Harley-Davidson Inc (HOG) 2010 Q2 法說會逐字稿

Good morning.

My name is Krista and I will be your conference operator today.

At this time I would like to welcome everyone to the second-quarter 2010 earnings results conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks there will be a question-and-answer session.

(Operator Instructions).

Thank you.

I will now turn the call over to Amy Giuffre, director of investor relations.

You may go ahead.

Thank you.

Welcome to Harley-Davidson's second-quarter 2010 call.

Today's call is being webcast live on harley-davidson.com, where you can also find slides containing supporting details.

The slides can be accessed by clicking on Investor Relations, then Events and Announcements.

Our comments today 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 on this call.

This morning you'll hear from Harley-Davidson's CEO, Keith Wandell; CFO, John Olin; and President of Harley-Davidson Financial Services, Larry Hund.

At the close of prepared comments we'll open the call for your questions.

We'd ask that each caller ask only one question.

We appreciate your cooperation.

Let's get started.

Keith?

Thanks, Amy, and thanks, everyone, for joining us on the second-quarter call, and good morning.

Harley-Davidson continues to make good progress at executing our strategy through delivering results through focus, and we are seeing the benefits of that progress in our earnings performance.

Harley-Davidson's first-half earnings from continued operations were $0.89 a share.

We saw continued improvement at HDFS, and there was a further moderation in the retail sales decline for new Harley-Davidson motorcycle sales in the second quarter.

Over the past year-and-a-half we've taken many actions, from an operations standpoint in marketing and product development, at HDFS and in every aspect of our business, to deal with the economy and focus our resources on long-term goals and priorities.

So let me thank our employees for the outstanding work they do each and every day.

I continue to be impressed by the dedication they show to the Company and to executing our strategy.

I'd also like to recognize our dealers for their commitment to Harley-Davidson customers and delivering a premium Harley-Davidson experience in local markets around the world.

It has been a challenging time for them and they are doing a lot of great work.

But while we still have a lot of hard work ahead when it comes to driving competitiveness and effective execution at every level of the organization, we believe that we're on the right path.

We are very purposefully transforming our entire Company to be more flexible and customer responsive.

In operations the transformation at York is continuing on pace and we are seeing remarkable changes in how people come to work every day, engaged and ready to do a great job for our customers.

Last month we started up the production of Trikes at York, the first product line to fully utilize the new operating system there.

Later this week we will formally sit down with our Wisconsin unions to begin negotiations on agreements for a similar transformation of our Milwaukee area and Tomahawk production operations.

Our goal and our preference is to find a way to close the large cost gaps and create a flexible operation in Wisconsin that enables to us produce closer to demand.

At the same time, we have indicated that we will take whatever actions necessary to ensure a cost-effective and flexible operation.

We are also making great progress with changes to our product development approach and processes, which we expect to result in shorter lead times, greater cost effectiveness, and most importantly, even more product wow for our customers.

After all, that's what it's all about, is bringing great products and experiences to our current customers and new customers alike.

We continue to expand our reach to new customers all around the globe.

Retail new Harley-Davidson motorcycle sales grew for the third straight quarter in Europe, which is our largest market region outside the US.

Over the past two weeks, three Harley-Davidson dealerships opened in India, in Hyderabad, Chandigarh and New Delhi.

We have established a subsidiary operation in China to improve sales and marketing capabilities, dealer support and distribution effectiveness, providing an enhanced customer experience.

We expect four new dealerships to open in China this year for a total of eight.

And in the US, no one is reaching new customers better than Harley-Davidson.

Based on recently provided Polk data, we have been the heavyweight motorcycle category market leader in new motorcycle sales to young adult men and women ages 18 to 34 since at least 2006.

We have also been the heavyweight market leader since at least 2006 in new motorcycle sales to women riders, Hispanic riders, and African-American riders ages 35 and older.

And of course, we're also the market leader among Caucasian men ages 35 and older.

When it comes to new motorcycle sales to young adults in all sizes of on-road motorcycles, Harley-Davidson has been the US market share leader since 2008.

Clearly, we believe the Harley-Davidson brand, our products and experiences remain powerful and strong, with great appeal to both current and new customers in the US, as well as globally, and John will elaborate on this in his comments.

Next week at our summer dealer meeting in Las Vegas we will be sharing new products and programs with our global dealer network that we believe will extend the reach of the brand even farther.

And while there are still many challenges ahead, we continue to feel good about the progress we are making on many fronts.

Our strategy of results through focus is clearly on track.

Now let me turn it over to John.

Thanks, Keith, and good morning, everyone.

I'll review the financial results starting on slide ten.

During the second quarter, Harley-Davidson motorcycles and related products revenue from continuing operations was down 0.1%.

Our solid financial performance in the quarter included slightly higher year-over-year shipments of Harley-Davidson motorcycles, strong gross margins from the motorcycle segment, and another good quarter from Harley-Davidson Financial Services.

Income from continuing operations and earnings per share were both up over threefold.

Moving on to retail sales on slide 11, during the second quarter our dealers' retail sales of new Harley-Davidson motorcycles were down 5.5% on a worldwide basis compared to last year.

While economic conditions continue to be choppy, we are encouraged by the sequential moderation in the rate of retail sales decline over the last four quarters in both the United States and our international markets.

In addition, the Europe region posted its third consecutive quarter of year-over-year sales increase, bringing our total international sales to year-ago levels for the second quarter.

Regarding market share, our US market share increased by 1 percentage point in the second quarter to 52.5%, and the June year-to-date market share was 53.6%, down 0.5 percentage points from last year.

Our market share in the US is holding up despite ongoing price competition from many of our competitors.

On slide 12 you will see wholesale shipments to our dealers for the second quarter were up slightly compared to last year.

Shipments in the quarter were in line with our expectations and resulted in nearly 21,000 fewer units in US dealer retail inventory than one year ago.

At 24.4% of the total, Sportster shipments were higher than the historical rang of 18% to 22%, as initial dealer shipments of the new Forty-Eight motorcycle continue into the second quarter.

We continue to expect that Sportster as a percent of total shipments will be within the historical range for the full year.

For the third quarter, we expect to ship between 53,000 and 58,000 Harley-Davidson motorcycles worldwide, which is in line with last year's third quarter shipments of just over 54,000 units.

On slide 13 you will see that the motorcycle inventory level in our US dealer network is down compared to a year ago.

While most of the inventory is current model year, previous model year motorcycle inventory is higher than normal at this time of year, and we will continue to support our dealers' efforts to sell these motorcycles while carefully managing supply in line with demand.

Despite significantly reduced retail sales, the Harley-Davidson network -- dealer network remains profitable as a whole and unrivaled in the motorcycle industry.

In the second quarter, US Harley-Davidson dealer retail sales were over 85% current model year bikes, while competitive brand dealers sold just over 30% current year motorcycles.

We believe US Harley-Davidson dealers continue to sell at or near MSRP for new bikes, and they are selling an increasing number of used bikes at their stores.

We are focused on the health of the dealer network and are proceeding with our plan to encourage consolidation in select US markets to help protect the integrity of our world-class dealer network.

We believe that some contraction of the dealer network is healthy at this time.

On slide 14 you will see revenue from the motorcycles and related product segment for the second quarter was largely flat compared to last year.

During the quarter, average revenue per Harley-Davidson unit sold increased $184 from the prior year as a result of favorable product mix partially offset by unfavorable foreign currency exchange.

We continue to be intensely focused on improving our cost structure and restructuring the business to be stronger and more profitable in the future.

During the quarter we incurred $30.1 million in restructuring expenses.

We are on track to deliver the full-year expected total costs and savings associated with our restructuring activities, which are summarized on slide 15.

The potential costs and savings associated with our Wisconsin operations' union negotiations, which Keith mentioned earlier, are not included on this chart.

We will provide more information when we finalize and disclose a decision later this year.

On slide 16 you will see gross margin in the quarter was 35%, 0.9 percentage points above the same quarter last year.

This was driven by a richer mix of products within the families and favorable manufacturing costs, partially offset by unfavorable foreign currency exchange and rising raw material costs.

Gross margin for the first six months was 35.7%, which was flat compared to prior year and exceeds our full-year guidance range of 32% to 33.5%.

We are very pleased with our first-half margin performance and now expect gross margin will be between 32.5% and 34% for the full year.

We do not expect that the second half will benefit from mix to the same extent as the first half, and we expect unfavorable headwinds from foreign currency exchange and raw material costs.

On slide 17, operating margin as a percent of revenue for the second quarter was 13.9% versus 15.3% in 2009.

Operating margin was adversely impacted by an increase in restructuring cost and higher operating expenses.

Now moving on to our quarterly results for our Financial Services segment on slide 18.

In the second quarter, HDFS posted a $60.8 million profit, an improvement of $151.3 million compared to last year.

Keep in mind that the year-over-year reconciliation as it is presented on this slide reflects $101.1 million of charges incurred in the second quarter of 2009 that did not reoccur in the second quarter of 2010.

The key drivers of the second-quarter 2010 improvement were net interest income was favorable by $63.9 million compared to last year, as a result of the increase in on-balance-sheet receivables and an improvement in the net interest spread of the cost of funds at HDFS has decreased.

Next, the provision for retail credit losses, which is associated with on-balance-sheet help for investment receivables, decreased by $61 million compared to the second quarter last year.

The decrease was driven by $72.7 million provision established in the second quarter of 2009 that resulted from the reclassifications -- reclassification of $3.14 billion in finance receivables held for sale to held for investment.

Additionally, the remaining variance of $11.7 million was mostly due to the increase of on-balance-sheet receivables in Q2 2010 versus last year, partially offset by a slight improvement in credit risk assumptions based on favorable credit performance.

Next, the impact of the provision for wholesale receivables is favorable by $4.5 million compared to last year, primarily due to a 28% reduction in wholesale receivables for prior year.

Also, in the second-quarter 2009, HDFS recorded a charge of $28.4 million to write off all HDFS goodwill, which resulted in a commensurate year-over-year improvement this year.

And last, the $3.5 million all other line primarily reflects the net effect of the fact that we no longer have securitization accounting.

The items that existed last year were income on retained securitization interest, servicer fees, [low com] adjustments, and the impact of impairment charges associated with retained securitization interests.

We are pleased to see HDFS's improving profitability.

Lower cost of funds and improving credit performance have contributed to another positive quarter at HDFS.

Larry will provide more detail on HDFS's operations.

Larry?

Thanks, John, and good morning.

During the second quarter, HDFS originated $653 million in retail motorcycle loans, down 5.4% compared to the same period last year, primarily due to lower retail sales of Harley-Davidson motorcycles in the US.

HDFS's retail market share of new Harley-Davidson motorcycles sold in the US was 47.1% in the first six months of 2010, down 1 percentage point compared to the same period last year.

Regarding competition, we continue to see increased activity, particularly in the prime rated customer segment.

At the end of the second quarter, of the approximately $6.4 billion of net financed receivables $5.6 billion were retail and $800 million were wholesale.

We continue to see good credit performance on early-stage delinquencies and defaults for loans originated after we made significant underwriting adjustments in January 2009.

For the first six months of 2010, 80% to 85% of our new loan originations were prime compared to our historical experience of approximately 75% prior to these underwriting changes.

Now, moving on to delinquencies and losses on slide 20, where you'll see the 30-day delinquency rate for managed retail motorcycle loans at the end of the quarter was 4.5%, which is better than the comparable quarter-end results in 2008 and 2009.

Our increased collections staffing levels, modified collections strategies, and changes in underwriting have enabled to us effectively reduce delinquency levels compared to last year, despite high unemployment in the US.

Annualized retail credit losses improved by 65 basis points to 2.04% for the first half of 2010, driven by lower frequency of loss, the impact of changes in underwriting, and some improvement in the recovery values of repossessed motorcycles.

So in conclusion, HDFS remains the primary source of funding for Harley-Davidson wholesale and retail motorcycle lending, and our profit this quarter is encouraging.

We continue to make progress, as our cost of funds has decreased and the performance of our portfolio has improved compared to last year.

Keep in mind, historically delinquencies and losses have increased during the second half of the year as we move out of riding season.

Additionally, with unemployment still near 10%, and ongoing economic challenges, we'll continue to watch losses and delinquencies closely.

We believe our underwriting criteria are appropriate at the present time, and we will continue to evaluate them on an ongoing basis.

Now I'll turn it back to John.

Thanks, Larry.

As most of you know, several quarters ago we began a comprehensive study of our strategic options related to HDFS's retail lending business.

We reviewed numerous scenarios, which included selling the business, partnering, and various other financing arrangements.

Our criteria included a business structure or relationship that would provide a consistent and reliable source of financing to our dealers and customers, adequate control or influence over underwriting and pricing, a long-term relationship that would enhance the brand, and an earnings stream back to the Company reflective of the value of the business.

We have concluded a thorough exploration of business models and relationships that might meet our criteria, and at this time we believe that it is in the Company's best interest to maintain our current captive finance model.

It comes down to this -- at this time we're not willing to give the keys away to a strategic asset that has served the Company, our dealer network, our customers, and our shareholders so well in the past and through the recent economic downturn.

We are very pleased with the management of the business, especially through the recession, and are excited to move forward with our current business model.

We believe there is much opportunity to improve our retail financing operations through continuous improvement of our underwriting, collections, and service aspects of the business.

HDFS's goal continues to be to provide credit while delivering appropriate returns on profitability.

As we have done throughout the recession and as part of our regular management of the business, we will continue to evaluate financing options and alternatives to diversify HDFS's funding and manage its risk.

Now let's take a look at cash and liquidity on slide 21.

You'll see at the end of the quarter we had $1.5 billion of cash and marketable securities.

In addition, HDFS had approximately $1.16 billion of available liquidity through bank credit and conduit facilities.

During the quarter, HDFS addressed a couple of debt maturities.

The previous 364-day $625 million and three-year $950 million credit facilities were replaced with a 364-day $675 million and a three-year $675 million credit facility.

HDFS also downsized the conduit to $600 million and extended it.

Our cash strategy continues to require maintaining a minimum of 12 months of projected liquidity in cash and committed credit facilities.

Now I'll review the remaining Harley-Davidson, Inc.

financials on slide 22.

I would like to highlight a couple of items on this slide.

First, with regards to operating cash from continuing operations, the Company generated operating cash of over $726 million during the first half of 2010.

The motorcycle business continues to generate strong cash.

Of the total, the motorcycle business generated $297 million of operating cash.

Our second-quarter effective income tax rate from continuing operations was 29.2% compared to 59.9% in the same quarter last year.

The rate decrease was generally due to the non-recurrence of a $28.4 million nondeductible goodwill impairment charge incurred in the second quarter of 2009; the favorable conclusion of an IRS audit; and in connection with the settlement, an adjustment to income taxes payable.

We now expect 2010 full-year effective income tax rate for continuing operations will be approximately 36.0%.

On slide 23 you'll find a summary of MV Agusta's business, which is presented as discontinued operations.

During the second quarter we posted an operating loss of $6.6 million, net of tax, and we wrote down the carrying value of MV Agusta's assets, resulting in a noncash charge of $61.5 million, net of related tax benefits.

We continue to be in discussions with potential buyers for MV Agusta.

Looking forward to the remaining quarters of 2010 we continue to expect that the global economies will remain challenging, and we will take a conservative approach to shipment volumes as we continue to aggressively manage supply in line with demand.

On slide 24 you will see that on a full-year basis our shipment and capital expenditure guidance for 2010 remained unchanged and, as I noted earlier, we have increased our expected gross margin range.

As we look back on the second quarter of 2010 we are pleased to see continued moderation in the rate of retail sales decline relative to previous quarters and continued profitability at HDFS, and we look forward to the launch of our 2011 model year motorcycles next week.

Before we open the phone lines, I want to address a question that has been coming up in investor meetings.

Many of you are asking what we believe the total demand for Harley-Davidson motorcycles will be in the future; more specifically, if we believe we will return to our 2006 peak retail sales of 349,000 motorcycles.

As you know, we do not provide long-term sales forecasts and I cannot give you a specific number, but I can tell you two things with absolute confidence.

First, we are prudently managing the Company in response to significantly lower volumes, and second, the brand remains strong and is at a significant competitive advantage.

With regard to the first point, the world and the motorcycle market have changed and we are taking appropriate action.

By the end of 2010 we expect Harley-Davidson motorcycle shipments in the year to be down approximately 40% from their 2006 peak.

In response to lower volumes we have been working hard to right-size our manufacturing footprint; address labor contracts to gain manufacturing flexibility and competitiveness; reduce administrative costs; and exit noncore businesses in order to focus on core operations.

The result is a new business model with a lower break-even point.

We are executing a solid plan designed to regain the lion's share of lost operating margin at significantly lower volumes.

Restructuring has already delivered significant results, but we have not compromised the capacity for future growth.

In fact, our plan will be able to more efficiently flex according to future demand.

In addition, throughout the economic downturn we have continued to invest in our future and have developed new products and features, such as the Iron 883 and the new Forty-Eight, invested in our outreach demographic segments in the United States, and developed new international customers and markets.

In short, as a recovery continues and when volumes do increase, we will be in a strong position to capitalize on future opportunities while positioning the Company to better contend with future economic cycles and turbulence.

And my second point, when you are contemplating future demand, consider that the Harley-Davidson brand has continued to strengthen even through the severity of the recession.

In the United States, when you look at Harley-Davidson's competitive position in terms of market share, we have gained a significant amount of market share since the end of 2007 and maintain a strong leadership position in the United States.

Internationally, the story is similar.

Harley-Davidson has gained share in many international marks, as well.

In Europe, the single-largest heavy-weight motorcycle market in the world, we have seen strong share gains during the last several years and retail sales growth in the past three quarters.

However, the power of the brand is even more clearly evident when you look at total demand for Harley-Davidson motorcycles in the United States on slide 25.

Despite the severity of the recession, when combining retail sales of both new and used motorcycles, Harley-Davidson's total retail sales in the United States were down 2% in 2008, 12.8% in 2009, and up 1.3% through May in 2010.

1 in 2007 to about 2:1 in 2009.

Consequently, the values of used Harley-Davidson motorcycles declined significantly from 2006 and 2007 levels.

In an effort to improve used bike pricing and return to a more normal ratio of used to new bike sales, we continue to aggressively manage the supply of new motorcycles in line with demand.

We believe we have made progress toward our goal of restoring used bike prices and further strengthening the brand.

Our strategy is focused on extending our powerful brand and exploring opportunities that exist.

As Keith mentioned, we are extending the Harley-Davidson experience to a much greater base of potential customers than ever before.

For example, we expect to add 100 to 150 new international dealerships through 2014, including dealerships in 19 countries this year.

We look to design products and features that are desired by international customers.

In the United States we expect to strengthen our leadership position in the young adult, women, Hispanic and African-American markets by delivering relevant products and experiences.

And of course, we will continue to serve our core customers with products and experiences that fulfill their dreams.

So while I can't tell you definitely what the future demand looks like, I can assure you that we are managing the business prudently given today's difficult environment and continue to invest in our future.

We are ready to expand our sales when the world economies improve and will remain disciplined as we manage the Company.

And now, let's open the call up to your questions.

(Operator Instructions).

Our first question comes from the line of Tim Conder from Wells Fargo.

Your line is open.

Thank you and congratulations, everyone.

Thanks, Tim.

John or Keith, whoever wants to take this, in relation to the commentary about obviously lowering the break-even, can you give us any directional goals as to where -- your operating margin peaked in the 20%, 24%, mid-20s% area in 2006.

What type of level of production would you need to get, or just any commentary, color on break-even levels and operating margin levels after all the restructurings are done.

Well, Tim, I can't give you a future margin, but again, the break-even point in the Company is much, much lower than it was two years ago, and all the actions that we're taking will deliver the lion's share of that margin peak in 2006 over the next couple of years.

Okay.

So --

Any additional volume on top of that would continue to drive them further.

Okay.

So the goal would be once the restructurings are done, say by the end of 2014, to potentially be close to those operating margins, obviously subject to where shipments go?

Yes, based on today's volumes we would expect to get the lion's share of margin back with the restructuring activities that we've undertaken.

Okay, based on today's volumes.

Okay, great, thank you.

Your next question comes from the line of Sharon Zackfia from William Blair.

Your line is now open.

Hi, good morning.

I apologize if I missed this but I know that used bike prices have been a focus in the US.

So maybe you can give us any color on how that's trending and maybe what inning you're in and how far you think used bike prices have to recover at this point?

We had trouble hearing --

Sharon, your voice is a little bit low, but the question I think I understood was where are we at with used bike pricing and how far do we have to go.

Is that right, Sharon?

Correct.

Used bike pricing has improved, again, since we largely started taking inventory out in the fourth quarter of 2009.

So again, as we built out the model year -- 2009 model year, got dealers filled, we took production down quite significantly in fourth quarter of 2009.

Since that point we've seen improvement in one of the first lead indicators, which is the repo market and the prices that we get through the repo market.

In addition, through dealer surveys and some of the public data available it appears that used bike prices to the end consumer is also improving.

And again, our strategy is to continue to be very disciplined and aggressively manage supply in line with demand in order to push up used bike prices.

So we're on our way, Sharon, but we still have a fair amount to go to get back to the 2006 and 2007 level of used bike prices, which is our goal.

Thank you.

Your next question comes from the line of Rod Lache from Deutsche Bank.

Your line is open.

Good morning, everybody.

Good morning, Rod.

I just had a couple just quick questions.

You're obviously taking out a lot of costs and resizing to the current demand levels.

I'm just wondering to what extent would you be constrained if demand were to recover?

At what point -- can you give us any color on -- at what point would you have to add in more labor or other fixed costs?

Then just on the market share, trends obviously looking pretty favorable.

Do you feel that you're actually capturing a lot of the Buell buyers that are obviously getting lost?

And then lastly, can you just give us any color on how you plan on managing FX risk looking into 2011?

Hi, Rod, this is Keith.

On the first part of your question the -- so the changes that we're making in transforming our operations are -- they're sustainable type of changes.

And the last thing we're worried about is where are we going to have to add more capacity, because what we're really doing is reconfiguring our entire operational system for greater flexibility where we'll be able to produce every family of product on every line, as an example, and, of course, there's three shifts that we could work and those kinds of things.

So I would just tell you that that's not a concern for us at all going forward.

I think we're going to be in really good shape in terms of our ability to produce at higher levels of demand.

Rod, I'll take the next question.

Your question was on market share is doing well, are we capturing our Buell buyers.

I can't specifically answer that, we don't have specific data.

What I can certainly tell with you with a lot of confidence is that we're capturing a tremendous amount of competitive riders and some of those may include Buell riders, but certainly from the rest of the competition, as well.

In the first quarter we ran a very successful promotion, competitive trade-up, to start to let our customers know that our dealerships will take competitive trade-ins on their Harleys.

And even Forty-Eight, while it's only been in the marketplace for six months, 72% of the customers are new to the brand.

And of those 72%, 60% are directed at our outreach customers.

So we feel very good about our actions and are taking advantage of some of the opportunities out in the marketplace with competitive riders.

Your last question, Rod, I believe was on FX risk.

That's right.

In general, we've seen the foreign exchange -- well, the majority of our sales outside of the United States and Canada are denominated in foreign currency.

Our largest exposure is to the euro, and we certainly manage that exposure through several vehicles.

One is we've got a fair amount of natural hedges, and that comes from the purchase parts that we bring back to the United States, the -- manufacture with our bikes.

Operating expenses are spent in our European operations and we have outstanding debt on our balance sheet of about $200 million in euro-denominated debt.

So those act as a natural hedge versus currency exposures.

And then in addition to that we buy forwards, typically over a 12-month period of time, and in the first quarter we saw revenue certainly benefit from the exchange rates, and we had some unfavorable, about $7 million of unfavorability.

In the second quarter we saw a reversal of rates.

The average euro for the 2010 was -- I'm sorry, for second quarter was $1.28 versus $1.36 and that hit revenue by about $9 million and overall costs were down to about $10 million -- I'm sorry, the impact of $10 million.

So as we look forward to the third and fourth quarter, the average euro exchange rate was $1.43 in the third quarter and $1.48 in the fourth quarter and currently, I think as of yesterday, we're sitting at $1.29.

So, again, we've got some natural hedges to protect us in the back half, as well as some financial forwards.

We do expect some headwinds and some unfavorable variances due to currency, but largely protected.

Okay, thank you.

Your next question comes from the line of Craig Kennison from Robert W.

Baird.

Your line is open.

Good morning, thanks for taking my question.

Keith, as you cut inventory and dealer supply gets tighter are you satisfied with the dealer allocation process, or does that need to be tweaked?

No, Craig, we are satisfied with it.

As a matter of fact, we did make some pretty significant changes to it, probably a little bit over a year ago, where a certain portion are allocated based on historical sales and a certain portion are based on ongoing current sales.

We just concluded recently -- it was actually about a month-and-a-half ago, a tour of all of our dealers around the country and that was a major issue that we discussed.

And I will tell you that by and large the dealers are pretty well satisfied with the allocation system the way it's working today.

Doesn't mean that it can't be improved, or that things that can't be tweaked, but we feel pretty good about how it's working.

Thank you.

Your next question comes from the line of Ed Aaron from RBC Capital Markets.

Your line is open.

Great, thanks.

Good morning, everybody.

My question's about mix.

The model mix was more Sportster weighted than I had expected.

And I wanted to get a sense of whether that's more timing of shipment related, or whether you're seeing a change in buying patterns at the consumer level because we had seen more relative strength in touring?

And then secondly, maybe, John, could you give me some color as to -- I think you showed a $24 million gross profit benefit from mix in the quarter on a year-over-year basis and I have a hard time getting to a number that that's high just based on the relatively small ASP improvement in the quarter?

Thanks.

Thanks, Ed.

Certainly during the second quarter we had another strong month of mix favorability.

The largest driver of motorcycle mix during the quarter was actually the mix of products within families, not the mix between families.

Typically the mix between families is the largest driver of motorcycle mix variation.

So when we look at that the overall $24 million at -- the biggest drivers of mix within family come from within the touring segment.

So a year ago we introduced the Ultra Limited, which is a $25,000 vehicle, and it has quickly become one of our top selling -- one of our, I think, top three or four selling vehicles in the whole lineup.

And when you compare that to the rest of the touring average without it, which is less than $20,000 on average a vehicle, we've seen significant mix -- favorable mix from that.

In addition, within the touring category is the CVO Ultra has sold very well, and that's got a retail price of around $35,000 a unit.

So that's added to the strong mix within the family.

Then finally, even in the Sportsters we have a fair amount of mix.

Forty-Eight model, for example is a 1200, and it sells at over $10,000, and that is a very large part of the mix in the second quarter, which has also skewed the model mix within that family to be favorable.

When we look at the Sportster mix, it was at a high percentage of 24.4%, down a little bit from a year ago, which was about 26%.

And really the reason that is, is the continued very strong demand for Forty-Eight and continued demand for Iron 883.

So we're continuing to fill the pipeline.

Sales in both those vehicles are going very well.

We expect the mix for the -- the Sportster mix in the back half to be a higher percentage than last year largely due to the fact the fourth quarter was down -- I think the fourth quarter was about 13% of the overall mix in 2009.

So as we lap that we would expect a higher Sportster mix in the back half.

And then in general, mix is -- there's a lot of factors that affect mix at Harley-Davidson.

We've got family mix, which we've talked about, and that's the difference between selling a touring bike and a Sportster with very different selling prices.

There's model mix, which I just talked about, and the difference between an Ultra Limited versus a Road King, for example.

But also we've got location mix, where in the world we're selling that product has a bearing on mix; option mix, whether it has ABS brakes, wheels, cruise, security; and then the related businesses have a lot of mix variation, as well.

When we look at parts we sell a can of oil for a couple dollars versus a replacement engine at several thousand dollars.

Accessories, from a foot peg to a GPS system, and motor clothes and licensing all contribute to a lot of mix variation at the Company.

Okay, thank you.

I have a couple of follow ups, but I'll get back in the queue.

Thanks, Ed.

Your next question comes from the line of Patrick Archambault from Goldman Sachs.

Your line is now open.

Hi.

Thank you, good morning.

Good morning.

A couple questions.

Just on -- well, just two, first on HDFS.

That run rate, I understand in the walk there you had a lot of nonrecurrences of one timers from last year, but it looks like the core run rate was in the low 60s.

Is that something that you see as sustainable on a go-forward basis, given where net interest margins are and where credit is headed?

Also, if you could give us the -- just the provisioning for this quarter, that would be helpful.

And then my second question is just on pricing.

You said that for new bikes you were at or close to MSRP and just generally across the board.

How does that compare to previous quarters?

Is that a little bit lower because you have a lot of older inventory that you're still trying to move forward, and how is that likely to look over the next couple of quarters?

Patrick, a couple of comments.

First, I'll give you the provision for the quarter was about $9.3 million.

And then regarding the run rate, what I would say is that there are probably some -- a little bit of wind at our back the way the market's performing at the moment.

Borrowing costs have certainly come down from where they were a year ago, and therefore we're earning some reasonably attractive margins.

The other thing is that our credit losses were relatively low in this quarter, and therefore we benefited some from reducing our provision level from what we would expect on future losses to be, so we did have about $7 million or so of benefit there, as well.

And is that largely seasonal?

I wouldn't say it's so much seasonal.

I would say it's -- obviously you set your provisions because you take a look out at the next four quarters, roughly, and say how do we think our portfolio is going to perform?

And our estimate would be we expect to perform maybe a little better than we would have expected back when we did that evaluation at the time of the first quarter.

Okay.

And just so I make sure I'm understanding that, you actually had provisioning expense of $9.3 million but relative to where that would have been given your book of new business, it was probably a little bit -- it was a $7 million good guy relative to how you provisioned at previous rates.

Is that the way to think about it?

That's correct.

Okay.

And, Patrick, I'll answer your question on pricing.

I believe it was, we're currently pricing or we're seeing that our dealers are at or near MSRP -- and has that changed over time?

It changes very little bit.

We're very pleased with the overall pricing, especially in the quarter when we've seen sales decline improve, and we continue to hold our pricing very well.

When you look at some of the old model years -- and certainly we've talked about that a lot -- but we've got to put in that perspective, as well.

It is unusual for Harley-Davidson to have any carry-over at this time of year.

But to put it in perspective, at this time, for the second-quarter retail inventory, the model year 2009s, or the carry-over inventory that we have, is less than 10% of the retail inventory that's out in the system.

And when you look at sales on a worldwide basis for the second quarter, our sales of that old model -- or carry-over model is less that 10%, as well.

I think in the United States, during the second quarter we sold about 84% current motorcycles.

And again, the competition was more in the range of 30% current motorcycles.

So while that does have an impact on the overall MSRP being at or near -- or price being at or near MSRP it's not a huge drag on that.

The models that we are selling, the carry-over models, are at a modest reduction to MSRP, though.

Most of the 2010 models are holding up very well at MSRP.

Okay, great, thank you very much.

Your next question comes from the line of James Hardiman from Longbow Research.

Your line is open.

Good morning, and congrats on a great quarter, especially at HDFS.

I actually wanted to follow up on the very last question in terms of credit loss provisions.

Just so I'm clear, the $9.3 million for the quarter, you add back maybe $7 million, that gets to you $16 million.

Last quarter we were looking at, I believe the number was $32 million.

Is there some seasonal stuff there that helped in the second quarter, or is that, say, $16 million, once I add back the $7 million, is that a reasonable number for the rest of the year in terms of that?

Obviously you're not going to get into guidance, but is that how I should think about it going forward?

No, James, you're absolutely correct.

There definitely is seasonality to credit losses.

Credit losses are higher in the first quarter of the year and the fourth quarter of the year and then they tend to be lower in the second quarter and the third quarter once you're in riding season, because you're getting greater recovery values on the motorcycles that you repossess.

And also, just like with delinquency, the delinquency level comes down so you're actually having fewer defaults during those two quarters of riding season than you do in the other two quarters.

So there definitely is a seasonality to it.

Is there a run rate that you're comfortable saying in terms of where that loss provision should be right now, or how should I think about that beyond just the second quarter?

I think we'll see -- every quarter we go through a very disciplined process, and we evaluate our portfolio and how things are trending, and we'll continue to do in that the third or fourth quarter, but I don't think we want to give any forward-looking information.

Obviously you still have high unemployment and as we get into the fourth quarter we'll be coming out of riding season, so I think we want to see how those trends play out over the rest of the year.

Fair enough.

And then just real quickly, the gross margin guidance that you have out there sounds like you're optimistic that the negotiations with the guys in Wisconsin could benefit some -- yield some positive benefits there, but the gross margin guidance does not include any benefit at this time, is that right?

Correct.

Great, thanks.

And we're also looking to negotiate the subsequent contract.

This contract ends in first quarter of 2012.

Excellent.

Thanks, guys.

Your next question comes from the line of Robin Farley from UBS.

Your line is open.

Thanks, yes, a couple questions.

First is, if negotiations go favorably in Wisconsin, when, timing-wise -- how quickly do you think that would translate into margin benefit?

In other words, would that even happen in calendar 2010, or is that really something further out?

And then also, I wonder if you could give us some color on how you think about the trends in retail sales versus production when you talk about managing supply in line with demand, because your guidance, the midpoint seems to call for production to grow again in the second half of the year.

And obviously with the seasonality of -- your inventory always gets reduced in the summer, so thinking about not just what bike sales in the second half, but the rate has changed.

Are you expecting retail sales to start to be positive, or I wonder if you could just give us some color on how to think about your production, that you're starting to grow production again in the second half?

I'll start with the second question, Robin, is we don't provide a future look at retail sales.

But when you look at our production, in the first half we've produced about 113,000 motorcycles and that's based on guidance -- full-year guidance of 2001 to 2012.

So in the second half, based on that, we could actually be down a couple percent to up 10% in the second half in terms of production.

And it's really hard to -- at this point to really translate a whole lot between retail sales and production because of all the production changes that we had, in particular last year.

And again, last year we took production down a significant amount in the fourth quarter to adjust the inventory levels, and that's been very successful in this quarter.

Some of that reduced production is flowing through with our retail inventories being down 21,000 units.

So again, it's very difficult to look at it as we lap last-year's production.

Hi, Robin, on the first part of your question with regards to the negotiation -- this is Keith.

First of all, we expect to have a successful negotiation here.

We really have a constructive relationship with our unions and this is really all about all of us just sitting down and understanding this new reality and what we have to do, and we think we'll be successful.

The point is, though, that this contract that we're negotiating is a replacement contract.

So in other words, the current contract expires in April -- I think it's April 1st of 2012, so the contract that we're negotiating would be effective then.

So we would continue to operate under the current contract and then when that one runs out we would already know what the replacement contract is.

The reason for that is because we have to know what the future looks like for our Wisconsin operations, and we have to understand what the contract's going to look like, or we're going to have to take some alternative action.

That's really the reason why we're doing it the way we're doing it.

So none of those savings, really, other than the continuous improvement initiatives that we have underway today, would be become effective until that timeframe.

Okay, that's great.

And just to clarify the other question on production, without asking you to make any forecast at all in retail sales, I guess let me just ask simply, are you comfortable growing production when sales are declining?

At this time we're very comfortable with our shipment guidance of being down 5% to 10% on the year, and we're down 10.7%, I believe, in retail sales through the first half.

And again, looking at that we feel very comfortable with our overall shipment guidance for the year, Robin.

Okay, thank you.

Your next question comes from the line of Himanshu Patel from JPMorgan.

Your line is open.

Hi, good morning, just a couple questions.

Going back to the original point made on reachieving historic peak volumes, I'm wondering if you guys have a sense for how much of that 40% peak-to-trough decline could be attributable to tighter credit underwriting standards?

Well, I don't know if I'd give a percentage on that.

I think that clearly some amount is.

If you go back, we did say that previously about 75% roughly of our originations were in the prime category, 25% were in the subprime.

If you look at where we are today we're probably 80% to 85% prime.

So clearly, when we made those underwriting changes back at the start of 2009 the most significant of those changes were in the subprime category.

But I think that change in mix can probably give you some sense of what the impact of that has been.

And then I was curious about your European comments.

I know the numbers are relatively small but the growth you're seeing in that market in the last couple of quarters was a little bit inconsistent, obviously, with what's going on with the broader macro picture there.

I'm curious, where is that growth coming from?

Is it from Eastern European geographies where the base effect was very low, or is this actually something you're seeing in the core Western European mature markets?

So in terms of -- for the quarter, actually -- give me a second here -- growth is coming largely from Western Europe.

So if we look at -- in the quarter Europe was up -- Europe region was up 5%.

We had strong performance out of Spain, France, and Italy, and we're down a bit in the UK and Switzerland, to give you a flavor for what's happening in Europe.

But, again, very pleased, three quarters in a row, that we've seen growth out of Europe.

And what do you attribute that growth to?

A lot of those markets are obviously going through a lot of broader concerns on the economy.

I'm just wondering, is there a base effect issue there that just makes the year-over-year growth rates very favorable, or is there something on pricing that's going on there?

Any color on that?

I don't -- the Europe numbers a year ago were down, certainly in double digits, but not -- I don't have it right in front of me, Himanshu.

But no, the brand is performing well, share is picking up, and we've really been on the same track in Europe for the last five years, strengthening the brand and our dealer network.

And sales have been performing well, certainly hindered by the recession, but we feel very pleased as to where we're at.

Yes, because the core Western Europe comp number doesn't look like it gets really easy until the third-quarter 2009, so this was -- it seemed like it wasn't really a comp issue.

So anyways, in a separate issue on -- lastly just on used car prices, I know there was a little bit of a discussion on that earlier, what is the absolute percentage decline that you've seen since the peak?

Where are used car price -- I mean used bike prices now relative to the 2006, 2007 level?

Yes, we don't deal in used cars, so.

Himanshu, we don't provide a number, as you know that every different model year, various makes all are different and it's hard to provide any given number.

So suffice to say that in -- certainly September of 2008 we saw the entire complex of used bike prices fall quite significantly, and we're very focused on improving it.

We've seen signs of that improvement, but we've not given -- and it's not right to give a single number based on all the different model years that are out there and different bikes.

And just lastly, I wanted to elaborate on that issue between used bike prices and how you see that impacting your business.

Given how weak used bike prices are today presumably relative to the peak, given that you're still selling at or near MSRP for new bikes, does that basically imply that the impact of a weak residual market essentially shows up on volumes for new bikes, meaning consumers just migrate into the used bike market?

Likewise, when used bike prices start recovering, what we should really not see is any impact on pricing for new bikes but really it should overall just help volumes on new bikes?

Well, the -- again, a tremendous shock to the system, right?

In 2007 we were selling one used bike to one new bike, and now we're at two used for every new.

So during the recession a lot of people have had to give up their motorcycle.

They've come on the market as used bikes.

We've seen used bike prices disconnect historically.

And so when we look at that we feel very happy that our new motorcycles have been continuing to sell at or near MSRP, but when a customer goes in to a dealership or makes a decision on a motorcycle, they see a tremendous amount of value in a used bike now because prices are so low.

And we've seen a lot of good things come out of that, Himanshu.

Number one is that the amount of young adult riders that are getting into the brand at these low prices have been -- significantly picked up a fair amount of share in that segment.

We're also getting dealers involved in selling used bikes, which we've been working on with them for several years.

So a lot of good things have happened, but what we do believe is as we limit the new bike inventories or keep it in line with demand we will see the used bikes as they clear the market, those prices come up, and we'll start to move more toward a more normalized used-to-new ratio and with that we'll see new bike growth.

Okay, great, thank you very much.

Your last question comes from the line of Ed Aaron from RBC Capital Markets.

Your line is open.

Thanks for taking the follow up.

Just wanted to ask about the HDFS market share in the quarter.

It looks like it was up a lot.

On a sequential basis I think it was low 40s in Q1 and I think you said 47% year to date, which would a imply a north of 50% in Q2, and I was just wondering if there was any real change in how you went about running that business that might have caused that sequential improvement in market share?

Yes, market share for the second quarter by itself was right around 50%, and it was about a point up from last year, but I would say that there weren't any dramatic changes.

We did do -- as we raised some funds that were a little bit cheaper we were able to lower some of our rates in tiers one and two, or the prime or super prime tier, so I think that helped us a little bit with volume in the quarter.

Okay, thank you.

Thank you, Ed.

And thank you for your time this morning.

We appreciate your investment in Harley-Davidson.

This concludes today's conference call.

You may now disconnect.