Harley-Davidson Inc (HOG) 2016 Q2 法說會逐字稿

Good morning. My name is Amy, and I will be your conference operator today. At this time, I would like to welcome everyone to the Harley-Davidson second-quarter 2016 earnings conference call.

(Operator Instructions)

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

Thank you, Amy, and good morning, everyone. You can access the slides supporting this call on Harley-Davidson.com. Click company at the top of the home page, then investor relations and events and presentations. If you have any trouble downloading this morning, please try again as the link has been fixed.

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 President and CEO, Matt Levatich; and CFO, John Olin, will be hosting the call. Matt, let's get started.

Thanks, Amy, and thank you, everyone, for joining us on the call today. We talk in depth about our Q2 results and what we see going forward. You've all read the news release we issued this morning. John and I will bring context and perspective to those results and highlight some of the factors that are at play so you can get the best read on our outlook for Q3, the full year, and beyond.

Before John into the detailed financials, I'd like to comment on two themes. Market performance and then Company performance.

From a market perspective, we are very pleased with our share performance in the US where we gained 2 points of share in the heavyweight segment for the quarter on top of our already strong share position. As the US remains highly competitive, this gain is an important validation that our initial investments to drive demand are working.

Since the beginning of the year, we made investments designed to impact customer choice and support our long-term strategy of growing our reach and impact with customers and strong returns to investors. Our demand-driving investments are focused in four areas: increasing product and brand awareness, growing new ridership in the United States, increasing and enhancing brand access, and accelerating the cadence and impact of new products. Our teams across the globe launched several initiatives behind these investments with precision and effectiveness delivering solid results in our international markets and driving the market share gains in the United States.

Looking internationally, our retail sales were up 4.3% driven by continued growth in Asia, Canada, and Mexico, and our best ever quarter for Harley-Davidson in our EMEA region. Our investments to increase demo rides in EMEA, for example, was a major contributor to our growth in the region in Q2. Nothing seals the deal better for a new customer than experiencing one of our great bikes first hand.

In Asia, where we maintained our number one market share in Australia, India, and Japan, we focused our -- (technical difficulty) demo rides and growing ridership. In the US, the Live Your Legend campaign and other demand-driving investments built significant relevance and helped drive a 30% increase in demo rides so far this year and a 40% increase in the number of students trained through the Harley-Davidson Riding Academy.

There also some real positives in the nature of retail sales and market share gains that further reinforce the strength of our work both near and long term. Notably, we are very pleased to have growth year to date in the all important young adults segment in the United States.

The young adults segment is not only important for the long term, it's the most competitive market segment in the US. All of these initiatives combined represent an important long-term play as we seek to grow the sport in the US and bring new customers into the brand in all of our markets.

I'm encouraged that the actions that we've taken so far this year have enabled us to make progress on our long-term growth strategy. However, global-wide sales for the quarter were down due to significant declines in the US industry which was far weaker than expected.

We expected the industry to be down in the first half of the year as we lapped industry growth in 2015 that was stimulated by the shift in currency and the resulting competitive discounting, and as we also expected by continued weakness in the oil dependent areas. We did not, however, expect the industry as a whole would be as soft as it is. While our share gains helped to blunt the full impact of this weak market, lackluster industry sales have had a significant impact on our results and our forward expectations.

As a result, we are taking the prudent step to lower expected 2016 shipments. This is largely due to what we believe will be continued pressure on industry growth in the US coupled with caution as we consider the potential impact of the macroeconomic uncertainty on sales globally. We remain steadfast in our commitment to keep supply in line with demand to protect the premium name and we believe the steps we are taking will ensure dealer inventory is in line by year end to support the expected sales environment.

All in, we now plan to ship fewer motorcycles for the full year and are revising our shipment guidance from 1% to 3% growth to approximately down 1% to up 1% from 2015. Our production plans and shipment expectations are intended to drive flat inventory at year end even with our expanded model range. These actions will have a drag on earnings for the full year, so we are revising our full-year expecting operating margin down one percentage point to 15% to 16%. Without question, we must assure inventory balance for our long-term competitiveness and profitability for both the Company and our incredible dealers.

Now, shifting from market to Company performance, you'll see that gross margin declined in the quarter. There are a number of factors here that both John and I will address.

As we've discussed in prior calls, we expected higher manufacturing costs due to the significant investments we are making to advance our flexible manufacturing strategy. These investments are complex and require discipline, planning, and execution including numerous down days, inventory bridges, and careful ramp plans. The net impact can be seen in changes to gross margin, shipments, and inventory patterns in the second quarter, and the impact will continue in Q3 as we ramp back to full production.

The investments are part of the manufacturing flexibility strategy that will enhance cost-effective flexibility now at our Kansas City plant. Another factor in gross margin performance in Q2 is the impact of volume and mix adjustments we made to capture the demand lift from the Cruiser success we experienced in the quarter while also adjusting downward the total volume in the softer than expected US industry.

The US industry turned swiftly in the second quarter. We responded with discipline and commitment in an effort to keep supply in line with demand, and these actions also impacted our gross margin in the quarter. While difficult, these actions were necessary to set us up for success for our model year launch and also for 2017 and beyond.

And speaking of new products and our new model launch, I'm incredibly excited about our line-up which we will unveil to our global dealer network at the end of August. We will add to the stable of products driving our current success, and we've got some incredible products in the pipeline for 2018, our 115th anniversary, and beyond.

Before I turn it over to John, I want to take this opportunity to thank everyone associated with this great Company, employees, dealers, suppliers, and our passionate riders. I am proud of our team and all the work that is being done at Harley-Davidson. We are in challenging times.

Political, economic, and cultural forces are all working against confidence and security for people everywhere in the world. Everyone in our Company is aware and attuned to what we need to do. We have a 113-year history of challenges we've stood up to and faced down. The power of personal freedom for our riders is stronger than ever, and we all aim to deliver for them.

We understand the intense need to manage through these challenges effectively and deliver results. We are stewards of this incredible brand and of your investment, and we do not take that responsibility lightly. Without question, driving demand, growing the business, and delivering strong returns are top priorities for all of us at Harley-Davidson, and we're focused every day on delivering for our riders near term and long term in order to do so.

With that, I'm going to turn it over to John. Thank you.

Thanks, Matt, and good morning, everyone. Today, I'll provide additional insight around our second-quarter financial results found in our press release and supporting slides starting on slide 9.

During the quarter, revenue was $1.86 billion. Net income was $280.4 million, and diluted earnings per share were $1.55. Operating income from the motorcycle segment was down 15.2% from last year's second quarter.

Segment revenue was up 1.2% in the quarter behind a 3.5% increase in motorcycle shipments. 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 manufacturing costs. SG&A was also up the quarter as we increased our demand driving and product development investments.

Operating income as a percent of revenue in Q2 was 19.3%. At HDFS, operating income was up 9.4% year over year in part driven by a gain related to a full securitization. The quarter also reflected higher corporate interest expense resulting from our 2015 recapitalization and lower effective tax rate. Despite the challenging conditions we continue to face, we remain focused on driving demand and delivering strong margins and strong returns over the long term.

On slide 10, you'll see worldwide retail sales of new Harley-Davidson motorcycles in Q2 were down 1.9% versus prior year. International retail sales were up year over year while the US retail sales were lower than expected on surprisingly weak industry results.

Despite the ongoing challenging macroeconomic and motorcycle industry conditions, we were encouraged with our share gains in the second quarter. Our ability to grow internationally and partially offset the industry headwinds in the United States reinforces our intensified focus on driving demand and enhancing our strong brand.

Our increased investments in driving demand in product development drove positive market share results in the US and in Europe during the first half of this year. In addition, the positive response to our new 2016 motorcycle models continued during the second quarter.

As Matt noted, we continued to be committed and steadfast in our resolve to manage supply in line with demand. Given the poor US industry retail sales in Q2 and softness expected into the second half of 2016, we are taking steps to adjust retail inventory in the US and now expect year-end retail inventory in the US to be in line with prior year versus our previous expectation to grow year-end retail inventory. Considering our desire to reduce year-end US retail inventory in the face of soft US industry sales and the uncertainty resulting from global macroeconomic challenges, we have lowered our full-year shipment expectations.

Let's take a closer look at the US on slide 11. Q2 retail sales in the US were down 5.2% versus prior year behind weak US industry sales. The impact of the weak US industry on our sales was partially offset by strong gains in market share. The US industry was down 8.6% during the quarter.

While we expected the industry to be down in the first half of 2016, we did not expect the extent to which the second quarter declined especially considering the high level of competitive discounting that continued during the quarter. We believe the industry was down due to the following two factors: lapping strong year-ago industry growth driven by the onset of aggressive competitive discounting in the year-ago period and weak sales in oil-dependent areas.

While the industry lagged our expectations, we are encouraged with our Q2 market share of 49.5% in the US, which was up a strong 2 percentage points. We believe our second-quarter market share gains were driven by our demand driving investments focused on growing product awareness and growing ridership in the US and a strong reception to our new 2016 motorcycle models. While our competitors continue to engage in levels of discounting similar to the first quarter and at a more aggressive levels than in last year's second quarter, we were very pleased that we were able to increase market share in the US -- (technical difficulty) and enhancing actions.

US retail inventory was up at the end of the second quarter driven by three factors. First, we offered five incremental models versus the prior year. Second, inventory was up as we shipped all model year 2016 motorcycles in advance of the Q3 ERP implementation. And, also as a result of lower than expected Q2 retail sales.

On slide 12, you'll see retail sales in our international markets were up in Q2. All regions were up except Latin America, which was impacted by weakness in Brazil. Excluding Brazil, international markets were up 5.6%. During the quarter, EMEA retail sales were up 8.2% behind a great reception to our new 2016 motorcycle models and increased demand driving investments.

This quarter's strong retail sales also benefited from lapping lower prior-year retail sales. Market share in EMEA was up 0.3% -- (technical difficulty) basis. Asia-Pacific retail sales growth slowed as we lapped very strong year-ago retail sales comps of up nearly 17% and as we temporarily exited the market in Indonesia earlier this year in order to establish a dealer network -- a new dealer network and improve customer experience.

Latin America retail sales trends improved significantly from last quarter behind continued strong growth in Mexico. Weakness in Brazil drove overall sales declines in the region as sales continued 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 over 20% to improve profitability per motorcycle. We continue to expect retail sales to be down for the year.

Finally, retail sales in Canada were up 2% in the second quarter. We believe the market continued to respond well to the change to a direct distribution model and pricing adjustments that were made at the model year.

As part of our strategic focus on increasing brand access, we plan to continue to expand our international distribution. We added 6 new international dealerships in the second quarter.

On slide 13, you'll see wholesale shipments of Harley-Davidson motorcycles in the quarter were slightly above our guidance as we shipped ahead of the Q3 ERP implementation. As a result, US shipments and retail inventory increased during the quarter and Company inventory fell below prior-year levels.

Our production plants were idled earlier this month, and overall production was down about 30% in July as we successfully implemented our ERP system in Kansas City. We began model year 2017 production on schedule. Second-quarter shipment mix reflected strong demand for our new 2016 Cruiser and Sportster motorcycles.

On slide 14, you'll see revenue for the motorcycles and related products segment was up in the second quarter behind a 3.5% increase in motorcycle shipments. Revenue in the quarter was unfavorably impacted --(technical difficulty) significant shift in mix to our Cruiser and Sportster motorcycles and slightly unfavorable currency exchange partially offset by higher pricing. As a result, average motorcycle revenue per unit was down for the quarter.

On slide 15, you'll see gross margin as a percent of revenue in the quarter was down 2.8 percentage points versus last year. While we expected Q2 gross margin to be unfavorable driven by mix, currency, and manufacturing, the impacts from mix and manufacturing were more unfavorable than we anticipated.

During the quarter, customer demand for our Cruisers and Sportsters exceeded our expectations, which led to higher than expected mix unfavorable of $17.6 million. As we expected, foreign currency exchange was negative as we lapped significant hedge gains in last year's second quarter and as we had lower revenues behind a slightly stronger US dollar.

Manufacturing expenses were higher than expected, unfavorable $36.1 million during the second quarter. We did expect significant unfavorable variances largely driven by startup costs related to the implementation of our ERP system in Kansas City and costs associated with significant plant retooling. However, as Matt explained, plant efficiencies were lower than expected due to lower production given soft sales in Q2 and other plant disruptions.

It is important to note the increase in manufacturing costs that we have experienced in the first half of this year are largely temporary in nature, and we would not expect the majority of these costs to recur in 2017. Looking forward, we continue to expect Q3 manufacturing expense to be unfavorable behind lower absorption and higher year-over-year startup costs. Conversely, we expect manufacturing favorability in Q4.

On slide 16, operating margin as a percent of revenue for the second quarter was 19.3%, down compared to last year's second quarter. Operating margin was unfavorably impacted by lower gross margin as well as [higher SG&A] resulting from both our increased investments in driving demand and product development and from costs associated with managing our Canadian operations, which we acquired in August of 2015. For the full year, we expect SG&A to be near year-ago levels. 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.

Moving on to HDFS on slide 16. During the quarter, HDFS's operating profit increased $7.7 million or 9.4% compared to last year. The primary factors impacting second-quarter results were first, net interest income was up over prior year by $5 million. This increase was driven by higher receivables partially offset by higher borrowing costs and lower yields due in part to the 2015 low interest rate promotional activity.

Second, the provision for retail motorcycle loan losses -- (technical difficulty) over prior year by $8.2 million driven by higher retail credit losses and an associated increase in the allowance. It is important to note that second-quarter provision increase was significantly less than what we experienced in the first quarter of 2016.

Finally, you will see on the slide a gain on full securitization. This represents a full securitization in which we sold retail finance receivables with a principal balance of approximately $302 million along with all the residual financial interest in those receivables. Because we have no ownership interest in the receivables, the transaction was recorded as a sale which in this case resulted in a gain of $9.3 million.

HDFS's operational results are summarized on slide 18. For the quarter, originations were down 3.9% compared to last year. But HDFS's share of US new retail motorcycle sales increased to 63.4%.

Year-to-date loan originations were comprised of approximately 80% prime loans and [2%] subprime. As a predominant industry leader to subprime customers, these originations continue to represent a significant number of retail sales to the Company at very attractive returns.

At the end of the second quarter, we had $419 million of cash and cash equivalents at HDFS. In addition, HDFS had $1.02 billion of available liquidity through bank credit and conduit facilities. HDFS also paid a $43 million dividend to H-D, Inc. during the quarter, which I will talk more about in the moment.

On slide 19, you'll see the 30-day delinquency rate for retail motorcycle loan receivables that remained on our balance sheet was 3.16% or 45 basis points higher than Q2 2015. 14 basis points of the increase represents a change in the mix of the portfolio after the securitization of 302 prime receivables. The delinquency rate on a managed basis, including those loans sold in full securitization, was still 31 basis points higher than the prior year due in part to deterioration in oil dependent areas. Despite the increase, delinquencies remained near historically low levels.

Annualized retail credit losses for receivables that remained on our balance sheet was 1.5% or 42 basis points higher than Q2 2015. On a managed basis, the credit loss rate was 1.49%. The increase was the result of higher losses on loans in oil dependent areas, normalizing loan performance, and lower used bike values at auction. During the quarter, HDFS continued to maintain a strong liquidity position and continued strong profitability to the Company.

The remaining Harley-Davidson, Inc. financial results are summarized on slide 20. A few things to note. Operating cash was down from last year driven by net income, higher working capital, and higher net wholesale lending. And year-to-date tax rate was 32.7%, which was lower than last year's tax rate behind a successful closure of various tax audits allowing us to reduce our tax reserves.

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. Returning value to our shareholders is a top priority. We expect to return all excess cash to our shareholders in the form of increasing dividends and continued share repurchases. On slide 21, you will see we did both during the second quarter.

In addition, as I mentioned earlier, during the quarter we completed a full securitization. Because we sold all ownership interest in the receivables, the receivables and any corresponding debt are not recorded on HDFS's balance sheet. Consequently, this allowed HDFS to pay a dividend to H-D, Inc. of -- (technical difficulty) without impacting HDFS's debt-to-equity ratio.

We used the dividend to repurchase shares under the existing share repurchase authorizations. While we believe the EPS impact was neutral, the shareholder repurchase associated with the full securitization increased our shareholders' ownership in the Company at a time when our stock is trading at historically low PE.

This was the first time HDFS or we believe any other manufacturer has utilized this market. Actions such as this demonstrate our commitment to explore avenues to improve funding costs, diversify funding sources, and return excess cash to our shareholders. We will continue to look for additional opportunities to return excess cash to our shareholders without damaging the long-term value of the Company or the brand.

On slide 22, you'll see our overall expectations for 2016. We now expect to ship 264,000 to 269,000 motorcycles, which is approximately down 1% to up 1% over last year. Expect third-quarter shipments to be approximately flat to down 9% versus last year's third quarter.

For the full-year 2016, we now expect operating margin for the motorcycle segment to be approximately 15% to 16%. We are lowering our expectations by approximately 1 percentage point due to lost absorption on lower production, unfavorable mix, and higher manufacturing expense.

Finally, we now expect our full-year 2016 effective tax rate will be approximately 33%. Our 2016 directional expectations for gross margin, SG&A, HDFS, and capital expenditures are unchanged and noted on the slide.

While the weak US industry and continued intense competition drove less than expected retail sales during the quarter, we are encouraged by the positive market share results from our demand driving investments and new models. We are also pleased to see international retail sales growth despite macroeconomic headwinds. We continue -- (technical difficulty) decisions to support a prudent retail inventory position and to protect our strong brand and profitability into the future.

We are maintaining our intense focus on maximizing shareholder value by returning cash to our shareholders through share repurchases and increased dividends. 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.

Now, let's take your questions.

(Operator Instructions)

Your first question comes from the line of Craig Kennison with Baird.

Thanks for taking my question. Matt, with respect to industry demand, what do you think accounts for the significant weakness in new bike sales? Specifically, what role did either credit conditions or a surplus in the supply of used bikes account for some of that weakness in new demand? Thanks.

Thanks, Craig. I actually think that there is a lot going on and so it is really difficult to lay it off on any specific thing. Certainly, the uncertainty in the political environment and the credit conditions as you mentioned, oil dependent regions that we discussed, we have sort of numbers associated with that in particular. Also, the significant growth last year, as I mentioned, and the corresponding comp for this year. We knew that was going to create pressure. The forecast for the industry growth were kind of in that 2% range. And clearly, it is not materializing that way.

And so we're looking at it very carefully, investing in new products and awareness and rider training and focusing on our efforts on what we can do to not only grow share but grow our sales and primarily doing that through growing the sport. There is a lot of real positive things in that realm. I mentioned some of them in my opening remarks, but clearly this is a disappointment and we are regrouping as a result of it and doubling down on what we know is working to drive the industry.

Thanks.

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

Hi, good morning. John, I had a question on the SG&A. I know you still expected it to be flattish year over year but it was up nicely in the first half of the year, so where are you going to see the opportunities to have those dollars decline in the back half and then when you look out in future years, is there more room to kind of keep that SG&A flattish in future years or how are you guys thinking about that?

Thanks, Sharon. As you pointed out, when we look at SG&A over the first half, it is up about 6%. And I'm looking at our full-year guidance to be flat to up slightly. Obviously, the back half is going to be down. We would expect the third quarter to still be up on a year-over-year basis as we continue to spend that incremental investment in driving demand, and then we would expect the fourth quarter to be down quite a bit in terms of SG&A.

And remember, Sharon, that in the fourth quarter of last year, there was a restructuring charge in that number of about $23 million in SG&A. As with that, as long as the other reductions that we've made in the core infrastructure of the Company to fund the incremental demand driving investments, we would expect the overall back half of the year to be down in SG&A. In terms of going forward, we are focused on managing SG&A but continuing to invest in the future, whether that be in new products or certainly the marketing of those.

Thank you.

Your next question comes from Felicia Hendrix with Barclays.

Good morning, thanks for taking my questions. I guess this question is for you both, Matt and John. Do you think that you are positioned appropriately for the declining industry that seemed to surprise you in the quarter? I'm just wondering about if your plans for the second half and also for next year are appropriate for the current environment. I understand the reasons behind the inventory build you talked about, positioning for the new models, getting ahead of Kansas City. But just given the environment, given the surprises that continue to come and given the competition, I'm just wondering how much you've stress tested your growth plans for the second half and for next year.

Thanks, Felicia. Let me break the question up into two answers. First, inventory as we exited the first half. Retail inventory was up 8,300 units largely driven by five incremental models. On average, our dealers have about 2.5 of each of those models in their dealerships and that adds up actually to over 8,000 units, but we also wanted to ship in ahead of the ERP implementation. When we look at second quarter and you look at the retail side, which is up 8,300 units, our Company owned inventory is down quite a bit, and when you net those two we were basically up in the second quarter one-third of July's production, and that's what we expect to lose.

So to answer your question, as we exit the first half, we are right in line with what we expected in terms of inventory on a year-over-year basis. Again, to compensate for the lost production in July. When we extend that forward, we were expecting inventories in the US to grow behind additional models, and given that environment that you've mentioned and certainly that we experienced in the second quarter, we are more cautious and want to be more prudent from an inventory perspective. And with that, we do not expect inventories to grow in the United States at year end. And yes, we absolutely feel that is the appropriate level of inventory given soft retail sales that we are seeing in the first half of this year.

That's a great answer, John. I'll just add my perspective on it. My short answer is, yes. I think we've looked very clear eyed at the condition in the industry year to date, projected that forward and what you see behind John's comments finishing flat with additional models is actually leaning out our inventory and you can read from that that we expect and we believe is embedded in our numbers, the industry to continue to be soft for the balance of the year and probably into next year as well. And so we feel we are adequately provisioning and preparing for that. I guess also with a healthy dose of realism given what we saw that was quite surprising here in the second quarter. So we feel like we are in very good shape on both sales and inventory for the balance of the year as well as heading into next year [new] level.

Your next question comes from Tim Conder with Wells Fargo Securities.

Thank you, gentlemen. On HDFS with the prime sales, how do you see any of those potential transactions going forward and then does this leave you with more loans that you still have on the balance sheet or exposure to a higher mix of prime? And then one other thing related to Brexit, what are you seeing in the UK and Europe retail trends post the Brexit vote? Any impact whatsoever? Thank you.

Thanks, Tim. We would look at the securitization that we recently did about a month ago, there were two changes in that securitization from normal securitizations that we execute. -- (technical difficulty) pointed out is that they were made up of 100% of prime receivables and the second one is we sold the residual interest that allowed us to classify it off balance sheet. Your question centers around the prime aspect of it so historically we've sold securitizations that resemble our originations, about 80% prime and 20% subprime. I've heard all kinds of speculation as to why we did 100% prime.

So let me clear that up. Some of that speculation has been is we can't sell subprime into the market, and that is absolute untruth nonsense. For over a decade, we have been selling a mix of prime and subprime into a very robust demand in the marketplace, and that has not changed at all. What has changed over the last couple of securitizations is that our spreads have widened on the securitization to our benchmark. Our benchmark is prime auto. And there is no one else that does a mixture of securitizations like we do so we benchmark to prime auto. What we have noticed over the last couple of securitizations -- (technical difficulty) widening out a little bit, and so the best way to tether them back was to get a comparable securitization to our benchmark, and with that we saw extreme tightening of those margins or of those spreads to prime auto.

As we look forward, whether we decide to do all prime or subprime and prime, kind of the tethering of the investment community to that spread against prime has been very important to us, and we will pay dividends as we move into the future. That is why we move forward with the prime securitization. Your second question is with regards to Brexit. At this point, there is not enough information or not enough time has gone by to understand the impact of Brexit.

I think what we are very certain of is that Brexit does not provide any benefit to retail sales or consumer confidence in Europe, and I think this is what Matt talked about a little -- (technical difficulty) is I would put it into a broader bucket instead of just Brexit as overall consumer comments driven by geopolitical concerns or macroeconomic concerns. We are very excited about the momentum that we have in our European business. As you can see for the quarter, it was up quite significantly. We will keep a close eye on Brexit but we are going to focus on what we can control and continue to drive a great customer experience for our customers around the world.

Your next question comes from the line of Greg Badishkanian from Citigroup.

Great, thank you. Two questions. First on to follow on to Tim's question just to Europe, the 8% growth this quarter. What was the key driver for that and how sustainable can it be? Because it was strong last quarter as well, pretty similar. And then second, there was some speculation that I think you were in discussions or maybe you received an offer from a private equity firm a few weeks back. I'm just wondering is that case or were you in any serious conversations or are you at this point?

All right. First question, Greg, is with regards to Europe. Again, we couldn't be more pleased. I think Matt mentioned it in his up-front remarks is the focus of our European team on getting people on our motorcycles. The demos that they are doing has driven a tremendous amount of volume in that market. Also our product offering, you've got to remember that Europe has got a bigger mix of Cruisers to Touring than we have in the United States. The product is just as well received in Europe as it is here in the United States.

That is certainly helping to drive some of the performance, and we expect that the team there to continue to focus on getting people exposed to our motorcycles. And we couldn't again be more pleased with where we are at in growing market share. Again, and just as a competitive market as the United States, not driven by price -- (technical difficulty) Europe, by tremendous addition of the lower displacement motorcycles, and again we are doing well and gaining share in a robustly growing market in Europe. The second comment is with regards to market rumors surrounding our stock and a potential private equity investor, we don't comment on any stock market rumors. That would consume our entire life if we did that.

Thanks.

Your next question comes from the line of James Hardiman with Wedbush.

Good morning. Thanks for taking my call. A clarification and then a question for me. I guess first, obviously, retail was materially worse than what you anticipated and yet the shipments were actually a little bit higher than the high end of your guidance. I guess, what was different there than how you anticipated heading into the quarter? And then maybe a little bit of a follow-up to Robin's question. We are trending towards the lower end of that down 1% to up 1% in terms of retail year to date. What gives you confidence that the industry and/or your numbers will get any better? What happens if the industry gets worse given the most recent data point is a step down from what we saw in the first quarter? Thanks.

Thanks, James. When you look at the second quarter, we did ship a little bit over the high end of guidance, and at the same time during the quarter, we were cutting production quite dramatically and our retail sales were down. You were saying is, can you help me understand this. Basically, as we got toward the end of the quarter, we had all of the product made and that was either in retail or in our Company-owned inventory, and typically we have a bit of Company-owned inventory in the United States that facilitates the flow and the orderly shipment of motorcycles. We made the decision to ship it all out prior -- (technical difficulty) the period.

The reason we did that is in the very outside chance that we had any issues with the ERP system. If they are in our system, we may have trouble getting them shipped, so it was a just a simple after de-risking of the overall ERP implementation. I couldn't be more pleased to say that the team did a fantastic job. Everything came up as expected. The ramp plans are on plan and everything is moving forward. But James, it was simply that is we could take a little more risk out of it. Having said that, overall inventories as I mentioned I think to Felicia, overall inventories didn't change. But we had Company-owned inventories lower on a year-over-year basis, and we put a little bit more into the field.

So overall inventories are where we would have expected them despite the lower unexpected sales based on our production reductions and lower Company-owned inventory. The second question that you asked is with regards to our revised guidance, which is down 1% to up 1%. We go through a robust process looking at all factors and everything we know in the marketplace, which is centered around new dealerships coming up in the international markets. We will have more dealers in the back half -- new dealers in the back half than the front half. We look at the performance of outreach in the United States; that's performing extremely well.

We look at the investments that we made in the demand driving activities, what we expect to come out of those. And certainly and most importantly, we look at the new models we're going to be launching here in three to four weeks and we couldn't be more excited about that. You take all those together, James, we are very confident that we are going to ship from 264,000 to 269,000 motorcycles for 2016.

Great, thanks. I will hop back in the queue.

Your next question comes from Jaime Katz with Morningstar.

Good morning. Thanks for taking my questions. First, I'm curious with regards to inventory and what's in the channel now in light of the slower growth environment, can you guys talk about your thoughts on the ability to take prices in the next model year coming online? And then if you would comment on where you might be seeing the most share gains. I think the share losses last year were from international competitors, but it sounds like there is still a decent amount of discounting going on so if have color on that, that would be really helpful. Thanks.

Yes, with regards to inventory retail sales, we talked a little bit about that. We feel that we are at the right spot given our forward look at retail sales given where we expect inventories to be. If we haven't shown our resolve to manage this Company for the long-term value of our shareholders in the actions that we've taken to keep the marketplace, aggressively manage supply in line with demand, or to hold to -- we're not going to discount our way out of this soft spot that we are expecting. People aren't looking. We have got tremendous resolve, and we will manage the inventory at appropriate levels.

With regards to pricing, I'm not going to speak a lot about that because in three weeks, you will see the new models and you'll see the pricing and you can answer that question for yourself, Jaime. Again, we feel very comfortable where we are at with regards to the market, and we will continue to manage it very tightly. I'm glad you asked about share gains in the United States. I couldn't be more thrilled to answer this question. A year ago we sat here, Matt and I, and Matt's first conference call, and we said that we had an issue giving the shift in world currencies and the incredible competitiveness that came out of it, in particular in discounting, and we said that we were not going to discount our way out of it. We were not going to drain the industry of profits and chase this thing, and it was going to take us some time but we were going to spend more time understanding what we need to do and how we can compete in the world of expanded price gaps without cheapening our brand.

And now dial forward a couple quarters, we are there, and we delivered 2 points of market share gains, so let me talk a second about those. The gains were very strong and wide. Number one, they came in all of our segments, our touring segment, our cruisers, and our street Sportster segment size of motorcycle. They came in the seven sales regions that we have in the United States. We gained share in each and every one of them. Our gains were over double the nearest competitor. When you look broadly at those share gains, what we saw is the biggest loser were in aggregate Japanese competitors.

We also saw while we had mentioned in the preamble that overall discounting was higher on a year-over-year basis, we did see the Japanese discounting be down a little bit versus a year ago and it seems to be reflecting in their market share. With that, we saw rotation in the brand discounting from the Japanese to the American brands in the second quarter, and we are seeing some of the share gains in there. Overall, European's market share was down a little bit but we had some big winners and big losers in the segment. Hopefully that helps, Jaime.

Thank you.

Your next question comes from the line of David MacGregor with Longbow Research.

Good morning, everyone. I realize there is a limit on what you want to say about model year 2017 just given we are so close to the rollout, but I guess what I wanted to ask you was, what did you learn from the model year 2016 product and the way it was received in a more competitive environment that has guided you on your plans for 2017?

Thanks, David. I appreciate the question, and actually we are incredibly pleased with the model year 2016 products and how they drove the market globally. This is a lot of the S models that we launched a year ago basically as well as the products we introduced during the model year. Clearly, there are a lot of constraints in this competitive environment that we are in but our product drives customer passion, customer loyalty, and sales and market share. We saw that with the shift in sales to large cruisers, which helped us gain share.

Those large cruisers are a little lower margin than our touring motorcycles so that is part of the gross margin deterioration that we just spoke about on the call today. But product is a very key lever for us, one of our four focus areas to increase both the cadence and the impact of the product, and 2016 is a good example of both. High impact product at an increased cadence and 2017 is going to be no different. It is a formula working for us, and we have invested more heavily, both capital and expense as part of the demand driving shift to make sure that the product that we deliver makes a difference in the marketplace and that we do it well and we do it more rapidly. So that's a new pattern for us that we can expect rolling forward in 2017, 2018, and beyond.

Thanks very much.

Your next question comes from the line of James Hardiman with Wedbush.

Thanks for taking a couple of follow-ups here. The gain on sale with HDFS, help us understand. I'm assuming that gain comes out of future potential income that we would have otherwise seen in a normal securitization transaction. How should we think about that?

Thanks, James. Good question. In the 8-K that we put out, we talked about this overall transaction is neutral when you look at the present value of earnings per share so it is a great question. Basically, here's what's happened -- what happens is in a securitization, we sell off a bunch of bonds to investors and it goes into a trust and all the residual earnings that we get off of that, we keep because we keep the risk and we keep that reward. What we -- (technical difficulty) into a slightly different market and we found an investor to buy that. What they did is they paid us a bunch of upfront cash to buy that residual interest in the trust or those trailing earnings.

We believe that the opportunity cost of the transaction that we did is about $7 million of those trailing earnings. So to do broad math, we took a $9 million gain, gave up about $7 million of opportunity costs, so they would've earned about $16 million. We took $9 million today. If you take and you discount over the next seven years that $7 million that would've come in, bring it to the present value and net impact on EPS, along with the fact that because it is off balance sheet, we have freed up equity at HDFS to maintain the same debt to equity. We have now got more equity, so HDFS wrote a check that works out to be $43 million and we bought shares back with that. If you take that impact on EPS, they are about neutral.

The question is, is well why did we do it if it's neutral? Number one is once you get into market, you don't know how the market is going to exactly respond but there are two reasons that we did this. Number one is it's an additional source of liquidity so we are always looking for opportunities, more investors, more liquidity, and this is a great opportunity. The other thing, with the additional liquidity opportunity, we also learned that we can monetize the assets on our balance sheet to some extent, and that is very important to know. That's number one reason.

Number two and the more important reason is, is we talk about it at every conference call, a top priority of ours is to return value to our shareholders in the form of rising dividends and share repurchases, and we will look at every opportunity to do that with the caveat that were not going to do anything to damage the long-term value of the brand or the Company. This transaction fits squarely in there. There is absolutely no extra -- (technical difficulty) the Company or anything like that. What it did is it liberated $43 million of excess cash. That excess cash was used to buy share repurchases.

And even though again, from a present value basis, we're neutral on EPS, we believe that our long-term shareholders would prefer to have at this moment in time, more equity in our Company given the historically low PEs that we are trading at. And so they get the ownership today versus waiting over that period of time for the opportunity cost of that money.

That's really helpful. And then maybe just two real quick hitters here. Inventories are going to be down domestically -- flat domestically, are they also going to be flat internationally or will we see some growth there? You also mentioned I think earlier in the Q&A that you maybe had some stats on oil areas versus non-oil areas. I was wondering if you would care to share those. Thanks.

Sure, James. Internationally, we do expect to grow modestly as well. We'll be adding a lot of dealerships this -- (technical difficulty) year, and they are growing markets and we would expect to add a little bit of inventory internationally. Your second question is on oil dependent areas. Again, we talked about this last quarter. It is certainly a headwind to the industry and what we saw about a year ago, first quarter 2015, we first noticed that those areas were declining more than other areas in the United States, obviously driven by the depression in the oil prices.

We saw that increase from a modest amount in the first quarter. It increased through the second and third quarter and it hit about a 10% rate in the fourth quarter. We've seen that hold at 10% in the fourth quarter of last year, the first quarter of this year, and on the second quarter was also a 10. And as we look forward, we're going to start to lap on more significant rises on a year-over-year basis. Hopefully, we will start to see it temper a little bit but at this point, it is not getting worse but it is not getting better either.

Very helpful. Thank you.

Your last question comes from the line of Scott Hamann with KeyBanc Capital Markets.

Thanks, good morning. Can you talk a little bit about the demand creation money that you are spending? Is $70 million still a good number for this year? When did you start to deploy that? Where are you seeing some of the best traction and then would you consider spending more or even less as you kind of look forward? Thanks.

Thanks, Scott. Great question. Again, going back to a year ago, we tried some things in the second and third quarter. Some worked, some didn't. We kind of regrouped, looked at what was working, what wasn't, and we sized the overall opportunity. We came back as a Company and said we needed $70 million to really address the widened price gaps, which is a headwind to us, and compete without lowering price or discounting. We got into the marketplace early in the first quarter, -- (technical difficulty) $70 million and again, we are very pleased with what we're seeing in terms of new people coming in and being trained through our Rider Academy.

The motorcycles that they are buying with that, the demos that are going on, Live Your Legend campaign, again, Heroes Ride Free, that promotion that we're getting, people that identify very closely with our brand, getting them free training to get on motorcycles. All of that is working well and you are seeing that manifest itself in our competitiveness with expanded price gaps in the second quarter. In terms of where we go with the $70 million, that is something that we evaluate on an ongoing basis. Not only the overall dollar amount of the $70 million, we will look at and change when need be whether that be more or less.

We are also looking at what is working and what is not and trying to become very nimble on how we redirect the money in the right spots, whether that be within a market or between markets or within a promotion or between promotions. There is nothing but single-minded focus here on driving demand.

Thank you, everyone, for your time this morning. Thanks for your time this morning, everyone. The audio and slides will be available at Harley-Davidson.com. The audio can also be accessed until August 11 by calling 404-537-3406 or 855-859-2056 in the US. The pin number is 42415321#. We appreciate your investment in Harley-Davidson. If you have any questions, please contact investor relations at 414-343-8002. Thanks.

This concludes today's conference call. You may now disconnect.