Harley-Davidson Inc (HOG) 2012 Q2 法說會逐字稿

Good morning.

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

At this time, I would like to welcome everyone to Harley-Davidson's second quarter 2012 earnings 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 and I'll now introduce and turn the call over to Ms. Amy Giuffre, Director of Investor Relations.

You may begin your conference.

Thank you, Tracy.

Good morning, everyone.

The audio for today's call is being webcast live on harley-davidson.com.

The supporting slides can be accessed by clicking on Company, Investor Relations, then Events and Presentations.

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 in this call.

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

Then we'll open the call for your questions.

So let's get started.

Keith?

Thanks, Amy.

Good morning and thanks, everyone, for joining us on the call.

We appreciate your spending this time with us today and for your interest in Harley-Davidson.

As you saw in this morning's earnings release, Harley-Davidson reported continued strong performance, including EPS growth of 32% for the second quarter and retail sales that exceeded our expectations through the first six months.

We believe these results are a reflection of the effective implementation of our business strategy, combined with strong dealer execution at retail.

Our strategy provides the road map for success over the long-term through exceptional product development, manufacturing, and retail capabilities.

And I want to recognize all the continued outstanding work by our employees, our dealers, and suppliers who are making such a difference.

Together, we're doing great things working as one team, moving in one direction to deliver for our customers.

Among the many initiatives underway as part of Harley-Davidson's strategy is the installation of our ERP system at our vehicle operations in York.

The migration of data from legacy systems to the new ERP system in early July went extremely well.

This has been followed by a ramp up of production under the new ERP system in York, which also is going according to plan.

You don't have to look any further than this truly outstanding job to understand the passion and the dedication of our employees.

The implementation of ERP at York supports our efforts to introduce greater flexibility to manufacturing.

In the years to come, we expect to have much greater ability to produce any bike on any line anywhere.

Among the other benefits, ERP enhances our ability to expand Harley-Davidson's leadership in factory customization over time.

It's a win for the Company, for our shareholders and our dealers, and a big win for our customers.

A moment ago, I touched on Harley-Davidson's retail sales growth, and we again gained market share in the US in the second quarter.

We also continue to make progress at reaching new customer groups.

One of our goals is to grow faster -- to grow sales faster to outreach customers than to core riders, and I'm pleased to report that in each of the past three quarters, we've done just that.

And as we've noted previously, we are the US market share leader among outreach customers, defined as young adults, women, African-American and Hispanic riders, a position we've held for the past four years.

So clearly, our products and the unique Harley-Davidson experience exert a powerful pull for many different groups of riders, and not just in the US, but around the world.

We continue to deliver on our commitment to bring Harley-Davidson experience to more locations internationally.

Since the beginning of the year, 12 new Harley-Davidson dealerships have opened in international markets, including Croatia, Russia, Taiwan, Poland and China.

And while we are pleased with the progress in these and many other areas of our operations, we're also being cautious in our expectations for retail in the back half of the year, given the economic uncertainty in many markets.

Dealer retail sales in a number of euro zone countries, in particular, are reflecting the effects of the economic challenges, so we will continue to keep a close watch on those conditions.

You know, this August is our kickoff for a year of Epic experiences to celebrate our 110th anniversary.

We've got two crews of riders heading out at the same time, starting next week, who will be blogging and sharing their adventure with their GoPro cameras.

The first is a group of young athletes who have never been to the Sturgis Motorcycle Rally, and they'll be riding from Seattle to the Black Hills.

Simultaneously, on the opposite side of the world, our Chief Marketing Officer, Mark-Hans Richer, and Asia-Pacific Managing Director, Dave Foley, are celebrating with an amazing ride across Tibet, along with some of our new Chinese dealers.

And anyone can go along on both of these Epic 110th experiences through the on-line world in social networks, at HD.com\110.

Later this month, we're expecting a record number of Harley-Davidson dealers and staff from around the globe to gather in Milwaukee for our annual summer dealer meeting.

The summer meeting is always a great time to connect with dealers, share our plans for the business and to have some fun.

And at the end of every summer dealer meeting, we head off for a few days of riding with many of our dealers.

It's a longstanding tradition and helps us connect with one another and what this business is all about.

So in summary, it's been a great first half, and there's a lot to look forward to in the back half of the year and beyond.

All of us are working hard every day to unleash the full potential of our Company and our globally iconic brand.

So thanks again for your continued interest, and now let me turn it over to John Olin.

Thanks, Keith, and good morning, everyone.

I'll review the financial results for the second quarter, starting on slide 9.

During the quarter, Harley-Davidson, Inc.

consolidated revenue was up 14.9%, behind a 25% increase in motorcycle shipments.

Our second quarter income from continuing operations improved to $247.3 million, an increase of $56.7 million.

Similarly, diluted earnings per share rose to $1.07 per share, up from $0.81 in the year ago quarter, a 32.1% increase.

Operating income for the Motorcycle business was $309.6 million, up 40.8% compared to last year's second quarter.

The strong increase in the Motorcycle business was driven by increased motorcycle shipments, higher gross margin, and favorable restructuring spending as compared to last year, partially offset by higher SG&A.

Operating income at Harley-Davidson Financial Services was flat compared to last year's second quarter.

Now, let's take a look the retail sales on slide 10.

Overall, worldwide retail sales of new motorcycles were up 2.8% in the second quarter, and 9.3% year-to-date.

Retail sales reflect our strong global brand and product appeal, but also reflect very challenging economic environments in many worldwide markets.

Moving on to slide 11, as we expected, retail sales growth in the US in the second quarter moderated from the first quarter, which benefited from an early and unusually warm spring, which pulled forward some sales from the second quarter.

Sales in the US were up 4.0% during the quarter, and 12.0% on a year-to-date basis.

US market share strengthened by 1.2 percentage points to 55.1% in the second quarter versus prior year.

Year-to-date, US market share was up 2.3 percentage points to 56.1%, which is our highest June year-to-date market share on record.

During the second quarter, we shipped all of the model year 2012 product from our Company inventory in the US, as we prepared for the ERP implementation in Europe and for the cut-over to our 2013 model year production.

As a result, US retail inventory was up 6,800 units versus year ago.

This retail inventory increase will help bridge dealers until we begin shipping model year 2013 motorcycles, which typically coincides with our summer dealer meeting.

The meeting, which has historically happened in July, will occur in mid- to late August in the future, and is scheduled for August 20 this year.

Despite the increase in retail inventory at the end of the second quarter, we continue to expect retail inventory in the US will be below year ago levels for most of the third quarter, due to lower shipments versus prior year as a result of the production we have lost during the ERP implementation, and due to the later date of the summer dealer meeting.

The chart in the lower right-hand corner of slide 11 illustrates how we expect US retail inventory will change between historical levels and future expectations.

As we have discussed in the past few years, one of our key strategies is to aggressively manage supply in line with demand.

This strategy, coupled with our new, more flexible manufacturing capability, enables us to adjust the timing of motorcycle shipments, which we expect will result in retail inventory levels to be more in line with customer demand.

We believe this will allow us to improve availability of motorcycles that customers want, when they want them, with greater operational efficiency for our dealers and the Company.

As we have discussed, York will be capable of flexing its production in the first half of 2013, followed by Kansas City in the first half of 2014.

Consequently, we expect US retail inventory to be slightly lower in the future fourth quarters, which will be aligned with the seasonal low point for retail sales, and retail inventory to be modestly higher in future first, second and third quarters, also to better align with retail seasonality.

On slide 12, you'll see retail sales in international markets for the quarter grew 0.5%, driven by strong growth in Latin American and Asia-Pacific regions, partially offset by lower sales in the Europe region.

During the second quarter, Latin American was up nearly 38%, driven by strong performance in Brazil, as the dealer network continues to gain momentum compared to last year's second quarter, when there were only a few dealers establishing their new businesses.

We remain very pleased with the progress of Brazil's dealer network and our future potential in the region.

Retail sales in the Asia-Pacific region were up 10.0%, driven by strong growth in Australia and in our emerging markets.

We continue to be very excited about our businesses in India and China, and our small but rapidly growing dealer network in these two key emerging markets.

In Japan, retail sales fell as a result of a challenging economic environment and increased competitive activity.

The EMEA region was down 6.4% for the quarter, compared to 2011.

During the quarter, we saw significant softness in southern European countries and in the UK.

Northern Europe's retail sales continue to grow behind strength in Germany, but at a slower rate than we've experienced in the last several quarters.

In addition to challenging retail conditions in Europe, our market share decreased slightly, to 13.2% through May.

During the quarter, Canada was up 1.8%.

As we've discussed, international expansion is one of our core areas of investment for future growth.

It is our objective to open 100 to 150 new international dealerships between 2009 and 2014.

Since 2009, 74 incremental international dealerships have been opened, with roughly two-thirds in emerging markets.

On slide 13, you'll see wholesale motorcycle shipments during the quarter were up 25% compared to last year, as we depleted our Company inventory in the US in anticipation of our July 2 ERP launch and our 2013 model year cut-over.

During the second quarter, custom and touring as a percent of total shipments were up versus prior year, and all categories were within their historical mix ranges.

International shipments as a percent of total were down slightly compared to last year, as we allocated more motorcycles to the US market, given the very strong first half -- first quarter retail sales and tight retail inventory situation in the domestic market.

On slide 14, you'll see revenue from Motorcycles & Related Products segment was up 17.1% in the second quarter, behind strong growth for motorcycle shipments.

Parts & Accessory revenue was up 4.0% and General Merchandise revenue was up 3.1% in the quarter, as related businesses revenue generally tracks with worldwide retail motorcycle sales.

Average motorcycle revenue per unit decreased $410 compared to last year, largely as a result of unfavorable currency translation in the quarter.

On average, our major foreign currencies devalued by approximately 8% between the second quarter of 2011 and the second quarter of 2012.

Slide 15 is intended to provide a clearer view of the cadence and impact of our restructuring activities as we enter into the home stretch of our restructuring.

We are pleased to announce that the ERP launch started as planned on July 2. As of today, the ERP implementation is on plan; our employees are successfully working with the new system, and are producing model year 2013 motorcycles.

We will continue to work to increase efficiencies and maintain high quality levels that we've experienced throughout the launch.

We incurred approximately $9 million in temporary inefficiencies during the quarter, as we continue to expect temporary inefficiencies in 2012 to be generally in line with 2011, which were $32 million.

The expected ranges for our remaining quarters are noted on the slide.

Turning to the restructuring costs and savings on slide 16, we incurred $6.2 million in restructuring expenses during the quarter.

We are lowering our cost estimates by $10 million, and now expect to spend $40 million to $50 million for the full year and $490 million to $510 million in total.

We continue to expect total ongoing annual savings of between $315 million and $335 million upon completion of our restructuring activities.

We are very pleased with our progress as we enter into the final stages of restructuring.

On slide 17, you'll see gross margin in the quarter was 35.9%, 0.9 percentage points higher than last year and slightly favorable to our expectations.

During the quarter, gross margin percent benefited from lower manufacturing costs as a result of restructuring savings and incremental margin on higher production versus prior year.

Gross margin also benefited from the model year 2012 pricing increase and lower raw material costs, which posted the first year-over-year improvement in ten quarters.

Foreign exchange negatively impacted gross margin by $15.6 million, driven by the devaluation of most key currencies, partially offset by favorable hedge positions and the positive impact of lapping year-ago foreign currency losses.

Over the next several quarters, we expect downward pressure on gross margins as a result of the devaluation we are experiencing in most key currencies.

The adverse financial impact of devaluation will be somewhat tempered in the near term by our currency hedges.

We are very pleased with our gross margin performance during the first quarter and first half, despite absorbing significant currency weakness; however, we continue to expect second half gross margin to be lower than the first half as a result of unfavorable currency exchange, and production levels that are expected to be lower than the first half and below year-ago levels.

On slide 18, operating margin as a percent of revenue for the second quarter was 19.7%, up 3.3 percentage points compared to last year's second quarter.

Operating margin was favorably impacted by higher gross margin and favorable restructuring, partially offset by increased SG&A.

SG&A was $248 million, or 5.6% higher during the quarter, compared to the second quarter last year.

On a year-to-date basis, SG&A was up 10.6%, driven by three factors.

First and foremost, we continue to invest in our future growth.

We believe there's great opportunity to grow our businesses worldwide; therefore we are investing in our brand and our products, as well as the way we deliver the Harley-Davidson experience to our customers.

Second, our first half SG&A expense included 6 additional days of spending compared to last year's fiscal calendar.

This is a result of synching up our fiscal calendar with the regular calendar.

Conversely, the fourth quarter of this year will have 5 fewer calendar days compared to last year's fourth quarter.

Lastly, our warranty and recall expense was up versus the six months of last year, primarily driven by significantly higher motorcycle shipments.

As a percent of revenue, SG&A continued to trend favorably through the first half of the year, and was 1.2 percentage points lower than the same period last year, at 17.1%.

As we look forward, we expect third quarter SG&A to be up moderately versus prior year and down in the fourth quarter compared to last year, resulting from the 5 fewer days in the quarter, and as we lap the 2011 Q4 retail expense -- recall expense of $12 million.

We continue to expect SG&A spending will increase on a year-over-year basis as we invest in growth, but will decrease as a percent of revenue.

Now, moving on to the Financial Services segment on slide 19.

HDFS operating profit decreased by $0.1 million compared to last year's second quarter.

The key drivers of the second quarter results were, first, net interest income was up $2.6 million due to favorable borrowing costs, partially offset by lower revenue as our book of retail loans continues to contract, reflecting lower motorcycle sales since the downturn.

Second, the provision for retail credit losses was $0.7 million higher in the second quarter of 2012 versus the second quarter of 2011, primarily due to a $15.2 million 2011 credit loss reserve release versus $9.7 million 2012 release, partially offset by lower credit losses.

And finally, provision for wholesale credit losses was $2.6 million higher in the second quarter of 2012, behind increased wholesale receivables resulting from increased shipment to the dealer in the quarter.

We continue to believe that HDFS's operating profit will decrease in 2012 compared to 2011.

We remain pleased with HDFS's performance and believe that it is critical to the sales of Harley-Davidson Motorcycles & Related Products.

Now, Larry will provide more detail on HDFS's operations on slide 20.

Larry?

Thanks, John, and good morning.

During the second quarter, HDFS retail motorcycle loan originations increased 6.4%, or $49.6 million, compared to the same period last year.

The increase was driven by growth in used motorcycle loan originations and higher new motorcycle retail sales compared to last year, partially offset by a 1 percentage point decrease in retail market share of new Harley-Davidson motorcycle financing.

Total financed receivables outstanding increased 0.4% compared to a year ago, driven by higher wholesale receivables due to higher shipments in the quarter.

HDFS has focused on prudently increasing credit application approval rates for near-prime and subprime customers over the last several quarters.

Our goal is to maintain a portfolio that continues to perform well over time and delivers an appropriate return on equity.

We are very pleased with the improved retail delinquency rate and retail credit losses compared to last year, which you will see on slide 21.

The 30-day delinquency rate for retail motorcycle loans at the end of the second quarter 2012 was 2.68% or 85 basis points better than the same date last year.

Annualized retail credit losses are at their lowest level in over 10 years.

For the first six months, retail credit losses came in at 58 basis points, considerably lower than prior year of 106 basis points.

Credit loss performance was driven by our continued strong underwriting, collection, and loss mitigation efforts, as well as consumer credit behavior in the US.

While we continue to be disciplined in how we manage the loan portfolio and the overall business, we have no assurance that current consumer behavior will continue.

At some point, we expect shifting consumer behavior will temper the extremely strong credit performance we have experienced.

We are pleased with the continued progress at HDFS.

We remain focused on enabling sales of Harley-Davidson motorcycles, while providing an attractive return to Harley-Davidson, Inc.

Now, let me turn it back to John.

Thanks, Larry.

Now let's take a look at cash and liquidity on slide 22.

You will see that at the end of the quarter, we had $1.21 billion of cash and marketable securities.

In addition, HDFS had $0.96 billion of availability liquidity through bank, credit and conduit facilities.

We currently have and intend to continue to maintain a minimum of 12 months of projected liquidity needs in cash and/or committed credit facilities.

During the second quarter, we repurchased 3.1 million shares of Harley-Davidson stock for $150 million.

As we have stated, returning value to our shareholders through increasing dividends and share repurchases is a top priority.

We will continue to evaluate opportunities to enhance value for our shareholders.

Early in the third quarter, HDFS completed a $675 million asset-backed securitization transaction at a weighted average interest rate of 0.81%.

Now, I'd like to highlight one item on slide 23, which provides the remaining Harley-Davidson, Inc.

financials.

The Company provided operating cash of $288 million during the first six months, compared to $473 million provided in 2011.

The decrease in cash flows was primarily driven by an increase in HDFS wholesale lending activities, driven by an over 20% increase in shipments during the period.

The Motorcycle business generated operating cash of $220 million during the second quarter.

On slide 24, you will see that for 2012, we continue to expect motorcycle shipments to be between 245,000 and 250,000 motorcycles on a worldwide basis, up 5% to 7% from 2011.

We continue to be committed to aggressively managing the supply of new motorcycles in line with demand.

In the US, we expect our dealers to retail more units than they ship in 2012, thereby lowering year-end retail inventories in the US, as we expect our flexible manufacturing capability at York will be up and running in the first half of next year.

During the third quarter, we expect to ship between 51,000 and 56,000 units, which is down 9% to 17%.

We expect shipments to be down behind lower production, as a result of the downtime associated with the ERP implementation per our plan.

As we have previously discussed, we also expect Q4 shipments and production to be down versus prior year, because we expect to utilize flexible production in York in the first half of 2013.

Consequently, we do not expect to produce and ship as many motorcycles in the fourth quarter to support spring sales.

Also, this year we'll be lapping last year's excess inventory build of 7,000 motorcycles for the fourth quarter, to support the ERP launch.

And finally, this year there will be 5 fewer calendar days in Q4 compared to last year's fourth quarter, as we reset our corporate calendar.

We continue to expect full year 2012 gross margin will be between 34.75% and 35.75%.

We expect gross margin will be positively impacted by incremental restructuring savings, increased productivity from everyday continuous improvement, motorcycle pricing, and product mix.

We believe that raw material costs and temporary inefficiencies related to our restructuring activities will be comparable to 2011 levels.

Currency is also expected to be unfavorable for the full year, behind significantly weaker foreign currencies.

Finally, we continue to expect 2012 capital expenditures to be between $190 million and $210 million, which includes approximately $35 million of capital related to restructuring.

As we look back on the second quarter of 2012, our overall results are in line with our expectations.

Retail sales growth moderated, but we gained share in the US, reinforcing brand strength and product appeal.

Despite a negative impact from foreign currency exchange during the quarter, gross margin percentage was up over last year.

HDFS continues to perform well, as we experienced incredibly strong loss performance.

Also during the quarter, we repurchased over 3 million shares of our stock.

Today, we are thrilled that our ERP launch in York is on plan.

It's a huge step in our progress towards transforming to world-class manufacturing.

We remain focused on executing against our strategies as we complete our final activities and our manufacturing restructuring, continue to transform our organization, and grow our business while delivering strong margins, strong returns, and value to our shareholders.

Thank you for your continued confidence and investment in Harley-Davidson.

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

(Operator Instructions) Tim Conder, Wells Fargo Securities.

Thank you.

Keith and John, you mentioned that year-to-date retail sales are a little bit ahead of your expectations, yet clearly there was slowing during the second quarter.

And yet you did not change your annual guidance for shipments.

Could you just maybe comment on your comfort level with US channel inventories?

And prior to, you'd commented that those were a little bit low and you said you kept more in the US versus international this quarter due to that fact.

Just in light of all that, comment where US channel inventories are, and in light of your cautionary comments also looking forward with retail.

Okay, Tim.

First starting with overall retail sales.

You know, we're very pleased with retail sales growth in the first half of 2012, but we do remain cautious on the US economic recovery.

As we expected in the second quarter, retail sales moderated from the first quarter levels and they did.

Our dealer sales were up 12%, despite the slow economic growth in the US.

We gained 2.3 points of market share, which we feel great about as well.

And finally, sales to outreach customers outpaced that of our core customers, which is one of our core objectives.

So we're feeling very good about the first half.

Again, cautious on the second half as we move into some more uncertain economic times.

But when we look at the overall channel inventories, as we have been discussing, we shipped out as much as we could into the second quarter, which were all the model year 2012 motorcycles that we had in inventory in the US.

That pushed our quarter end retail inventories in the field up about 6,800 units.

And we're looking for that to bridge us until when we ship the new model year 2013 product, which is the time of the dealer show in about the third week of August.

So what we believe is that given the fact that production was down after that, and we've got about seven weeks until we ship again, is that we expect third quarter inventories to be below year ago levels.

Even though they're starting out at 6,800 units higher, we would expect them to dip below year ago levels until we start replenishing with the model year 2013 motorcycles.

Now the good news is, is that our dealers and customers typically experience this model year cut-over at the same point during this year.

It's just a little bit longer of a bridge.

Okay.

So in general then, John, in light of all that, are you guys comfortable with the US channel inventories at this level?

And given everything you know at this point about the trajectory of retail, or would you term them a little bit still under ideal levels where you would want?

And again, I know the surge is coming for next spring, but just in the context of everything.

We would still characterize them as a little bit under where we would like them to be.

Certainly we entered -- exited the first quarter very light.

The second quarter again we built it up, but that's going to deplete very quickly, and we would like to add a little bit more in the third quarter, as well.

As we've discussed, though, we feel very comfortable with the fourth quarter and actually expect those to come down a bit.

Craig Kennison, Robert Baird.

Good morning.

Thanks for taking my question as well.

Just following up on a topic from the analyst meeting in New York, do you expect year-end dealer inventory to fall in 2013, next year?

Yes.

Yes.

So let's take a look at overall.

Our objective is pretty simple.

It's one of produce and deliver our products that customers want, when they want them, and where they want them.

And so what we're doing is changing historical patterns that we've seen in the past when we were at level production.

So as we gain the capability to produce more when customers want them, we then have the ability to produce less when customers don't want them.

And that's what the previous question was all about, is in the fourth quarter we would expect those inventories to be down this year, because now for product produced at our York facility, we'll be able to do more in the springtime when the customers are looking for them, so we don't need as much inventory to sit in the dealer network in December.

Now when we look into 2013, the same thing is going to happen, it's just that that capability of flexible manufacturing or our ability to surge production at Kansas City takes place in the first half of 2014.

For the exact same reason, is we don't need to make as many products out of Kansas City and put them in dealer inventory in the fourth quarter, because we'll now be able to do it in the spring selling season.

So yes, we would expect both the fourth quarter retail inventory to be down slightly in 2013 and 2014.

Thank you.

Sharon Zackfia, William Blair.

Hi.

Good morning.

I just had a few questions.

I think -- first, on the ERP implementation, can you help us understand how that might impact the mix of bikes that you're shipping this quarter?

And then secondarily, given what's going on in Europe and maybe some more global uncertainty, how are you thinking about your potential for price in the 2013 models?

Okay, Sharon.

The ERP, again, we couldn't be more pleased with the ERP launch.

Everything is on plan.

We feel great about where we're at.

Having said that, we are producing all models on a single combined line using the new system.

So we don't expect any big changes or dramatic changes to the mix that our customers want in the third quarter.

I think the next question, Sharon, was with regards to 2013 pricing.

We don't provide anything on 2013, or the next model year pricing, until we deliver it to our dealers.

So what we will do is announce pricing of our motorcycles in the US and around the world on August 20 at our worldwide dealer meeting here in Milwaukee.

Okay.

And maybe just a follow-up on that.

Given the currency pressure, can you help us understand where you're coming out on currency versus raw materials as you look forward?

Because I would expect perhaps raw materials are a partial offset at least to the currency pressure.

Okay.

Well, let's talk about currency first.

During the quarter, it was certainly a tough quarter when we look at foreign currency.

If you look at a year ago second quarter versus this quarter, they devalued by 8%.

The euro was down 11%.

I think the real was down 19% over that period of time.

That had a very unfavorable impact on revenue of about $33.2 million.

Some of our hedging activities got about $18 million of it back, so for the quarter, it was unfavorable by $15.6 million.

So that was certainly more than we had anticipated, and the foreign currencies in the quarter devalued by 3%.

So, very unfavorable; however, we did see some favorability in raw materials; first time in ten quarters that we've seen the year-over-year improvement in raw materials, and certainly it came in pretty strong, at $4.7 million.

Of that, most of that was metal, about $4.2 million of it was metals, and the other was fuel.

So in the second quarter, the two certainly didn't offset one another.

As we look forward, overall raw materials we expect to be flat on a year-over-year basis, but we are seeing a pretty good trend -- or pretty good number here in the second quarter.

Currency, we are pretty certain that it is going to be unfavorable as we move forward.

So when we look at the third quarter, the euro a year ago was at $1.42 exchange rate; and as we closed the markets yesterday, it was at $1.23.

That's a 14% difference between quarters.

So we would expect pressure on revenue from foreign currency exchange, and that will be somewhat mitigated by some of our hedges.

But we would expect currency to be unfavorable in the third and fourth quarter.

So we do not expect that raw materials can cover what we're seeing in currency.

Ed Aaron, RBC Capital Markets.

Thank you.

I just wanted to ask a question on the gross margin.

It sounds like your expectations for mix have shifted more positively from last quarter's.

Is that accurate?

And if so, was that a driver of some positive variance in the gross margin in the second quarter?

And then, can you also speak to why mix might be moving more positive?

Well, yes, so last quarter we were expecting mix to be slightly unfavorable, because as we took up volumes, most of that was coming out of Kansas City, which typically has a lower mix.

But as we got through this quarter and everything is going so well on the ERP implementation -- and to the prior question, we are able to build all the products that we are looking for out of York -- the proper mix of product, that we now feel that product mix will be slightly favorable as we end the year.

So through the first half, mix is largely flat, up a half million, was up a million bucks in the second quarter, but we would expect it to be somewhat favorable as we end the year.

Thank you.

Patrick Archambault, Goldman Sachs.

Yes.

Good morning.

I just wanted to follow up on one of the earlier questions.

I guess -- you said that inventory was not quite where you wanted it to be.

You ended up year-on-year this past quarter, but you were going to deplete it, obviously a lot of that is what happened through August.

Can you just maybe tell us how the September quarter -- or how the September period is tracking?

Are you fully up to levels where you're able to produce at the volumes that you want to?

Are there still remaining testing measures that need to be taken at York just to -- as a final stage before you really get up to volumes that you would like to be at?

Thanks, Patrick.

The York ERP implementation, we said at the last conference call that we started on July 2, and it would largely be behind us as we exited the month of July.

And I'm happy to say that we're there.

So we had a ramp plan that had us returning to pre-ERP implementation line speeds in just four weeks.

And that's at the end of this week.

And so right now, we're exactly where we want to be on plan; and over the next couple shifts, we will be producing at pre-ERP launch line rates.

So there is not an issue in terms of production coming out of York at all, with regards to overall inventory or mix.

Okay.

So basically, the draw down was exactly as expected.

It's just that you would have liked to have gone into the quarter maybe with just a little bit more padding?

Yes.

And again, it kind of goes back to the fact that retail sales are over -- exceeded our expectations for the first half.

So originally, we would have expected a little bit more going in, in retail inventory.

But we're up 6,800 units, and that will have to do over the next several weeks until we launch the new product.

Okay.

Makes sense.

Thank you very much.

Rod Lache, Deutsche Bank.

Thank you.

I was hoping you could just be a little bit more explicit on what you expect for the rest of this year for FX based on where your hedges are at, assuming spot rates stay where they are now.

And if they did stay where they are now, what would be the headwind for 2013?

Thanks, Rod.

Rod, we don't provide a forward look at currency, and the reason is, there's so many factors that come in.

There's so many currencies at play, compared to year ago, movements within the quarter, mix of products and sales.

So we don't provide that if we're here, this is where we're going to end up.

But suffice it to say that revenue is going to be impacted quite significantly if rates stay where they're at in the third and the fourth quarter.

We do have hedges on that were put on over the last four quarters.

So those are put on at more favorable rates than we're experiencing right now, and that will mitigate some of the impact that we're seeing in revenue.

But overall, we expect both revenue and gross profit to be hurt by the currency exchange and the devaluation of the currencies that we have.

But there's so many factors that came in.

If I gave out a number, tomorrow it would be wrong.

Okay.

Then maybe you could just comment on your -- the production guidance for Q4 looks like it's slightly lower than Q3, despite the ERP implementation issues in the third quarter.

Is there some aspect of this that's rolling into the fourth quarter or are you just looking to keep production pretty close to where sales are coming in this year?

Well, we're looking to match our customer demand.

So we have fire power in the fourth quarter to produce more.

The production will be down versus year ago levels because of the fact that now we can produce them in the first half closer to demand.

And we'd much rather do that than produce them and put them in inventory in the fourth quarter.

The other things that are going to have production down year-over-year is the fact that, again, a year ago we were building excess inventory for the ERP launch, and we've got 5 fewer days for production.

So we do have the capability to produce more product out of both Kansas City and York in the fourth quarter.

But at this time, we feel comfortable with our estimate of shipments being up 5% to 7%, and taking inventories down in the fourth quarter, and moving that production to the first half of next year.

James Hardiman, Longbow Research.

Hi.

Good morning.

Thanks for taking my call.

You mentioned that there was some demand pulled forward into the first quarter, due to the weather.

That seems to make all the sense in the world.

I don't think that anybody thought that the 20% first quarter growth was remotely sustainable.

I guess my question is, when you look at the third -- I'm sorry, the 3% growth rate in 2Q, if we were to strip away any of that weather impact, I know that's hard to do, but do you think that the underlying momentum of your business is any better than that?

Or do you think that that's about the run rate we should expect going forward?

James, there is absolutely no way for us to tell how much sales was pulled forward.

There is certainly every indication that a fair amount was pulled into the first quarter.

With the first quarter weather, I think over the entire quarter was the best in a hundred years.

But we would not speculate on the split between what the quarter should have been.

What we do know is that the first half was up 12% and we feel very good about that, especially given the soft economic environment in the United States.

And we're up 9.3% on a worldwide basis.

And again, that's done in an environment that we've got a deepening recession in Europe.

So we feel very good about overall first half, but there is absolutely no way, and we don't know how many were in first quarter versus second quarter.

Well let me ask the question this way.

Given your guidance for the back half of the year, and it's hard to ask the question, because I know you guys don't want to give any retail guidance.

But built into that lower production guidance for the back half, are you assuming a retail that's generally about where we are right now?

I can't provide that.

That would be giving retail guidance, James.

Again, we feel good about our shipment guidance of 5% to 7%.

If retail sales warrant, we can produce a little bit more in the fourth quarter.

But at this point, our preference would be to make it closer to the customers' demands in the spring of 2013.

Greg Badishkanian, Citigroup.

Great.

Thanks.

In just kind of looking out at the retail inventory levels for 2013, I know you'd like to bring those down by design, which is a favorable, make the supply chain more efficient.

Let's say retail demand is robust.

What level of production can you achieve, though, given the Kansas City facility switch over?

Can you really step up demand if you need to, or are you constrained by supply?

I'm sorry, that was in 2013?

Yes.

I'm thinking looking at 2013 and 2014?

Okay.

As we've discussed, we'll be able to surge capacity in York in the first half and we feel comfortable with meeting any demand out of our York facility.

With Kansas City -- Kansas City capacity is not an issue in the short-term.

What we want to do, though, is to be able to make units closer to customer demand.

So we will not experience the same type of capacity constraints at our Kansas City facility as we did in York.

Remember, York was completely transformed.

Everything was moved onto a single line.

We don't have those same things happening at Kansas City.

And again, overall we have plenty of capacity at Kansas City, but what we want to do is better utilize and more efficiently make units out of Kansas City, and again using the surge capability to get closer to customer demand.

So overall in 2013, we do not have any --- we don't foresee any capacity constraints.

Okay.

Perfect.

Thank you.

Robin Farley, UBS Securities.

Great.

Thanks.

I had a question on your gross margin guidance, because you had originally said you thought Q2 would be in line with Q1, and then kind of in late June at your Analyst Day, you said it would fall below Q1 levels.

It seems like last minute it came in in line.

I don't know if you can give us any color on it, if that was just some last minute shipment mix that shifted that or FX not being as negative an impact as you thought.

Or what was of such a last minute nature to change gross margin?

And then I don't know if you -- normally you give out a comment about used bike prices or repo values or something, and you didn't comment on used bike prices.

I don't know if you have any color there to share.

Thanks.

Okay.

Robin, with regards to the gross margin, yes, gross margin came in a little bit higher than we expected in the second quarter, which we're very pleased with.

There's nothing that happened at the last minute.

Again, we don't update guidance between and within the quarter.

But what happened is, and why we came in a little bit more favorable to what we had anticipated, is largely driven by raw materials.

Raw materials were $4.7 million favorable in the first quarter.

They were unfavorable by, I believe it was $1.6 million, or in that neighborhood.

So that was really what pushed us over where we thought we would be, which again was below the first quarter gross margin, which was 35.9%.

Again, we came in even and certainly pleased with that.

With regards to used bikes.

So used bikes over the last three quarters, the gap -- the pricing gap between new and used, or the value gap, has remained very constant.

As we had discussed in the fourth quarter of 2011, was really the inflection point where we saw new grow faster than used.

And that was after a period of many quarters where used was growing faster than new.

And we have kept that for the last three quarters, is new has grown slightly faster than our used bike sales over the last three quarters.

And we really take that to mean that the gap between new and used is at probably where it's going to be going into the future.

We can grow both new and used bikes at the price levels that we have, so we feel pretty comfortable and would not expect huge movements in the price gap between new and used, moving forward.

Jaime Katz, Morningstar.

Good morning.

Can you guys maybe offer us some insight on how European demand was overall?

Because it's a little bit hard to parse out currency versus price per unit of the bike, and I'm curious if maybe the promotional cadence had updated or there was some additional incentives to get units out the door over there.

Jaime, there was no price discounts going on in Europe.

When we look at the overall price per bike that we had mentioned, $410 of that was driven by currency.

There was a little bit of offset because of favorable pricing that we took a year ago, but that is currency.

And again, that's the 8% devaluation across all our international currencies.

When we look specifically at Europe, Europe held up very well last year.

Actually Europe, our core sales in Europe were up over 5% last year, and we saw a little bit of weakness in the first quarter and that certainly continued into the second quarter.

I think we're down 3.1% in the first quarter and down 9.1%.

And what's really happening in Europe is kind of a tale of two markets.

The south started deep declines in third quarter of 2011, and we'll start to lap those coming up in this quarter.

And the north has largely been growing quite robustly.

And over the last couple of quarters, we've seen the north, while still growing, fall a little bit.

Really the story in Europe is with regards to the recession and consumer confidence that's the financial crisis that's happening there.

Again, we're going to focus on what we can control and continue to build the brand and the distribution network.

Ed Aaron, RBC Capital Markets.

Thanks for the follow-up.

Just wanted to clarify something from your earlier comments.

I think you had indicated that dealer inventories would end lower in 2013 and 2014, just because of the seasonal change in your production model.

And I can understand the step down in 2013 because you have the KC surge coming into effect.

But why would there be an incremental change in 2014 as well?

If I said that, I apologize.

We expect inventory to be lower this year, 2012, because of our ability to surge capacity at York in 2013.

We expect 2013 retail inventory to be down slightly, given our ability to surge Kansas City production in 2014.

I did not intend to make any comments with regards to retail inventory at the end of 2014.

So if I did, I apologize.

We expect to be down in 2013 and 2014.

Okay.

Thanks.

Just one more quick one, if I could.

Could you comment on your -- what you saw competitively in Japan that you flagged in your prepared remarks?

Yes.

Japan, one is the economy is slow, as well.

But two, there's more price competition in Japan, in particular by Honda.

So we lost a little bit of share in the second quarter, and the team's addressing that.

But it was a little bit lower than we had anticipated, so we'll work through that.

Tim Conder, Wells Fargo Securities.

Thanks for the follow-up also.

John, any color you can give here on the channel inventories in Europe?

You mentioned again that you tilted shipments in the second quarter to the US because it was so strong.

And then clearly, you cited a couple of cases of what's going on in Europe.

Any color you can give us on those channel inventories in Europe?

Yes.

We feel fine with the inventory in Europe, given the sales were down.

And so we did shift that production into the growing market, which was the US in the second quarter.

But remember, Europe inventory is handled a little bit different than in the US.

That's what we call a pipeline method.

So every -- all dealers have floor stock.

And when they sell one, they get one out of the warehouse, which allows smaller dealerships to utilize less working capital.

That's been incredibly beneficial as we've seen the south volume declines and the north accelerate.

It allows us to get product where we want it when we need it.

So by moving a couple thousand units out of that, which is in a consolidated warehouse, given their sales were lower, into the United States is we don't have any concerns with that.

We feel very good about our inventories in Europe, as well as in Asia and Latin America.

Okay.

Great.

Thank you.

Patrick Archambault, Goldman Sachs.

Hi.

Yes.

Just actually wanted to ask one on HDFS.

I think you had cited -- I guess, two questions.

Number one, in terms of borrowing costs, I think you had said that borrowing costs were favorable this year -- or this quarter, excuse me.

What's the outlook for that?

Is there any more diversification in funding away from shorter term to medium term notes that you need to do, and could that be a potential headwind from a borrowing cost perspective going forward?

And then also, can you just give us the math on where reserves -- or provisions should end the year?

I think it sounds like you took down provisions a little bit as well this quarter, if I heard that correctly.

Okay.

Patrick, I'll take the first part of the question, then I'll let Larry answer the second.

Yes, we're very pleased with borrowing costs.

As we discussed, we were just in the market and did a securitization for $675 million at 0.81%.

In the first quarter, we were in the medium term note market and did the lowest MTN for a 5-year period that we've ever done, at 2.7%.

So we feel fantastic about our borrowing costs.

To answer your question with regards to diversification, we also feel very comfortable where we are at today.

As you may all recall is that, over the last couple of years, we've been looking to more diversify our funding and move more into a more balanced approach between term notes as well as the securitization and CP.

So we feel great about where we're at in terms of the overall diversification.

We're not looking to make any major changes, so that should not have an impact on borrowing costs as we go forward.

I'll let Larry answer the second question.

Sure.

Thanks, John.

Regarding the allowance, we had an allowance at the beginning of the period of $122.5 million.

Our provision for the quarter was actually a credit of $5.3 million.

That was driven, as John said, by the allowance release of $9.7 million in our retail portfolio.

Net charge-offs for the quarter were $3 million, and that left us with a provision at the end of the quarter of $114.2 million.

We are not going to give any guidance regarding where we expect to end the year regarding our allowance or what provisions in the third or fourth quarter.

I'll just continue to reinforce my remarks, which were, credit conditions remain favorable right now.

I think we've done a lot of good things in underwriting, but also there's some favorable consumer behavior trends which are driving our relatively low delinquency and loss levels at the present time.

Your last question comes from the line Greg Badishkanian with Citigroup.

Please go ahead.

Great.

Thanks.

Without discussing anything real specific, to front run yourself at the dealer day, but what level of innovation do you expect?

And are you planning to maybe hit different demographics or different segments, or is it just going to be kind of really innovative new products with -- maybe some color versus even historical levels of innovations coming out of your new products would be helpful.

Greg, we're not going to provide any look to what you might see in the next couple of weeks at the dealer show.

You know, what I would say broadly is, we're making great progress on our product development transformation and the ability to move product through there quicker and to better target product toward our outreach groups in the US and around the world.

And as we've said before, we would expect to start to see kind of the fruits of that restructuring and transformation on next year's product model year 2014 product.

But with regards to this model year, I'm not going to provide anything.

We'll have it out in about four weeks here -- or three weeks.

At this time, there are no further questions in queue.

I turn the call back over to the presenters.

I want to thank you for your time this morning.

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Ladies and gentlemen, this concludes today's conference call.

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