Harley-Davidson Inc (HOG) 2014 Q2 法說會逐字稿

Good morning.

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

At this time, I would like to welcome everyone to the second-quarter 2014 earnings conference call.

(Operator Instructions)

Thank you.

Amy Giuffre, Director of Investor Relations, you may begin your conference.

Okay.

Thanks very much, Tonya, and welcome to Harley-Davidson's second-quarter 2014 earnings conference call.

Our calls are webcast live on Harley-Davidson.com, and you can access the supporting slides on that site by clicking About Harley-Davidson at the bottom of the home page, then Investor Relations and Events and Presentations.

This morning, Harley-Davidson's CEO, Keith Wandell; CFO, John Olin; and President of Harley-Davidson Financial Services, Larry Hund, will provide their perspective on the quarter.

Following our prepared remarks, we will open the call for your comments.

Our comments will include forward-looking statements that are subject to risks that could cause actual results to be materially different.

Those risks include, among others, matters we have noted in our latest earnings release, and filings with the SEC.

Harley-Davidson disclaims any obligation to update information in this call.

With that, let's get started.

Keith?

Thanks, Amy.

Good morning, and thanks to all of you for joining us on the call.

As always, we appreciate your interest in Harley-Davidson.

In the second quarter, we continued to see strong gains in our financial performance.

Revenue was up 11.5%, net income was up 30.3%, and operating margin improved by nearly 4 points to 25.8%, as the many improvements in operations of the last few years continued to show up on the bottom line.

However, retail motorcycle sales were flat overall, compared to a year ago, and fell short of our expectations, in the US in particular, for reasons that John will go into in a couple minutes.

Given where we are in the US selling season, we don't believe will get back fully on track with our US retail plan for the full year, so in this morning's press release, we announced that we are lowering our full-year 2014 shipment guidance to a range of 270,000 to 275,000 motorcycles, compared to prior guidance of 279,000 to 284,000.

This new guidance has shipments growing about 3.5% to 5.5% over 2013.

The reason for this adjustment is simple: protecting our premium brand is of utmost importance, and we will continue to aggressively manage supply in line with demand, in order to do so.

We believe the flat retail sales numbers are a temporary situation, and that the underlying demand fundamentals of the business remained intact, driven by, first, the strong appeal of the Harley-Davidson brand, continuing outreach momentum in the US, international expansion, and at the top of the list, outstanding motorcycles.

The Project Rushmore motorcycles have performed extremely well at retail since their launch last August, and we believe they will continue to be a strong draw, as riders migrate to these outstanding bikes.

And we couldn't be more pleased with how the Rushmore motorcycles have been received, which we believe is a reflection of the strength of our customer-led approach.

Late in the second quarter, the Street models began to hit US dealer showrooms.

Street is designed for a new generation of riders, and US dealers report continued strong interest, enthusiasm, and sales of initial shipments.

In India, initial sales of the Street 750 have exceeded our expectations, and the initial response in Italy, Spain, and Portugal have also been strong.

We look forward to expanding Street to other markets in 2015.

Speaking of 2015, the new model launch is just around the corner, and it includes a return of Road Glide.

While I won't get into the specific features and upgrades, we anticipate Road Glide customers and others will be excited by the changes that we've made.

We'll share all the news about the complete 2015 motorcycle line in late August, when some 5,000 people from our global network of more than 1,400 dealers gather for our annual dealer meeting.

There's also been tremendous interest and enthusiasm for Project LiveWire, the electric motorcycle we revealed last month.

The reveal has generated more than 340 million media impressions to date, and those who have had the chance to test ride LiveWire had great things to say about it.

We're taking Project LiveWire to the streets for customer test rides this year and next.

We will gain deeper insight into what customers are looking for, from Harley-Davidson, in this type of motorcycle.

So that if we launch it commercially, it will deliver on customer expectations and be authentic to the Harley-Davidson brand.

Project LiveWire builds other successes at Harley-Davidson.

In the last few years, we've broadened our reach to a more diverse customer base in the US and globally, and we've accelerated time to market with cutting edge products.

LiveWire is just the latest example of how we are pushing the boundaries with awesome products, and innovation that builds on our market leadership.

One of the things I am personally most excited about when it comes to our future is all the new products that are under development.

As always, I want to acknowledge the efforts of our employees, our dealers, and suppliers, who use their abilities and talents every day to provide outstanding products and great customer experiences.

Together, we are focused on continuously improving all the ways we serve customers, and ensuring an outstanding future for the Company.

And now, I'll turn it over to John, with more details on the quarter.

Thanks, Keith, and good morning everyone.

I'll review the second quarter financial results, starting on slide 11.

During the quarter, Harley-Davidson, Inc.

consolidated revenue was up 11.5% to $2.0 billion.

Our second-quarter net income improved to $354.2 million, an increase of $82.4 million, or 30.3%.

Similarly, diluted earnings per share rose to $1.62 per share, up 33.9% from the year-ago quarter.

Operating income for the motorcycle segment was $473.3 million, up 32.3% compared to last year's second quarter.

The strong increase in the motorcycle business was driven by a 12.4% increase in revenue, behind a 9.0% increase in shipments.

Motorcycle segment operating income also benefited from a higher gross margin percent, partially offset by higher year-over-year SG&A spending.

At Harley-Davidson Financial Services, operating income was up slightly year-over-year.

Also, during the quarter, we had lower year-over-year interest expense behind the retirement of our high-interest debt in February.

We are pleased with our second-quarter financial results, and continue to focus on delivering strong margins and strong returns.

Now, let's take a closer look at the second-quarter performance, starting with retail sales on slide 12.

Worldwide retail sales of new Harley-Davidson motorcycles were flat to prior year in both the US and international markets.

Second-quarter worldwide retail sales tracked below our expectations due to prolonged poor weather conditions across parts of the US, and soft US Sportster sales in the wake of the highly-anticipated Street motorcycles, coupled with Street start-up issues, which are impacting the timing of Street availability.

Despite the soft Q2 sales results, we believe the core demand fundamentals for the business remain intact, and underlying growth trends are strong, when adjusting for the absence of Road Glide.

As Keith mentioned, as a result of the slow start to 2014, we believe it is prudent to adjust our shipment plan for the full year.

We now expect to ship between 270,000 and 275,000 motorcycles worldwide, which represents growth of approximately 3.5% to 5.5% versus prior year.

The previous guidance was 279,000 to 284,000 motorcycles.

It is critical for Harley-Davidson to support a healthy retail channel, and protect our premium brand by aggressively managing supply in line with demand, as we have consistently done for the past several years.

During the second half of this year, we expect continued success from Project Rushmore motorcycles, increasing product availability of our very well-received Street motorcycles, and a very exciting 2015 model year motorcycle line-up, which will be introduced in late August, and include our new Road Glide motorcycles.

On slide 13, let's review the US market, where retail sales were flat to prior year in the second quarter.

As I stated, we believe the factors that adversely impacted US retail sales during the quarter were, first, as we anticipated, the absence of the popular Road Glide models in the 2014 model year, continued to impact year-over-year sales results.

Road Glide represented about 10% of US's retail sales in the second quarter of 2013.

Second, we believe that the prolonged weather conditions across parts of the US likely resulted in lost sales, which we believe will not be fully recovered in 2014.

Dealers also experienced a sharp decline in Sportster motorcycle sales in the US, which we believe was a result of even better than expected enthusiasm we are experiencing for the new Street motorcycles.

Some customers are waiting to compare the two product offerings firsthand; however, we are experiencing a slower than expected dealer retail fill of Street, due to start-up issues that have resulted in very low product availability to date.

During the quarter, we had a market share of 50.3%.

While market share continued to be at near record levels, it was down 2.6 points on a year-over-year basis.

We believe the decline was driven by the absence of Road Glide in the 2014 model year, and our share of the small Cruiser segment within the 601-plus cc motorcycle market declined behind lower Sportster sales, as I just mentioned.

Through the first six months, US retail sales were up 1.1% compared to last year, and market share declined 1.8 percentage points.

While retail sales finished short of our expectations, we remain focused on the many strengths within our business, including strong demand for our Project Rushmore touring bikes.

In fact, year-to-date touring retail sales were up significantly, despite the absence of Road Glide.

And with regards to our new Street motorcycle line-up, the bikes have received a great reception from our worldwide dealer network, the motorcycle press, and customers.

Early feedback from our Riding Academy suggests graduates are excited about the opportunity to purchase the Street as their first Harley.

And early customer sales in India and southern Europe are very encouraging.

Street motorcycle sales to US dealers for use in our Riding Academy were completed late in the second quarter.

A total of approximately 1,600 Street 500s were sold to dealers in the second quarter, and approximately 2,200 during the first half.

Street motorcycle shipments for customer retail sales began in late Q2 in very limited quantities.

As I noted earlier, we experienced difficulties with the start-up of Street, which resulted in a slower Q2 rollout of bikes to US dealers, for sales to customers.

We now plan to ship each US dealer two Street motorcycles for retail by the end of August.

We anticipate that our ability to supply the US dealer network will improve toward the end of Q3 and into Q4, however start-up costs will continue.

While we continue to expect to ship between 7,000 to 10,000 Street motorcycles worldwide in 2014, shipments will be skewed more toward the end of the year, versus our original plan.

Overall US dealer retail inventory was up approximately 6,600 motorcycles at the end of Q2, compared to the same quarter last year.

Inventory was higher than desired, due to our soft retail sales during the quarter.

As we have discussed many times, we are committed to aggressively managing supply in-line with demand, as demonstrated by our shipment guidance reduction.

We continue to expect US year-end retail inventory to be up moderately from 2013 levels, driven primarily by the addition of the new Street models.

On slide 14, you will see retail sales in our international markets were up 0.1% in the second quarter.

In the EMEA region, Q2 retail sales were up 7%, driven by growth across most countries, in particular, southern European countries and emerging markets in the region posted very strong growth.

During the first six months of 2014, our 601-plus cc market share in Europe was 12.1%, down 0.4 percentage points versus the same period last year, behind the introduction of several new low-price competitive models.

In the Asia-Pacific region, retail sales were up 1.5% in Q2.

Very strong retail sales in our emerging markets offset a steep decline in Japan.

We believe the Japan sales tax increase that went into effect on April 1, 2014 pulled significant sales forward into Q1, resulting in a 33% increase in that quarter, and drove a 20.9% decrease in Q2 retail sales.

On a year-to-date basis, Japan retail sales were up 1.0%.

Emerging markets in the Asia-Pacific region posted very strong gains, driven by India, where retail sales were more than doubled during the quarter, as a result of a very strong demand for the new Street motorcycles.

The Latin American region was down 10.4% during the quarter, as we lapped last year very strong growth of 39.2%.

Brazil's retail sales have also been impacted a slowing economy, consumer uncertainty, and very aggressive price competition.

Retail sales in Canada were down 18% in the second quarter, which we believe is due to poor weather conditions and an adverse response to recent price increases by our Canadian distributor, initiated to recover unfavorable currency exchange impacts.

During the quarter, we added five new international dealer points, as we continue to increase our international distribution.

We believe that we can realize strong international growth opportunities by expanding our dealer network and increasing our brand relevance, by delivering new products, such as Street.

On slide 15, you will see wholesale shipments of Harley-Davidson motorcycles in the quarter were up 9.0% compared to last year.

Second-quarter shipments finished at the low end of our expected shipment range, of 92,000 to 97,000 motorcycles.

During the quarter, the mix of touring motorcycles increased 6.3 percentage points from the prior year, as our new Rushmore touring motorcycles continued to create demand in the market.

Also during the quarter, shipment mix of our Street and Sportster category was up, however not as much as we had anticipated, given the challenges with Street start-up.

We will continue to ramp up Street motorcycle production through Q3, and expect to be up to speed during the fourth quarter of the year.

On slide 16, you will see revenue for the motorcycles and related products segment was up 12.4% in the second quarter, behind a 9% increase in shipments.

During the quarter, the average motorcycle revenue per unit increased nearly $1,000 from the year-ago quarter, primarily driven by higher pricing, favorable mix, and favorable currency.

On average, our key currencies in the second quarter were stronger against the US dollar by approximately 1%, compared to 2013.

Parts and accessory sales were up 0.7% in the second quarter.

General merchandise sales were down 6.5% during the quarter.

As we move forward with our efforts to transform the Harley-Davidson customer experience, we have initiated an aggressive SKU reduction plan across our apparel product offering.

We believe the reduction will better focus dealers on fast-moving product, and improve the customer experience with a more targeted assortment a popular styles.

We anticipate a couple quarters of flat revenue, as dealers sell through discontinued items.

On slide 17, you'll see gross margin in the quarter was 39.5%, which was up 2.6 percentage points, compared to last year.

Volume, price, mix, currency, raw materials, and manufacturing were all favorable for the quarter.

During the quarter, mix was $30.9 million favorable behind a higher mix of touring motorcycles, compared to 2013.

Looking forward, we expect mix will become significantly unfavorable in the second half of the year, as Street shipments increase, and Rushmore laps its Q3 2013 introduction.

Foreign currency exchange was $17.2 million favorable during the quarter.

This favorability was driven by improved revenues behind a strengthening Euro, and lapping last year's large Q2 foreign exchange losses.

Manufacturing costs in Q2 reflect the benefits from increased year-over-year production, restructuring savings, and lower pension costs compared to last year's second quarter.

On slide 18, operating margin as a percent of revenue for the second quarter was 25.8%, up 3.9 percentage points, compared to last year's second quarter.

Operating income of $473.3 million for the quarter was favorably impacted by higher gross margin, partially offset by slightly higher SG&A spending, and an unfavorable comparison to last year's period, which included $5.3 million in restructuring benefit.

We are pleased with our ability to leverage both our gross margin in operating expenses in the second quarter.

Going forward, we will remain intensely focused on improving our cost structure and managing the business to be stronger, more flexible, and more profitable.

Now, moving on to our financial services segment on slide 19.

In the second quarter, HDFS operating profit of $74.4 million was 0.4% higher than last year.

The three primary factors impacting second-quarter results were, first, net interest income was favorable $8.5 million, driven by increased receivables, and favorable interest expense, partially offset by lower yields on receivables, due to increased competition.

Second, the provision for retail credit losses was unfavorable by $5.0 million, due to higher retail credit losses, an increase in the reserve rate, and growth in retail receivables.

And finally, HDFS operating expenses were up $3.4 million.

Going forward, we continue to expect pressure on HDFS's operating income, as a result of modestly higher credit losses, and tightening net interest margins, due to increasing competition and rising borrowing costs.

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 10.5% or $95.3 million, compared to the same period last year.

The higher originations were driven by a 2.2 percentage point increase in retail financing market share for the second quarter, compared to last year, and a higher average amount financed.

For the second quarter, HDFS retail financing market share of new Harley-Davidson motorcycles sold in the US increased to 56%, compared to 53.8% in 2013.

The primary driver of the year-over-year market share gain was the price changes in the prime segment, which were initiated during the second quarter last year, in response to increasing competition.

Finance receivables outstanding increased 9.5% compared to a year ago, driven by growth in both the retail and wholesale portfolios.

We believe the overall loan portfolio was solid, comprised of profitable loans in both the prime and sub-prime segments.

In the second quarter, between 75% and 80% of our new retail loan originations were prime.

Moving on to credit performance on slide 21, the 30-day delinquency rate for retail motorcycle loans at June 30, 2014 was 2.68%, or 7 basis points lower than 2013.

The delinquency percentage at June 30, 2014 is the lowest it has been in 13 years.

Annual retail credit losses for the first six months increased by 17 basis points to 0.97% compared to 2013, due to lower recovery values on repossessed motorcycles, some changes in consumer behavior, and lower levels of recoveries from accounts charged off in prior years.

During the second quarter, HDFS continued to maintain a strong liquidity position, delivered solid credit performance, and contributed strong profitability.

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.

Thank you Larry.

Now, let's look at slide 22.

You will see that at the end of the quarter, we had $1.06 billion of cash and marketable securities.

In addition, we had approximately $1.3 billion of available 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, HDFS successfully completed an $850 million asset backed securitization transaction at a weighted average interest rate of 0.93%.

In addition, we repurchased 1.9 million shares of Harley-Davidson stock for $135.7 million during the quarter.

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.

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

financials on slide 23.

I would like to highlight two items.

First, with regards to operating cash flow, we generated operating cash of $570.6 million through the first half of 2014.

Operating cash flow was up $180.9 million from last year, primarily driven by lapping last year's pension contribution of $175 million, lower working capital, and increased earnings, partially offset by higher wholesale finance originations.

And second, the year-to-date tax rate was 35.3%, compared to 34.8% in the year-ago period.

The higher tax rate reflects the expiration of the R&D tax credit at the end of 2013.

On slide 24, you'll see our overall expectations for the remainder of the year.

As previously stated, we now expect to ship 270,000 to 275,000 motorcycles on a worldwide basis in 2014, up approximately 3.5% to 5.5% from 2013 shipments.

During the third quarter, we expect to ship 49,000 to 54,000 motorcycles, which is approximately flat to down 9%, compared to last year's third-quarter shipments of 54,025 motorcycles.

Even with the change in shipment guidance, we continue to believe 2014 operating margin for the motorcycle segment will be between 17.5% and 18.5%, up from 16.6% in 2013.

We believe 2014 operating margin will benefit from a modest increase in gross margin, and from SG&A falling as a percent of revenue.

We expect Q3 gross margin to be approximately 2.5 percentage points below Q3 2013's gross margin, driven by, one, unfavorable mix.

As anticipated, Rushmore, which delivered strong mix gains since its introduction, will be lapping its initial launch in Q3 2013, while at the same time, we believe Street, at a much lower price point, will be an increasing portion of shipment mix.

Two, lower year-over-year production, as we adjust our shipment expectations.

And three, start-up costs of approximately $5 million for Street.

For HDFS, we continue to expect operating income will be down modestly in 2014 compared to 2013.

We continue to expect capital expenditures in 2014 to be between $215 million and $235 million.

Finally, we continue to expect our full-year 2014 effective tax rate to be approximately 35.5%.

So to recap, during the quarter, we successfully increased gross margin and operating margin, which resulted in a 33.9% increase in diluted earnings per share, shipped the first all-new Street motorcycles to customers in the US, India, and southern Europe.

Revealed Project LiveWire, an electric motorcycle experience, which is generating a great deal of customer excitement, and delivered shareholder value through dividends and the repurchase of $136 million of Company shares.

While we are disappointed in Q2 retail sales, we are pleased with our second-quarter financial results, and key accomplishments throughout the quarter.

We will continue to position the Company for long-term success by remaining focused on executing our growth strategies, and delivering strong margins, strong returns, and value to our shareholders.

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

Now, let's take your questions.

(Operator Instructions)

Sharon Zackfia, William Blair.

There was a lot of conversation in the script about Sportster, and the potential weakness there ahead of Street.

Is there -- I know you don't normally quantify retail sales by family, but could you give us any kind of granular information on how much that did impact retail sales in the June quarter?

And then secondarily, there seems to be increased investor concern over competition, particularly from Indian, but it sounds like touring sales remained very strong.

So perhaps, if you can give us some color on that?

Sure, Sharon.

When we look at the Sportster, the impact again, taking you back, we announced that Street would be coming to market in November of last year, and at that time, we knew it would have some adverse impact on Sportster sales, but we anticipated that to be over the very low months, and it ended up extending out, being through the entire first half.

The reception that we've had to Street was much greater than we anticipated, and the impact, we believe, to our Sportster sales, was also greater than we had anticipated.

And again, we originally expected to have bikes available for sale very early in the second quarter to consumers.

So when we look at the first half, Sportster sales were down double-digit, and in addition, we didn't ship and didn't have any significant retail sales that we had certainly anticipated to have with our Street motorcycle.

I think, for Street, for the quarter, for bikes available to customers in the United States, we shipped in about 150, and we retailed a good percentage of those very quickly, but it was significantly lower than we had anticipated.

So we really got hit by both significantly lower Sportster sales, and the fact that we didn't have Street available for sale, and we believe there's a very strong demand for that product.

Your second question, Sharon, is with regards to competition from Indian.

And Indian's -- most of the bulk of Indian sales are in the touring segment, I think two of their three models, and the two that are selling the most are in the touring segment.

And again, our Rushmore bikes have done fantastic, and in the first half, they were up in double digits as well.

And when we look at overall market share for the first half, we've got by far the vast majority of that share, and we're largely flat.

Indian was up a bit, and the rest of the competition in touring bikes was down a bit.

Felicia Hendrix, Barclays.

I have two questions.

The first one is on ASPs in the second half, and can you help us think about that for a second, because as your Street shipments increase, I would assume that the ASPs was be down year-over-year.

But you mentioned that the Road Glide is coming back, and you have product launches coming soon.

So just when you put all of the variables together, how should we think about ASPs for the second half?

And then my second question goes back to the market share question.

But just looking forward, as you go to Street which is a smaller bike, it seems like your comparable market share numbers are going to be skewed, because that part of your production isn't going to be captured in that area.

So I'm just wondering how we should think about that going forward?

Okay.

The first question, Felicia, is ASPs in the second half.

We certainly expect them to drop or mitigate, and let's talk a little bit about that.

As we saw in the second quarter, ASPs were up $1000.

The largest driver of that was mix and then price, and to a much lesser extent, currency, it's the first time in numerous quarters that we've seen currency actually benefit our ASPs.

But the biggest piece of that is mix.

The mix favorability that we're seeing in the second quarter, which is on our bridge there, $31 million, is certainly more than we had anticipated, given the fact that we didn't ship the Street that we expected.

And so basically, we pulled some margin favorability out of Q3 into Q2, and also, we pulled some of that ASP from Q3, or the back half, into Q2.

So even despite the Road Glide coming back, we would expect ASPs to be down a fair amount in the second half, just because of the magnitude of the lower selling price of Street, and impact on mix, the lower profit there, as we increase the percentage of our total shipments of Street in the second half.

Now, having said that, we expect, again from a financial standpoint, overall gross margins to grow modestly on a year-over-year basis, and when we look at mix in total, we would expect mix to be a benefit on an absolute dollar basis to our profits.

And as a percent of margin, we expect it to be neutral.

At the beginning of the year, we expected it to be a little bit unfavorable, and now we're expecting to be more neutral because of the fact that we've had very strong model mix within our touring segment, as people are opting for the higher trim Limited as well as the Street Glide Special.

The second question that you had was on market share of Street, and I'm not sure I completely understand the question, Felicia, but I think what we're dealing with is, when we talk about 500, of Street 500, that will not be picked up in our market share, because the market share is a 601-plus cc.

However, all of the Street 750s will be picked up and market share.

So that we certainly could have retail sales growing faster on a Company-wide basis than retail sales for the 601cc segment.

James Hardiman, Longbow Research.

Just a couple questions on Road Glide, here.

You mentioned that it was 10% of the mix in Q2 of last year, that seems pretty comparable with the number you gave in the first quarter.

Obviously it's difficult to tell how many people are holding off until the upcoming Road Glide is released, but it seems like that rumor has gotten out there.

I guess, at the end of the day, do you think that it was a bigger headwind in the second quarter than it was in the first quarter, when you account for switching?

And as I think about the third quarter, I'm assuming that a represented a very small number of your shipments in the third quarter of last year.

Was it a significant part of retail for 3Q?

Just trying to think about hopefully getting to a tailwind from a Road Glide perspective.

Thanks

Thanks, James.

In the first and second quarter, it's been 10%.

I think we believe that the impact is consistent between the two quarters.

We don't see, or we don't believe that as we get closer to it, more are holding off.

Again, we've talk about, it's a very loyal customer to that type of riding experience and frame, so I don't think that there is a curve here, that would suggest, that as we get closer, more are holding off.

We have done some research and looked at the sales that we've had of Road Glide up to this point, and a very, very small percentage of Road Glides have been purchased to date have been by Road Glide -- folks that brought a Road Glide in the last five years.

So that gives us increased confidence or renewed confidence that most of our Road Glide riders are loyal, and are waiting for the return of Road Glide.

But to answer your second question, in Q3 of last year, Road Glide accounted for 8% of the total US sales, and remember at that time, we were just announcing that Road Glide was being discontinued.

We didn't talk about when it was coming back, and we had a tremendous amount of activity on customers buying the Road Glide, and snapping them up in the third quarter.

That fell, continued into the fourth quarter, but fell as a total percentage of US sales, down to just shy of 4% in Q4.

And then, as we move out into the first half of next year, the first half of this year is essentially zero.

Craig Kennison, Robert W. Baird.

John, I wanted to clarify, did you say that 150 Street bikes were shipped in the quarter?

Essentially, in the US.

Certainly, more were shipped internationally.

Right, and then of those 150, did any of them count as retail units, because they were sold to a dealer who sold it to himself, or to a customer?

Yes.

I'm sorry, the 150 I was referring to were sales just for our customers, not for Rider Academy, and I think some were, in about the third of those retailed, so they just started shipping out in the very last days of the quarter.

So how many went into the Rider Academy, and ultimately were counted as retail, because the dealer registered that unit?

Okay.

So we're talking just the US market.

In the second quarter, 1,600 500s were shipped into the dealers for use in Rider Academy program.

All of those were recorded as a retail sale, because that is their use, it's by the dealer.

And in the first quarter we had about 600 that went into Rider Academy, so in total, in the first half, about 2,200 bikes went into Rider Academy, and then again in the United States, we were able to ship out -- we're on, again, very strict allocation of Street going forward, of two or dealer, but we shipped out somewhere in the range of 150 for sale to customer, and probably a third of those retailed within a day of getting on the floor.

That's great color.

Can you just maybe clarify the production issues you mentioned with respect to Street, and how you have rectified them?

Thanks

Yes.

So to understand some of the Street start-up issues that we're experiencing, is really to focus on the fact that this is the first time we're manufacturing product internationally, and with that, the majority of the supply chain is international, which is unlike what we have experienced in the past, where the majority of the supply chain is domestic.

And not only is it a much longer supply chain, but it is with a lot of new suppliers.

And I know this is important, as we start to deliver Street around the world, at a price point that we feel real good about.

Anyhow, with regards to that, we're going through a learning curve with our suppliers, and our expectations around finishes and quality, we've struggled with ordering and delivery, and the very long supply chain.

So in essence, Craig, those issues we believe are behind us at this point.

However, some of the implications are still in front of us, and those implications being the fact that we're on the strict allocation of Street through August, and we expect to ship two Street vehicles to each dealer in the United States through the end of August, and toward the end of the second, third quarter we'll be up to speed.

And what's basically happened is there's just not enough parts on their way to us, and because of those issues that we've had.

Now to mitigate that, and get as many bikes in our dealers' hands and to fulfill the demand that's out there, is we are experiencing higher start-up costs, namely in the vein of air-freighting parts in, and what we're trying to do is to leapfrog the supply chain.

So from a production and a manufacturing standpoint, we're not experiencing issues, it's much more on the start-up and supply side of that equation.

That's also having an impact on our profitability between quarters, because we expected to ship out a lot more bikes in the second quarter, and we would have expected a little bit less gross margin in the second quarter, and that's going to come out of the third quarter.

And as we have talked about, Q3 gross margin is going to be down at 2.5 percentage points, largely borrowed from the second quarter, and the extreme mix favorability that we've had.

That's helpful.

Thanks, John.

Rod Lache, Deutsche Bank.

It's actually Pat Nolan on for Rod.

I had two questions, just following up on the walk.

First, on the manufacturing line, John, could you give us a little clarity on what the breakdown of that $25 million is?

It seems like restructuring is maybe $4 million to $5 million, and then you have a couple million that you probably picked up from overhead absorption, but it seems like a pretty large number just for the quarter.

And second, on the currency, the $17 million, if you can give us some clarity of, based on where currency is today, what you expect that impact to look like in the back half?

Okay, I'm not going to break out, Pat, the individual pieces of manufacturing.

But we can certainly talk about the buckets of favorability, and you adequately touched on a couple of them.

The largest driver is incremental margin, and the benefit that we're getting out of that incremental production.

And I guess, to take a step back, and to look at that number, and yes, it is a big number, and on a first-half basis, the $28 million is a big number too.

But these are the things that we've been working toward for the last several years, and all the restructuring we've done, and the transformation, and the product that we're delivering, and the margin structure of the new products that are coming out is really, we're seeing the benefit of a lot of that hard work over the past couple years.

The biggest driver is incremental margin, and you have got productivity.

And remember this year we worked on surge manufacturing in Kansas City, so that's delivering it, and our plants are running very well.

We've got temporary inefficiencies that are starting to dissipate from where they were at a year-ago level, so on a year-over-year basis, there is lower tempering efficiencies.

And then we've got pension favorability because of the lower discount rate, and that starts to flow through the pension expense.

And then, we've got some offsets going the other way in terms of inflation, and Street start-up costs in the quarter.

But overall, very pleased with that manufacturing number.

The second question that you asked is with regards to currency, and the currency was favorable $17.2 million, as I had mentioned in the preamble, driven by favorable Euro and lapping a year ago losses.

When we do look at the quarter, we're still experiencing devaluation of our Yen, Australian Dollar, and British Real on a year-over-year basis, and we would expect that to continue for the remainder of the year, and the Euro is making up the difference.

The Euro is about 5% stronger.

So when we look at the back half of the year, we're looking at currency to be flat to slightly negative, and our full-year view of overall currency is a bit more favorable than it was at the start of the year.

Which we felt currency would be on the negative side, certainly on a full-year basis, currency will be positive, and we think we'll largely hold the gains that we've seen in the first half.

Adam Jonas, Morgan Stanley.

So I saw my first Street 750 near Alicante in Spain a week or so, and I have to admit, it looked pretty sweet.

A question, first I think it's admirable you are maintaining tightness in the supply chain to protect pricing, but I'm wondering if you can comment, from some of your competitors who maybe aren't either willing or as able technically to be as tight as you.

To the extent that there is softness in the overall market, are you seeing, or are you otherwise expecting increased pricing and competition in the US market in particular?

That's my first question.

And I guess more broadly, you're citing a lot of Company-specific reasons and launches and start-up and timing as to the second-half outlook, which is essentially flat or even slightly down, potentially volume year-on-year shipments for all of the second half.

You're suggesting almost all of it's Company-specific, but I'm just giving you a chance to highlight any broader macro or market reasons for the weakness, as well.

Thanks

Okay.

Adam we don't see any structural change in pricing in the industry, as we move forward.

What we're seeing in the first half is the weaknesses that we expressed, which is due to weather and some self-inflicted wounds on Sportster and Street, and the interaction between the two.

And what our volume guidance is basically doing, is taking out that mix in the first half.

And we're back on our growth trajectory for the second half, that we originally anticipated, with the year, actually it's slightly a higher growth trajectory.

So as we've said for quite some time, is we're going to deal with the issue and take the volume out.

We've got too much inventory, and I can't stress enough how much these commitments mean to us, certainly shipment guidance one of them.

But the other one is our strategy to aggressively manage supply in line with demand, and we are going to maintain the integrity of the market and our dealer network, and also the premium nature of the brand.

So, a tough and painful decision.

We could've talked about promoting our way out, or growing our way out, but we got an issue, we're addressing and we're pulling it out.

But when we talk about the first-half second-half, the brand fundamentals remain intact, and nothing has changed n any of those between coming out of the first quarter, or last year.

We couldn't feel better about the brand.

We are very disappointed in the second-quarter results, but the drivers that we look for in the fourth quarter or the back half of the year, in terms of retail growth, as well as into the future, are the same drivers that got us here over the last couple of years.

And those are strong appeal of the brand.

And while market share is down 1.8% in the first half, it's certainly within our expectations, and I'll explain, and then some by Road Glide.

But also, Sportster hurt us.

About a third of that margin are share losses due to Sportster.

When we look at the industry, the industry has grown for three straight years coming into this year, and in the first half, the new bike industry is up 2%, and that's despite the tough weather as well as the fact that Road Glide represents 5% of the industry in the first half.

We're seeing more investment in the industry than we've seen in the last five years, in terms of new products, marketing and advertising.

And we're seeing in across all segments, so feel great there, continued success on outreach.

International, 75% of our international markets are growing very strong in terms of EMEA and Asia-Pacific.

Some difficulties in Canada and Brazil, and otherwise, the motorcycles that we've brought to market have been fantastic.

Tim Conder, Wells Fargo Securities.

John, you've given some good explanation of the self-inflicted wounds with the miscalculation on the Street versus the Sportster, and start-up issues and so forth.

But regarding retail, can you give us, as much as possible, any commentary on what you're seeing so far in July?

It appears that weather is starting to get a little bit better.

Just any comments from that standpoint?

And then also regarding the Street margin impact cadence, if we're understanding you right, are you saying that impact should be largest in the third versus the fourth, even though your volume mix of Street will be skewed more to the fourth?

And then one final would be recall cost.

Any in the current quarter, being the second that you reported, or will those fall more in the third?

Thank you.

Okay.

First question, we're not going to provide any retail guidance on July.

Our comments are through the end of the quarter.

As we look, and as I just mentioned, we're back on the growth trajectory.

We expect the same growth trajectory as we expected when we started the year, and gave our 7% to 9% guidance.

We've taken down our miss on the first half, but expect that.

Now having said, that we know that the retail comps in the back half are pretty significant, in particular in the third quarter.

But again, the fundamentals are strong, and we're moving forward in the second half.

The second question that you had with regards to which quarter Street will have a bigger impact on, is probably the fourth quarter.

But largely in the back half, and again, as we get up to speed, full speed won't be until the fourth quarter.

I don't know if mentioned that we still expect to ship 7,000 to 10,000 units that we originally did in Street, except for they're be skewed much more to the back half.

And the final question was recall costs.

Recall costs are booked when the recall is announced, and so all recalls are booked in the second quarter, and there is nothing anticipated for the third quarter.

Joe Hovorka, Raymond James.

Question, want to clarify on the Road Glide.

I think the first time we started to talk about it was the third quarter of last year, when you take it out of the line-up.

And at the time, you said it was 10% of touring volume and 4% to 5% of total volume, and now we've been talking about 10% of retail for the first two quarters for domestic.

Is the numbers you originally gave, were those worldwide, and that's why the overall number is lower, or is there something else that those don't flow?

Like what do those start?

Joe, you are exactly right.

When we first talked about Road Glide, we were doing it versus worldwide numbers.

Touring is skewed to the US, and as we started to talk more about the impact on US sales, we moved toward what percentage of Road Glide was of US sales.

So all the numbers are correct, the difference is, some are worldwide, and the ones that we've been most recently talking about in terms of the 10% in the second quarter and the 8% in the third quarter, coming up here, are of US sales.

Of all motorcycle, or all retail, or all US retail sales.

Pat Archambault, Goldman Sachs.

Two questions for me.

One is just a clarification on the manufacturing issue.

Am I summarizing this correctly?

You -- some of these supplier issues, you have corrected, or you've gotten them in line to where you want them to be.

Now it's really just a matter of premium freight going forward, and that's the cost that you see trickling into the second half.

That's my first question.

And then the second one relates to a country that's near and dear to my heart.

What's going on with Canada?

I guess I wouldn't have expected down 18.

Is there something unusual happening there?

So those are two for me.

Okay, Pat.

Number one is, you're absolutely correct.

The issues that we've faced largely in the supply chain, delivering and ordering of Street parts is behind us.

However, there are costs to catch-up that supply chain, because we do not have enough parts, and a very long supply chain, basically on the water coming to us.

And given the very strong demand that we have, we're going to try to leapfrog that supply chain to get parts in the US plant.

And we been talking about the US, we've kept the flow parts to India, it's much closer to the source, much easier to get parts there, and that has been largely unaffected.

It's the US plant that we're talking about, and obviously affecting US sales.

The second question is with regards to Canada, and to understand what's happening in Canada, we have to talk about -- Canada is a distributor market for us.

In most other markets around the world, we act as the distributor.

The distributor's responsibility is to build the brand and manage the dealer network, as well as manage currency and credit risk.

The distributor we have had in Canada has always done a fantastic job.

And as you know, Pat, over the last year we've seen a strong weakening of the Canadian Dollar.

I think on a year-over-year basis, about 8%.

To deal with that, our distributor pays us in US dollars, so we do not have a currency risk with Canada per se, and that's why, when we talk about our basket of currencies, Canada never comes up.

However, our distributor there has experienced essentially an unfavorable currency exchange impact, for which he priced the motorcycles to recover a portion of that.

The rising prices has created a growing gap to competition, as well as to bikes, predominantly used bikes in the United States.

And that has had an impact on our volumes, as well as the tough weather conditions, but we've also got a pricing gap there.

Now the distributor in Canada, working with us here in Milwaukee, is working on mitigating that, and has put some store-level promotions in place in the month of June, and carrying that through into July, and we've seen some bend of the trend there.

But clearly, we're disappointed with overall sales results in Canada.

Jaime Katz, Morningstar.

You specifically called out India and southern Europe as being really strong for Street demand.

Can you quantify how many units you expect to go over there, and whether or not you're seeing an actual end-user that is a much broader sub-segment of the population, than maybe you originally anticipated?

And then, would you comment on how you feel the inventory in the channel is?

The quality?

Okay with regards to the overall sales, we're not going to break them out.

They come in through the Street and Sportster segment.

But I can tell you that we're ahead of plan in terms of retail sales in India and southern Europe, and we're finding it in particular, in southern Europe.

A lot of people coming off scooters and small motorcycles, and things are going on plan to very well.

And it has been very well received in those markets.

Joseph Spak, RBC Capital Markets.

One, first just one quick clarification.

When you are saying currency is now a slight positive for the year, that's at the profit level, right?

Not at the sales level?

Or is it both?

On a year-to-date basis, currency is about flat, for the first half.

So in the quarter, currency revenue was very favorable.

It was $7.6 million favorable, and then we had cost of goods sold, $9.6 million of favorable as we lapped year-ago losses.

So those numbers the $17.2 million are for the quarter.

When we look at revenue for the half, its flat.

Great.

Thank you for your time, everyone, this morning.

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