Harley-Davidson Inc (HOG) 2016 Q1 法說會逐字稿

Good morning.

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

At this time I would like to welcome everyone to the first-quarter 2016 earnings conference call.

(Operator Instructions) Thank you.

Amy Giuffre, you may begin your conference.

Thank you and good morning, everyone.

You can access the slides supporting this call on Harley-Davidson.com.

Click Company at the top of the homepage, then Investor Relations, and Events and Presentations.

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.

This morning our CFO, John Olin, and President and CEO Matt Levatich will be hosting the call.

Let's get started.

John?

Thanks, Amy, and good morning, everyone.

Today all provide additional insight around our first-quarter financial results, found in our press release and supporting slides.

The summary of our first-quarter financial results starts on slide 4.

Overall we are pleased with the first-quarter performance.

Despite the challenging conditions we continue to face, we remain focused on driving (technical difficulty) financing and delivering strong margins and strong returns over the long term.

During the quarter, revenue was $1.75 billion.

Net income was $250.5 million, and diluted earnings per share were $1.36.

Operating income from the Motorcycles segment was down 3.8% from last year's first quarter.

Segment revenue was up 4.4% in the quarter, behind a 4.3% increase in motorcycle shipments.

As anticipated, gross margin as a percent of revenue decreased versus prior year as a result of unfavorable product mix and currency exchange in addition to higher year-over-year startup costs.

SG&A was also up in the quarter, as we significantly increased our investments in demand-driving marketing and product development.

Operating income as a percent of revenue in Q1 was 21.1%.

At HDFS, operating income was down 12.8% year-over-year.

The quarter also reflected higher corporate interest expense resulting from our 2015 recapitalization.

Now let's take a look at retail sales on slide 5. Worldwide retail sales of new Harley-Davidson motorcycles in the first quarter were up 1.4% versus prior year, an improvement from being down 0.6% in Q4 2015.

Retail sales were up in our international regions and down slightly in the US.

During the quarter, we made progress against our long-term growth objectives.

We are driving demand in an environment of intense global competition.

We believe Q1 retail sales benefited from our demand-driving marketing investments and a strong reception to our new 2016 model year motorcycles.

Starting in the first quarter and throughout 2016 we plan to invest an incremental $70 million to drive demand.

We expect our 2016 year-over-year investment in customer-facing marketing to be up 65% and product development investment to be up 35%.

Our new 2016 model year motorcycles continued to sell well during the quarter.

(technical difficulty) sales were strong driven by our two new Softail S models and our two refreshed Sportsters.

Touring sales also benefited from the new Road Glide Ultra.

While retail sales were up on a worldwide basis, we continue to experience headwinds from intense competitive environment and challenging macroeconomic conditions around the world.

We are confident in our strong brand and our ability to grow in this highly competitive environment without engaging in brand-damaging discounting.

Let's take a look at the US market on slide 6. In the first quarter we saw a slight decline in retail sales of 0.5%.

As we anticipated, retail sales improved from recent trends despite the increasingly intense competitive discounting and declines in oil-dependent areas.

During the quarter, we significantly increased our marketing investment, focused on growing product awareness and growing ridership in the US.

Retail market share for the first quarter continued to stabilize, down slightly compared to the same period last year.

The industry continued to grow, up 0.8% in the first quarter on top of the 9.0% increase in Q1 of last year.

Finally, as expected, US dealer retail inventory was up approximately 4,900 motorcycles at the end of the quarter compared to 2015, largely due to the initial dealer fill of our new 2016 models.

We continue to be diligent in our efforts to manage supply in line with demand, and we're comfortable with the dealer inventory at the end of the quarter.

On slide 7 you'll see retail sales in our international markets were up 4.5% in the first quarter, driven by sales increases in EMEA, Asia-Pacific, and Canada, partially offset by weakness in Brazil.

In fact, excluding Brazil, international markets were up a strong 8.9%.

EMEA region retail sales were up 8.8% in Q1, reflecting the significant increase in demand-driving investments in that market.

All major markets across EMEA were up in the quarter, with strong gains in France, Switzerland, Italy, and emerging markets in the region.

First-quarter market share in Europe was 10.3%, up 0.5 percentage points versus prior year, which is an improvement in recent market share trends.

Market share growth was driven by increased investment and a great reception to our new motorcycles.

Asia-Pacific retail sales were up 6.6% in the first quarter, our best-ever first quarter.

This growth was accomplished despite the adverse impact of temporarily exiting retail sales in Indonesia as we replaced the dealer network in order to improve the customer experience in that market.

Latin America retail sales were down 26.5% in the quarter as a result of declines in Brazil, partially offset by strong growth in Mexico.

Brazil's retail sales continue to be impacted by a challenging economy and consumer uncertainty.

In response to the nearly 50% devaluation of the Brazilian real last year, we raised model year 2016 prices approximately 20%.

While profitability per motorcycle improved, we expect retail sales to be down for the year.

Finally, retail sales in Canada were up 16.3% in the first quarter.

We believe the market continued to respond well to the change to a direct distribution model.

In support of our strategic focus on increasing brand access, we plan to continue to expand our international distribution.

We added five new international dealerships in the first quarter.

On slide 8 you'll see wholesale shipments of Harley-Davidson motorcycles in the quarter were up 4.3% compared to last year, at the high end of our expected range for the quarter.

During the quarter we shipped a higher percent of Cruiser motorcycles compared to last year, given our product investments in model year 2016 motorcycles launched last August, as well as the Low Rider S and CVO Pro Street Breakout, which started shipping toward the end of the first quarter.

We exited 2015 with increased motorcycle inventory on our balance sheet.

This increase was aimed at supplying more motorcycles earlier in the year than typical in order to support our 2016 marketing plan and investment.

While Q1 Company inventory with down from year-end, it was still up versus prior year to support the selling season and our increased investments in marketing.

Throughout the second quarter, we expect elevated year-over-year inventory as we anticipate lost production in the third quarter associated with the implementation of our ERP system in our Kansas City plant.

On slide 9 you will see revenue for the Motorcycles & Related Products segment was up in the first quarter, behind a 4.3% increase in motorcycle shipments.

Q1 revenue was unfavorably impacted by currency exchange, which reduced revenue growth by nearly a percentage point.

The average motorcycle revenue per unit was up slightly for the quarter behind higher pricing, partially offset by unfavorable currency exchange.

During the quarter, P&A revenue was flat and general merchandise revenue was up 6.3% behind stronger sales of riding gear.

Both P&A and general merchandise revenues were adversely affected by unfavorable currency exchange during the quarter.

On slide 10 you'll see gross margin as a percent of revenue in the quarter was down 1.7 percentage points versus last year.

Gross margin was supported by favorable volume, price, and raw materials, offset by unfavorable mix, foreign currency exchange, and manufacturing costs.

During the quarter, overall mix was a headwind of $14.8 million driven by a shift in both Motorcycles and Related Product mix.

Foreign currency exchange was unfavorable behind the significant weakening of our key foreign currencies on a year-over-year basis.

On a combined basis, the euro, yen, Brazilian real, and Australian dollars devalued an average of 4% compared to the prior-year quarter.

In the first quarter, gross margin was adversely impacted by $10.6 million as a result of lower revenue.

Manufacturing was unfavorable by $15.6 million, driven by higher year-over-year startup costs including the costs related to the implementation of our ERP system in our Kansas City plant, which we expect to be complete by the end of Q3.

In addition we experienced lower fixed-cost absorption as a result of lower production in Q1 versus the same period last year.

On slide 11, operating margin as a percent of revenue for the first quarter was a very strong 21.1%, but down 1.8 percentage points compared to last year's first quarter.

As anticipated, operating income of $332.5 million for the quarter was unfavorably impacted by higher SG&A.

While SG&A spending was lower than we expected due to a shift in timing of spending from Q1 to Q2, SG&A was up $13.0 million year-over-year, driven by our increased investment in marketing and product development and costs associated with managing our Canadian operations which we acquired in August 2015.

We remain intensely focused on a cost structure that will enable growth and continuous improvement to drive our business to be stronger, more flexible, and more profitable.

Now let's take a look at our Financial Services segment on slide 12.

During the quarter, HDFS's operating profit decreased $8.3 million, 12.8% compared to last year.

The primary factors impacting first-quarter results were, first, net interest income was up over prior year by $1.6 million, driven by higher receivables, partially offset by higher interest costs and lower yields on receivables due in part to the 2015 low interest rate promotional activity.

And second, the provision for retail motorcycle loan losses was increased over prior year by $12.9 million, driven by higher retail credit losses and an associated increase in the allowance for retail credit losses.

HDFS's operations are summarized on slide 13.

During the first quarter, HDFS's retail motorcycle loan originations increased 8.9% compared to the same period last year.

In the first quarter, loan originations were comprised of approximately 80% prime loans and 20% subprime.

As a predominant industry lender to subprime customers, these originations represent a significant number of retail sales to the Company at very attractive returns.

For the quarter, HDFS continued to have a strong US retail market share of new Harley-Davidson motorcycles at 56.8%, up 3.5 percentage points.

At the end of the quarter, we had $344.7 million of cash and cash equivalents at HDFS.

In addition, HDFS had $1.1 billion of available liquidity through bank credit and conduit facilities.

This quarter, HDFS issued $1.2 billion in medium-term notes and paid a $140 million dividend to Harley-Davidson, Inc.

On slide 14 you'll see 30-day delinquency rate for retail motorcycle loans at the end of the first quarter was 2.88%, or 24 basis points higher than Q1 2015.

The delinquency rate was up particularly in oil-dependent areas.

Despite the increase, delinquency remained at low levels.

Annual retail credit losses increased by 42 basis points to 1.98% compared to 2015.

The increase was a result of higher losses on loans in oil-dependent areas, normalizing subprime performance, and lower used bike values at auction.

During the quarter, HDFS continued to maintain a strong liquidity position and contributed strong profitability to the Company.

The remaining Harley-Davidson, Inc., financial results are summarized on slide 15.

The Company generated operating cash of $41.1 million during the quarter, down from last year, driven by increased wholesale lending and higher working capital.

Also, the tax rate was 34.5%, which is in line with last year's rate.

The Company has and intends to continue to maintain a minimum of 12 months of projected liquidity needs in cash and/or committed credit facilities.

Switching our focus to shareholder value on slide 16, returning value to our shareholders is a top priority.

During the first quarter, we raised our quarterly dividend from $0.31 to $0.35 per share, up 12.9%.

In addition, we repurchased 3.4 million shares of our stock for $144.6 million.

Looking forward, we expect to continue to return excess cash to our shareholders in the form of increasing dividends and continued share repurchases.

On slide 17 you will see our overall expectations for 2016.

In 2016 we continue to expect to ship 269,000 to 274,000 motorcycles, an increase of approximately 1% to 3%.

We expect second-quarter shipments to be approximately down 3% to up 3% versus last year's second quarter.

US dealer retail inventory is expected to be up at year-end 2016 to support incremental models and increased marketing investment.

For the full-year 2016 we expect operating margin for the Motorcycles segment to be between 16% and 17%.

We believe 2016's gross margin as a percent of revenue will be down year-over-year, driven by unfavorable foreign currency exchange, unfavorable mix, and higher year-over-year startup costs associated with the implementation of our ERP system at our Kansas City plant.

To dimensionalize the foreign currency exchange risk, if currencies held their recent exchange rates for the remainder of 2016 we estimate that our expected full-year Motorcycles segment revenue would be slightly unfavorable on a year-over-year basis.

We would expect an unfavorable impact to gross margin of approximately $50 million, driven by lapping last year's hedge benefits, an unfavorable impact to gross margin of nearly 1 percentage point on a full-year basis.

During the second quarter, we expect gross margin expressed as a percent of revenue to be down on a year-over-year basis driven by, first, unfavorable currency exchange.

Currency is expected to adversely impact gross margin by $25 million to $30 million in the quarter primarily due to lapping a year-ago hedge gain of $20 million, lowering gross margin by approximately 1.5 percentage points.

Next, we expect shipment mix will continue to be unfavorable in Q2 behind a stronger shipment mix of Cruisers and Sportsters, supporting the strong demand we have seen in these segments and our recently announced new product introductions.

Finally, we expect manufacturing costs to continue to be unfavorable behind higher year-over-year startup costs.

Looking at SG&A, while we will invest a significant amount more in marketing and product development, we expect full-year spending to be flat to up modestly from 2015.

As a percent of revenue, we expect SG&A will decrease.

For HDFS, we expect operating income will be down modestly in 2016 compared to 2015 as a result of increased borrowing costs and higher credit losses, partially offset by increased revenues.

Capital expenditures in 2016 are expected to be between $255 million and $275 million as we increase investment in product development focused on bringing exciting products to market and as we continue to invest in our systems infrastructure, most notably the implementation of an ERP system.

Finally, we continue to expect our full-year 2016 effective tax rate will be approximately 34.5%.

We are pleased to deliver a return to retail sales growth and stabilizing market shares in the first quarter.

We will continue to navigate through the challenging environment and are making investments to drive demand and deliver strong margins and strong returns over the long term.

Thank you for your investment in Harley-Davidson.

Now I'll turn it over to Matt.

Thanks, John, and good morning, everyone.

As we shared in January, our plan for 2016 and beyond increases our focused investment and resolve to drive increased demand for our exceptional brands and products.

I'll share with you some highlights and how we're progressing in the plan, but first I'd like to provide my perspective on our first-quarter results.

As John mentioned, we saw overall growth in worldwide retail sales reach 1.4%.

It demonstrates the initial success we're having with our strategy to drive demand and deliver results in a highly competitive environment.

As I've said before, competition is a great thing for the entire industry and the customer.

It drives us to be better than we've ever been in every respect, to grow our leadership position, and run a strong and profitable business while we do so.

We don't expect the current environment to change.

In fact, we view it as the new normal, so we'll continue to take steps necessary to further strengthen the Company and compete effectively in our quest to lead in every market.

As I reflect on the quarter, international continues to be a real bright spot, with great results in the EMEA, Asia-Pacific, and Canada.

Our international retail sales have continued to grow, and we anticipate growing international retail sales at a faster rate than in the US over time.

While retail sales were down 0.5% in the US, they were an improvement over recent trends.

And we're working with diligence, skill, and commitment to maintain and enhance our leadership position here in the United States.

Importantly, while we recognize we've made progress in the first quarter, we also recognize we still have more to do and more to deliver.

So let's get to the key elements of our demand-driving strategy.

Harley-Davidson enjoys customer loyalty and brand appeal that would be the envy of any business, and the core goal of our plan to drive demand is to build an even stronger, deeper bond with our existing loyal customers while creating powerful connections with new customers.

To do this, we set our focus on four key areas: first, increase product and brand awareness; second, grow new ridership in the United States; third, increase and enhance brand access; and finally, accelerate the cadence and impact of new products.

We kicked off a number of initiatives in these four areas at various points in the first quarter, some of which influenced first-quarter performance and others we anticipate will bear fruit in the months and years ahead.

To increase product and brand awareness, we've stepped up our advertising and PR presence in every region, taking full advantage of digital and traditional media to tell our story and the stories of our customers.

We've also increased our presence at major events and increased the number of demo opportunities for riders to experience firsthand our motorcycles, accessories, and apparel that offer unlimited potential for them to make a unique and bold statement about who they are.

Nothing reinforces the fundamental of appeal of our products and the many enhancements we've made to our motorcycles in recent years better than a demo ride, so we've been dialing up our demo opportunities around the world.

In EMEA, for example, the Discover More touring campaign more than doubled demand for demo rides during the first quarter compared to the same period in 2015.

In Asia-Pacific our increased media investment is driving greater awareness for the brand and our demo events, with encouraging results.

In Japan, for example, demo rides are up 57% over last year; and Australia and New Zealand are seeing a substantial increase in demo rides year-over-year as well.

In the United States we've stepped up our presence at key events such as South by Southwest, the X Games, and of course Daytona Bike Week, where we engaged riders and connected them with our great dealers.

During Bike Week we saw a 30% increase in the number of demo rides and a 27% increase in total retail sales of new motorcycles through local dealers as compared to 2015.

In mid-March we launch the Live Your Legend integrated marketing campaign.

This global campaign highlights real-life stories from current Harley-Davidson riders, dealers, and employees to encourage new riders to get out and live their legend.

What is most powerful about the campaign is the message.

It's a rallying cry to inspire the next generation of riders to act now and invest in the experiences that define their legacy.

The emotional appeal of our brand crosses borders, cultures, and generations.

It's more than just a motorcycle; it's a way of life and a personal expression for millions of riders around the world.

And it's inspiring others to take up the sport and learn to ride on a Harley-Davidson motorcycle.

Growing the sport of motorcycling in the United States is also about increasing our investment in the Harley-Davidson Riding Academy.

In the first quarter we increased the number of dealers offering the program by 8% and the number of classes offered by 35%.

Through March, our dealers trained over 8,000 students, a 37% increase from last year.

A big driver of that increase is our incredibly successful Learn to Ride for Free program which we're offering to current and former members of the US military and first responders throughout 2016.

Increasing access to our brand through our dealers also remains an important demand catalyst, and we're continuing our progress in expanding and enhancing the dealer network, which we believe is the absolute best in the world and a key competitive advantage.

During the first quarter, we opened new dealer points in Belgium, Brazil, Hong Kong, India, and the Philippines.

By (technical difficulty) we plan to add 150 to 200 new dealerships internationally.

Now let's talk a little bit about some awesome products.

Our first-quarter results reflect the strength and impact of our new 2016 motorcycles, including the refreshed Iron 883 and Forty-Eight as well as the S Series Cruisers and the Road Glide Ultra.

We announced the Low Rider S and the CVO Pro Street Breakout Cruisers this quarter and started shipping them to dealerships in March.

Just yesterday we unveiled the new Harley-Davidson Roadster to the world at a media event in Marseilles, France, and the reaction has been fantastic.

This new model joins the Dark Custom lineup and is featured in the Live Your Legend campaign.

We've included a link to the latest spot in today's earnings release, and I encourage you to check it out.

What I've outlined here is just a sampling of the all-in, comprehensive nature of our work to drive demand, work that leverages all the great and strong dimensions of our brand, further strengthening and reinforcing our incredible foundations of industry-leading products, experiences, customer passion, and loyalty that are wrapped up in the Harley-Davidson brand.

These are investments to deliver the near-term results that will drive long-term performance and value for all our stakeholders.

We're confident that our investments will generate interest, drive traffic, and drive sales.

We're also confident that they will enhance our already unrivaled industry and brand leadership and business performance, too.

Before we move on to questions I'd like to share some important customer information with you.

As you know, one of our strategic objectives is to grow the sport of motorcycling in the United States, in part by growing the number of core customers and growing outreach at a faster rate.

As highlighted in today's press release, for the eighth straight year we remain the number-one seller of new on-road motorcycles in the US to young adults age 18 to 34, to women, African-Americans, and Hispanics (technical difficulty) Caucasian men ages 35 and up.

This is the case in the 601+

CC segment and across all on-road motorcycles of all displacements.

We continue to sell more Harley-Davidson motorcycles to today's young adults than we did to the Baby Boomers when they were young adults, and we're bringing new riders of all ages into the sport.

Over the last five years an increasing number of on-road first-time riders in the United States have purchased new Harley-Davidson motorcycles.

In 2015, one-third of new Harley-Davidson purchasers in the US had not owned a motorcycle previously.

We know we've got more to do and more to deliver.

We're confident in the strength of our strategy, the passion of our people, and the power of our brand.

The Harley-Davidson brand is among the most iconic on the planet, a position of strength we've built during our continuous 113-year history.

No one else has a network of dealers like we do, made up of individuals who get up every day with the sole purpose of delivering exceptional Harley-Davidson experiences.

And no one else has employees like ours, who take such great pride in creating and building legendary Harley-Davidson motorcycles and delivering our unique experiences to every corner of the planet.

Our inspiration and our drive comes from our customers: millions of riders who yearn to experience personal freedom on their individual terms.

This is what we do, and we do it like no one else.

So with that, let's take your questions.

(Operator Instructions) Craig Kennison, Robert W. Baird.

Morning; thanks for taking my question.

With respect to the $70 million in redeployed spending, how will you measure success?

I'm guessing there may be a volume bogey that you need to reach in order to ensure the Harley-like ROI you are used to.

Yes, Craig; this is John.

We've got numerous measures to measure the effectiveness of all the types of things that we're doing with regards to the $70 million.

Again that's made up of customer-facing marketing and things like Live Your Legend that Matt just talked about.

Heroes Ride Free: we've talked about our training military folks and police and fire for free.

We're seeing great results on that; as Matt mentioned, that's up 37%.

So one of the measures is: Are we increasing the number of people we're training?

And overall sales are up quite significantly when you look at graduates that are buying motorcycles.

So that is clearly a value measure there.

We've also got Discover More Demos and demos taking place all over the world.

The metrics on that is: Are we getting people on motorcycles?

And we certainly follow through with those sales -- or those demos to make sure that they are turning into sales and doing the follow-ups.

The other big thing that we're investing in is Battle of the Kings, which accentuates and highlights our customization, personalization, which is unique to Harley-Davidson.

So all of these things are what we're doing to drive demand, versus the alternative and the easy way out, which is the discount.

So we're taking the high road on this.

We're doing what builds the brand and creates customer loyalty, and we've got measures across all of it.

But you're absolutely right, Craig, at the end of the day, it's measured in: Are we selling more motorcycles to our customers?

If I could just segued to the new bikes that you've launched recently in March and in May, what bikes are most likely to have the largest impact on volume among those three?

Those three are all fantastic motorcycles.

They will all have a big impact on Motorcycles.

You know, Craig, when we looked at the 2016 model year, we talked about a focus on Cruisers, and we added a lot of power with the high-output 103 engine across all (technical difficulty) and Softails; and we came out with a couple S Models at that time and refreshed Sportsters.

We've now fortified it with three more models, two that began shipping at the end of the first quarter, the Low Rider S and the Pro Street Breakout; and then just announced yesterday the Roadster.

They've all got a place in the portfolio.

We talk about the tail strategy as we look to segment our customers and deliver what they're looking for.

So all of those are aimed at doing that, and they're all going to be additive to the overall portfolio in driving the entire business forward.

Yes, I'll just add to that, Craig -- this is Matt -- the other thing that new products like this do is they generate interest and they drive traffic.

And that's a key part.

When we talk about the cadence and impact of new products, you're seeing both unfold in these three announcements.

They generate interest, they drive traffic, they lead to sales of other motorcycles and, overall, the demand for Harley-Davidson.

I'll just share a personal anecdote: on Facebook this morning it was just lit up with people sharing the latest news about the Roadster as well as the spot that we've put out on that, which is really cool.

And just people are buzzing about Harley.

So this is all part of the mix of driving demand.

Thank you.

Tim Conder, Wells Fargo Securities.

Thank you; just a couple here.

John or Matt, any color that you can give us on used prices trends within each of the families?

Then as it relates to HDFS, we've been getting several questions, especially given what's going on in subprime auto, which is clearly a different situation; but several questions regarding subprime.

Where do you see that maxing out as a percent of your loan mix and also maybe you're, I guess, level where you want to see delinquencies or credit losses max out?

So, Tim; this is John.

Talking about used prices, whenever we talk about used prices, we've got to be clear on what market we're talking about.

There's really three different markets the way we look at it.

There is the market that is bikes are sold in driveways, on eBay, and those types of things.

About two-thirds of the used bikes are sold in that market.

We do not have a lot of data with regards to what's happening to used bike prices.

Supply-demand driven; very local.

The other part of the market is used bikes that are sold in our dealership.

About one-third of the used bikes go through our dealer network, and that we do have more data on.

Then, finally, is the repo market.

It's a very small market, only about 7% of overall used bike sales go through it; but an important market in that a lot of the services take that data and try to project it forward under retail prices.

And it obviously has an impact, because we sell repossessed motorcycles on our credit losses.

So when we look at the dealer network, we talked about (technical difficulty) better part of 2015 prices held up very well.

We saw a little bit of softening in the fourth quarter, which we talked about last quarter.

That softness has continued into the first quarter.

It's not out of line with what we're seeing in the industry, but it is a little bit softer.

To answer your question on what's driving it or the lead of it, is Cruisers.

Cruisers are falling more, and that's what we would expect because that's what we're investing in.

We certainly sell it when Rushmore came out; it was the touring bikes that fell more.

So we're adding a lot of content with power and the new models, and that's where we're seeing more softness.

But that's also where we're adding a lot of the content.

Tim, the other question that you asked is on HDFS.

I think the question was around subprime.

Subprime has been about 20% of our portfolio.

Over time, subprime has represented between 15% and 25%.

Subprime is a fantastic business (technical difficulty).

We have tremendous returns on it and sell a lot of incremental motorcycles.

We are seeing subprime normalize a little bit.

But the fact of the matter is for the last seven years subprime has not behaved like subprime; it has performed extremely well.

We have priced our models for more of a normalized subprime performance, and we are starting to see more of a normalization, which we've talked about in the last several quarters.

Overall, subprime is at about 20%.

We do not have a target on subprime.

Our objective is to do well-structured loans, and we're always looking for opportunities to improve, but we do not have a target per se.

Okay.

John, just to clarify that, then, driving the higher losses, is that more the subprime or lower used prices?

How would you characterize, I guess, the couple buckets of driving the higher loan losses and delinquencies?

Yes and yes.

The losses are up in the quarter and they're driven by three things, Tim.

Number one is weakness in the oil-dependent areas.

Remember, a lot of local economies are in recession and there's a lot of layoffs in those areas.

So we're seeing higher losses in oil-dependent areas of the United States.

Number two is we see a continued normalization of subprime.

Again, subprime is starting to behave a little bit more like subprime; nothing of great concern, because we've priced for that.

Then the third area is lower used prices that we're seeing at the auction.

We saw again softness in the first quarter at auction.

However, they firmed up quite a bit in the month of March, so we'll keep a close eye on that.

But it's all three.

But again, Tim, I want to reiterate that we've talked about this for several years, is that we've expected credit losses to normalize coming out of what has been a very great credit loss performance.

We're just starting to approach average levels of credit losses.

So we feel very good about where we're at; we feel very good about the entire portfolio.

It remains incredibly profitable, and it's doing what we expected and what we guided on at the beginning of the year.

We expect HDFS income to be down modestly because of rising credit losses and higher interest expense.

Greg Badishkanian, Citigroup.

Great, thanks.

I just wanted to get a little bit of color on your 1% to 3% shipment growth guidance.

Obviously, international was very strong; US was a little bit soft -- and improved, by the way, the US.

But how do you see that progressing throughout the year?

Do you expect that difference to narrow, that they become more similar in terms of their growth rates to achieve that 1% to 3% shipment growth guidance?

Greg, when we look at the overall drivers, as we've talked about, is certainly the brand fundamentals.

The brand fundamentals have been strong over the last couple years and still remain very strong in the first quarter, and we project that for the remainder of the year.

Model year 2016 is doing great.

We've got model year 2017 lineup coming out here in several months.

Outreach continues to grow faster than core.

We've got $70 million of incremental money that we're spending.

And as you pointed out, international growth is doing very well.

We expect both international and US to be up in retail sales.

US is still down a little bit.

We're very pleased to see a significant improvement from the way we exited last year to this year.

We're not going to break out the split between the two; but again, we feel very good about both our US business and (technical difficulty) international business.

Just a follow-up.

Is there anything in, let's say, Europe or Asia, any best practices, any of the investments that you've made that you think you could implement in the US to accelerate sales here, just given the performance in those markets?

Good question, Greg.

We're doing a lot of things across the world.

We talked a lot of them: Live Your Legend is a worldwide campaign; Discover More Demos.

So what we're seeing in Europe is great blocking and tackling in terms of getting people on motorcycles and demoing them.

We saw strong share improvement during the quarter in Europe; it was up a half a point after several quarters of being soft because of a lot of new product entries.

Battle of the Kings is a worldwide effort of dealers in Europe, Asia-Pacific, and certainly in the United States.

So we're always taking learnings that we've got from any market and fast adapting around the world.

But we are very pleased to see that Europe is up almost 9%.

Asia-Pacific was up, and Japan within Asia-Pacific was very strong, which is great news especially after we took down about 25% of the dealers out of Japan last year, and felt that that would give us great footing moving forward and better customer experience.

We're seeing that pay off.

So things around the world are going very well in the dealer network.

Gerrick Johnson, BMO Capital Markets.

Thank you; good morning.

The increase in dealers offering Riding Academy, what was that on an absolute basis?

Did you have 200 last year, so a net gain of 16 or so?

Then I also want to ask you, John -- you were pretty quick in your commentary.

Did you say shipments will shift from 3Q to 2Q owing to the Kansas City ERP implementation?

Thanks.

Okay, I'm going to start with the second question, Gerrick, is -- we are implementing an ERP system that will go live right after the end of the second quarter.

So that will be implemented in the month of July.

Very similar, if you remember, when we did this in our York facility a few years ago.

With that we will lose a fair amount of production in the month of July.

Production will be down about 30% in the month of July.

So what you will see throughout the second quarter is a higher level of inventory because we're going to lose that production in July that we cannot make up in the rest of the third quarter.

Leading up to that we're going to experience startup costs in readying the organization in the plants to receive this system.

It is a big implementation.

It's bigger than what we did at our York facility.

Primarily at Kansas City, but there's other aspects to the launch; and that's what you're seeing in manufacturing expense in the first quarter and you're going to see it for the next several quarters.

So a lot of it gets capitalized, but there's a fair amount of expense that goes on and on a year-over-year basis is showing unfavorability.

And that is to ready the organization, the training, the tabletop exercises, a lot of the testing that goes on.

So we're going to see that for the next several quarters.

But it will launch in the third quarter, and we will lose some production in July.

Okay.

I think the other question that you asked, Gerrick, was with regards to the number of dealers that have Riding Academy.

Right.

It's around 200, and we've increased that by 8% in the first quarter here.

Okay, great.

Thank you.

Rod Lache, Deutsche Bank.

Good morning, everybody; a couple questions.

One is just to clarify the manufacturing $16 million headwind on a year-over-year basis in the quarter.

Should we be expecting a similar magnitude in Q2 and Q3, given what you mentioned about the ERP implementation?

And is there some -- like a quantifiable return that you can convey from that investment as we look out beyond this year?

Thanks, Rod.

Yes, we would expect manufacturing expense to be unfavorable in the next couple quarters about the same level.

It again, on a full-year basis our operating margin will be between 16% and 17%, so we figured all of that in.

There is absolutely a strong return associated with the investment, both in expense and startup costs as well as capital.

We've seen that at our York facility, and we've continued to talk for the last several years about the strong productivity levels that are delivered.

Certainly the ERP system is a part of delivering that productivity.

We're getting common with facilities and certainly the systems that run them.

And we're very excited and the folks in Kansas City are excited to receive the system and, again, to continue to drive productivity forward.

We're not -- we don't provide specific investment returns on the investments that we make, though.

Okay.

But at the very least it sounds like there is a non-recurrence of this $16 million a quarter when we look out to 2017.

Absolutely.

Okay.

Just thinking about the $70 million increase in product development and marketing, I think that you guys were suggesting that this is, like, a new normal level of investment.

So should we just plug that in, in addition to the normal relationship of 80% variable and 20% fixed on the SG&A?

Also on the SG&A, you mentioned that you shifted some spending from Q1 to Q2.

Can you give us some color on how we should expect Q2 to look, or what's the magnitude of the shift that you implemented?

Yes.

When we look at the investment spending that we're doing to drive demand -- again, as Matt had mentioned, we are competing against wider price gaps and we're not going to compete by discounting.

We're going to compete by driving equity into the brand.

And with that we believe we need the $70 million to grow the business despite wider price gaps that we expect to compete into the future.

Having said that, Rod, we expect that $70 million to continue on into the future.

A lot of that was funded out of taking other fixed cost out of our SG&A base.

So overall we don't expect a big shift when we look at what's variable and fixed in SG&A because of this shift.

It's going to be a part of our ongoing spending.

We've taken another $70 million out of our ongoing spending.

And therefore there is not a big shift in the 80/20 when we talk about fixed/variable on SG&A.

Then again, in the preamble we talked a little bit about a shift in timing.

We expected there to be more SG&A -- to be more unfavorable in the first quarter.

It was $13 million higher, and we would expect certainly the second quarter to be higher and shift some of the spending in the first quarter into the second quarter.

In aggregate, on a full-year basis we would expect SG&A be about flat up modestly.

But we are going to see more of that spending take place in the first three quarters, because that's when the motorcycles take place and a lot of marketing investment will happen.

Joe Spak, RBC Capital Markets.

Thanks for taking my questions.

The first one centers around the new-used you talked about.

One would be if you could provide any update to that used-to-new ratio.

And then, what percent of new Harley purchases come with a Harley trade-in?

Because if the used prices continue to fall, are you at all worried about how that's going to manifest itself in terms of purchasing power go-forward and mix of new bikes?

Then the second question just relates to what's going over in Japan.

What you know as of now, are there any disruptions to your supply chain?

And maybe you could remind us how in the past some of your Japanese competitors have reacted in the marketplace when they have experienced production disruptions.

All right.

The first question, Joe, was the used-to-new ratio.

That has been about 2.4-to-1.

It's up about a 10th of a point since 2014.

So 2015 we had a shift in new-to-used.

Used sold at a faster rate than used, and that affected that ratio by about 0.1%.

As we've talked about, we don't expect to see that ratio to change much.

It inflected and it changed a fair amount in the downturn, and that is just more of the new normal.

We would expected to be in the 2.2 to 2.5 range for the long-term.

The second question is with regards to -- I think our mix of sales in the United States is what you were asking.

Right now, 33% of our sales is to folks that are new to Harley-Davidson and new to motorcycling.

We call it new-new: they are new to the sport and new to Harley-Davidson, which is one of the key focuses as we look to grow ridership in the United States.

So we're very pleased with it.

We believe it's a very strong percentage.

When you look at that worldwide, that percentage is up in the 60%s.

So overall we're bringing a tremendous amount of new people in.

We've talked at different times and Matt mentioned it today: outreach.

About 40% of the folks that buy a motorcycle in any given quarter or month are outreach customers and important to keep the business moving forward.

So there is a percentage -- I do not know it off the top of my head -- which is folks that come with a trade-in.

That has not changed dramatically on a year-over-year basis.

That's part of the business, and one of the reasons we're investing in motorcycles is to encourage people to trade up.

The third question that you asked was with regards to Japan.

I think referring to the recent earthquakes in Japan.

First of all, all of our employees and our dealers and their families are well.

We sustained a little bit of damage to some of the dealerships, but it is an incredibly resilient country and they'll work through it.

We do not see any disruption in the supply chain coming from Japan at this time.

Jaime Katz, Morningstar.

Thank you.

Can you guys quantify maybe how much weaker the oil-producing regions were performing relative to the aggregate performance across the enterprise?

Or is there a way to let us know what percentage of either sales or loans are coming from maybe Texas and Western Canada together?

Thanks, Jaime.

We talked about oil-dependent regions I think in the last couple quarters.

What we've seen in 2015 is softness starting in the first quarter, and that continued to deteriorate in the four successive quarters in 2015.

It topped out at about a low double-digit decline in retail sales in the fourth quarter.

The good news is that it has not gotten worse in the first quarter.

The bad news is it hasn't gotten better.

So it has leveled off here, at least in the first quarter; and hopefully as we start to lap the successively weaker first-quarter performance in 2015 it will get a little bit better here.

Overall, it does have an impact on our US retail sales, probably in the range of 1.5% of retail sales.

Felicia Hendrix, Barclays Capital.

Hi, good morning and thanks.

Hey, John and Matt, you guys have talked about the new marketing campaign and all your efforts there.

I was just wondering: How much of your total budget has been allocated to marketing that's run thus far?

We don't provide an absolute dollar.

I think in the 10-K it provides what advertising expense was, Felicia.

But if you're referring to the $70 million, the majority of that is in customer-facing marketing, which will be up 65%.

So to try to give you a flavor for how impactful that would be is, all of the marketing spending that we do that impacts the customer and reaches the customer in some way, shape, or form is up 65%.

Then the smaller piece of that is an increase in product development.

And again to dimensionalize that, that's about a 35% increase from levels that we will have had in 2015.

Joe Hovorka, Raymond James.

Thanks.

Actually I'm not sure if this is what Felicia just asked or not.

I -- someone set them off.

But how much of the $70 million was spent in the first quarter for the increased marketing?

We don't provide a breakdown of marketing spending by quarter, Joe.

Sufficient to say that marketing spending was up quite a bit, over a 50% increase.

And again on a full-year basis we expect to be up 65% when we look at customer-facing marketing.

Then the other piece is -- you can see that in the financials -- is product development spending was up a little bit over 7% in the first quarter.

James Hardiman, Wedbush Securities.

Good morning; thanks for taking my call.

A two-part question here on the inventory front.

I guess first on the retail side, it seems like a pretty big number.

I know you're attributing that to new models.

It seems like you've got some new models every year, and they normally displace other models.

I understood when it was Street, which was a whole new line of bikes; but maybe walk us through why the magnitude of that inventory build at retail.

I don't think you're saying that any of it has to do with the third-quarter production thing and shipping out in front of that.

But maybe walk us through that.

Then on a factory inventory side, up 30% in the fourth quarter; up 15% in the first quarter.

Presumably that was a sizable benefit to the 4Q gross margin as you get the higher fixed-cost absorption.

How should we think about that impact in the first quarter?

And then as those inventories come back in line with prior-year levels, maybe help us out with the impact and the timing of gross margin impact from inventories coming back in.

Thanks.

Okay.

The first question is with regards to retail inventory.

It was up 4,900 units.

When you look at the -- you're right, James, that years we have models in and out.

But when we look at from a year ago there are five incremental models that we shipped.

So with that, there are 730-ish dealers that need to have models on the floor.

And if you do the math it's I think less than a couple models for each of those.

So that is the driver of why inventory is up.

Those dealers need the models to sell.

In addition to that, though -- that's the primary driver -- is that we are carrying higher inventory because we are increasing marketing spending by 65%, most of that coming in the early part of the year.

And we want to make sure that the availability is there.

As we talked about, we pulled forward a lot of the production, and we made some more in the fourth quarter of last year so that we could get out to a quick start.

Part of the strategy has been to spend a lot more marketing money in the South and get units there quicker, because they are not in -- their springtime happens a lot earlier than in the north.

So we did that and it's been effective.

With that though we had, as you pointed out, a higher level of inventory on the balance sheet at the end of the year.

It was up $137 million or 33%.

That's come down significantly at the end of the first quarter.

I think we're up 15%.

That is driven by finished goods inventory.

We do have a higher level of inventory in finished goods at the second quarter.

That is based on, one, being able to supply the market as we invest more and the fact that we have an ERP system that is coming at the end of the second quarter.

So overall inventories that we have, whether they be on the balance sheet or in the market, will be elevated in the second quarter because we've got to get that trajectory to have enough inventory to bridge the ERP implementation and deliver the model-year 2017 motorcycles in the third week of August.

So you will see it higher.

That inventory will come out as the year progresses.

We did shift to more production into the fourth quarter last year.

We had talked about some of the inefficiencies and the time that our workers were off, and we put that in.

That should be more of a one-time adjustment, and that production will be at similar levels in the fourth quarter of this year, so you're not going to see a big impact.

The impact was in lower production in the first quarter here, which is part of the unfavorable manufacturing expense, as we did not produce as much in the first quarter because we carried forward more from the fourth quarter.

David MacGregor, Longbow Research.

Thanks.

Just a quick question on the $70 million promotional spend.

Does this investment support market share stabilization, or should we see growth from this?

Well, the $70 million supports retail sales, supports market share, and all those types of things.

This is the way that we're going to combat expanded (technical difficulty) gaps without discounting, and it's going to drive our business forward.

When we talk about overall market share, where we talked about I believe last quarter, is we're looking to stabilize overall market share in the United States.

Over the last couple quarters we have seen US market share stabilize and Europe as well.

Matter of fact, Europe is growing in the first quarter here.

So the idea is to first stabilize market share and then is to grow at retail.

Neel Mehta, Morgan Stanley.

Thanks and good morning, everyone; just two questions.

First off, moving forward in the medium to long term, where should we expect the bulk of the product development spending to be going?

Do you see potential to expand your lower-priced offerings in the Street, Sportster segments to accelerate growth, particularly in emerging market customers and younger demographics?

And then just a second question on HDFS.

I was wondering if you could give us a sense for average loan terms and loan-to-value for banks financed through HDFS, and how that's been trending over time.

And maybe if you have any color on what the competitors are doing on the financing front.

Thank you.

All right, Neel, I'll take the second question first; and then Matt will finish up with the answer to your first question.

HDFS average loans over the last year or two have been largely flat.

We have not seen an expansion of that.

We have not changed our terms in terms of length of loans for I think 15 years.

So there hasn't been a change there.

Neel, with respect to product, we've talked over the last several years about our product investment strategy being focused in a balanced way on three different growth and performance categories, and they are customer categories.

One is with our traditional core customers; one is with international growth opportunities and customers; and the other is with outreach.

What we do with the product development investment is seek to put the right balance across those three customer-led strategies and make sure that we have an offering that is going to drive the growth and performance of the business from a customer perspective in those three categories.

So it will vary year-to-year or within a year, but over time we're looking for that balance to grow the impact of the business where the market for Harley-Davidson is strongest.

All right.

Thank you, guys; and thank you, everyone, for your time.

The audio recording and supporting slides will be available at Harley-Davidson.com.

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I'd like to thank my retired colleague, Bob Klein, for his many years of supporting this quarterly earnings communication process.

Ride Free, Bob.

We appreciate your investment in Harley-Davidson.

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Thank you.

This concludes today's conference call.

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