We continue to make it easier for people to learn how to ride a Harley-Davidson and are aggressively inviting new people into the Harley-Davidson family.

  • Our focus on being close to the customers ensures that we develop the best possible ownership experience in the industry, and over the past several years, we've positioned ourselves internationally, continue to drive growth at a rate faster than the growth in the domestic market.

  • For these reasons, among others, we believe that worldwide retail sales of Harley-Davidson motorcycles will support a long-term wholesale unit growth rate in the range of 5 to 9% annually, and an annual EPS growth rate of 11 to 17%.

  • With over 20 years of record results, the most passionate and loyal customers in the world, a great brand, and incredible opportunities for growth, Harley-Davidson is an exceptional company.

  • I will now open it up for questions.

  • Operator

  • Thank you. [OPERATOR INSTRUCTIONS] Our first question is coming from David Cumberland of Robert Baird.

  • Please go ahead.

  • - Analyst

  • Good morning and congratulations.

  • - CEO

  • Good morning, David.

  • Thanks.

  • - Analyst

  • Jim, in the past you've talked about starting to make changes to the allocation approach to respond more quickly to retail trends by market.

  • Did those changes start to help your retail sales in Q2, and will those have a bigger impact in model year '07?

  • - CEO

  • No, our changes are being implemented with the start of the '07 model year, so we'll begin to see those going forward.

  • Those will be slow and gradual.

  • It takes awhile to change the makeup of the allocation out there, but they have been implemented starting with the current shipments this month and going forward.

  • And that's just in the U.S. market.

  • - Analyst

  • Okay.

  • And also for Jim, in the past, you have talked about new products and product enhancements as a positive gross margin driver.

  • Would the new engine and broader use of the six-speed transmission contribute to gross margin improvement over time?

  • - CEO

  • Bottom line, between the new products, again, all the drivers of gross margin, volume, working with our workforce, working with our suppliers, the benefits we do get from engineering and leveraging the capital intensity of the business as we add new machinery to improve our quality and increase capacity.

  • All those will be drivers to gross margin.

  • And as Tom said earlier, we believe that our margin will continue to -- our margin will continue to expand going forward.

  • - Analyst

  • One other question.

  • With the earlier transition of new model year production, did some model year transition costs that normally would be in Q3 fall into Q2?

  • Then related to that, or timing issues aside, were transition costs much different than usual due to the extensive amount of change?

  • - CEO

  • I mean, your last note, there was an extensive amount of change.

  • We have been planning for this for over a year.

  • I mean, when you put a new engine in and transmission and -- I mean, basically the engines have 700 new parts in it.

  • It was significant.

  • So there were some start-up costs involved in the second quarter.

  • We'll see those continue as you go up any running curve.

  • It's not a short period of time.

  • But we are well, we planned for this change.

  • It was executed extremely well.

  • If that was a big number, we would have gone over those details.

  • It was within our expectations.

  • - Analyst

  • Thank you.

  • Operator

  • Thank you.

  • Our next question is coming from Ed Aaron of RBC Capital Markets.

  • - Analyst

  • Thanks.

  • Good morning.

  • Good job on the quarter.

  • - CEO

  • Thank you, Ed.

  • - Analyst

  • Couple questions going back to the new engine.

  • Presumably it's going to have a positive impact on sales.

  • It's kind of hard for us to draw on historical comparisons though, because when you last introduced your new engine back in 1999 it was a fairly different environment.

  • Can you give us some just -- kind of relative to the last few years, do you think -- or maybe using last year as a comparison, in the back half of the year last year you talked about stronger retail sales because of the strength of the new products.

  • Relative to last year, do you think that this -- the '07 year will have more of an impact on it this coming year than the new products last year did on model year '06?

  • - CEO

  • There's always a lot of things to go into competitive environment, whether it's competitive responses, or economy, or whatever, but we have, high, high hopes that this engine and transmission, product changes, the V-rod, the changes to the Sportster, all are going to take us to our next level.

  • We really think that -- again, I think that the '06 model showed that when we come up with significant changes, and last year we did change -- touch every single model, and certainly have experienced the last 12 months of good retail sales.

  • That will continue.

  • Going forward with this engine change and powertrain change.

  • There's no doubt that we think this will do a lot of great things and help us continue to lead and define the heavyweight motorcycle market.

  • I don't think that the competition was expecting this, and this is going to take us to the next level, and we need to continue to do these things.

  • - Analyst

  • The shipment number for the quarter, 78,000 units, you said it was as expected, but I -- sorry, I think your guidance was 78,000 units and it came in a bit above that, but you said it was as expected.

  • I'm trying to understand that a little bit better.

  • - CEO

  • Basically we're saying that within reasonable range, it's within expected.

  • There's no doubt that with the European market truly being hot and growing significantly, double digits, that we had the opportunity, because our units from York in Kansas City get shipped to Europe, but are not counted as wholesale shipments until they are shipped to the dealers.

  • Where as the dealers have been running lower than expected of inventory, there were some more shipments, and that contributed to slightly exceeding that 78,000 unit guidance.

  • We didn't produce any more.

  • It's just that the timing of those being released to the European market was a little different.

  • - Analyst

  • Okay.

  • Last question, and I'll open it up, for the quarter you had a pretty good retail quarter, and even in the U.S. here.

  • But the overall heavyweight market grew even a little bit faster.

  • I think you had mentioned earlier in the year that you expected your shares to actually improve during the riding season.

  • Were you surprised by -- I don't know if you were surprised by your number, but were you surprised at the rest of the competition relative to your number?

  • - CEO

  • The rest of the competition is made up of, number one, they had many more promotions, and different kinds of promotions.

  • But number two, a lot of that happened in the performance segment of the market.

  • That's always hard to gauge.

  • But as our comment was we expect to gain market share in the riding season.

  • We still have a significant amount of riding season to go and we think that here's no doubt with this '07 model year that that still is going to come true.

  • Operator

  • Thank you.

  • Our next question is coming from Tim Conder of A.G. Edwards.

  • Please go ahead.

  • - Analyst

  • Thank you.

  • Again, Jim, let me offer my congratulations to you and everyone there.

  • - CEO

  • Thanks, Tim.

  • - Analyst

  • A couple of items.

  • On the operating expenses, maybe Tom or Jim, whoever wants to take this.

  • Can you just elaborate, are we getting to the point where we're going to be lapping this two-year warranty?

  • If you could maybe just elaborate a little bit more there, why that came up again.

  • I think you had had it also in the first quarter.

  • And then secondly, on the earning term, the allocation formula, Jim, you mentioned that that would be effective here for the current model year.

  • Our understanding is that basically any now '06 or prior models that any dealer may have, that they have to retail that by the end of October in order for it to qualify on their earn and turn.

  • If you could just clarify that.

  • And then just more from a clarification purpose on your new products, what is the incremental number of new SKUs?

  • Did you lose a SKU or two, then you're adding a SKU or two here with the bikes?

  • If you could just clarify that number for us.

  • - CEO

  • Great series of questions, Tim.

  • You never let me down.

  • Okay.

  • On warranty, we just offered a second-year warranty two-and-a-half years ago, and until the bike gets out there and you experience the second year and you get experience, it's kind of hard to tell where it's going.

  • We actually thought we had some information based on our second year warranty in Europe, but that was somewhat lacking.

  • I mean, in terms of Europe is different than the United States.

  • So in our estimations, we were short, and we've had to adjust our reserves, and then retune them slightly this quarter, but that's -- again, as we get better and more information on the second part of that two-year warranty, it's just been adjusting reserves, I think we've got really good information right now, so I don't think that's going to be an issue going forward.

  • On the allocation, and as I mentioned, again, trying to come up with a formula that responds to changing markets, we're changing the allocation formula, one of the things we've done out there is that all dealers are not alike.

  • Some dealers need a sense of urgency.

  • And to create this sense of urgency we have just said that for credit, for retail sales, I mean, they can keep the bike as long as they want, but if they want a credit in their formula for turn and earn, so what you retail in a certain period of time, you'll get in the next year's allocation, we've put a cut-off period of time, a slightly shorter period of time than we previously had.

  • And that we picked as October 31.

  • That basically is just to build a sense of urgency within the whole dealer network so that, again, trying to adjust the, in some cases, imbalances that we do have.

  • - Analyst

  • Okay.

  • - CEO

  • And then on new products, basically we had 37 models last year, and I think we discontinued two and added three.

  • So now we're at 38 models.

  • So there's plus and minuses in there, but at the end of the day, we've gone up one total model.

  • - Analyst

  • Okay.

  • And would you anticipate the operating expenses that you saw in the quarter?

  • I know you've mentioned before that operating expenses can be lumpy from time to time.

  • So as a percentage of sales on the back half of the year potentially we should not see that type of trend that we saw in the second quarter?

  • - CEO

  • A lot of things on the expense side are somewhat fixed, and so when you have variations in revenue your percents show some things, but we are running the business on a long-term basis.

  • We're not running it on a quarter.

  • So when unit sales, especially in this case, if we were to ship out what we've produced, that percent of -- your expenses as a percent of revenue would have been much lower.

  • So we're not paying attention to that.

  • We're running the business, and the long answer to your question, I would think that percent comes in mind in the back half of the year, especially as volume picks up.

  • And part of that volume was already produced, and it's '07s on its way to dealers right now.

  • - Analyst

  • Okay.

  • Lastly, Tom, you mentioned that 4X was a benefit.

  • Any quantification there?

  • - CFO

  • Yes, for the quarter, we didn't break out currency specifically, but we did get the benefit from it through our hedging program, but it's in the several million dollar range.

  • - Analyst

  • Okay.

  • Thank you very much, gentlemen.

  • - CEO

  • Thank you.

  • Operator

  • Thank you.

  • Our next question is coming from Julia Crowell of Goldman Sachs.

  • - Analyst

  • All my questions have been answered.

  • Thanks.

  • - CEO

  • Thank you, Julia.

  • Operator

  • Thank you.

  • Our next question is coming from David Anders of Merrill Lynch.

  • Please go ahead.

  • - Analyst

  • Two questions.

  • Hey, Tom, do you have the fully diluted share count at quarter end?

  • Because when you buy lots throughout the quarter I know the quarter end number can be off meaningfully from the average.

  • Also, maybe Jim you could talk about, this is the second quarter in a row that it looks like if I just do motorcycle revenue divided by units we've seen a decline in pricing year-over-year.

  • I know last quarter there was a mix shift within the bigger bikes.

  • Can you talk a little bit about the shift again, and is that still affecting pricing?

  • - CEO

  • I'll jump in for a second.

  • Remember, we don't have the diluted shares at the end of the quarter with us.

  • Market certainly can call at a later time and get that information.

  • - Analyst

  • Okay.

  • - CEO

  • As for mix, there's no doubt that when you come out with new products that has a swing and the mix of your products, our Dyna certainly had an impact since last year.

  • We have totally redesigned the Dyna and had the six-speed transmission with that product.

  • It certainly was hot.

  • We responded to the market.

  • As we've just come out with '07s, I would -- we're going to have a whole new dynamic with the new models and the bigger engines, better improved engines, like I said, there's 700 new parts and transmissions.

  • That will change the dynamics.

  • We're looking for -- the mix change has not been tremendously significant, but there was a shift from Softails to Dynas.

  • I think that there's no doubt we've given a nice enhancement to the Softails, and that will pick up some in mix.

  • So we should have some positive mix going forward.

  • - Analyst

  • Thank you.

  • Operator

  • Thank you.

  • Our next question is coming from Robin Farley of UBS.

  • Please go ahead.

  • - Analyst

  • Thanks.

  • I have two or three questions, so, operator, so if you could just please make sure my line is open so I can come back with a follow-up.

  • Had a question on when you look at margins in the third quarter, your guidance for production, when you back out what you've already manufactured in the second quarter, just what you'll actually be manufacturing in Q3 looks like a decline year-over-year.

  • So I guess what would you expect to happen to third quarter margins?

  • You talked about being up for the year.

  • Would that be difficult in Q3 with the production being down?

  • - CEO

  • Okay.

  • Your first question, I mean, we're giving you shipments.

  • We're not giving you production.

  • So our shipments and productions--.

  • - Analyst

  • I'm just taking what you've produced in Q2 that you didn't ship and minusing that from your total shipment guidance for Q3 to get what you would be producing in Q3.

  • - CEO

  • What we're shipping in Q3, and some of that contains production at the end of Q3 that will go out in Q4, which is quite normal.

  • So, I mean, and there is differences from quarter to quarter.

  • I don't have the absolute number, but I am relatively certain that our production is exceeding the third quarter that of last year.

  • Shipments may be a little bit different, but production is better.

  • - Analyst

  • And so in terms of the impact on margins?

  • - CEO

  • Margins, we look at -- just the second quarter, your costs still got put into the inventory, and they will be relieving some of those costs do not -- the fixed absorption of those costs do not skew either quarter.

  • Second or third.

  • - Analyst

  • Okay.

  • Then you made a comment earlier about shipments, somebody asked were shipments greater than what you had guided to and you said they weren't, it was just the timing of the release to the European market.

  • And just to make sure, because I also thought they were -- if they were up 3%, I thought the guidance was for shipments to be up 1%, and in terms of the release to the European market, the bike that you were planning to hold back are a different model year, right?

  • So you wouldn't have been shipping model year '07s yet to the European market.

  • So can you talk about the increase that's a couple percentage points more of '06 model year bikes that were shipped in the quarter?

  • - CFO

  • Yes, Robin, we guided with 78,000 for the quarter, and we came in with actual 79, 796, so just over a days production worth of extra bikes were shipped and they were all shipped to the international markets.

  • Just given the strong demand.

  • You saw the retail percentage growth that we had so it just was all due on strong international demand that we shipped out extra '06 based on market needs.

  • - Analyst

  • Okay.

  • Great.

  • And then last question, when you just look at the U.S., the heavyweight market, Harley's increase at the dealer level in retail sales versus the heavyweight market overall, with the market overall being a little bit ahead of Harley, do you attribute that to -- do you think it's just because you held shipments back this quarter?

  • Or I wonder if you could just address that.

  • - CEO

  • I think the retail market was -- we did quite well in the second quarter, and right now I think that what we're looking at, the numbers you're looking at is really a very small change in the total number of bikes for the second quarter, and it's a difference basically of maybe a day's retail sales.

  • I think we're looking at less than 2,000 bikes.

  • The difference between the two, and retail sales wise that's probably in total industry is one day.

  • So depending on the cutoff and the quality of the information coming in certainly could lend itself to that small of a change.

  • It's not very significant.

  • - Analyst

  • But if you look back over a couple of quarters we've seen -- and they're not huge differences, so I just wonder if you'd attribute that -- because I think it's more than just Q2 if you look back the last few quarters, but if you don't think it's significant, just wondered if you had any color on that?

  • - CEO

  • We are looking -- we always look at the competitive models, and manufacturers, and, again, that's why we're responding with this new great model year lineup, new powertrains and EFI, and V-rods, and et cetera, so we can lead and define that market.

  • We think that we've been going as planned for a good period of time.

  • - Analyst

  • Great.

  • Thank you.

  • Operator

  • Thank you.

  • Our next question is coming from Dean Gianoukos of JP Morgan.

  • Please go ahead.

  • - Analyst

  • Just one question.

  • I think you said, and I might have misheard, if I did, just tell me, did you say that the dealers you thought now were selling at MSRP?

  • And if so, when you look at that, do you adjust for dealers giving free P&A, and things like that, or do you just look at the actual sticker price on the bike?

  • Thanks.

  • - CEO

  • We have some very good data that we get from two different sources, our Harley-Davidson Financial Services, and we have in a-house system where we exchange information with about half our dealers, and we are looking at the bike price -- which does pull off the P&A.

  • What was charged for the P&A is always hard to get to the bottom line, if there was a bike given, but we do pull off what the price of the bike is and P&A is a separate line.

  • Typically what a dealer would do is they'd give you a price, then a discount later on.

  • That, we would allow for.

  • - Analyst

  • So the MSRP number you said is sort of adjusting for any deals the dealer might have given.

  • - CEO

  • As far as we know, yes.

  • - Analyst

  • Thanks a lot.

  • Good quarter.

  • - CEO

  • Thank you.

  • Operator

  • Thank you.

  • Our next question is coming from Brian Rayle of Keybanc Capital Markets.

  • Please go ahead.

  • - Analyst

  • Hello?

  • - CEO

  • Good morning.

  • - CFO

  • You're on.

  • - Analyst

  • Actually, this is Steven Nissan with Galva Research.

  • Congratulations on a good quarter.

  • A couple of things.

  • How are you guys streamlining the buying process to outproduce your order necrosis and to allow your customers to price your product much more efficiently as in the past?

  • - CEO

  • Hello?

  • - Analyst

  • Yes.

  • - CEO

  • Okay.

  • - Analyst

  • Can you hear me okay?

  • - CEO

  • Not quite sure I got the question, but I mean the--.

  • - Analyst

  • Well, how are you guys further streamlining your buying process so your customer can reduce order inaccuracies and allow them to be able to configure and price your product much more efficiently and make the buying process much more efficient?

  • - CEO

  • The customers have always -- the whole process is done directly with our dealers face to face.

  • It's not done on line.

  • All our business is done with the dealers.

  • They order the parts and accessories, they order the MotorClothes, they order the bikes, they sit down with their chrome consultants face to face, and they can see, as the bike is being ordered, configured, whatever, right there what's going on.

  • So, I mean, that has always been our approach, is doing with it the dealers.

  • They can order things on line, but we always, they have to go back to the dealer and pick those up.

  • We never compete with the dealers, so our whole process is done through the dealer network.

  • And we have always found that that's the best process.

  • It builds -- we're a relationship-based company, and that helps reinforce that relationship between the customer and the dealer.

  • Operator

  • Thank you.

  • Our next question is coming from Bob Simonson of William Blair.

  • Please go ahead.

  • - Analyst

  • Good morning.

  • A little bit longer term question.

  • Jim, you've reiterated the production guidance of 5 to 9%.

  • You have such prodigious cash flow, your CapEx has only been about $200 million the last couple years, but you generate well in excess of $1 billion in net income and depreciation.

  • At what point in the normalized growth of production would you need to kick the CapEx dollars up and do another plant or a major expansion?

  • It could be that could use some of that cash in a future period?

  • - CEO

  • We continue to put pressure on the existing management team and workforce to continue to get greater capacity out of existing plants.

  • Typically, whenever we put a new facility in place, we give it a big footprint, then we add machine and people and refine the processes as we go along.

  • You mentioned $200 million.

  • The guidance we've given right now I believe is 275, 250 to $275 million.

  • So a little higher than the 200 million.

  • Still, I agree with you, we are a very good user of capital, and certainly our cash generated greatly exceeds that.

  • Going forward, we'll continue to look at that and try to balance.

  • I do not see a new plant for a couple of years yet, and those things will be planned, and we'll let you know ahead of time, but right now I think that we have sufficient capacity to grow within the 5 to 9 for several years.

  • - Analyst

  • Do you have in your own mind what your operating capacity rate is?

  • Again, relative to what you said about changing how you run individual plants.

  • - CEO

  • Obviously your capacity -- our capacity, I should say, is always based on the lowest bottleneck.

  • That could be in the supplier, that could be within the plant.

  • It's typically certainly not been assembly.

  • Typically it's in fabrication supporting the line, whether it be in frames or paint or whatever the case may be.

  • So every day, basically we're running close to capacity, dictated on some bottleneck someplace in the process, and those bottlenecks are the ones that we're always after.

  • I've always pointed out that there's about 2500 parts in a motorcycle.

  • There may be anywhere from 5 to 15 or more operations in that part.

  • It just takes one operation to be the bottleneck.

  • We continue to work on those in various different ways, but there's always a bottleneck.

  • Right now we're running at very close to capacity.

  • It was just like last year when we took -- we changed our production schedule in the second quarter last year.

  • We were unable to put those units back in the back half of the year, because we typically ar running very close to capacity, us and/or our suppliers.

  • There's always a bottleneck.

  • Operator

  • Thank you.

  • Our next question is coming from Greg Badishkanian of Citigroup Investments.

  • - Analyst

  • Great.

  • Thanks.

  • Just wanted to follow-up on Europe.

  • You had very strong results there.

  • Last year in the second quarter I believe you were up about 24% due in part to a price cut, if I'm not mistaken.

  • This year it's up about 16%, outpacing the market on a tough comparison.

  • What's driving that?

  • Is there some things there besides just the industry, which you are already outpacing?

  • - CEO

  • I'm glad you asked the question.

  • Number one, we do participate in a smaller part of the industry.

  • In Europe, 20, 25% of total market is cruising bikes and touring bikes what we manufacture.

  • So we participate in a smaller part of the market.

  • We're doing quite well in responding to that market, but in terms of -- and we've been working with the -- retuning the dealer network, rationalizing it, reducing the number and increasing it somewhat with better dealers, better capitalized, better locations.

  • With that, we have improved some of the distribution.

  • We mentioned, there was some price decreases on about 40% of the product, between 2 to 9% last year.

  • Certainly not the driver of the 20% increase that we had last year, but certainly responding to the market and recognizing the foreign exchange changes that occurred over the prior year.

  • So between responding to the market, improving distribution, improving the dealer network, responding with some products that are more suited to the European riding style like the V-rod, which although Europe -- prior to last year was about 9% of our sales, after last year was 10%, 30% of our V-rods, which is a liquid-cooled, higher performance engine more suited to the riding style, certainly helps support that market.

  • We did some different changes within some other models to help support that market.

  • The many things we've been doing over the last several years in all our markets, five, six years ago it didn't make any sense to try to grow markets when we didn't have enough units to support the domestic market.

  • Now we're back to a more normalized growth rate.

  • We have been investing over the last several years in different programs, processes, activities, making our product more relevant through some marketing activities in the markets and they have all been successful.

  • Not just Europe.

  • - Analyst

  • Great.

  • That was very helpful.

  • Thank you.

  • - CEO

  • Thank you.

  • Good question.

  • Operator

  • Thank you.

  • Our next question is coming from Tony Gikas of Piper Jaffray.

  • Please go ahead.

  • - Analyst

  • Good morning, guys.

  • I have a few questions.

  • In terms of the new engine roll-out for the year, as a rider I know how powerful this is going to be at the retail level.

  • My question would be, why not take a bigger price increase, at least in the first year?

  • I think your average price increase is about 1% for the year.

  • I think what ultimately can happen here is the dealers are going to start marking these up again and taking advantage of that at least for the first year or so.

  • Why wouldn't you implement more of a 3% price increase this year and a more marginal increase in 2007?

  • Then I have a couple of follow-ups.

  • - CEO

  • Thanks, Tony.

  • Pricing is always one of those things that, it's -- we believe in relationships with the dealers and with the customers.

  • Our philosophy has always been pricing below inflation.

  • Not market pricing the product, because when you market price it too high, at some point in time you end up discounting the product and that would be something that would not be advantageous to our brand, to our dealers, or to our customers.

  • That starts a direction that we don't want to go.

  • Basically our philosophy has always been, even price increases, there's no doubt -- you kind of hit the nail on the head, some parts of the aspect, with this new engine, transmission, certainly greatly exceeds the price increase, the value that we're offering.

  • But there is a balance, and we're trying to balance this over a long period of time and not grow a big gap between our price range and the competitive price range.

  • So between balancing relationships with customer and dealer, not trying to put a big gap between us -- not getting to a spot where we end up discounting.

  • We have elected to go to this price.

  • Now that is an average.

  • Some models went up higher, some models didn't have any price increase.

  • So it's kind of model-specific, balancing between our own product line and addressing our competition that may be in the same ballpark.

  • - Analyst

  • Okay.

  • Couple of follow-up questions.

  • In terms of the caller a couple callers ago was talking about manufacturing, there have been some constraints on the Touring product line recently.

  • Have those been alleviated, at least for the next year or two?

  • And then my second question would be, there's been a lot of HDFS promotional activity in the market here in the first half of the year.

  • Will those promotions follow through on the 2007 product line?

  • - CEO

  • As for Touring, we have greatly increased our mix over the last couple of years on Touring.

  • Our Touring bikes are quite popular, and sometimes there are some constraints on getting the most popular combinations, but we have certainly increased and responded to the market both in Road Kings and Electraglides, and Ultras.

  • So that has been -- and I think we've seen it in the mix change quite a bit.

  • As for the second part of your question there's not been a lot more promotional activity.

  • There is promotions that dealers can choose to do through HDFS, certainly not sponsored by the Motor Company, but even as we look at that and we do measure that and it's one of the things we look at there has not been a lot more promotional activity through the dealers across the country.

  • Regionally, that may change from time to time, but certainly overall it has not changed.

  • - Analyst

  • Okay.

  • Thanks.

  • - CEO

  • Thanks, Tony.

  • Operator

  • Thank you.

  • Our final question will be coming from Joe Hovorka of Raymond James.

  • Please go ahead.

  • - Analyst

  • Hi.

  • Two quick questions.

  • One, can you give the warranty numbers for the quarter, how much charge to the P&L, the claims and the ending balance?

  • Then just a clarification on the raw material surcharges that you were talking about.

  • The $12 million, that's $3 million more than what you did last year, correct?

  • Not an incremental 12 million, just to clarify?

  • - CFO

  • Yes, Joe, quickly, on warranty we don't break out the specific dollar amounts, but as Jim said we feel we've done a good job and have good data and we feel pretty comfortable that we've got that captured going forward.

  • Then it is an incremental $3 million in the second quarter on surcharges, you're correct.

  • - CEO

  • On warranty though, there is a schedule in the 10-Q that you can go from quarter to quarter and look what the increases in charges and additions to reserves are.

  • When we come up with the 10-Quarter you'll probably be able to get an answer to that question.

  • - Analyst

  • Right.

  • Thank you.

  • When will the Q be filed?

  • - CFO

  • Just over a couple weeks.

  • - Analyst

  • Great.

  • Thanks.

  • - CEO

  • Thanks, Joe.

  • Operator

  • Thank you.

  • At this time, I'd like to turn the floor back over to management for any further or closing remarks.

  • - CEO

  • Is that mine or Mark's?

  • Okay.

  • Thanks again.

  • Remember the taped replay of this conference call can be heard by calling 973-341-3080, entering the pin number 7433466 with the pound key.

  • And that's until July 24.

  • Or by accessing it on the Harley-Davidson website.

  • If you have any questions, please call or contact Mark Van Genderen at Harley-Davidson's office of Investor Relations, 414-343-8002.

  • Thanks again, and have a great day.

  • Operator

  • Thank you.

  • This does conclude today's Harley-Davidson conference call.

  • You may disconnect your lines at this time, and have a wonderful day.